the trading and profit and loss account and the balance sheet

The Trading and Profit The Trading and Profit and Loss Account and and Loss Account and the Balance Sheetthe Balance Sheet

What’s Inside ?

Learning ObjectivesLearning Objectives

hink Corner

uiz Corner

Trading and profit and loss account

Trading account


Net purchases and net sales

Capital account 1 2

Departmental accounts


Describe the flow of preparing final accounts.

Prepare the trading account and calculate the cost of goods sold and gross profit or gross loss.

Prepare the trading account with appropriate adjustments for sales and for items affecting the cost of goods sold.

Prepare the profit and loss account and calculate the net profit or net loss.

Prepare the trading and profit and loss account.

After reading this chapter, you will be able to:


Balance off the capital account at the year end.

Draw up the balance sheet and put relevant account balances under appropriate headings.

Prepare the final accounts in vertical format.

Prepare departmental accounts for companies having several departments.

Prepare a profit and loss account for a business in the service sector that is not trading in goods.

After reading this chapter, you will be able to:

Flow of preparing final accounts When business transactions occur, we need to

enter these transactions into _______.

At the end of each month, the accounts need to be _____ to have an overview of the business.

At the end of the financial year, the accounts need to be closed to prepare the ___________.

A __________ needs to be drawn up before the final accounts are prepared.

A _____________ and a ___________________ are prepared to calculate the profit or loss made by the firm.

The ______ account needs to be closed by transferring the net profit / loss and the drawings against it. A ___________ can then be drawn up.

accounts

final accounts

trial balance

trading account profit and loss account

capital

balance sheet Learning Objectives

closed

Trading account and cost of goods soldA trading account is an account in which __________

or ________ is calculated.

Gross profit is the excess of ____ over the _______ _________ for the period.

Gross loss is the excess of _______________ over ____ for the period.

Trading account is a double entry account where the left-hand side is the _________ and the right-hand side is the _________.

Gross profit = Sales – Cost of goods soldGross profit = Sales – Cost of goods sold

Gross loss = Cost of goods sold – SalesGross loss = Cost of goods sold – Sales

Gross profit = Sales – Cost of goods soldGross profit = Sales – Cost of goods sold

Gross loss = Cost of goods sold – SalesGross loss = Cost of goods sold – Sales

gross profitgross loss

salesgoods sold

cost of

cost of goods soldsales

debit sidecredit side

Trading account and cost of goods soldAt the end of a financial year, businesses

usually have unsold goods; we call this __________. An annual _________ is usually held at the end of a financial year to ascertain the value of closing stock. Closing stock is carried forward to the next financial year; we call this the ___________.

A ____ account is opened to record closing stock and opening stock.

Cost of Cost of = Opening stock + Purchases – Closing stock = Opening stock + Purchases – Closing stock goods soldgoods sold

Cost of Cost of = Opening stock + Purchases – Closing stock = Opening stock + Purchases – Closing stock goods soldgoods sold

closing stockstocktaking

opening stock

stock

Total stock Total stock availableavailable

Stock Stock remained remained

unsoldunsold

Trading account and cost of goods sold

The steps for preparing the trading account are as follows:

Example 1: Flora Company’s financial year ended on 31 December 20X8. Here is the information extracted from her books:

$

Sales 100,000

Purchases 60,000

Opening stock 8,000

Closing stock 10,000


teptep Close the sales account and transfer the credit balance to the trading account.

Dec 31 Trading 100,000 Dec 31 Total for the year 100,00020X8 $20X8 $

Sales

Sales 100,000$$

Trading


Dec 31 Trading 60,000Dec 31 Total for the year 60,00020X8 $20X8 $

Purchases

Sales 100,000$$

Trading

teptep Close the purchases account and transfer the debit balance to the trading account.

Purchases 60,000


Dec 31 Trading 8,000Jan 1 Balance b/f 8,00020X8 $20X8 $

Stock

teptep Calculate the cost of goods sold by transferring the opening and closing stock from the stock account to the trading account.

Dec 31 Trading 10,000 “ 31 Balance c/f 10,00018,00018,000

Sales 100,000$$

Trading

Purchases 60,000Opening stock 8,000 Closing stock 10,000


teptep Balance off the trading account and transfer the balance to the profit and loss account.

