Trading Account

Trading Account:



Learning Objectives:




Define and explain trading account.



What are the items of a trading account.



Prepare the format of trading account.



What are advantages of trading accounting?



Definition and Explanation:

A trading account is an account which contains, " in summarized form, all the transactions, occurring, throughout the trading period, in commodities in which he deals" and which gives the gross trading result. In short, trading account is the account which is prepared to determine the gross profit or the gross loss of a trader.



Items of Trading Account:


The following items usually appear in the debit and credit sides of the trading account.



Debit Side Items:

The value of opening stocks of goods (i.e., the stock of goods with which the business was started).



Net purchase made during the year (i.e., purchases less returns).



Direct expenses, if any.



Credit Side Items:

Total sales made during the period less the value of returns, i.e., net sales.



The value of closing stock of goods.



The difference between the two sides of the trading account represents either gross profit or gross loss. Thus if the credit side is heavier that would mean that the trader has earned gross profit i.e., the excess of selling price of the goods sold over their purchase price. If the debit side is heavier it would mean that the trader has suffered gross loss i.e., purchase price of goods exceeds the selling price.



The balance of trading account which represents either gross profit or gross loss is transferred to profit and loss account.





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Trial Balance

Definition of 'Trial Balance'


A bookkeeping worksheet in which the balances of all ledgers are compiled into debit and credit columns. A company prepares a trial balance periodically, usually at the end of every reporting period. The general purpose of producing a trial balance is to ensure the entries in a company's bookkeeping system are mathematically correct

Need for Accounting in a Business

Let us start our discussion with the help of a case study. Mr. X wants to start a business. He decided to set up a departmental store. He has $10 million with him which he can invest in the business. In addition to the cash he also has a plot of land worth $2 million. He also brings in furniture worth $20 thousands. Now as he has gathered all his sources the next step is to build a store on the plot of land. He spends $5 thosand on building the structure. Next he spends $4500 on electricity fittings in the store. As the basic struture is ready , he makes some purchaases of the commodities that he wants to sell in the store worth $ 2.5 million. He pays salaries of the staff, makes other expenses, sells goods and earns revenue.




At the end of one month he wants to know the position of cash and other assets with him. He wants to know how much he has spent and how much he has earned during the month. How much he owes to the creditors and how much his debtors owe to him. He has here and there noted some of the major transactions and left some to his memeory by thinking that he would recall all the things when needed. But as he started matching his roughly maintained records with the actual things in the store he just ended up in a lot of confusion.



Can you say what could be the reason for his confusion. The reason was in fact the lack of maintenance of proper records of the business. As the volume of present day business has increased tremendously, it is difficult or you can say rather impossible for us to memorize all the business transactions that occur daily in the course of our business. And in the absence of any reliable records its impossible for us to come to a conclusion about the results of our business.



The main purpose of entering into a business is to earn profits. Whether a business has earned profit or suffered a loss can be determined only if we keep an account of each and every business transaction. In accountancy the term transaction refers to a money transaction i.e. the transaction in which money is either given or received. From a small shop in a locality to a big corporate house, every business entity enters into a number of transactions during a day. It becomes difficult to remember each and every transaction. Apart from determining the profit earned or loss suffered during an accounting period, a business unit is also interested in knowing its sales, purchase,revenue, expenditure, incomes etc. It may also need to determine the value of its assets and liabilities. For example sales manager of a company would be interested in finding out the total sales of the company during an year so as to compare it with the previous year sales. A business man may be interested in finding out the value of accounts receivables as shown by the accounting books on a particular date. All this makes it necessary to keep a proper record of each and every financial transaction in a systemetic and uniform manner.



This is here that ACCOUNTING comes to our help. Now the question is what does the term Accounting precisely mean? The American Institute of Certified Public Accountants defines Accounting as"the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of financial character, and interpreting the results thereof."



Thus it is quite clear from the definition above that Accounting is the process of recording, classifying, summarizing and analyzing business transactions according to the set rules and principals.It records only money transactions.



The first step in the process of accounting is journalizing. In this process each transaction is entered into a book called Journal ( Journal means daily). After journalizing the next step is posting i.e. entering a transaction into ledger. After ledger we make trial balance and then final accounts. But this is not the end of accounting process. It further moves to the process of analyzing of business results as shown by our final accounts. The business results are then conveyed to the various interested groups i.e. shareholders. creditors, bankers, managers and the society at large.

Accounting terms- Balance sheet

Any business man is interested in knowing the position of its business as existing on a particular day. He may have many questions in his mind regarding his business like....................




