Nominal Accounts: - Information Relating To Profits

• Information relating to Profits
The ledger accounts relating to the organisation are classified into three types. Personal, Real and Nominal.
» Nominal Accounts
Nominal accounts are related to expenses, losses, incomes and gains.
Since ascertaining profits or losses involves dealing with incomes, gains, expenses and losses we can
conclude that all the nominal accounts together would give us the information relating to the profits or
losses made by the organisation.
» Trading and Profit and Loss Accounts

To derive the information relating to profits from these nominal accounts a ledger account by name
"Trading and Profit & Loss a/c" is prepared.
Almost in all cases, we use two separate ledger accounts "Trading a/c" and "Profit and
Loss a/c" to derive information relating to profits with a greater detail. [The more the
information we need, the more the accounting heads we need to maintain].
Preparation of these ledger accounts requires us to think beyond just transferring the information in the
nominal accounts into these accounts.
• The Position of the organisation

The ledger accounts maintained within an organisational accounting system are classified into three as
Personal, Real and Nominal.
» Real Accounts
Real accounts are related to tangible aspects. In general we can identify that all asset accounts are real
accounts.
» Personal Accounts
Personal accounts are related to persons and organisations. These are persons/organisation which owe the
organisation or to whom the organisation owes. In effect they either form creditors (liabilities) or debtors
(assets).
Since all the nominal accounts have been dealt with in deriving the information relating to profits and we
are left with only the real and personal accounts which represent either assets or liabilities we can conclude
that all the real and personal accounts together give us the information relating to the position of the
organisation.
» Balance Sheet
To derive the information relating to the position of the organisation from these real and personal accounts
a statement by name "Balance Sheet" is prepared.
However preparing the Balance sheet need us to think a bit beyond just listing out the information relating
to the personal and real accounts in the statement.
Debtors (Assets) and Creditors
(Liabilities)
• Assets
Real accounts and Personal accounts are capable of being called assets. Any element (account) that is
capable of being liquidated (that is capable of being converted to cash by giving it away) indicates an asset.
Machinery, Furniture, Cash, etc are real accounts that can be called assets.
» Debtors represent Assets

Debtors represent the persons and organisation who owe to the organisation. They would clear their dues
by paying out either in cash or in some other form. Thus Debtors get liquidated and as such can be called
assets.
• Liabilities
All elements representing liabilities are Personal accounts. An element that is capable of being cleared by
paying out indicates a liability.
» Creditors represent Liabilities

Creditors represent the persons and organisation to whom the organisation owes. The organisation would
clear its due by paying them either in cash or in some other form. Thus creditors are cleared by paying out
and as such can be called liabilities.
When is the information relating to profits & position
collected/derived
Information needs vary from organisation to organisation. Even the information relating to profits and
position would also be derived for such periods and on such dates respectively depending on the
organisations need or this information.
» Period for which profits are ascertained

The information relating to profits is something that is needed by the organisation
periodically.
For what period do we try to ascertain profits. Do we think of profits made every day or over a week or
over a month or over a six month period or over a year? This is dependent on the information needs of the
organisation.
Though theoretically it is possible to derive this information's for any time period, conventionally it is
derived for a year. That is in most cases, information relating to profits is derived over a year. We think of
profits made over a year.
» Day on which position is ascertained

The information relating to the position may be needed by the organisation at many points of time.
Theoretically this is also capable of being derived at any point of time we need it.
However, conventionally it is derived at a point which indicates the end of the period for which the profits
are ascertained. Say if we think of profits made for the period from 1st April 2005 to 31st March 2006, we
think of deriving the position as on 31st March 2006.

Accounting Period
Accounting Period is that period for which the organisation ascertains the profit or loss. If the organisation
is trying to ascertain the profits made over a year, then the accounting period is a year. If it is trying to
ascertain the profits made over a six months period, then the accounting period is six-months.
There are two aspects relating to an accounting period. The length of the period as well as the being/end
dates of the period. These can be ascertained from the way the accounting period is stated.
For example, where the accounting period of an organisation is stated as
 From 1st July to 31st December,

This implies that the length of the accounting period is 6 months.
 One year and starts on 1st January every year.
This implies that the accounting period is from 1st January to 31st December and is one year long.
• What Accounting Period to Follow?

What accounting period an organisation follows is dependent on the informational as well as statutory
needs of the organisation. The most common period followed all over the world is a period of 1 year which
starts from either 1st January or 1st April.
» Statutory Requirements
The need of the organisation to comply with the various laws that it has to adhere to would also influence
the decision relating to the accounting period.
Say in India, the Income Tax Act, needs organisations to calculate and present their business profits for the
period from 1st April to the following 31st March. Therefore, the organisations would follow the same
accounting period so that their accounting would serve their informational needs as well as enable them to
easily present the information that has to be presented to the Income Tax Department.
Ascertaining the how much of
Profit/Loss
• Profit = Total (Incomes + Gains) − Total (Expenses + Losses)

Using this relation, a positive profit figure indicates a profit and a negative profit figure indicates a loss.
• Math of Ascertainment of Profit/Loss

Nominal accounts are related to incomes/gains and expenses/losses. Thus the information relating to the
aspects that would define the profit or loss made by the organisation is contained in the Nominal accounts.
» Nominal Accounts with Debit balances

Those ledger accounts which have a debit balance in them represent expenses or losses
The total (sum) of balances in all the nominal (ledger) accounts with a debit balance indicates the total
(expense + losses).
» Nominal Accounts with Credit balances

