Trading Profit and Loss Account – JSS3 Business Studies Lesson Note (Second Term)

The trading account and the profit and loss account are final accounts prepared at the end of a business year to find the gross profit and the net profit.

Behavioural objectives

By the end of the lesson, students should be able to:

1. explain what a trading account is;
2. state the main items in a trading account;
3. explain what a profit and loss account is and why it is prepared;
4. state which items are debited and which are credited in a profit and loss account;
5. read a simple profit and loss account.

What are the trading account and the profit and loss account?

They are two accounts prepared one after the other at the end of the year to show how well a business has performed.

• Trading account: shows the gross profit or gross loss.
• Profit and loss account: follows the trading account and shows the net profit or net loss.
• Why they are prepared: to ascertain the profit or loss of the business at the end of the year.

What is a trading account?

A trading account is an account prepared to find the gross profit or gross loss of a business in a given period.

• Gross profit: the excess of sales over the cost of goods sold.
• Gross loss: the excess of cost of goods sold over sales.

What are the contents of a trading account?

The main items in a trading account are stock, purchases, returns, carriage inward, sales and gross profit.

• Opening stock: the stock at the beginning of the period.
• Closing stock: the stock not used up at the end of the business period.
• Purchases: goods bought for resale during the period.
• Returns outward: goods bought but returned to the supplier, for example because they are defective or substandard.
• Returns inward: goods sold to customers but returned for one reason or another.
• Carriage inward: the cost of carrying goods bought into the organisation.
• Net sales: sales less returns inward.
• Cost of goods available for sale: opening stock plus purchases plus carriage inward, less returns outward.
• Cost of goods sold: cost of goods available for sale less closing stock.
• Gross profit: net sales less cost of goods sold.

How is gross profit calculated?

Gross profit is found by working through four steps in order.

1. Find net sales: sales less returns inward.
2. Find cost of goods available for sale: opening stock plus purchases plus carriage inward, less returns outward.
3. Find cost of goods sold: cost of goods available for sale less closing stock.
4. Find gross profit: net sales less cost of goods sold.

Illustration with simple figures

The figures below are for practice only and do not come from the Diligent Stores example.

What is a profit and loss account?

A profit and loss account (P & L account) is an account prepared after the trading account to find the net profit or net loss of a business.

• Debit side: all operating expenses of the business.
• Credit side: the gross profit and all other revenue accruing to the business.
• Net profit: gross profit plus other income, less total expenses.
• Net loss: the result when total expenses are more than gross profit plus other income.

What is the purpose of a profit and loss account?

The purpose of a profit and loss account is to ascertain the net profit or net loss of the business.

What items appear in a profit and loss account?

Expenses are debited and gains are credited.

• Carriage outward: the cost of delivering goods to customers. It goes in the profit and loss account.
• Carriage inward: it goes in the trading account, not the profit and loss account.
• Drawings: money or goods the owner takes for personal use. It is not an expense of the business.

How do the two accounts differ?

The trading account deals with buying and selling of goods, while the profit and loss account deals with running costs and other income.

How is a profit and loss account prepared? (Worked example)

Add up all the expenses, subtract the total from the gross profit, and the balance is the net profit.

Question: From the trial balance of Diligent Stores Ltd, prepare the Profit and Loss Account of the company for the year ended 31st December 2009.

Solution

1. Write the gross profit of ₦7,165 on the credit side.
2. List all expenses on the debit side.
3. Add the expenses: 200 + 3,862 + 304 + 74 + 664 + 216 + 480 = ₦5,800.
4. Find net profit: 7,165 − 5,800 = ₦1,365.
5. Write the net profit on the debit side so that both sides total ₦7,165.

Diligent Stores Ltd: Profit and Loss Account for the year ended 31st December 2009

Evaluation

1. Write a short note on the profit and loss account.
2. State the purpose of preparing a profit and loss account.
3. Define gross profit and net profit.
4. Name four items debited and two items credited in a profit and loss account.

Assignment

Reading assignment

Business Studies by O.A. Lawal, pages 77 to 80.

General revision questions

1. What is a petty cash book?
2. Mention three items that can appear in the petty cash book.
3. Who keeps the petty cash book?
4. Define the imprest system.
5. What is the amount of money given to the petty cashier at the beginning of the period called?

Weekend assignment

1. Which of the following is an item in the profit and loss account? A. Sales B. Purchases C. Carriage inward D. Carriage outward
2. All of the following are expenses in the profit and loss account except ____. A. Discount received B. Electricity C. Discount allowed D. Rent and rates
3. ____ is an item credited to the profit and loss account. A. Insurance B. Drawings C. Rent received D. Salaries and wages
4. The purpose of preparing a profit and loss account is to ascertain the ____ of the business. A. net profit/gross loss B. net income C. gross profit/gross loss D. net profit/net loss
5. In the profit and loss account, all expenses are ____. A. debited B. credited C. closed down D. added to the gross profit

Theory

1. Write short notes on the profit and loss account.
2. Prepare a format of a profit and loss account with four items on the credit side and twelve items or entries on the debit side.