The account which is prepared to determine the gross profit or gross loss of a business concern is called trading account.
It is basically (Closing stock + Sales) - (Opening Stock + Purchases + Direct Expenses)
The result of the business determined through trading account is not true result, It is not the actual Profit. The true result is the net profit or the net loss which is determined through profit and loss account. The trading accounting has the following features:
1. It is the first stage of final accounts of a trading concern.
2. It is prepared on the last day of an accounting period.
3. Only direct revenue and direct expenses are considered in it. E.g., If you are running a manufacturing unit, we will consider only direct expenses of manufacturing e.g., Freight, oils and lubricants, electricity , generator expense, wages etc. But there are so many other expenses of a company like sale promotion, office expenses, salaries etc.
4. Direct expenses are recorded on its debit side and direct revenue on its credit side.
5. All items of direct expenses and direct revenue concerning current year are taken into account but no item relating to past or next year is considered in it.
6. If its credit side exceeds it represents gross profit and if debit side exceeds it shows gross loss.
Purpose of Preparing Trading Account:
The profit or loss determined by a trading account is the gross result of the business but not the net result. If so, then a question arises - what is the use of preparing a trading account? This account is necessary because of the following advantages.
Gross profit of a business is very important data, since all business expenses are met out of it. So the amount of gross profit should be adequate to meet the indirect expenses of a business concern.
Performa trading account
It reveals the net profits or net Loss. This is the next step after preparing the Trading account. Profit and Loss Account is prepared to get the net profit or loss for the given period.
Profit and loss account starts with the credit of Gross profit from the trading account and then all the indirect expenses are debited. You can see below the list of expenses that goes to profit and loss account.
Performa Profit and Loss Account.