Purchases 60,000 Sales 100,000$$

Trading

Opening stock 8,000 Closing stock 10,000Gross profit 42,000

110,000110,000

Transferred to the profit and loss

account


The accounts would be closed as follows:

Example 2: On 31 December 20X7, Panda Company had the following account balances:

$

Sales 70,000

Purchases 80,000

Opening stock 4,000

Closing stock 5,000



Sales


Purchases


Trading


Gross loss 9,00084,00084,000

Transferred to the profit and loss account

Opening stock 4,000 Closing stock 5,000Purchases 80,000 Sales 70,000

$$

Trading

Learning Objectives

Dec 31 Trading 4,000Jan 1 Balance b/f 4,00020X7 $20X7 $

Stock

Dec 31 Trading 5,000 “ 31 Balance c/f 5,0009,0009,000

Goods returned from customers reduce sales, therefore, the actual sales would be:

hink Corner

nswer

You have learned that goods may be returned to suppliers or returned from customers. How do these two items affect purchases and sales?

Net sales = Sales – Returns inwards Goods returned to suppliers reduce purchases, therefore the actual purchases would be:

Net purchases = Purchases – Returns outwards Therefore, both returns inwards and returns outwards should be entered in the trading account.

Trading account and adjustmentsAt the end of the financial year, returns accounts are

closed and their balances are transferred to the _____________.

trading account

Example 3: Assume that the total returns inwards and total returns outwards for Flora Company for the year were $3,000 and $5,000, respectively.


Returns Inwards


Trading

Opening stock 8,000 Closing stock 10,000Returns inwards 3,000

Trading account and adjustments


Returns Outwards

Opening stock 8,000Purchases 60,000 Sales 100,000

$$

Trading

Closing stock 10,000Returns inwards 3,000 Returns outwards 5,000Gross profit 44,000

115,000115,000

Since returns outwards reduce the amount of purchases, the cost of goods sold = Opening stock

+ Purchases – Returns outwards – Closing stock Net

purchases

Trading account and adjustmentsItems affecting the cost of goods

sold: To calculate the actual cost of goods sold, besides deducting returns outwards from purchases, we should include all _______ that increase the cost of goods. 1.Carriage inwards: This is the cost of delivering goods purchased from suppliers.

expenses

This cost of delivery _______ the cost of buying goods; thus, it should be included in the cost of goods sold by transferring the balance in the carriage inwards account to the ____________.

increases

trading account


sold: 2.Cost of making goods ready for resale: Some goods may need to be processed before they are sold to customers. This cost of making goods ready for resale ________ the cost of goods sold and should be shown in the ____________.

increasestrading account

Opening stockOpening stock+ Net purchases+ Net purchases+ Carriage inwards+ Carriage inwards+ Cost of making goods + Cost of making goods

ready for resaleready for resale- Closing stockClosing stockCost of goods soldCost of goods sold

Opening stockOpening stock+ Net purchases+ Net purchases+ Carriage inwards+ Carriage inwards+ Cost of making goods + Cost of making goods

ready for resaleready for resale- Closing stockClosing stockCost of goods soldCost of goods sold


sold: Example 4: Assume that Flora Company paid $5,000 for carriage inwards and $4,000 for goods packaging during the year.


Carriage Inwards

Purchases 60,000 Sales 100,000

Trading

Returns inwards 3,000Opening stock 8,000

$$

Closing stock 10,000Returns outwards 5,000

Carriage inwards 5,000

Gross profit 35,000

Trading account and adjustments


Packing Goods

Purchases 60,000 Sales 100,000

Returns inwards 3,000

Trading

Opening stock 8,000

$$

Closing stock 10,000Returns outwards 5,000

Carriage inwards 5,000

115,000115,000

Goods packaging 4,000

Learning Objectives uiz Corner

uiz Corner

Using the following information, prepare a trading account for the year ended 31 December 20X8.

$Sales 55,000Purchases 41,250Stock as at 1 January 20X8 11,500Stock as at 31 December 20X810,750Returns inwards 1,500Returns outwards 1,200Carriage inwards 2,100Goods packaging 2,500

Profit and loss accountA profit and loss account is an account in which ________ or ______ is calculated. All day-to-day running expenses and revenues are entered in this account. Net profit is the excess of ___________________ _______ over _______ for the period.

Net loss is the excess of ________ over the total of __________ and ____________ for the period.

Net profit = Gross profit + Other revenues – ExpensesNet profit = Gross profit + Other revenues – ExpensesNet loss = Expenses – Gross profit – Other revenues Net loss = Expenses – Gross profit – Other revenues

Profit and loss account is also a _________________ with a debit side and a credit side.

net profitnet loss

gross profit plus otherrevenues expenses

expensesgross profit other revenues

double entry account

Profit and loss accountExample 5: Flora Company received a commission of $2,000 and paid salaries amounting to $10,000, electricity amounting to $5,000 and $10,000 in rent during the year. Steps for preparing a profit and loss account are: teptep

Dec 31 Profit and loss 2,000 Dec 31 Total for the year 2,00020X8 $20X8 $

Commission Receivable

Gross profit b/f 35,000

Profit and Loss

$$

Commission receivable 2,000

Close the other revenues accounts and transfer the credit balances to the profit and loss account.

