How to prepare a Trading Account

Introduction

Trading Account is one of the three final accounts of a Sole Proprietor, alongside the Profit & Loss Account and the Balance Sheet.

The major purpose of preparing the Trading Account is to ascertain the Gross Profit or Gross Loss in trading within the given accounting period.

Items of a Trading Account

1. Opening Stock: This is the estimated monetary value of the business inventory on the first day of the business/accounting period.

2. Closing Stock: This is the estimated monetary value of the business inventory on the last day of the business/accounting period.

3. Purchases: This is sum total of purchases of goods (business inventory) made within the given business year. This includes both cash purchases and credit purchases.

4. Sales: This is sum total of sales of goods (business inventory) made within the given business year. This includes both cash sales and credit sales.

5. Carriage Inwards: This is the cost of transporting purchased goods to its business premises. It is usually added to purchases to arrive at Net Purchases in the Trading Account.

6. Returns Outwards: This is the sum total value of goods the business returned back to the suppliers, from the goods purchased within the given accounting year. Returns Outwards is usually deducted from Purchases to arrive at the Net Purchases in the Trading Account.

7. Returns Inwards: This is the sum total value of goods customers returned back to the business, from the goods sold to them within the given accounting year. Returns Inwards is usually deducted from Sales to arrive at the Net Sales in the Trading Account.

Practical Accounting Entries in the Trading Account

Watch this video for a practical guide on how to prepare a Trading Account.

How to Prepare a Trading Account

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Understanding the Basic Accounting Equation

Introduction

The Basic Accounting equation focuses on the equation that exists between the properties of a business(assets) and the claims on those properties(Owner's equity and Liabilities).

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Let's look at these three items involved in the equation:

Assets

Assets are possessions of the business. They are things that add value to the business and will bring it benefits in some form. This can be fixed assets(long-term assets) or current assets(short-term assets). Examples include furniture, machinery, motor van, land and building, cash, debtors etc

Equity

Equity, or owner's equity, is the value of the assets that the owner owns. It is the value of the business assets that the owner can lay claim to.

Liabilities

Liabilities are basically debts. The amount of liabilities represents the value of the business assets that are owed to others. It is the value of the assets that people outside the business can lay claim to. 

Basic Accounting Equation 

ASSETS = LIABILITIES + OWNER'S EQUITY

Applying Mathematical conversions...

LIABILITIES = ASSETS - OWNER'S EQUITY

OWNER'S EQUITY = ASSETS - LIABILITIES

In a nutshell, the accounting equation above shows us how much of the assets are owned by the owner (equity) and how much are owed to others (liabilities). It's as simple as that.

Practical Application

In preparation of the Balance Sheet in the final accounts of a business at the end of an accounting year, assets are placed on the credit side of the balance sheet, while owner's equity and liabilities are placed on the debit side(assuming you're using the t-square method of drawing a balance sheet).

The implication here is that the addition of owner's equity and liabilities must equal the total assets. If the reverse is the case in your final answer, it means there are errors in entries made along the way, beginning from the ledger entries.

What is a Bank Reconciliation System?

A bank reconciliation is the comparison of the bank statement you get from your bank with the business records concerning the bank account.

The bank statement comes once a month normally and shows all deposits, payments, etc.

You compare this to your cashbook (or cash receipts journal and cash payments journal) and look for any discrepancies.

If there are discrepancies, you draw up a bank reconciliation statement. This statement is for your own records and can also be sent to the bank so they correct any errors regarding the business bank account.


Some of the items that cause these discrepancies include:

1. Bank charges, which may include Commission on Transaction(COT), cost of cheque book etc
2. Credit transfer
3. Dishonoured cheque
4. Uncredited cheques
5. Unpresented cheques etc.

***Items of a bank reconciliation statements will be explained in the next class.