TRADING PROFIT AND / OR LOSS ACCOUNT / INCOME STATEMENT
The main purpose of going into business is to
make profit. Because, it is this profit that determines
what people earn as income to take care of their basic needs and improve their
economic status.
The profit of a business is determined by
matching its revenue against the expenses (Matching Concepts). If the revenue
is greater than the expenses, that indicates a profit but if the expenses are
less than the revenue, that is a loss for the business.
To determine whether a business makes profit
or loss, it prepares an account called trading, profit and loss account for the financial period which is usually one year.
Trading,
Profit and Loss Account Otherwise Known as Income Statement
- Trading Account: This is an account prepared to determine the gross profit of an organization. That is, profit before deduction of the expenses (Administration, Selling and Distribution expenses) for the period. Trading account can be prepared by subtracting cost of goods sold from ‘Net sales’ (turnover). Cost of goods sold can be calculated by adding opening stock, purchases and carriage Inward, then less return Outwards’ and closing stock. ‘Net sales’ otherwise known as turnover can be calculated subtracting return inward (Sales return) from sales.
- Profit and Loss Account: This according to the IFRS is also called statement of profit or loss account and other comprehensive income or mere income statement. This account is prepared to determine the financial position of an organization. It is prepared to determine the net profit of an organization. That is, profit after deduction of the expenses.
Key
Terms
Some of the Key terms like opening stock,
purchases, carriage Inward, Carriage Outward and Closing stock otherwise known
as closing inventory have been briefly discussed under manufacturing account and will not be detailed under this section.
- Open stock: This is the amount of goods available in the business at the beginning of the year.
- Purchase: This is the amount of goods bought with an intension of being sold during the year. Any item bought for intension of being used will be termed as an Asset, not Purchases.
- Carriage Inward: This is the cost of conveying the goods from the point of purchases to the business.
- Return Outwards: This is the amount of goods returned by the business to its suppliers due to some defects like damage in transit, wrong selection, and expiration of the product, among others.
- Drawings: This term is used to described goods or cash withdrawn from the business by the owner for personal use. The value of goods withdrawn by the owners will be deducted from purchases in the trading account and capital in the balance sheet. Any withdrawal by the owner is seen as a reduction from his capital as owners are separated from the business (Separate Entity Concept which states that the owners should be separated from the business). If it is a cash withdrawal, it is treated the same.
- Cost of Goods Available: This represents the total amount of goods available for the year. It is arrived at by adding Open stock, Purchases, Carriage Inward, then less return outward.
- Cost of Goods Sold: This is an amount realized after deducting closing stocks from the cost of goods available for sales. It represents the actual amount of goods sold for the financial year.
- Net Sales: This is the amount realized from sales after deducting all returns (Returns Inwards) by the customers. This is otherwise known as Turnover.
- Gross profit: This is a profit made before deduction of the expenses (indirect expenses) in an organization. It is the excess of ‘Net sales’ (turnover) over cost of goods sold.
- Net Profit: Is the income after all expenses have been deducted and can be ascertained by deducting overhead expenses from the Gross profit while Net loss arises when the expenses exceed the Gross profit.
- Expenses: This, according to IFRS can be described as a Gross outflow from the business and allocation of the cost of the assets. Gross outflow in this case refers to money being spent, leading to a reduction in cash value of the business while allocation of cost of the assets refer to depreciation and depletion charges on the assets.
Types of Expenses
Expenses of a business can be categorized
into three as;
1.
Administrative expenses: These are offices expensive incurred for
smooth running of the business. It includes all expenses except finance costs
and costs incurred to increase sales e.g. Office rent, Salaries, Rents,
electricity, etc.
2.
Selling and Distribution Expenses: This includes expenses incurred to increase sales volume of an
organization. For example, carriage outward, advertising, discount allowed, etc
3.
Finance Costs: These are costs of financing debts like
interest on Loans, Lease Expenses etc.
ILLUSTRATION
The trial balance extracted from the book of Fadworld Enterprises as at
31st December, 2022 is as follows:
N N
Sales 250,000
Purchases 120,000
Carriage
Inward
5,000
Carriage
Outward
2,500
Stock
at 01/01/2022 21,000
Sales
return 4,000
Drawings 15,000
Discount
received 4,500
Return
Outward
5,500
Discount
allowed
3,500
Rent 5,000
Wages 12,000
Advertising 3,500
Depreciation
on Plant & Machinery 6,000
Bad
debt
2,000
Stock of goods at 31st December, 2022 is 12,500
SOLUTION
FADWORLD ENTERPRISES
Trading, Profit and Loss Account for the Year
Ended 31st December, 2022
N N
Sales 250,000
Less: Return inward (4,000)
(Net Sales) 246,000
Open stock 21,000
Purchases 120,000
Carriage inward 5,000
146,000
Less: Drawings (15,000)
131,000
Less Return Outward (5,000)
Cost of goods Available 126,000
Less: Closing stock (12,500)
Cost of goods sold 113,500
(113,500)
Gross profit 132,500
Discount
received 4,500
Expenses
Carriage outward 2,500
Discount
allowed 3,500
Rent 5,000
Wages 12,000
Advertising 3,500
Dep. on
Plant & Machinery 6,000
Bad debt 2,000 (34,500)
Net profit 102,500
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