Those ledger accounts which have a credit balance in them represent incomes or gains.
The total (sum) of balances in all the nominal (ledger) accounts with a credit balance indicates the total
(incomes + gains).
If the total of (expense + losses) and (incomes + gains) are set off, we would be able to arrive at the profit
or loss made.
Thus the relation to ascertain the profit or loss can be written as
Profit = Sum of balances in Nominal accounts with a Credit Balance

− Sum of balances in Nominal accounts with a Debit Balance .
Preparation of Trading and Profit and Loss account
(a/c)
The "Trading and Profit & Loss a/c" is a ledger account. Like all ledger accounts, the postings in this ledger
account also flow from the journal. "No Journal No Ledger".
• Transactions making up the Trading and Profit & Loss a/c

The transactions relating to the journal entries that would go into the "Trading and Profit & Loss a/c" are
not ones that are take place in the ordinary course of business. These are transactions that are specifically
meant to create this "Trading and Profit & Loss a/c".
Consider the above formula for ascertaining the profit or loss,
Profit = Sum of balances in Nominal accounts with a Credit Balance

− Sum of balances in Nominal accounts with a Debit Balance .
» For Ascertaining the sum of balances in Nominal Accounts with a Debit

Balance
This is done by transferring the balances in the nominal accounts with a debit balance, to an account by
name "Trading and Profit & Loss a/c".
Transferring a debit balance from one account to a second results in the second
account being debited and the first account being credited.
Therefore the Journal Entry would be
Journal in the books of M/s __ for the period from ____ to _____
Credit
V/R Debit Amount
Date Particulars L/F Amount
No. (in Rs)
(in Rs)
March 31st – Trading and Profit & Loss a/c Dr – xxxx
To Nominal a/c [with a debit balance] – xxxx
[For the debit balances in the nominal accounts

transferred to the "Trading and Profit & Loss
a/c" for the purpose of ascertaining the profits
on the last day of the accounting period ]
» For Ascertaining the sum of balances in Nominal Accounts with a Credit

Balance
This is done by transferring the balances in the nominal accounts with a credit balance to an account by
name "Trading and Profit & Loss a/c".
Transferring a credit balance from one account to a second results in the second
account being credited and the first account being debited.
Therefore the Journal Entry would be
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
March 31st – Nominal a/c [with a credit balance] Dr – xxxx
To Trading and Profit & Loss a/c – xxxx
[For the credit balances in the nominal accounts

transferred on the last day of the accounting
period to the "Trading and Profit & Loss a/c" for
the purpose of ascertaining the profits.]
• Trading and Profit and Loss Account (a/c)

Thus the "Trading and Profit & Loss a/c" would appear as follows
Dr Trading and Profit & Loss a/c Cr
J/ Amount J/ Amount
Date Particulars Date Particulars
F (in Rs) F (in Rs)
31/03/0 – xxx 31/03/0 By Nominal a/c 1 – xxx

6 To Nominal a/c 1 – xxx 6 [Cr] xxx
31/03/0 [Dr] – xxx 31/03/0 By Nominal a/c 2 xxx
6 To Nominal a/c 2 – xx 6 [Cr] xxx
31/03/0 [Dr] – xxx 31/03/0 ... xxx
6 To Nominal a/c 3 6 ...
31/03/0 [Dr] 31/03/0
6 ... 6
31/03/0 ... 31/03/0
6 6
sub-total 3,24,000 sub-total 5,80,000
31/03/0
To Bal (Profit) – 2,56,000
6
Total 5,80,000 Total 5,80,000
Thus the "Trading and Profit & Loss a/c", is nothing but a consolidated account formed by transferring the
balances in the nominal accounts.

Nature of Trading and Profit & Loss a/c
Since the "Trading and Profit & Loss a/c" is prepared by transferring the ledger account balances in all the
nominal accounts in the books of accounts it is appropriate to consider it to be a nominal account.
Any Ledger account prepared to ascertain the profits or losses out of a set of
transactions is a nominal account. Thus, "Trading and Profit & Loss a/c" is a
nominal account.
When are the entries
recorded?
Accounting period is the period for which we wish to ascertain the profits or losses. The "Trading and Profit
& Loss a/c" is prepared at the end of the accounting period.
Say if the accounting period is a year from 1st April 2005 to 31st March 2006, the journal entry for
transferring the amounts to the "Trading and Profit & Loss a/c" is recorded at the end of the accounting
period i.e. on 31st March 2006.
What happens to the Nominal
a/c's?
To ascertain the profits, we transfer the balances in the Nominal accounts (with debit balances as well as
credit balances) to the "Trading and Profit & Loss a/c", thus creating that ledger account.
• Nil Balance
When the total balance in a nominal account is transferred to the "Trading and Profit & Loss a/c", its
balance becomes Nil.
Dr Rent Paid a/c Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
01/04/0
5
To Cash a/c – 8,000
01/05/0
5
.. – ..
..
.. – ..
..
01/03/0
6
sub-total 96,000 sub-total 96,000
31/03/0
By Trdg and P/L a/c – 96,000
6
Total 96,000 Total 96,000

• Closing the Nominal Account at the end of the accounting period
The act of transferring the balance in a nominal account to the Trading and Profit and Loss Account and
thereby making its balance Nil is identified as Closing the Nominal Account at the end of the accounting
period.
All the nominal accounts are closed at the end of the accounting period by transfer
to the "Trading and Profit and Loss Account.
• How do Nominal a/c's appear in every accounting period if they are closed
The nominal accounts are closed at the end of the accounting period. But we see the same nominal
accounts being used in accounting in all the accounting periods. Say, the "Rent Paid a/c" would appear in
the accounting books in all the accounting periods.
This is for the reason that all the nominal accounts are closed at the end of the accounting period and are
opened afresh at the beginning of the next accounting period for being used in that accounting period.
Therefore, the "Rent Paid a/c" appearing in the books in a particular accounting period is different from the
"Rent Paid a/c" appearing in the same books in any other accounting period.
All the nominal accounts are opened anew at the beginning of the accounting
period.
Illustration »
Problem
To get an understanding and feel of the process of final accounting, let us go through an example of an
organisations accounting consisting of a few transactions during an accounting period.
Following are the transactions relating to M/s Trinity Foods, over an accounting period from 1st June 2005
to 30th June 2006.
 Started business with Capital Rs. 1,00,000