How much cash do I have in hand ar at bank?



What is my investment in the inventories?



How much others owe to the business?



How much I have invested in fixed or long term assets like land and building,plant and machinery, furniture and fixture?



How much expenses I have paid in advance?



What is the amount of accrued incomes i.e. the incomes earned but not yet received?



How much do I owe to others (like creditors)?



What is the amount of Long term liabilities of the business?



The amount of outstanding expenses(the expenses which are due but not yet have been paid) ?



What the amount of my total investment in the business?



.... and many more questions of these types........







All these questions are answered by one single statement and that is the Balance sheet of the firm or company.It is a quick snapshot of the financial position of the company. It shows what the company owns and what it owes to others. Balance sheet is a statement of assets and liabilities of a business. It shows the position of the business as existing on a particular day. It has two sides- Asset side and Liabilities side. All the assets of the business whether fixed or current, tangible or intangible,are shown on the right side of the balance sheet. And all the Liabilities, long term or short term, along with the Capital of the Business are shown on the left side of the balance sheet. Balance sheet is generally prepared at the end of the accounting period. But now a days accounting softwares allow the electronic recording, storing, and retrieval of accounting information. Thus you can generate financial statements at any time if you are in a habit of entering your financial transactions on regular basis.

Assets-Meaning and Definition

Assets in common language means anything that we own e.g. your house, your car, your office, the furniture in your house as well as office


the cash balance you hace in your hand as well as in bank, the jewellary etc are all your assets. However

in accounting we have some broader meaning of the term assets.

Assets are anything which has got some economic value and which is owned by the business entity. Some examples of assets are

cash, bank balance, investments, stock, land, building, plant, machinery,goodwill, debtors,prepaid expenses etc

Assets can be classified in to different categories on two basis


1. On the basis of their convertability into cash


2. On the basis of their physical existence


1. On the basis of how easily assets can be converted into cash, assets can be classified as current assets and fixed assets.

2.On the basis of their physical existence, assets can be classified into tangible assets and intangible assets.

a) Current assets vs. fixed assets


Some of the assets that the company owns are liquid in nature i.e. they can easily be converted ito cash. e.g. bank balance, debtors, stock, marketable investments are some of the assets which can be turned into cash easily when required. These assets are called current assets or liquid assets. The more easily an asset is convertible into cash the more liquid it is. Can you guess which is the most liquid asset for a business?

Yes, it is cash itself. Other examples of current assets are Bank balance, debtors, stock (finished as well as semi finished), marketable securities, prepaid expenses, accrued incomes etc. Current assets are important for working of a business unit because these assets provide the cash for the day to day working of the business. However unnecessary investment in current assets should be avoided as it results in ideal funds which could be invested elsewhere profitably.

Fixed assets are those assets which are held in the business for a long time say for many years e.g. land and building, plant and machinery, furniture,fixtures, office equipments, vehicles etc. These assets give their benefits for many years and hence are very important for a business. In almost any business a lot of money is invested in fixed assets.So these are among the most important assets of the business. For small business owners fixed assets are even more important because lenders or financial institutions examine the fixed assets of the business more closely while making lending decisions.

Fixed assets are also known as hard assets, non current assets or long term assets. These assets have a life expectancy of many years. But these assets lose thier value with the passage of time (except real estate). This loss in the value of fixed assets is called depreciation.

Since fixed assets involves major investment of the funds of the business and funds are blocked for a long time in these assets, care should be taken while investing in these assets. Any wrong decision on the investment in non-required fixed assets can affect the operating efficiency of the business.

b) Tangible vs. intangible assets


Some of the assets of the business are such which you can touch, see and feel e.g. Land, machinery, furniture are such assets which can be seen, touched and felt. These assets are called tangible assets. Tangible assets have physical existence. Some of the examples of tangible assets are cash,inventories, debtors,securities, land, building, machinery, furniture, equipments, vehicles etc.

In business its not necessary that all assets must have a physical existence. Some assets are such which can not be touched, seen or felt but still they have an economic value. The example of such assets are Goodwill, patents, trademarks, brand value, human intelligence. These assets are called intangible assets. These assets just like tangible assets can be sold and bought in the market and these appear on the balance sheet of the company together with other assets.

Double Entry System of Accounting

Earlier transactions in the books of accounts were recorded under single entry system. But this system had some shortcomings as there was not a complete record of all the transactions. Also problems were faced while preparing final accounts. Problems were also faced as there was no self balancing system of accounting which could guarantee, to some extent, the accuracy of the books of accounts. So a need was felt for some uniformly accepted system of accounting which could help in the verification of the accuracy of books to some extent. These problems were solved by the Double Entry System of accounting. This system has totally replaced the single entry system. This system is now followed universally.




