Trading Account: A Comparison With Profit & Loss Account

A "Trading Account" in accounts is just like a profit and loss account with some deviations.

In a profit and loss account, we calculate the net profit or loss of a company, whereas in the trading account, we calculate the Trading Profit or Loss.

Due to this fact, the trading account is also known as the "trading profit and loss account".

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

Significant Differences of Trading Account vs P&L Account 

• A trading account is prepared before the preparation of a Profit and Loss account.
• A trading account provides you with the actual profit or loss incurred in the product-related activities of your business (say, manufacturing and selling activities that are directly related to your product). It provides the gross profit or loss of your product.
• Expenses not directly related to the product are not considered in preparing this account. But a profit and loss statement considers all types of expenses for deducing the profit/loss.
• By preparing a trading account, you can assess whether your core business activities are fruitful or not. In other words, it tells you whether you are selling your product at a profit or a loss, before considering other administrative costs.
• You are able to know whether you are realizing the manufacturing cost/ trading cost of the product. 
• By studying the trading account, you can suitably control your expenses by locating where you are spending more money (whether it is raw materials, sales activities, tools and equipment, and other product-related costs).

How to Prepare Trading Account

 To prepare the trading account, you must first identify whatever expenses are directly related to your production or trading activity.

1. 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 to produce cement. 

So all the above-mentioned ingredients constitute the cost of producing your cement. 

Thereafter, include the direct wages paid to the labour involved in production operations as cost. 

You may include any other direct costs like rent or depreciation of the machinery which are directly related to production.

2. For Trading Businesses:

If you are dealing in buying and selling of products, your product cost will include the purchase price of goods, transportation charges incurred, and delivery charges (if you make home deliveries). 

Also include the Godown rent or shop rent, wages to labour, etc.

If you have to pack the goods while delivering, include the packaging charges also as a cost item.

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 including all your other overhead costs and your own profit element also while deciding your sale price. 

So, while comparing the trading account with the Profit and Loss Account, you should compare it with the Gross Profit. 

All overhead costs are 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 recovering even the product cost.