 Paid into Bank
Rs. 10,000
 Bought Furniture and paid cash Rs. 25,000
 Bought goods for cash Rs. 50,000
 Bought goods from Ram on Credit Rs. 15,000
 Sold a part of the goods for Rs. 75,000 and paid the proceeds into bank directly
 Sold the remaining goods on credit for Rs. 50,000 to Rahim
 Paid Salaries and Wages Rs. 5,000
 Paid rent by cheque Rs. 8,000
Illustration » Solution [Journal and
Ledger]
Journal Entries » Hide/Show
Journal in the books of M/s Trinity Foods for the period from 1st June 2005 to 30th June
2005
V/R Debit Amount Credit Amount
Date Particulars L/F
No. (in Rs) (in Rs)
1st to 30th – Cash a/c Dr – 1,00,000
To Capital a/c – 1,00,000
[For the amount brought in by the proprietor

towards his capital contribution.]
1st to 30th – Bank a/c Dr – 10,000

[For the amount paid into bank.]
1st to 30th – Furniture a/c Dr – 25,000

[For the amount paid towards purchase of

Furniture.]
1st to 30th – Purchases a/c Dr – 50,000

[For the amount paid towards purchase of

goods/stock.]
1st to 30th – Purchases a/c Dr – 15,000

To Ram a/c – 15,000
[For the value of goods bought from Ram on

credit.]
1st to 30th – Bank a/c Dr – 75,000

To Sales a/c – 75,000
[For the sales made for cash and the proceeds

paid into bank directly.]
1st to 30th – Rahim a/c Dr – 50,000

[For the value of goods sold on credit to Rahim.]
1st to 30th – Salaries and Wages a/c Dr – 5,000

[For the amount paid in cash towards salaries

and wages.]
1st to 30th – Rent Paid a/c Dr – 8,000

To Bank a/c – 8,000
[For the amount paid towards rent by cheque.]
Ledger Accounts » Hide/Show
Dr Cash a/c Cr
Amount Amount
Date Particulars J/F Date Particulars J/F
(in Rs) (in Rs)
1st-30th To Capital a/c – 1,00,000 1st-30th By Bank a/c – 10,000

" By Furniture a/c – 25,000
" By Purchases a/c – 50,000
" By Sal. & Wages – 5,000
a/c
30/06/05 – 10,000
By Balance c/d
Total 1,00,000 Total 1,00,000
30/06/05 To Balance b/d – 10,000

Dr Capital a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/05 To Bal c/d – 1,00,000 01/06/05 By Cash a/c – 1,00,000
Total 1,00,000 Total 1,00,000
30/06/05 By Balance b/d – 1,00,000

Dr Bank a/c Cr
Amount Amount
(in Rs) (in Rs)
1st-30th To Cash a/c – 10,000 1st-30th By Rent Paid a/c – 8,000

30/06/05 By Bal c/d – 77,000
30/06/05 To Balance b/d – 77,000

Dr Furniture a/c Cr
Amount Amount
(in Rs) (in Rs)
1st-30th To Cashl a/c – 25,000 30/06/05 By Bal c/d – 25,000
30/06/05 To Balance b/d – 25,000

Dr Purchases a/c Cr
Amount Amount
(in Rs) (in Rs)
1st-30th To Cash a/c – 50,000 30/06/05 By Bal c/d – 65,000

" To Ram a/c – 15,000
30/06/05 To Balance b/d – 65,000

Dr Ram a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/05 To Bal c/d – 15,000 1st-30th By Purchases a/c – 15,000
30/06/05 By Balance b/d – 15,000

Dr Sales a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/05 To Bal c/d – 1,25,000 1st-30th By Bank a/c – 75,000

– " By Rahim a/c – 50,000
Total 1,25,000 Total 1,25,000
30/06/05 By Balance b/d – 1,25,000

Dr Rahim a/c Cr
Amount Amount
(in Rs) (in Rs)
1st-30th To Sales a/c – 50,000 30/06/05 By Bal c/d – 50,000
30/06/05 To Balance b/d – 50,000

Dr Salaries and Wages a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/05 To Balance b/d – 5,000

Dr Rent Paid a/c Cr
Amount Amount
(in Rs) (in Rs)
1st-30th To Bank a/c – 8,000 30/06/05 By Bal c/d – 8,000
30/06/05 To Balance b/d – 8,000
Illustration » Solution [Trial
Balance]
The trial balance is nothing but a statement of ledger account balances as on a particular instance.
Trial Balance of M/s Trinity Foods" as on 30th June 2005
Debit Credit
L/
Particulars Amount Amount
F
(in Rs) (in Rs)
Cash a/c — 10,000

