Placing Carriage and Other Income Correctly

Financial Statements of a Sole Proprietorship without Adjustments

Skill: Apply

Stimulus

Question

(a) Classify each item above into the Trading Account, the Profit and Loss Account (expense or income), or the Statement of Financial Position. For carriage inwards and carriage outwards, explain why they are NOT placed in the same section.

(b) Calculate the correct gross profit and net profit.

(c) Explain the effect on gross profit if commission received and discount received were entered in the Trading Account as Encik Zulkifli assumes.

Thinking steps

1. Separate the Trading Account items: sales, returns inwards, opening inventory, purchases, returns outwards, carriage inwards and closing inventory. These relate directly to the cost of buying and selling the goods traded.
2. Compute net sales = sales − returns inwards = 120,000 − 5,000 = 115,000. Compute net purchases = purchases − returns outwards + carriage inwards = 58,000 − 3,000 + 2,000 = 57,000. Carriage inwards is added because it is the cost of bringing goods into the premises.
3. Cost of sales = opening inventory + net purchases − closing inventory = 12,000 + 57,000 − 15,000 = 54,000. Gross profit = net sales − cost of sales = 115,000 − 54,000 = 61,000.
4. Identify other income: commission received (4,000) and discount received (1,000). These are NOT from selling goods, so they are added on the credit side of the Profit and Loss Account after gross profit, not in the Trading Account.
5. Identify Profit and Loss expenses: carriage outwards (3,500), salaries (18,000), rent (6,000), utilities (2,500). Carriage outwards is the cost of delivering goods to customers (a distribution expense), so it differs from carriage inwards.
6. Net profit = gross profit + other income − expenses = 61,000 + (4,000 + 1,000) − (3,500 + 18,000 + 6,000 + 2,500) = 61,000 + 5,000 − 30,000 = 36,000. Closing inventory 15,000 is also reported as a current asset in the Statement of Financial Position.

Model answer

(a) Trading Account: sales, returns inwards, opening inventory, purchases, returns outwards, carriage inwards, closing inventory. Profit and Loss (income): commission received, discount received. Profit and Loss (expenses): carriage outwards, salaries, rent, utilities. Statement of Financial Position: closing inventory (current asset). Carriage inwards goes into the Trading Account because it is the cost of bringing goods IN and adds to the cost of purchases, while carriage outwards goes into the Profit and Loss Account because it is the expense of delivering goods OUT to customers after a sale; they serve different purposes despite both being "carriage".

(b) Net sales = 115,000; net purchases = 57,000; cost of sales = 12,000 + 57,000 − 15,000 = 54,000; gross profit = 115,000 − 54,000 = 61,000. Net profit = 61,000 + 5,000 (other income) − 30,000 (expenses) = RM36,000.

(c) If commission received and discount received were entered in the Trading Account, gross profit would be wrongly inflated by 5,000 to 66,000. This is wrong because gross profit may only arise from selling goods; other income is counted only after gross profit. However, net profit stays RM36,000 because the same amount is ultimately added. The error affects gross profit only, not net profit.