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.

Profit and Loss Account: Importance and Guidelines for Preparing A P&L Account

The Profit and Loss Account is a statement of income and expenditure for a given period, and the net amount of these two elements is known as the profit or loss for that company. It is prepared to assess whether the company has generated profit or loss through its activities. 

Normally, Profit and Loss Statements are prepared at the end of each accounting year. The accounting year, as defined by our accounting standards, starts on the 1st of April each year and ends on the 31st of March of the next year.

Importance of Profit and Loss Account

• Profit & Loss statements must be prepared under the Companies Act rules and regulations.
• It is a part of the Balance Sheet.
• The financial health and achievements of your business are assessed with this statement. You will know whether your business is earning profit or incurring losses through this statement. 
• It is the preliminary stage for preparing your Balance Sheet. 
• One should first arrive at the Profit or Loss figure before preparing the Balance Sheet of any company, as that figure is to be shown in assets or liabilities as the case may be.
• The Profit and Loss Statement is to be submitted along with the Balance Sheet for filing your tax returns and for Income-Tax assessments.
• Banks require this statement along with the Balance Sheet while sanctioning loans to business.

How to Prepare Profit and Loss Account

It is very simple to prepare a profit and loss statement. It is a summarised statement of expenses and incomes to derive the net result.

1. First of all, you need to balance each account in the Main Ledger or General Ledger of your business and copy them to the Trial Balance Sheet.
2. Then tally your Trial Balance.
3. On the basis of that trial balance, you can easily prepare a profit and loss statement. Enter all expenses in the expenditure column and all income in the income column. The net result will give you the profit and loss.
4. There are two types of preparation. One is horizontal P&L a/c, and the other is vertical P&L a/c.

Horizontal Profit and Loss Account Sample

              Income                                                   Expenditure

Sales                       5,000,000                        
                                                              Goods purchased            37,50,000

                                                              Freight/transportation         2,50,000

                                                              Labour charges                    50,000

                                                              Godown rent                       30,000

                                    _______                                                 _________      

                                    50,00,000                                                  40,80,000                                                                                                      
                                                             Gross/Trading Profit           9,20,000

                                         1) Staff salary                        1,80,000

                                                             2) Electricity         50,000

                                                              3) Stationery        30,000

                                                              4) Package charges  30,000

                                        5)  Sales promotion                    30,000

                                                            6) Other expenses      20,000

                                                                  Total (1 to 6)                   3,40,000

                                                                                   
                                                         Profit before interest/depreciation 5,80,000  

                                                             Interest on loans                      100000    

                                                             Depreciation of assets              180000

                                                                                                            2,80,000
                                                             NET PROFIT                         3,00,000    

The above is a sample format of profit and loss account prepared in horizontal format.

In a vertical format, you will start with sales income, and below it, all the expenses are mentioned in the same manner as in the above format. The three elements of Gross profit, Profit before Depreciation and Net profit will be calculated in the same manner and in the same column under income.

All expenses directly related to the production of goods are taken for calculating the Trading profit of the company. Then salaries and administrative expenses and sales promotion are taken to arrive at the net profit before interest and depreciation. Then, you can separately calculate profit after depreciation and profit after interest, if you want them separate, to get separate statistics for each element of cost.

It is customary to provide the figures of the previous year also in the profit and loss statements, to enable comparison with previous achievements.

Bank Reconciliation Statement- How to Tally Your Cash Book with Passbooks

Bank Reconciliation Statement

Bank reconciliation means reconciling your account book entries with the bank's records. Reconciliation is the process of tallying and aligning the records.

Every business keeps a bank account to make transactions easy. You can make transactions online, including receiving payments, making payments, and transferring funds, with the click of your mouse or a tap on the phone. Now, you are expected to record all these transactions in your books of account. Banks will automatically update your accounts with each transaction. But your entries are based on the vouchers prepared at your end. So, there can be slips in your entries.

Due to the enormous workflow, some omissions or commissions may occur at both ends in recording these transactions. Because even banks can make mistakes. 

So, you need to tally the entries from your books with your bank. This tallying of accounts is known as Bank reconciliation.

Importance of Bank Reconciliation Statements 

The need for a Bank Reconciliation statement arises due to the fact that at any particular point of time, the balances in your books may not tally with the Bank statement, as there can be time gaps.