Capital a/c —
1,00,000
Bank a/c — 77,000
Furniture a/c — 25,000
Purchases a/c — 65,000
Ram a/c —
15,000
Sales a/c —
1,25,000
Rahim a/c — 50,000
Salaries and Wages a/c — 5,000
Rent Paid a/c — 8,000
Total 2,40,000 2,40,000
Preparing Trading and Profit and Loss Account : Journal &
Ledger
Consider the above Trial Balance. There are a total of 4 nominal accounts with either debit or credit
balances.
 Purchases a/c [Debit Balance]
 Sales a/c [Credit Balance]
 Salaries and Wages a/c [Debit Balance]
 Rent Paid a/c [Debit Balance]
To ascertain the profit or loss made by the organisation, the balance in these accounts should be
transferred to the "Trading and Profit & Loss a/c". The journal entries for these transfers would be:
» Journal Entries Hide/Show
2005
Date V/R Particulars L/F Debit Amount Credit Amount
No. (in Rs) (in Rs)
June 30th – Trading and Profit & Loss a/c Dr – 78,000
To Purchases a/c – 65,000
To Salaries & Wages a/c – 5,000
To Rent Paid a/c – 8,000
[For the transfer of debit balances in nominal

accounts at the end of the accounting period to
the Trading and Profit & Loss a/c for the purpose
of ascertaining profits.]
June 30th – Sales a/c Dr – 1,25,000

To Trading and Profit & Loss a/c – 1,25,000
[For the transfer of credit balances in nominal

accounts at the end of the accounting period to
the Trading and Profit & Loss a/c for the purpose
of ascertaining profits.]
» Trading and Profit & Loss a/c

The "Trading and Profit & Loss a/c" would be
Dr Trading and Profit & Loss a/c Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
30/06/0 To Purchases a/c – 65,000 30/06/0 By Sales a/c – 1,25,000

5 To Salaries & – 5,000 5
" Wages a/c – 8,000
" To Rent Paid a/c
sub-total 78,000 sub-total 1,25,000
30/06/0
To Bal (Profit) – 47,000
5
Total 1,25,000 Total 1,25,000
Since the credit side total is greater, the account has a credit balance. Since a credit balance in a nominal
account indicates a gain, we can say that there is a profit.
» Other Ledger Accounts Affected Hide/Show
Dr Purchases a/c Cr
Amount Amount
(in Rs) (in Rs)

" To Ram a/c – 15,000
30/06/05 To Balance b/d – 65,000 30/06/05 By Trdg. P/L a/c – 65,000

Dr Sales a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/05 To Bal c/d – 1,25,000 1st-30th By Bank a/c – 75,000
– " By Rahim a/c – 50,000
Total 1,25,000 Total 1,25,000
To Trdg, &
– 1,25,000 30/06/05 By Balance b/d – 1,25,000
P/L a/c
Total 1,25,000 Total 1,25,000

Dr Salaries and Wages a/c Cr
Amount Amount
(in Rs) (in Rs)

Dr Rent Paid a/c Cr
Amount Amount
(in Rs) (in Rs)
1st-30th To Bank a/c – 8,000 30/06/05 By Bal c/d – 8,000

The balance in these nominal accounts becomes zero after the balances are transferred to the "Trading and
Profit & Loss a/c". Thus, nominal accounts are closed at the end of the accounting period by transfer to the
"Trading and Profit & Loss a/c".
In the subsequent accounting period, if the same nominal account heads are used, they are opened anew.
Thus these accounts pertaining to the current accounting period are independent of the nominal accounts
with the same name in any other accounting period.
Trial Balance
Redrawn/Remade
The trial balance is a list of ledger account balances at an instance when it is drawn. If we consider the
instance after having prepared the "Trading and Profit & Loss a/c", we do not find a balance in any nominal
account. All the nominal accounts are closed by transfer to the "Trading and Profit & Loss a/c", thereby leaving
a nil balance in all of them.
The "Trading and Profit & Loss a/c" is also a nominal account and has a credit balance if there is a profit and a
debit balance if there is a loss. If we make a trial balance after having prepared the "Trading and Profit & Loss
a/c" we will find only real and personal accounts in it apart from the nominal account "Trading and Profit & Loss
a/c".

[After closing Nominal accounts]
Debit Credit
L/
F
(in Rs) (in Rs)
Cash a/c — 10,000

Capital a/c — 1,00,000
Bank a/c — 77,000
Furniture a/c — 25,000
Ram a/c — 15,000
Rahim a/c — 50,000
Trading and Profit & Loss a/c — 47,000
Total 1,62,000 1,62,000
Author Credit : The Edifier
What indicates the Position of an Organisation

What is it that comes to our mind when we think of a person's position? It is the value of his/her property
and the liabilities he/she has.
Even in accounting, in trying to ascertain the position of a business entity, this is what we think of.
The position of an organisation is indicated by the value of the assets and liabilities held by the
organisation.
Information relating to the Assets and
Liabilities
The information relating to the assets and liabilities of an organisation is available in the Real and Personal
Accounts.
» Real Accounts
Real accounts are related to tangible aspects. In general we can identify that all asset accounts are real
accounts.
» Personal Accounts
Personal accounts are related to persons and organisations. These are persons/organisation which owe the
organisation or to whom the organisation owes. In effect they either form creditors (liabilities) or debtors
(assets).
Since all the nominal accounts have been dealt with in deriving the information relating to profits and we
are left with only the real and personal accounts which represent either assets or liabilities we can conclude
that all the real and personal accounts together give us the information relating to the position of the
organisation.
• Where to obtain the information relating to assets and liabilities

The value of the assets and liabilities of an organisation is revealed by the balances in the real and personal
accounts.
Therefore, if we need the information relating to the assets and liabilities, we just need to collect the ledger
account balances relating to real and personal accounts in the books of accounts.
» Utility of Trial Balance