Profit and loss account

teptep Close the expenses accounts and transfer the debit balances to the profit and loss account.

Dec 31 Profit and loss 10,000Dec 31 Total for the year 10,00020X8 $20X8 $

Salaries

Salaries 10,000 Gross profit b/f 35,000

Profit and Loss

$$

Commission receivable 2,000Electricity 5,000


Electricity


Rent 10,000

Salaries 10,000Electricity 5,000


Profit and Loss

$$



Rent

Balance off the profit and loss account. A credit balance represents a net profit and a debit balance represents a net loss. Then, transfer the debit or credit balance to the capital account.

teptep


Rent 10,000

Salaries 10,000Electricity 5,000


Profit and Loss

$$


Net profit 12,00037,00037,000

Transferred to the capital account

Note: After the profit and loss account is prepared, the other revenues and expenses accounts are closed and their balances will not be carried forward to the next year.


Example 6: Assume that the electricity paid by Flora Company was $20,000, the profit and loss account would appear as:


Electricity

Electricity 20,000Gross profit b/f 35,000

Rent 10,000

Salaries 10,000

Profit and Loss

$$

Commission receivable 2,000Net loss 3,000

40,00040,000

Transferred to the capital account Learning Objectives

Trading and profit and loss accountIf the final accounts are to be presented to outsiders

like banks, investors and the Inland Revenue Department, we need to combine the trading account and the profit and loss account into one, called the ____________________________. The format of the trading and profit and loss account is similar to that of the trading account and the profit and loss account; only a few changes are made to make the account more _________ and easier to _________.When the two accounts are combined, it is described as a ________________. The ____ of the company and the ______________ are shown.

trading and profit and loss account

informative understand

financial statement nameperiod concerned

Example 7: Using the information in Examples 4 and 5, the trading and profit and loss account for Flora Company would appear as:

Less Closing stock 10,000


Sales 100,000Purchases 60,000Opening stock 8,000

Flora Company

$$ $

Less Returns inwards 3,000

Trading and Profit and Loss Account for the year ended 31 December 20X8

Less Returns outwards 5,00055,000

Add Carriage inwards 5,000Goods packaging 4,000 64,000

72,000

Cost of goods sold 62,000Gross profit c/d 35,000

Salaries 10,000Electricity 5,000Rent 10,000Net profit 12,000

Gross profit b/d 35,000Commission receivable 2,000

97,000

97,000 97,000

37,000 37,000

Name of the company




Flora Company

$$ $





72,000




97,000

97,000 97,000

37,000 37,000

Period concerned




Flora Company

$$ $





72,000




97,000

97,000 97,000

37,000 37,000

Net sales




Flora Company

$$ $





72,000




97,000

97,000 97,000

37,000 37,000

Net purchases




Flora Company

$$ $





72,000




97,000

97,000 97,000

37,000 37,000

Total cost of goods purchased for the year




Flora Company

$$ $





72,000




97,000

97,000 97,000

37,000 37,000

Total goods available for sale for the year

hink Corner

nswer

What are the differences between the format of the trading and profit and loss account and that of the trading account and the profit and loss account?

1. Returns inwards are put on the credit side and are deducted from sales to get the net sales figure. 2. Returns outwards are put on the debit side as a contra item and are deducted from purchases to get the net purchases figure.

3. Closing stock is deducted from the figure of total cost of goods purchased to get the figure of the cost of goods sold.

uiz Corner

Below are the balances extracted from the trial balance of Gowell Company as at 31 March 20X7. Prepare a trading and profit and loss account for Gowell Company for the year ended 31 March 20X7.

$Stock as at 1 April 20X6 16,000Purchases 66,700Sales 93,800Returns inwards 2,500Returns outwards 2,000

uiz Corner

$Carriage inwards 5,000Packaging goods for resale 5,000Stock as at 31 March 20X7 12,000Rent received 20,000Wages and salaries 10,000Insurance 5,000

Learning Objectives

hink Corner

nswer

After getting the net profit from the profit and loss acount, what should we do?

You have learned that profit increases capital and loss decreases capital. After calculating the net profit/loss, we should transfer the net profit or net loss to the capital account to obtain the updated amount of capital. Old capital + Net profit = New capital

Old capital – Net loss = New capital

hink Corner

nswer

Can you think of any other items which affect the amount of capital?

