Final Account Basic Concept and Trading Account Definition and Items

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Introduction of Final Account

Final Accounts are the accounts, which are prepared at the end of a financial year (fiscal year or sometimes budget year). The final accounts are primarily prepared for ascertaining the operational result and the financial position of the business/organization to its owners, management, or other interested parties. These are prepared with the help of Trial Balance.

Final Accounts/ Financial statements are primarily recorded in a journal; then transferred to a ledger; and thereafter, the final account is prepared. d. The preparation of a final accounting is the last stage of the accounting cycle.

Usually, a final account includes the following components −

  1. Trading Account
  2. Profit and Loss Account
  3. Balance Sheet

These accounts or statements are collectively known as Final Accounts or Financial Statements.

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Accounting Elements

  1. Assets
  2. Liabilities
  3. Expenses
  4. Income
  5. Capital
  • Elements of Trading and Profit and Loss Account
  • Incomes
  • Expenses
  • Elements of Balance Sheet
  • Assets
  • Liabilities
  • Capital

The trial balance is simply a list of ledger accounts balances at the end of an accounting period. This summary of the ledger at the end of an accounting period, is a convenient starting point in the preparation of the final accounts i.e. trading and profit and loss account and balance sheet.

A trial balance usually contains the following types of balances:

  • Balances from expenses accounts
  • Balances from revenue accounts
  • Balances from assets accounts
  • Balances from liabilities accounts
  • Balances from capital or owner’s equity account

Balances from expenses accounts, Balances from revenue accounts are transferred to trading and profit and loss account to find out profit or loss.

Balances from assets accounts, Balances from liabilities accounts and Balances from capital or owner’s equity account are transferred to the balance sheet to know the financial position of the business.

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Trading Account

Trading account is nominal account which is prepared at the end of accounting year. It is the first stage of final accounts A trading account helps in determining the gross profit or gross loss of a business concern, made strictly out of trading activities. Trading involves buying and selling activities.

In the trading account, the cost of goods sold is subtracted from net sales for the period to calculate gross profit. Only direct revenue and direct expenses are considered in it. Trading account is prepared mainly to know the profitability of the goods bought by the businessman.

The account consists of two sides; debit side indicates direct expenses and credit side is for direct incomes. Direct expenses which are incurred by the organization, to bring goods into the condition, fit for sale. Such expenses include fuel, power, freight, insurance, carriage inward, consumption of stores, etc. On the other hand, direct incomes refers to income from the activities that are earned from the sale of goods.

Gross Profit = Sales – COGS (Sales + Closing Stock) – (Stock in the beginning + Purchases + Direct Expenses)

Trading Account Items

  • Opening and closing stock
  • Net purchase and sale of goods
  • All expenses relating to purchase of goods, and
  • All expenses relating to the day-to-day operation of the factory like wages, factory rent, factory lighting, factory insurance, work manager’s salary, etc.

Objectives of trading account

The main objectives of trading account are as follows.

  • Trading account helps to know gross profit or loss.
  • Trading account provides information about the direct expenses.
  • Trading account provides safety against possibilities of loss.
  • .Trading account helps in comparison of closing stock with last year’s stock

Importance of Trading Account

  • It helps to measure profitability position of the business by showing the relationship between gross profit and sales.
  • It shows the ratios between costs of goods sold and gross profit.
  • It provides the information regarding the efficiency of trading activities.
  • It makes easier to compare among sales, cost of goods sold and gross profit.
  • It helps to provide information regarding closing stock.

Trading concern

Trading concern are those which do not manufacture goods, rather, they buy finished goods from the manufacturer or wholesaler and sell them to retailer or direct to customers.

Followings are the items which are include in the debit side of the trading account

  1. Opening Stock:

Opening stock consists of raw materials, work in progress and finished goods depending upon the nature of business. In merchandising business, the opening stock consists of finished goods. In manufacturing concern, opening stock consists of raw materials.