The Trial balance is a statement that gives the ledger account balances as at a particular point of time.
Therefore, we can find the balances in those accounts which are capable of being identified as assets and
liabilities from the trial balance.
Thus, if there is a Trial Balance, it would provide the information relating to the assets and liabilities as on
the date of the trial balance ready hand.
When does the organisation need the information relating
to its position?
The organisation may need this information at many points of time during the course of the conduct of the
business.
Theoretically, the information may be derived as and when needed by collecting the ledger account
balances relating to the real and personal accounts, but is conventionally derived at a point which indicates
the end of the accounting period (i.e. the period for which the profits are ascertained).
Say if the organisation ascertains the profits made for the period from 1 st April 2005 to 31st March 2006, it
would ascertain the position as on 31st March 2006.
The ending day for an accounting period would be the beginning day for the subsequent accounting period
and as such the information relating to the position of the organisation as on the last day of a particular
accounting period would be the information relating to its position as on the first day of the subsequent
accounting period. Thus we can say that the information relating to position is derived in relation to the
opening and closing days of the accounting periods.

Ascertainment of the Position vs Ascertainment of Profits
Practically, in deriving the information relating to the correct position of the organisation, there are a
number of aspects to be taken care of. It is not as simple as collecting the ledger account balances of the
real and personal accounts as and when we intend to ascertain the position.
For example, the information relating to profits is also necessary to arrive at the position of an
organisation. We know that profits increase capital and loss decreases capital. Capital is a liability.
Therefore, the balance in capital account cannot be used to reflect the correct position of the business
unless the profits or losses (up to that point of time) are adjusted in the capital account. And for this the
profits till that point of time are to be ascertained.
This should explain the reason why the ascertainment of the position generally goes along with the
ascertainment of the profits of the business.

Balance Sheet » Statement for Presenting the information

relating to Position
The information relating to the position of an organisation is presented in the form of a statement titled
"Balance Sheet".
• Format of the Balance Sheet

The "Balance Sheet" is a statement and is made in a "T" format. It has two sides named the "Assets" side
and the "Liabilities" side put side by side. The Liabilities side is placed to the left and the assets side to the
right.
Balance Sheet of M/s Trinity Foods as on 30th June 2005
Liabilities Amount Assets Amount

–
Total Total
• Preparation of the Balance Sheet

In its simplest form this statement is nothing but a statement of ledger account balances remaining after
ascertainment of the profits of the organisation, arranged in a such a way that all the ledger accounts with
a debit balance on the assets side and all the ledger accounts with a credit balance on the liabilities side.

Illustration » Preparation of Balance Sheet
Consider the Trial Balance after having ascertained the profits (from the illustration relating to
ascertainment of profits)

(after closing Nominal accounts)
Debit Credit
L/
F
(in Rs) (in Rs)
Cash — 10,000
Capital — 1,00,000
Bank — 77,000
Furniture — 25,000
Ram — 15,000
Rahim — 50,000
Trading and Profit & Loss — 47,000
Total 1,62,000 1,62,000
• Note
After getting accustomed to accounting we avoid using the word a/c in the Ledger accounts, Trial Balance,
Balance Sheet and other places where we do not find it essential, just to make the statements and the
ledger accounts look more appealing.
• Preparation of the Balance Sheet

The Balance sheet is obtained by arranging the figures in the trial balance (ledger accounts left after having
ascertained the profits) in an order. One simple rule of arrangement is "The accounts with debit balances
on the assets side and the accounts with credit balances on the liabilities side". [As you move forward you
will notice that we violate this rule at times to derive additional information.]
The Balance Sheet drawn from the above Trial Balance would be:
Balance Sheet of M/s Trinity Foods as on 30th June 2005

Capital 1,00,000 Cash 10,000
Ram 15,000 Bank 77,000
Trading & Profit/Loss 47,0000 Furniture 25,0000
Rahim 50,000
1,62,000 1,62,000
Be conscious of the fact that the Balance Sheet is just a statement and not a ledger account.
We are not transferring the balances in the real and personal accounts into the balance sheet. We are only
showing them here.

Combined Trading and Profit and Loss Account (a/c)
The "Trading
and Profit & Loss a/c" is prepared by transferring the balances in all the nominal accounts to it. This
amounts to setting off all the debit balances and the credit balances to obtain the profit/loss made. Thus
the "Trading and Profit & Loss a/c" gives us the information relating to the profits available after setting off
all expenses/losses with all incomes/gains.
» Information obtained from the Trading and Profit and Loss a/c
The "Trading and Profit & Loss a/c" that is prepared to ascertain the profits or losses made by the
organisation gives us the information relating to the overall profit or loss made by the organisation.
» Illustrative Explanation
The following is the information relating to the Nominal accounts in an organisation for four accounting
periods (calendar year being its accounting period)
Account Head 2002 2003 2004 2005
Purchases 2,00,000 2,40,000 3,25,000 4,00,000

Salaries 15,000 18,000 28,000 32,000
Rent 12,000 18,000 24,000 30,000
Interest 80,000 96,000 1,35,000 1,65,000
Sales 3,00,000 3,60,000 4,87,500 6,00,000
If we are making a single "Trading and Profit & Loss a/c" the profits/losses made by the organisation would
be:
Account Head 2002 2003 2004 2005
Incomes:
Sales 3,00,000 3,60,000 4,87,500 6,00,000
Total 3,00,00 3,60,00 4,87,50 6,00,00
Expenses: 0 0 0 0
Purchases
Salaries 2,00,000 2,40,000 3,25,000 4,00,000
Rent 15,000 18,000 28,000 32,000
Interest 12,000 18,000 24,000 30,000
Total 80,000 96,000 1,35,000 1,65,000
Profit/Loss: 3,07,00 3,72,00 5,12,00 6,27,00
Income − Expenditure 0 0 0 0
− 7,000 − 12,000 − 24,500 − 27,000
The profits ascertained through this method indicate a growing loss over the years. If, the organisation
should take a decision to whether to continue with the business or not, it has to opt for moving out of the
business.
» Combined Trading and Profit & Loss a/c