Drawings. Drawings reduce capital and therefore we should transfer the balance of the drawings account to the capital account in order to calculate the amount of new capital at the end of a financial year. Old capital + Net profit – Drawings = New capital Old capital – Net loss – Drawings = New capital

Closing the capital accountRemember, the balance of capital in the trial balance is the _____________. At the end of the year, we need to close the capital account by transferring the net profit or net loss and the drawings to get the ____________.

opening balance

closing balance

Example 8: Assume that the opening capital balance as at 1 January 20X8 and the drawings for the year ended 31 December 20X8 for Flora Company were $50,000 and $5,000, respectively. The capital account would be closed as follows:

Dec 31 Capital 5,000Dec 31 Total for the year 5,00020X8 $20X8 $

Drawings

Closing the capital account

Dec 31 Drawings 5,000 Jan 1 Balance b/f 50,00020X8 $20X8 $

Capital

The steps for closing the capital account are:

Close the drawings account and transfer the balance to the capital account.

teptep



Capital

“ 31 Balance c/f 57,000 Dec 31 Net profit for the year 12,000

62,000 62,000

Transfer the net profit or net loss from the profit and loss account to the capital account.

teptep

Balance off the capital account. The balance is carried forward to the next financial year.

teptep

“ 31 Balance c/f 42,000

Example 9: Assume that Flora Company had a net loss of $3,000 in 20X8 and the opening capital balance and the drawings for the year ended 31 December 20X8 were $50,000 and $5,000, respectively. The capital account would be closed as follows:

Dec 31 Capital 5,000Dec 31 Total for the year 5,00020X8 $20X8 $

Drawings



Capital

“ 31 Net loss for the year 3,000

50,00050,000

Learning Objectives

Balance sheetA balance sheet is a statement showing the _______ ______ of a business at a ____________. After the ____________________________ is prepared, all the accounts should be closed except the _____, _______ and _____ accounts. These accounts are then listed on the ___________. Balance sheet is not part of the ________________; it is only a ___ of assets, liabilities and capital balances. These accounts are not closed at the year end, and the balances in these accounts are carried forward to the _________________.

Balance sheet is a presentation of the _________ _______ in a statement form.

financialposition particular date

trading and profit and loss account assets

liabilities capital balance

sheetdouble entry system

next accounting year

accountingequation

list

Details of current liabilities XXX

Balance sheetLayout of a balance sheet:

Details of fixed assets XXXCapital

Current Assets

Fixed Assets

Balance Sheet as at (date)

$$

Details of capital XXXLong-term Liabilities

Details of current assets XXX Details of long-term liabilities XXXCurrent Liabilities

XXX XXX

Assets Capital + Liabilities

Balance sheet

Steps for preparing a balance sheet:

Example 10: Based on the information in Examples 7 and 8, and the following balances extracted on 31 December 20X8 (after the trading and profit and loss account was prepared and the capital account was closed), prepare a balance sheet for Flora Company as at 31 December 20X8. $

Furniture and fittings 30,000Motor vehicles 20,000Debtors 20,000Bank 10,000Cash 5,000Long-term loan from Kowloon Bank 30,000Creditors 8,000

Classify the balances remaining in our books (after preparing the trading and profit and loss account) into fixed assets, current assets, capital, long-term liabilities and current liabilities.

teptep

Balance sheet

$

Furniture and fittings 30,000 Fixed asset

Current asset

Long-term liabilityCurrent liability

Fixed asset

Current assetCurrent asset

Creditors 8,000Long-term loan from Kowloon Bank30,000Cash 5,000Bank 10,000Debtors 20,000Motor vehicles 20,000

Balance sheet

Furniture and fittings 30,000Fixed Assets $ $

Balance Sheet as at 31 December 20X8Flora Company

Motor vehicles 20,00050,000

Current AssetsStock 10,000Debtors 20,000Bank 10,000Cash 5,000 45,000

95,000

List the balances of fixed assets and current assets on the left-hand side of the balance sheet. Get their subtotals and add them up to arrive at total assets.

teptep

Balance sheet

Capital $

Current Assets50,000

Furniture and fittings 30,000

Debtors 20,000

95,000

Balance Sheet as at 31 December 20X8

Fixed Assets $

Flora Company

Motor vehicles 20,000

Stock 10,000

Bank 10,000Cash 5,000 45,000

Balance as at 1 Jan 20X8 50,000Add Net profit for the year 12,000

Less Drawings 5,000

Long-term LiabilitiesLoan from Kowloon Bank 30,000Current LiabilitiesCreditors 8,000

95,000

62,000

57,000

List the balances of capital, long-term liabilities and current liabilities on the right-hand side of the balance. Get their subtotals and add them up to arrive at the total of capital and liabilities.

teptep

Balance sheet

95,000

Furniture and fittings 30,000

Balance Sheet as at 31 December 20X8

Capital $Fixed Assets $

Flora Company

Motor vehicles 20,00050,000

Current AssetsStock 10,000Debtors 20,000Bank 10,000Cash 5,000 45,000

Balance as at 1 Jan 20X8 50,000Add Net profit for the year 12,000

62,000Less Drawings 5,000

57,000Long-term LiabilitiesLoan from Kowloon Bank 30,000Current LiabilitiesCreditors 8,000

95,000

teptep Enter the totals of the two sides that should be level with each other.

