Tuesday, 9 December 2014

Trading Account: How it differs from Profit & Loss atatement

A "Trading account" in accounts is just like a profit and loss account.

In profit and loss account, you will calculate the net profit or loss of a company whereas, in the trading account, you will be calculating the trading profit and loss.

Trading account is also known as trading profit and loss account.

Trading accounts are very useful for manufacturing units and trading units.

Importance of Trading Account
  • Trading account is prepared before preparing the Profit and Loss account.
  • A trading account gives you the actual profit or loss in conducting your business or in manufacturing and selling of your product. But, it tells you the gross profit or loss of your product.
  • By preparing a trading account, you can know whether your business activities are fruitful or not. In other words, it tells you whether you are selling your product at profit or a loss.
  • You are able to know whether you are realizing the manufacturing cost/ trading cost of the product. Thereby, you can suitably control your expenses by locating where you are spending more money.
  • You are able to know the real profit or loss of your product before adding all overhead expenses to it.
How to prepare Trading Account
For preparing the trading account, you must first locate whatever expenses are directly related to your production or trading activity.

For Manufacturing Units
Suppose, you are producing cement. You will need limestone, gypsum and some other additives for making it strong. Then you need coal for furnaces and power for running the machines for producing cement. So all these ingredients constitute the cost of producing your cement. You will include the direct wages paid to the labour involved in production operations also as cost. You may include any other direct costs like rent or depreciation of machinery.

For trading businesses
If you are dealing in buying and sale of products, you will take your product cost to include the purchase price of goods, transportation charges, delivery charges (if you make home deliveries), Godown rent or shop rent, wages to labour, etc.

So you are able to see that expenses directly related to your operations only are to be taken in this trading account to find out whether you are recovering the full cost of expenses or not from your sales.

Generally, your sale price will always be more than your actual product cost in this approach.
This is due to the fact that you will be included all your other overhead costs and your own profit element also while deciding your sale price. All these other costs are to be taken in the final profit and loss statement to arrive at the net profit of your business as a whole.

Evidently, if your trading account is not showing a profit, it means that you are not quite fit for running the business at any cost.

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