The same information pertaining to a particular year presented in the Trading and Profit and Loss account
would be
Dr Trading and Profit & Loss a/c (for the year 2003) Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
31/12/0 To Purchases – 2,40,000 31/12/0 By Sales a/c – 3,60,000

3 To Salaries – 18,000 3
" To Rent – 18,000 By Bal (Loss) – 12,000
" To Interest – 96,000
Total 3,72,000 Total 3,72,000

Limitations of the Combined Account » Remedy
The combined Trading and Profit and Loss Account gives an overall comprehensive view of the profits or
losses.
» Profits influenced by Events not related to Operations

The expenses/losses that are to be borne by the organisation may not be directly related to its operations.
For example, where the organisation has incurred a loss on account one of its vehicles getting damaged
because of an accident, it has to absorb this loss as it is related to the organisation. This loss is also
considered in ascertaining the overall profit or loss made by the organisation.
But, this loss is not directly related to the business operations of the organisation. This loss is not on
account of conducting the business in the normal course, but an abnormal one.
» Information used in Decision Making

Profits/Losses are figures based on which a number of business decisions are taken.
Since, the overall profit/loss is a figure that is influenced by a number of factors which may not be directly
related to the business operations, any decisions made based on that figure may be detrimental to the
organisation.
» Remedy : Segregating Trading and Profit & Loss accounts

To arrive at a profit/loss figure that would take into consideration only the basic business operations, the
nominal accounts that are considered in the process of preparation of the "Trading and Profit & Loss a/c"
are grouped into two.
The first set of accounts are related to a ledger account by name "Trading a/c" and the remaining accounts
are related to another ledger account by name "Profit and Loss a/c".
The basic purpose of accounting is derivation of information and the more the
information we need, the more the accounting heads we need to maintain.
Breaking the Combined Trading and Profit & Loss account into
two Accounts
The same information relating to profits is broken down into two and derived at two different stages. At the
first stage, the profit from the core operations relating to the business is derived and in the next stage the
overall profits are derived.
» Segregating the Information

The information in the above statement giving the overall profit, segregated into two
Account Head 2002 2003 2004 2005
Direct Incomes:
Sales 3,00,000 3,60,000 4,87,500 6,00,000
Total 3,00,00 3,60,00 4,87,50 6,00,00
Direct Expenses: 0 0 0 0
Purchases
Total
2,00,000 2,40,000 3,25,000 4,00,000
Core Profit:
2,00,00 2,40,00 3,25,00 4,00,00
Direct Income − Direct
Exp. 0 0 0 0
Indirect Expenses:
Salaries 1,00,000 1,20,000 1,62,500 2,00,000
Rent
Interest 18,000 18,000 28,000 32,000
Total 12,000 18,000 24,000 30,000
Overall Profit: 80,000 96,000 1,35,000 1,65,000
Core Profit − Indirect 1,07,00 1,32,00 1,87,00 2,27,00
Expenses.
0 0 0 0
− 7,000 − 12,000 − 24,500 − 27,000
If we look at the remade statement, we will be able to identify that the organisation is conducting a
business which is generating reasonably good amount of profits (50% on cost or around 33% on sales).
The turnover has been increasing, the core profit has been increasing, but the organisation is ultimately
making an overall loss.
The segregation of information also indicates that the business is good enough to be conducted, but the
indirect expenses are a reason for the loss being made by the organisation. This should make the
organisation think as to the real reason for the loss being made and take corrective steps or actions if
possible.
The organisation would be able to arrive at such conclusions only if the information is presented a manner
so as to reveal the basic/core profit and the overall profit figures separately.
Trading and Profit & Loss
Accounts
Almost in all cases, there are two ledger accounts used in the exercise of ascertaining the profits made by
the organisation, (1) "Trading a/c" and (2) "Profit & Loss a/c". The information contained in the combined
"Trading and Profit & Loss a/c" is spread over the two accounts.
» Journal Entries » Preparation of "Trading a/c", "P/L a/c" Hide/Show
The journal entries relating to the preparation of separate "Trading a/c" and "Profit and Loss a/c" would
thus be as follows:
Journal in the books of M/s ___ for the period from ____ to ____
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
31st Dec – Trading a/c Dr – xxxx
To Direct Expenses a/c – xxxx
[For the transfer of debit balances in the direct

expenses accounts to the Trading a/c.]
31st Dec – Direct Incomes a/c Dr – xxxx

To Trading a/c – xxxx
[For the transfer of credit balances in the direct

incomes accounts to the Trading a/c.]
31st Dec – Trading a/c Dr – xxxx

To Profit and Loss a/c – xxxx
[For the transfer of Gross Profit to the Profit and

Loss a/c.]
31st Dec – Profit and Loss a/c Dr – xxxx

To Trading a/c – xxxx
[For the transfer of Gross Loss to the Profit and

Loss a/c.]
31st Dec – Profit and Loss a/c Dr – xxxx

To Indirect Expenses/Losses a/c – xxxx
[For the transfer of debit balances in the

indirect expenses accounts and accounts
indicative of losses to the Profit and Loss a/c.]
31st Dec – Indirect Incomes/Gains a/c Dr – xxxx

To Profit and Loss a/c – xxxx
[For the transfer of credit balances in the

indirect incomes accounts and accounts
indicative of gains to the Profit and Loss a/c.]
The two ledger accounts would therefore be
Dr Trading a/c [For the year 2003] Cr

