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Separate Trading account and Profit & Loss (P/L) account

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... From Page 5

Combined Trading and Profit and Loss Account (a/c)

 
 
The "Trading and Profit & Loss a/c" is prepared by transferring the balances in all the nominal accounts to it. This amounts to setting off all the debit balances and the credit balances to obtain the profit/loss made. Thus the "Trading and Profit & Loss a/c" gives us the information relating to the profits available after setting off all expenses/losses with all incomes/gains.

» Information obtained from the Trading and Profit and Loss a/c

The "Trading and Profit & Loss a/c" that is prepared to ascertain the profits or losses made by the organisation gives us the information relating to the overall profit or loss made by the organisation.

» Illustrative Explanation

The following is the information relating to the Nominal accounts in an organisation for four accounting periods (calendar year being its accounting period)

Account Head 2002 2003 2004 2005
Purchases
Salaries
Rent
Interest
Sales
2,00,000
15,000
12,000
80,000
3,00,000
2,40,000
18,000
18,000
96,000
3,60,000
3,25,000
28,000
24,000
1,35,000
4,87,500
4,00,000
32,000
30,000
1,65,000
6,00,000

If we are making a single "Trading and Profit & Loss a/c" the profits/losses made by the organisation would be:

Account Head 2002 2003 2004 2005
Incomes:
    Sales
    Total
Expenses:
    Purchases
    Salaries
    Rent
    Interest
    Total
Profit/Loss:
    Income − Expenditure

3,00,000
3,00,000

2,00,000
15,000
12,000
80,000
3,07,000

− 7,000

3,60,000
3,60,000

2,40,000
18,000
18,000
96,000
3,72,000

− 12,000

4,87,500
4,87,500

3,25,000
28,000
24,000
1,35,000
5,12,000

− 24,500

6,00,000
6,00,000

4,00,000
32,000
30,000
1,65,000
6,27,000

− 27,000

The profits ascertained through this method indicate a growing loss over the years. If, the organisation should take a decision to whether to continue with the business or not, it has to opt for moving out of the business.

» Combined Trading and Profit & Loss a/c

The same information pertaining to a particular year presented in the Trading and Profit and Loss account would be

DrTrading and Profit & Loss a/c (for the year 2003)Cr
Date Particulars J/F Amount
(in Rs)
Date Particulars J/F Amount
(in Rs)
31/12/03
"
"
To Purchases
To Salaries
To Rent
To Interest



2,40,000
18,000
18,000
96,000
31/12/03 By Sales a/c

By Bal (Loss)


3,60,000

12,000
  Total   3,72,000   Total   3,72,000
               

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Limitations of the Combined Account » Remedy

 
 
The combined Trading and Profit and Loss Account gives an overall comprehensive view of the profits or losses.

» Profits influenced by Events not related to Operations

The expenses/losses that are to be borne by the organisation may not be directly related to its operations.

For example, where the organisation has incurred a loss on account one of its vehicles getting damaged because of an accident, it has to absorb this loss as it is related to the organisation. This loss is also considered in ascertaining the overall profit or loss made by the organisation.

But, this loss is not directly related to the business operations of the organisation. This loss is not on account of conducting the business in the normal course, but an abnormal one.

» Information used in Decision Making

Profits/Losses are figures based on which a number of business decisions are taken.

Since, the overall profit/loss is a figure that is influenced by a number of factors which may not be directly related to the business operations, any decisions made based on that figure may be detrimental to the organisation.

» Remedy : Segregating Trading and Profit & Loss accounts

To arrive at a profit/loss figure that would take into consideration only the basic business operations, the nominal accounts that are considered in the process of preparation of the "Trading and Profit & Loss a/c" are grouped into two.

The first set of accounts are related to a ledger account by name "Trading a/c" and the remaining accounts are related to another ledger account by name "Profit and Loss a/c".

The basic purpose of accounting is derivation of information and the more the information we need, the more the accounting heads we need to maintain.

Breaking the Combined Trading and Profit & Loss account into two Accounts

 
 
The same information relating to profits is broken down into two and derived at two different stages. At the first stage, the profit from the core operations relating to the business is derived and in the next stage the overall profits are derived.

» Segregating the Information

The information in the above statement giving the overall profit, segregated into two

Account Head 2002 2003 2004 2005
Direct Incomes:
    Sales
    Total
Direct Expenses:
    Purchases
    Total
Core Profit:
    Direct Income − Direct Exp.
Indirect Expenses:
    Salaries
    Rent
    Interest
    Total
Overall Profit:
    Core Profit − Indirect Expenses.

3,00,000
3,00,000

2,00,000
2,00,000

1,00,000

18,000
12,000
80,000
1,07,000

− 7,000

3,60,000
3,60,000

2,40,000
2,40,000

1,20,000

18,000
18,000
96,000
1,32,000

− 12,000

4,87,500
4,87,500

3,25,000
3,25,000

1,62,500

28,000
24,000
1,35,000
1,87,000

− 24,500

6,00,000
6,00,000

4,00,000
4,00,000

2,00,000

32,000
30,000
1,65,000
2,27,000

− 27,000

If we look at the remade statement, we will be able to identify that the organisation is conducting a business which is generating reasonably good amount of profits (50% on cost or around 33% on sales). The turnover has been increasing, the core profit has been increasing, but the organisation is ultimately making an overall loss.

