Trading Account: Meaning, Definition, and Advantages

Trading Account Essay [in Hindi]: The first step of the final account is a trading account. A trading account is a nominal account that prepares at the end of the accounting year. They help to find out gross profit or gross loss during the accounting period. The trading account consists of two sides “debit and credit”. All direct expenses are debited and direct incomes are credited in the trading account. The trading account contains mainly the purchase of goods, The sale of goods, and expenses relating to the daily operation of the factory.

Here are the essay and article of Trading Account: Meaning, Definition, Advantages, Disadvantages, Limitations, Needs & Importance, and Objectives.

What is the Trading Account in Accounting? The account prepares to know the gross profit or gross loss of a company concern calls a trading account. It should note that the report of the business determined through a trading account is not final. The true reports the net profit or the net loss which is determined through profit and loss account. It can calculate using the following formula;

Cost of Goods Sales = Opening Stock + Goods Purchase – Closing Stock

After preparing the trial balance, the next step is to create a trading account; A trading accounts one of the financial statements that show the result of the purchase and sale of goods and services during the accounting period; The main purpose of preparing the trading accounts to find out the gross profit or gross loss during the accounting period; Gross profit is said to be when the goods sold have more income than sales.

Conversely, when sales proceeds are less than the cost of goods sold, there is a gross loss; to calculate the cost of goods sold, we have to take into account the direct expenditure on stock, purchase, purchase or manufacture of goods and closing of stock; The balance of this account i.e. gross profit or gross loss can mention on the profit and loss account in accounting.

Meaning and Definition of Trading Account in Accounting:

A business account is designed primarily to know the profitability of “goods” bought or manufactured and sold by businessmen; The difference between the selling price and cost price of goods is the gross result.

The term “consignment” means goods purchased for resale; It does not include property; If the sales proceeds exceed the cost of goods sold, then the gross profit made; If the amount sold is less than the cost of goods sold, a gross loss occurs.

After the Trading account, the Profit / Loss account can be prepared separately or they can be shown as an account in which Trading and Profit and Loss account is with two classes; The first part of this section which deals with the study of the result of trading transactions alone is known as a trading account. A trading account can define as an account that discloses the consequences of buying and selling goods.

Advantages of Trading Account in Accounting:

The following are the Major Benefits or Advantages below are;

• It shows the relationship between gross profit and gross loss, sales that help to measure profitability or losses position.
• The account shows the ratio between the cost of goods sold and gross profit.
• They give information about the efficiency of trading activities.
• They help to compare the cost of goods sold and gross profit.
• It provides information regarding stock and the cost of goods sold.
• The result of trading can know separately.
• The various items of this account of different periods can compare.
• The adjustment in the selling price can make by knowing the percentage of gross profit on net sales.
• Over-stocking/under-stocking can know to act wisely.
• If the gross loss discloses, the business can close immediately because the loss will further increase when the indirect and non-expenses add to it.
• The progress can study based on the gross profit ratio, year after year.

Disadvantages and limitations of Trading Account in Accounting:

The following are the Major limitations or disadvantages below are;

• It only defines the gross profit or gross loss, so this account can not result from net profits and net loss for the company; the company needs to make another account in accounting for net profits and net loss, it calls profit or loss account.
• Its report can not share with the company shareholder.
• They only mention direct expenses, not to indirect and non-expenses.

Needs & Importance of Trading Account in Accounting:

It is very important to want to know what is the gross profit or gross loss; for the company to also want to know whether purchasing goods, what manufacturing of goods and sales are sufficient for earning or not.

The following main needs and importance below are.

• It helps to know gross profit or loss.
• They provide information about direct expenses.
• They provide safety against possibilities of loss.
• It helps in comparison with closing stock with last year’s stock.

Trading Account: Meaning, Definition, Advantages, Disadvantages, Limitations, Needs & Importance, and Objectives; Image from Pixabay.

Objectives of preparing a Trading Account in Accounting:

What are the purpose or objectives of preparing a trading account in accounting for the business year? The profit or loss rated by trading accounts the gross result of the business but is not the net profit report. If so, then a question in mind why we need to prepare a trading account? So we got an answer; this account is necessary because we need to prepare a balance sheet for our company revenue and expense transaction; and, also need to know what gross & net profit.

First objectives:

• The 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 or non-expenses of a company’s concern.
• The number of net sales can determine through this account. Gross sales can ascertain from the sales account in the ledger, but net sales cannot so obtain. The true sales of a business are net – not gross sales. Net sales determine by deducting sales returns from gross sales in the trading account.
• The success or failure of a company can fixate by comparing net sales of the current year with that of the last year. It should note that an increase in the number of total sales of the current year over the last year may not observe as a sign of success, since sales may increase because of rising in the price level.
• To Show Gross Profit and Loss; the Trading account determines gross profit and the gross loss of the business at the end of the period. For Net Purchase and Sales; the Trading account determines the amount of net purchase and sales during the accounting period. Cost of Good Sold; It calculates the cost of goods sold at the end of the period.

Second objectives:

• The percentage of gross profit on net sales (gross profit ratio) can easily determine from the trading accounts. This percentage is a very important yardstick for measuring the success or failure of a business. Compared to last year, if the rate increases, it indicates success; on the other hand, if the rate decreases, it is an indication of failure.
• The percentage of different items of buying expenses (direct expenses) on gross profit can easily determine and by comparing the percentage of the current year with that of the previous year the variations can be ascertained. An analysis of variances will disclose their cause which will help in controlling the number of expenses.
• Inventory or stock turnover ratio can analyze from the trading account in accounting. The success or failure of a company can measure by this determination. A higher rate indicates a favorable sign i.e. goods sold soon after their purchase. On the other hand, a low rate of signifies deterioration, i.e. goods sold long after their purchase.
• Fixation Of Price; They help to fix the selling price of the product by showing the relationship between sales and cost of goods sold. To Know Expenses; It helps to know the factory expenses. To Show Stock Position; They give detailed information about the stock position. The efficiency of Business; It helps to measure business efficiency by comparing sales and expenses.