Amount Amount
Particulars Particulars
(in Rs) (in Rs)
To Purchases 2,40,000 By Sales a/c 3,60,000
To Gross Profit 1,20,000
3,60,000 3,60,000
Dr Profit & Loss a/c [For the year 2003] Cr
Amount Amount
(in Rs) (in Rs)
To Salaries 18,000 By Gross Profit 1,20,000

To Rent 18,000 By Net Loss 12,000
To Interest 96,000
1,32,000 1,32,00
The Trading and Profit and Loss accounts are generally shown together to indicate the flow of information
from one to another.
Dr Trading and Profit and Loss a/c [For the year 2003] Cr
Amount Amount
(in Rs) (in Rs)
To Purchases 2,40,000 By Sales a/c 3,60,000

3,60,000 3,60,000

To Rent 18,000 By Net Loss 12,000
To Interest 96,000
1,32,000 1,32,00
• Note
Though the heading used here seems to indicate that it is a single account, it is in effect two different
accounts.
Trading Account : Gross Profit » Profit & Loss Account :
Net Profit
• Trading a/c : Gross Profit

The profit that is indicated as the Core/Basic Profit is what is called Gross Profit and that information is
provided by the "Trading a/c".
The "Trading a/c" is prepared to ascertain the Core (Gross) Profit relating to the business. It is debited with
the Direct Expenses and Credited with Direct Incomes, i.e. the balances of all the nominal accounts
representing Direct expenses and Direct Incomes are transferred to the Trading a/c.
» Gross Profit
The profit/loss revealed by the "Trading a/c" is called "Gross" Profit/Loss.
The "Gross" Profit/Loss is transferred from the "Trading a/c" to the "Profit and Loss a/c" to enable the
ascertainment of the overall profit/loss.
• Profit and Loss a/c : Net Profit

The profit that is indicated as the overall profit is what is called Net Profit and that information is provided
by the "Profit and Loss a/c".
The "Profit and Loss a/c" is prepared to ascertain the Overall (Net) Profit relating to the business. This
account is created by transferring the Gross Profit/Loss from the "Trading a/c". It is also debited with the
Indirect Expenses and losses and Credited with Indirect Incomes i.e. the balances of all the nominal
accounts representing Indirect expenses, losses and Indirect Incomes are transferred to the "Profit and
Loss a/c".
» Net Profit
The profit/loss revealed by the "Profit and Loss a/c" is called "Net" Profit/Loss.
The "Net" Profit/Loss is transferred to the "Capital a/c" or the "Profit and Loss Appropriation a/c", thereby
closing the "Profit and Loss a/c".

Nature of Trading Account & Profit and Loss Account
» Nominal Accounts
The "Trading a/c" and "Profit and Loss a/c" are ledger accounts derived by breaking up the information in
the "Trading and Profit & Loss a/c" i.e. these accounts together replace the "Trading and Profit & Loss a/c".
Since the "Trading and Profit & Loss a/c" is a nominal account, these two accounts are also nominal
accounts.
Any ledger account made to ascertain the profits or losses

made out of a set of transactions is a nominal account.
Balances in Trading a/c, Profit and Loss
a/c
to either the Trading a/c or the Profit and Loss a/c as the case may be.
• Balance in Trading a/c

The "Trading a/c" is a nominal account. It is closed at the end of the accounting period by transferring its
balance (Gross profit/loss) to the "Profit and Loss a/c".
Thus the trading account can be placed on par with any other nominal account.
• Balance in Profit and Loss a/c

The Profit and Loss a/c is a nominal account. It is closed at the end of the accounting period by transferring
its balance to either the Capital a/c or the Profit and Loss Appropriation a/c (or Retained Earnings a/c).
The "Trading a/c" and "Profit and Loss a/c" relating to a particular accounting period are independent of
similar accounts relating to any other accounting period.
Transfer of Profit and Loss a/c balance : To Capital
a/c
» Influence of Profits on Capital

Profits (including losses which can be understood as negative profits) are the returns for the risk that
Capital takes in business. Profits increase capital and losses decrease capital.
» Transfer to Capital a/c

The net profit belongs to the ownership of the business which is represented by the Capital account.
Therefore, the net profits or losses are ultimately transferred to the Capital account.
The Profit and Loss a/c is closed by transferring the balance to either the "Capital a/c".
Transfer of Profit and Loss a/c balance : To Profit and Loss
Appropriation a/c
At the time of starting the business, the owner invests certain amount as his capital contribution for the
business either in the form of cash or any other assets.
As time goes by, the organisation would be making profits or losses over the various accounting periods
that it passes through.
When profits or losses are transferred to the Capital account, the balance in that account increases when
there are profits and decreases when there are losses. Thus, the capital account balance is a figure that
gets altered by the amounts of profits and losses made over the years.
• Distinct Information
If the organisation intends to have the information relating to the contribution made by the owners towards
capital as well as the addition/shortage of capital that has accumulated in the business on account of the
profits/losses made by over the years (through its operations) separately, it would transfer the profits or
losses to a separate account by name "Profit and Loss appropriation a/c" or "Retained Earnings a/c" instead
of to the "Capital a/c".
The basic purpose of accounting is derivation of information and the more the
Transferring Profits » Illustration : Trading a/c, Profit and
Loss a/c
Consider the following ledger account balances relating to an accounting period
Trial Balance of M/s Razmataz Chemicals" as on 31st December 2005
Debit Credit
L/
F
(in Rs) (in Rs)
Opening Stock a/c – 20,000