Under this system of accounting, every transaction in business involves atleast two accounts. That is why this system of accounting is called the ' Double Entry System'. Under this system every transaction has two aspects i.e. debit aspect and credit aspect. Under this system every transaction is entered into atleast two accounts in the Ledger. In one account the transaction is entered on the Left hand side i.e on the debit sideof the account and on the other account an entry for equal amount is made on the right side of the account i.e. the credit side of the account.



For example suppose X paid cash salaries to his staff. The two accounts affected are cash account and salaries account. As cash is going out it, cash account is credited. Salaries is an expenditure for the business, salaries account is debited.

Again X bought raw material for the production unit, the two accounts involved are

Cash account and Purchases account.

He paid carriage to bring goods to his factory, the two accounts involved are cash account and carriage account.

He sold finished goods to customers on credit, the two accounts involved are the customer's personal account(debtor) and sales account.

He further purchased furniture for his office on credit. The two accounts involved are furniture account and the personal account of the seller(creditor).



Thus we can see that every transaction has two aspects in the Double entry system of accountancy.

Now which account is debited and which is to be credited depends on the types of accounts involved and the rules of debit and credit for that type of account.

Accounting Basics

Lets start our discussion with an example. Suppose you start a new business by investing money in the business. You purchased land, furniture, raw material etc. You opened a bank account. You made some credit purchases form a vendor named Mohit. You sold the goods to a cusomer named Rahul. You also paid salaries to the staff and incurred many other expenses. Apart from the sales revenue you also received some non operating incomes like rent and interest. Now how would you record the transactions in the books. The first question that would come in you mind is " Under what name i have to record this transaction?" Now this name which you are going to assign to different constituents of you transaction is the name of the account. An account is the summary of transactions that took place under a particular head during a time period. For example, you paid salaries to your staff. The two accounts involved in the transaction are, Salaries account and Cash account. Theses accounts would appear in the Ledger(the book which contains all the accounts of the business).


We enter into a number of transactions in the course of our business. We keep a record of all the transactions of financial nature. These transactions are recorded in the books under a unique account. Each account is assigned a separate name to distinguish it from other accounts. While making an entry in the books, first we should see, to which category of accounts it belongs. There are mainly three types of accounts.

1. Real Accounts.

2. Personal Accounts.

3. Nominal Accounts.

This classification is based on the nature of accounts i.e. asset, liability, legal entity,expenses, incomes etc.

1. Real Accounts

Accounts related to assets (tangible or intangible) come under the category of real accounts e.g. land, furniture, machinery, goodwill, patents etc are real accounts.Some of the assets of the business are such which you can touch, see and feel e.g. Land, machinery, furniture are such assets which can be seen, touched and felt. These assets are called tangible assets. Tangible assets have physical existence. Some of the examples of tangible assets are cash,inventories, debtors,securities, land, building, machinery, furniture, equipments, vehicles etc.



In business its not necessary that all assets must have a physical existence. Some assets are such which can not be touched, seen or felt but still they have an economic value. The example of such assets are Goodwill, patents, trademarks, brand value, human intelligence. These assets are called intangible assets. These assets just like tangible assets can be sold and bought in the market and these appear on the balance sheet of the company together with other assets.



2. Personal Accounts.

Accounts related to persons (living ar non living) are called personal accounts. In business we have to deal with a number of persons. Some are living like us and some are artificial which do not have a living existence but have a separate legal existence.Thus in accountancy we classify persons into Natural Persons and Artificial Person.

Natural persons are the persons who are living e.g. Rahul, Mohit, Sam, Peter etc.

Artificial persons are all the firms, companies, institutions with whom you deal. In accounts business is a separate legal entity which has an existence of its own . Simailarly the other companies, firm or organisations are regarded as separate legal entities.These are regarded as artificial persons. When we enter into any transaction with these artificial entities, we record the transaction under the name of that company, firm or organisation. Examples of artificial persons are ABC Ltd, Wipro Ltd, Hindustan Lever, X and Co, Ahuja & sons etc.

3. Nominal Accounts

These are the accounts related to incomes and expenditures of a business entity. Expenditure or expenses are the amount paid or payable which has given its benefit to the business in the fiscal year.e.g. salaries, wages, carriage, transportation, rent, electricity, stationary, taxes, commisions paid, interest paid etc.

Incomes are the receipts which increase the profits of the business. Examples of incomes are rent received, commission received, interest received,dividend received etc.

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