The segregation of information also indicates that the business is good enough to be conducted, but the indirect expenses are a reason for the loss being made by the organisation. This should make the organisation think as to the real reason for the loss being made and take corrective steps or actions if possible.

The organisation would be able to arrive at such conclusions only if the information is presented a manner so as to reveal the basic/core profit and the overall profit figures separately.

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Trading and Profit & Loss Accounts

 
 
Almost in all cases, there are two ledger accounts used in the exercise of ascertaining the profits made by the organisation, (1) "Trading a/c" and (2) "Profit & Loss a/c". The information contained in the combined "Trading and Profit & Loss a/c" is spread over the two accounts.

» Journal Entries » Preparation of "Trading a/c", "P/L a/c" Hide/Show

The journal entries relating to the preparation of separate "Trading a/c" and "Profit and Loss a/c" would thus be as follows:
Journal in the books of M/s ___ for the period from ____ to ____
Date V/R
No.
L/F Debit Amount
(in Rs)
Credit Amount
(in Rs)
31st Dec Dr
xxxx
xxxx
[For the transfer of debit balances in the direct expenses accounts to the Trading a/c.]
31st Dec Dr
xxxx
xxxx
[For the transfer of credit balances in the direct incomes accounts to the Trading a/c.]
31st Dec Dr
xxxx
xxxx
[For the transfer of Gross Profit to the Profit and Loss a/c.]
31st Dec Dr
xxxx
xxxx
[For the transfer of Gross Loss to the Profit and Loss a/c.]
31st Dec Dr
xxxx
xxxx
[For the transfer of debit balances in the indirect expenses accounts and accounts indicative of losses to the Profit and Loss a/c.]
31st Dec Dr
xxxx
xxxx
[For the transfer of credit balances in the indirect incomes accounts and accounts indicative of gains to the Profit and Loss a/c.]

The two ledger accounts would therefore be
DrTrading a/c [For the year 2003]Cr
Particulars Amount
(in Rs)
Particulars Amount
(in Rs)
To Purchases
To Gross Profit
2,40,000
1,20,000
By Sales a/c 3,60,000
  3,60,000   3,60,000
DrProfit & Loss a/c [For the year 2003]Cr
Particulars Amount
(in Rs)
Particulars Amount
(in Rs)
To Salaries
To Rent
To Interest
18,000
18,000
96,000
By Gross Profit
By Net Loss
1,20,000
12,000
  1,32,000   1,32,00

The Trading and Profit and Loss accounts are generally shown together to indicate the flow of information from one to another.
DrTrading and Profit and Loss a/c [For the year 2003]Cr
Particulars Amount
(in Rs)
Particulars Amount
(in Rs)
To Purchases
To Gross Profit
2,40,000
1,20,000
By Sales a/c 3,60,000
  3,60,000   3,60,000
To Salaries
To Rent
To Interest
18,000
18,000
96,000
By Gross Profit
By Net Loss
1,20,000
12,000
  1,32,000   1,32,00

• Note

Though the heading used here seems to indicate that it is a single account, it is in effect two different accounts.

Trading Account : Gross Profit » Profit & Loss Account : Net Profit

 
 

• Trading a/c : Gross Profit

The profit that is indicated as the Core/Basic Profit is what is called Gross Profit and that information is provided by the "Trading a/c".

The "Trading a/c" is prepared to ascertain the Core (Gross) Profit relating to the business. It is debited with the Direct Expenses and Credited with Direct Incomes, i.e. the balances of all the nominal accounts representing Direct expenses and Direct Incomes are transferred to the Trading a/c.

» Gross Profit

The profit/loss revealed by the "Trading a/c" is called "Gross" Profit/Loss.

The "Gross" Profit/Loss is transferred from the "Trading a/c" to the "Profit and Loss a/c" to enable the ascertainment of the overall profit/loss.

• Profit and Loss a/c : Net Profit

The profit that is indicated as the overall profit is what is called Net Profit and that information is provided by the "Profit and Loss a/c".

The "Profit and Loss a/c" is prepared to ascertain the Overall (Net) Profit relating to the business. This account is created by transferring the Gross Profit/Loss from the "Trading a/c". It is also debited with the Indirect Expenses and losses and Credited with Indirect Incomes i.e. the balances of all the nominal accounts representing Indirect expenses, losses and Indirect Incomes are transferred to the "Profit and Loss a/c".

» Net Profit

The profit/loss revealed by the "Profit and Loss a/c" is called "Net" Profit/Loss.

The "Net" Profit/Loss is transferred to the "Capital a/c" or the "Profit and Loss Appropriation a/c", thereby closing the "Profit and Loss a/c".

Nature of Trading Account & Profit and Loss Account

 
 

» Nominal Accounts

The "Trading a/c" and "Profit and Loss a/c" are ledger accounts derived by breaking up the information in the "Trading and Profit & Loss a/c" i.e. these accounts together replace the "Trading and Profit & Loss a/c". Since the "Trading and Profit & Loss a/c" is a nominal account, these two accounts are also nominal accounts.

Any ledger account made to ascertain the profits or losses made out of a set of transactions is a nominal account.

Author Credit : The Edifier ... Continued Page 7

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