Learning Objectives

Final accounts in vertical format

Example 7 is now shown in vertical format:

Final accounts (trading and profit and loss accounts and balance sheets) are sometimes prepared in ____________ instead of horizontal format. The results are the ____ using either presentation method.

vertical formatsame

$ $ $

Final accounts in vertical formatTrading and Profit and Loss Account for the year ended 31 December 20X8Flora Company

Sales 100,000Less Returns inwards 3,000

97,000Less Cost of goods sold:

Opening stock 8,000Add Purchases 60,000

Less Returns outwards 5,000 55,000Add Carriage inwards 5,000

Goods packaging 4,00072,000

Less Closing stock 10,000 62,000Gross profit 35,000Add Other revenues:

Commission receivable 2,00037,000

Less Expenses:Salaries 10,000Electricity 5,000Rent 10,000 25,000

Net profit 12,000

Net current assets occur when current assets ______ current liabilities. When current liabilities exceed current assets, their difference is called _________________.

Final accounts in vertical format

We have mentioned that the balance sheet is a presentation of the _______________ in statement form. In a vertical style balance sheet, it shows Fixed assets + Net current assets – Long-term liabilities = Capital.

Example 10 is shown in vertical format:

accounting equation

exceed

net current liabilities

57,000

Fixed Assets $ $

Final accounts in vertical formatBalance Sheet as at 31 December 20X8

Flora Company

Furniture and fittings 30,000Motor vehicles 20,000

50,000Current AssetsStock 10,000Debtors 20,000Bank 10,000Cash 5,000

45,000Less Current Liabilities

Creditors 8,000Net current assets 37,000

87,000Less Long-term Liabilities

Loan from Kowloon Bank 30,00057,000

Financed by:Capital as at 1 January 20X8 50,000Add Net profit for the year 12,000


87,000

Final accounts in vertical formatSometimes, long-term liabilities are shown

under capital in a vertical style balance sheet. Below is an example:

57,000

Capital $Balance as at 1 January 20X8 50,000Add Net profit for the year 12,000


Balance Sheet as at 31 December 20X8 (extract)Flora Company

Long-term LiabilitiesLoan from Kowloon Bank 30,000

Learning Objectives

hink Corner

nswer

Sometimes, businesses may have several departments. Are the final accounts for these companies prepared in the same way as mentioned before?

No. There will be extra columns in the trading and profit and loss account for companies with several departments. Sales revenue and expenses are split among various departments and are recorded in these extra columns.

Departmental accountsExample 11: The following balances were extracted from the books of Longway Company as at 31 March 20X7.

$

Sales: Audio department 50,000Digital camera department 70,000

Stock (1 Apr 20X6): Audio department 10,000Digital camera department 20,000

Purchases: Audio department 20,000Digital camera department 40,000

Stock (31 Mar 20X7): Audio department 15,000Digital camera department 10,000


Audio Digital Camera$ $ $ $

Trading Account for the year ended 31 March 20X7Longway Company

Sales 50,000 70,000Less Cost of goods sold:

Opening stock 10,000 20,000Purchases 20,000 40,000

30,000 60,000


Audio Digital Camera$ $ $ $

Trading Account for the year ended 31 March 20X7Longway Company

Sales 50,000 70,000Less Cost of goods sold:

Opening stock 10,000 20,000Purchases 20,000 40,000

Less Closing stock 15,000 15,000 10,000 50,00030,000 60,000

Gross profit 35,000 20,000

Learning Objectives

Final accounts for the service sectorIn a trading account, we calculate the gross

profit by subtracting the costs of goods sold from the sales. What if a business does not trade in goods? For businesses not trading in goods, there is no need to prepare a trading account. A __________________ is enough. The final accounts for these businesses are a profit and loss account and a balance sheet. Examples of businesses not trading in goods are those in the ____________, such as dentists, accountants and lawyers.

Revenue earned by service providers is usually called fees earned, commission earned or services charged.

profit and loss account

service sector

the trading and profit and loss account and the balance sheet

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