Trading and Profit and Loss Account (T-Form and Statement Format)

Explanation

The Trading Account and the Profit and Loss Account are two nominal accounts prepared at the end of an accounting period to measure the performance of a sole proprietorship business. The main purpose of the Trading Account is to calculate the Gross Profit or Gross Loss, which is the profit from buying and selling goods alone, before operating expenses are deducted. The purpose of the Profit and Loss Account is to calculate the Net Profit or Net Loss, which is the true profit of the business after adding other revenues to the Gross Profit and deducting all expenses. Both accounts are prepared from the Trial Balance after all transactions have been recorded, and in this chapter they are prepared without adjustments (no accrued expenses, prepaid expenses, accrued revenue or revenue received in advance).

In the Trading Account, the basic formula is Gross Profit = Net Sales - Cost of Sales. Net Sales is obtained by deducting Sales Returns (Returns Inwards) from Sales. Cost of Sales (Cost of Goods Sold) is calculated as: Opening Inventory + Net Purchases - Closing Inventory. Net Purchases is Purchases less Purchases Returns (Returns Outwards), plus the costs of bringing goods into the business such as Carriage Inwards, Import Duty and Insurance on Purchases. If Cost of Sales exceeds Net Sales, the business suffers a Gross Loss. In T-form, the debit side of the Trading Account contains Opening Inventory and Net Purchases (including carriage inwards), while the credit side contains Net Sales and Closing Inventory.

After the Gross Profit or Gross Loss is obtained, the balance is transferred to the Profit and Loss Account. In T-form, Gross Profit is recorded on the credit side of the Profit and Loss Account (because it increases profit), while Gross Loss is recorded on the debit side (because it reduces profit). The double entry to transfer Gross Profit is: Debit Trading Account; Credit Profit and Loss Account. This transfer links the two accounts so that the result of trading activities becomes the starting point for calculating the overall profit of the business.

In the Profit and Loss Account, Gross Profit is increased by other revenues such as Discount Received, Commission Received, Interest Received, Rent Received and Bad Debts Recovered. Then all expenses are deducted, for example Salaries, Rent, Rates, Insurance, General Expenses, Carriage Outwards, Discount Allowed, Bad Debts and Depreciation. The resulting balance is the Net Profit (if revenues and Gross Profit exceed expenses) or Net Loss (if expenses exceed Gross Profit and revenues). This Net Profit is transferred to the Capital Account in the Statement of Financial Position and increases the owner's equity, while a Net Loss reduces capital.

Both accounts can be prepared in two forms. The T-form (account form) uses a two-column debit and credit layout like an ordinary ledger. The statement form (vertical form) arranges the information downward in a single column, beginning with Net Sales, less Cost of Sales to arrive at Gross Profit, then plus revenues and less expenses to arrive at Net Profit. The statement form is easier for the owner to read and is more commonly used in modern financial reporting. Students must be able to prepare both forms because either may be required, and both must produce the same Gross Profit and Net Profit figures.

Worked examples

Practice

Exam tips

Key terms

Gross Profit

Profit from the activity of buying and selling goods, that is Net Sales minus Cost of Sales.

Cost of Sales

The cost of goods that have been sold, calculated as Opening Inventory plus Net Purchases minus Closing Inventory.

Net Profit

The true profit of the business, that is Gross Profit plus other revenue minus all expenses.

Net Purchases

Purchases minus Purchases Returns, plus carriage inwards and related costs of bringing goods in.

Source: DSKP KSSM Prinsip Perakaunan Tingkatan 4

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