Trading account & profit and loss account

The sole aim of a business is to make profit. However, many a times, businesses incur loss instead of making profits. The calculation of such profits and losses is no doubt the most important objective of the accounting function. The owners of the businesses would want to know whether their business is going down hill or burgeoning. Knowing what profits are made helps the decision makers decide to plan ahead and take important financial decisions such as when and how to take loans, etc.

Note : trading/ profit and loss account is not an account in the real sense, it is a financial statement to be exact.

Trading is basically a term given to business activity including sales and purchase or income and expenses. All sales are credit and all purchases are debit. Expenses incurred on purchases e.g loading, wages, carriage inwards, power, freight, etc are called direct expenses.

Take into account the following formulas : (Memorise them)

Gross profit : Net Sales – cost of goods sold

Net sales = Sales – Sales returns

Cost of goods sold : (opening stock + net purchases+ direct expenses) – closing stock

Net purchase : Purchase – purchase returns

Opening stock is the monetary value of items left for sale and brought down from the previous period.

Trading account

Debit Credit
Opening stock Closing stock
Net purchases Net sales
Direct expenses  
If Debit side is greater then “Balance gross loss” If credit side is greater then “Balance gross profit”

Gross profit is transferred to the profit and loss account

Profit and loss account

Debit Credit
Indirect expenses (Discounts allowed, salaries, rent, insurance, commission, bad debts, advertisement) Gross profit transfered from trading account
  Any other income (commission received, interest received, discounts received)
Net loss if Dr is bigger Net profit (if Cr is bigger)


Profit and loss account does not record capital, assets and liabilities. The net balance (profit or loss) is transferred to capital account.



Direct  Expenses

Expenses which may be regarded as the part of cost of purchasing a good. Sometimes direct expenses are also explained as the cost incurred on converting raw materials to finished goods. Another hint to identify direct expenses is that they are always accompanied by the word “In” e.g carriage in wards, etc.

Indirect expenses

Exact opposite of Direct expenses. They are the accompanied by the word “Out”

Trading and profit and loss accounts can both be integrated into a single statement form as follows:

            ($)                                           ($)

Sales                                                                                                                                    XXXXX

less cost of goods sold

Opening stock                                                                         XXX

Net purchases                                                                          XXX

Direct Expenses                                                                                  XXX

less closing stock                                                        ______XXX



Gross profit/loss                                                                                                                 XXXXX


less indirect Expenses

Rent                                                                                         XXX

Lighting                                                                                              XXX

Carriage outwards                                                                  XXX

Salaries                                                                                                XXX

General expenses                                                                    XXX



Net profit / Loss                                                                                                                   XXXXX