 

Under such circumstances, you should prepare to explain the reasons for the differences at both ends. This is for your own balance confirmation and for explaining to the Board of Directors and auditors who check your accounts each year. 

So, it is important to prepare bank reconciliation statements regularly.

Reasons for Differences in Bank Books

There can be various reasons for differences in your Bank balance and the balance as per Bank Books. The most common reasons are:

1. You may have issued a cheque to one of your parties but not yet presented to the bank by the receiver of the cheque.
2. You deposited some drafts or cheques received from others into your account, but the bank did not collect those amounts and so not credited to your account.
3. Banks might have charged some bank charges, and the entries were not done in your books.

Above are common features which affect your bank balances. 

When you account for all these things, then only your balances tally with the bank passbook.

A Sample Format of Bank Reconciliation Statement

Generally, a typical bank reconciliation statement will project only cheques issued but not presented and deposits made but not collected as the only differences. 

All other discrepancies get sorted out and corresponding entries made in your books before closing your books.

• If the Bank debits any charges to you, you will account for them in your expenses and credit the Bank A/C. 
• If any interest is credited to your account, you will credit your income and debit the bank in your books.

But, there will be no corresponding entries for cheques issued but not presented or deposits made but not credited to your account. 

You can not reduce your expenses by reversing the cheques or reduce your receipts by reversing the deposits made into the bank. So these two items will stand in the Bank Reconciliation Statement as reasons for the differences between your Books and the Bank Books.

So a typical Bank Reconciliation Statement will be like this:

Balance as per our Books                  (say)         10,000 Dr.

Add:

Cheques issued but not presented     (say)           5,000

                                                 Total                  15,000 Dr.

Less:

Drafts deposited but not collected    (say)           3,000    

Balance as per Bank statement or PassBook     12,000 Dr.

In the reconciliation statement above, we are adding back the amounts of those checks issued by us (but not presented to the bank) because we already reduced our balance when we issued the checks. Similarly, we already increased our bank balance when the drafts were deposited into the bank. Therefore, we have to decrease the amount in the bank reconciliation statement (if the draft is not collected by the bank) to match the bank balance.

This is the general procedure for preparing a Bank Reconciliation Statement.

Trial Balance and its Importance in Accounts

A trial balance is a list of your account book balances mentioned in two columns- as debits and credits; the totals of which should tally.

The Trial Balance is named so because it is a trial to test whether you have entered your account books correctly. If the sheet tallies, you can confidently prepare your Profit & Loss and Balance Sheet Accounts.

Normally, trial balances are prepared each month to verify whether you entered your accounts correctly during that month. It is a kind of preliminary exercise. Though at times, your entries could be wrong, such as when you might have made a credit or debit entry correctly, but the corresponding entry might have been posted to the wrong account heads.

How to Prepare A Trial Balance

At the end of each month, you will draw the closing balances for each and every account in the primary accounting book known as the General Ledger or Main Ledger. When you do this, each account will show either a debit balance or a credit balance at the end of each month. Now, you can prepare a Trial Balance by writing down those balances on a sheet of paper, debits in one column and credits in the other.

You should depict the columns as below:

Particulars(Head of Account)        Ledger Folio                   DEBITS               CREDITS        

Now, enter all the balances of your accounts from the General Ledger into this sheet accurately, mentioning all the debit balances in the debit column and credit balances in the credit column. Enter the cash balance also on this sheet (taking it from the cash book) and then total both columns.

The totals of both debit and credit columns should tally. This is because, for each debit entry, there will be a corresponding credit entry in your books of accounts. 

If the totals do not tally, then you should know that there is some mistake either in your account books or in the balancing of the Ledger accounts, or maybe you have made a mistake while copying the balances from each page into the trial balance statement. So, you need to check all these points.

Importance of Trial Balance   

• Trial balance confirms the accuracy of all your debit and credit entries.
• It serves as a quick picture of your accounts.
• You can know the amount spent or incurred under each expenditure head or the amount received under each income head by looking into this trial balance statement for any particular period.    
• It is the preliminary stage for preparing your financial statements. You can prepare your Profit & Loss statement or Balance sheet statements with the help of this Trial Balance.  
• Other important documents, like Budget and Cost Sheets, are also prepared with the help of this trial balance.
• It serves as a managerial information statement for having a quick look at revenue, expenses, and income during any period.

What to Do if Trial Balances Do Not Tally 

If the Trial Balance does not tally, you should check the following factors.