  1. Purchase

Purchase includes both credit purchase and cash purchase. Purchase is available in trial balance.

  1. Purchase Returns

Purchase returns is appear in the credit side of trial balance. Purchase returns may be shown by deduction from purchases.

  1. Purchase discount/Discount on purchase

A purchase discount, also called a cash discount, is a reduction in the price of a good if the buyer pays for it within the allowable period. In other words, this is an incentive that the seller gives to the buyer in hopes that the buyer will pay for the purchase in full before the actual due date.

Purchase discount may be shown by deduction from purchases.

  1. Direct Expenses

Direct expenses are directly related to the production of the product sold or service rendered.

Or

Direct expenses means all the expenses which are directly attributable to the purchase of goods. These are the some examples of direct expenses.

  1. Wages/direct wages/productive wages:

The remuneration paid to the workers for the loading and unloading of purchased goods or Wages paid to workers, who are directly engaged in the production, are direct expenses. Workers may be employed to manufacture merchandise or make it more saleable. Similar types of items are debited to Trading Account.

  1. Carriage /carriage inward/carriage on purchase:

These are transportation expenses met for bringing the goods purchased to the business place. It is debited to the trading account.

  • Freight /freight inward/transportation inward

Charges paid on bringing purchased goods from abroad through steamer, rail or air are known as freight. Being an expense connected with the purchase of goods, it is debited to the trading account.

  1. Import duty/customs duty:

In case of goods imported from abroad, import duty, customs duty or dock charges etc. have to pay. Since these are related to purchase of goods for resale purposes, these expenses are shown in the debit side of the Trading Account.

  1. Coal/coke/fuel/power/lighting etc:

Machines are used in the production process with the help of coal or electricity. Such charges are direct and are debited to Trading Account.

  1. Packaging charges:

Sometimes, it is necessary to pack the goods in a special type of packages in order to protect the goods or attract the customers. In these circumstances, the cost of packaging is a direct expense and is debited to Trading Account.

  • Clearing charges

In case of imports from abroad goods are cleared from ports. For this, port authorities charge something which is called clearing charges. It is debited to the trading account.

  • Dock charges

These are the dues imposed on ships and their cargoes when they are unloaded on the port. It is debited to the trading account.

  1. Excise duty on goods manufactured

Duty imposed by the government on goods manufactured or produced within the country is called excise duty. This being an expense connected with saleable goods or production. It is debited to the trading account.

  1. Octori duty

This is a duty which is imposed by the municipal corporation or the municipal committee when goods purchased enters its territory. So when the goods are purchased from another city, this duty has to be paid. It is debited to the trading account.

  1. Royalty on production

Royalty means rent. A manufacturer has to pay such rent, when he acquires the right to produce an article. For example, amount payable to the owner of patent for the use of patent right, amount payable to the author of a book on acquiring the right to publish this book etc. when he royalty is paid on production basis, it is debited to the manufacturing account or the trading account.

  • Manufacturing expenses

All expenses incurred in manufacturing or producing the goods in a factory as factory insurance, factory rent, depreciation on factory building etc, are direct expenses and are debited to trading account.

      Followings are the items which are include in the Credit side of the trading account

  1. Sales

Both cash sales and credit sales are included in trading account.

  1. Sales returns

Sales returns must be deducted from total sales and to be shown in the credit side of trading account. Sales returns are the sold goods which are returned from customers.

  1. Sales Discount/Discount on sale

A sales discount is a cash discount that manufacturers often give retailers for paying off accounts during the discount period. A sales discount is useful for both the retailer and the manufacturer. The retailer can pay less for its inventory while the manufacturer can receive its cash sooner.

  1. Closing stock

Closing stock means the value of goods which are remain unsold in a particular accounting period. Closing sock may be in the form of raw materials, work in progress or finished goods.

A prudent accounting principle is the concept of “Conservatism”, the basic point of which is anticipate no profit, but provide for all possible losses. Under this concept closing stock is valued at cost or market price whichever is lower.

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