1. Check/recheck the totals of both columns in the trial balance.
2. Compare the amounts of balances entered in the trial balance with your ledger and ascertain whether they were entered accurately.
3. Check whether the debit balance is entered correctly in the debit column and credit balance in the credit column of the sheet.
4. Check the balancing of each head in your General Ledger- whether it is correctly done or not.
5. If, in spite of all these verifications, the trial balance does not tally, then there can be mistakes in your original postings of accounts while entering them from your original bills and vouchers. 
6. So you need to check each and every entry done in your Main Ledger with their corresponding vouchers, which can take many days to locate the mistake.

Here is "A Smart Tip"

One simple trick, which may or may not work, is to take half of the amount (half of the difference between Debit and Credit side totals in the Trial Balance) and check for that half amount in your accounts. Whether any entry was done for such amount in your books. If there is an entry equal to that half amount, whether it has been wrongly entered on the debit side instead of the credit or vice versa. 

This method sometimes works and can save a lot of time and energy in locating the mistake. But it only works if you made one simple mistake of that kind. If you made many mistakes, it will not help much.                                             

Basic Records or Documents Needed for Building Your Accounts

Some fundamental records must be maintained to build any type of account, whether it is your Individual Account, Business Account, or any other field that attracts income tax. 

You cannot create or maintain an account without basic records that support your transactions. At least, you need to remember the nature and purpose of your payments and receipts. A scrap book where you note down as and when you bought something or received some money.

These basic records and documents 9for example, bills and receipts) are the most essential and important foundations for an accountant or auditor to create or maintain accounts and verify their authenticity.

Some of the essential documents are discussed below:

Purchase Bills

Bills for any purchases, whether you pay cash or credit, are to be safely maintained as your primary record. You make entries from these bills by preparing vouchers. I will discuss vouchers at a later stage. So, these bills should be kept safely either pinned to the vouchers or in separate files. 

If kept in files, you should maintain separate files according to the nature of transactions and the account head of that purchase and mark the files with their identity/nature. Or, you can simply arrange your bills and documents chronologically and mention the period on the file cover. 

In either case, you may pin the duplicate copies or xerox of the bills along with those vouchers. Keep original bills for record-keeping in their respective topic files for any urgent reference in the future.

Sales Bills

When you make sales, you should prepare sale bills to your customers.  It helps buyers understand the details of the payments made or to be made by them for those purchases. Additionally, it serves as the document for their accounting purpose. 

There may be cash and credit bills. Credit bills refer to Credit Sales. 

In either case, a copy of the bill is to be retained by you for record and for preparing your accounting entries. Cash bills may be enclosed with your sale vouchers. But credit bills are to be kept separately in files, and copies of them are to be enclosed with the voucher (you will be preparing a Debit Voucher debiting the receiver of the goods/items). 

If transactions are too many, you cannot enclose all bills with vouchers. In that case, you can give the bill number and date in your vouchers and keep the bills in files.

Asset Purchase and Sale Records:

You should maintain these bills as well to calculate the value of assets that are of significant value in your possession. If you sell any of them, keep a record of the sale value and date of sale, with supporting evidence. You can maintain an Assets Register if you are holding or selling too many assets.

Vouchers

Vouchers can be either Cash or Bank (voucher), or Journal voucher according to the nature of transactions.

• Cash vouchers are made for cash transactions when you purchase in cash or sell against cash. You can keep the cash bills enclosed with the vouchers. But if you make any big purchases, like assets or equipment, keep the bills in secured files, and only copies may be attached to vouchers.
• Bank vouchers are prepared for entering bank transactions. If you purchase by giving cheques or sell by receiving cheques or drafts, these bank vouchers are prepared. Here also, tiny payment bills may be enclosed with the vouchers, and big payment bills need to be kept in relevant files for a safe record.
• Journal vouchers are prepared for transactions other than cash or bank payments. These can be prepared for monthly total entries against sales or purchase day books or for any internal transfer accounts and adjustments or for salaries and wages sheets and depreciation accounting, etc.

Business Property Documents

Whatever property you hold in the name of your business requires proof of the holder, its authenticity, and valuation. You should be able to justify your property and its valuation and its holdings duly certified or verified by some legal authority.

Passbook

If you hold Bank or Post office accounts, you should keep the passbooks properly updated from time to time, for verification purposes and making entries in your account books. Your entries should always be tallied with the passbook entries, and keep everything updated.