Purchases a/c – 1,20,000
Salaries a/c – 25,000
Rent a/c – 18,500
Wages a/c – 47,000
Carriage Inwards a/c – 12,400
Cash a/c – 24,600
Furniture a/c – 44,000
Capital a/c – 1,84,000
Bank a/c – 75,000
Creditors a/c – 37,300
Sales a/c – 3,32,000
Debtors a/c – 62,900
Machinery a/c – 1,76,000
Bank Loan a/c – 72,100
Total 6,25,400 6,25,400
Trading a/c
Dr [of M/s Razmataz Chemicals for the period ending 31st Cr
December 2005]
Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000 By Sales a/c 3,32,000

To Purchases 1,20,000
To Wages a/c 47,000
To Carriage Inwards a/c 12,400
3,32,000 3,32,000
Profit & Loss a/c
December 2005]
Amount Amount
(in Rs) (in Rs)

To Rent 18,500
To Net Profit 89,100
1,32,600 1,32,600
Transfer of Net Profit : To Capital
a/c
 The P/L a/c shows a credit balance when there are profits.
 Transferring a credit balance from one account to a second would result in the second account
being credited and the first account being debited.
» Journal
The journal entry for transfer of the net profit from P/L a/c to the Capital a/c would therefore be
Journal in the books of M/s Razmataz Chemicals for the period from __ to 31st December
2005
No. (in Rs) (in Rs)
1st to 30th – Profit and Loss a/c Dr – 89,100
To Capital a/c – 89,100
[For the transfer of the net profit to the capital

account.]
» Ledger
Dr Capital a/c Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
30/06/0 To Bal c/d – 2,73,100 __-31st By bal b/d – 1,84,000

5 31/12/0 By Net Profit – 89,100
5
Total 2,73,100 Total 2,73,100
01/01/0
By Balance b/d – 2,73,100
6
• Trial Balance and Balance Sheet » Hide/Show
» Trial Balance
The "Trial Balance" redrawn after closing the "Profit and Loss a/c"
Debit Credit
L/
F
(in Rs) (in Rs)
Cash a/c – 24,600

Bank a/c – 75,000
Total 3,82,500 3,82,500
» Balance Sheet
Balance Sheet of M/s Razmataz Chemicals" as on 31-12-2005

Capital 2,73,100 Cash 24,600
Creditors 37,300 Bank 75,000
Bank Loan 72,100 Furniture 44,000
Debtors 62,900
Machinery 1,76,000
3,82,500 3,82,500
Transfer of Net Profit : To Profit and Loss Appropriation
a/c
 The P/L a/c shows a credit balance when there are profits.
 Transferring a credit balance from one account to a second would result in the second account
» Journal
The journal entry for transfer of the net profit from P/L a/c to the "Profit and Loss Appropriation a/c" would
be
2005
No. (in Rs) (in Rs)
To Profit and Loss Appropriation a/c – 47,000
[For the transfer of the net profit to the profit and

loss appropriation account.]
» Ledger
Dr Profit and Loss Appropriation a/c Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
30/06/0 To Bal c/d – 47,000 30/06/0 By Net Profit – 47,000

5 5
30/06/0
By Balance b/d – 47,000
5
» Trial Balance
The "Trial Balance" redrawn after closing the "Profit and Loss a/c" in this case would be
Debit Credit
L/
F
(in Rs) (in Rs)
Cash a/c – 24,600

Bank a/c – 75,000
Profit and Loss Appropriation a/c – 89,100
Total 3,82,500 3,82,500
» Balance Sheet

Capital 1,84,000 Cash 24,600
P & L Appropriation 89,100 Bank 75,000
Creditors 37,300 Furniture 44,000
Bank Loan 72,100 Debtors 62,900
Machinery 1,76,000
3,82,500 3,82,500
• Alternative
Liabilities Amount Amount Assets Amount Amount

Capital 1,84,000 Cash 24,600
(Add:) P & L 89,100 2,73,100 Bank 75,000
Appropriation 37,300 Furniture 44,000
Creditors 72,100 Debtors 62,900
Bank Loan Machinery 1,76,000
3,82,500 3,82,500
The basic purpose of accounting is derivation of information. Where the organisation feels that in addition to
having the information relating to the Capital a/c and the accumulated profits separately, it also needs to
know the total amount of capital available with it (including accumulations), the two accounts are clubbed
and shown in the Balance Sheet.
Since here both the accounts lie on the same side of the balance sheet, the two amounts are added up.

Transferring Net Loss » Trading a/c, Profit and Loss a/c
Consider the following ledger account balances relating to an organisations accounting
Debit Credit
L/
F
(in Rs) (in Rs)
Opening Stock a/c – 50,000

Purchases a/c – 2,35,000
Salaries a/c – 48,000
Postage & Stationary a/c – 8,500
Wages a/c – 15,000
Carriage Outwards a/c – 24,400
Rent & Insurance a/c – 18,250
Cash a/c – 86,000
Bank a/c – 61,000
Sales a/c – 2,63,400
Land and Buildings a/c – 1,45,000
Debenture Loan a/c – 2,02,100
Total 7,73,750 7,73,750
Trading a/c
December 2005]
Particulars Amount Particulars Amount
(in Rs) (in Rs)
To Opening Stock 50,000 By Sales 2,63,400

To Purchases 2,35,000 36,600
To Wages a/c 15,000 By Gross Loss
To Gross Profit
3,00,000 3,00,000
Profit & Loss a/c
December 2005]
Amount Amount
(in Rs) (in Rs)
To Gross Loss 36,600 By Net Loss 1,35,750

To Salaries 48,000
To Postage and 8,500
Stationery 24,400
To Carriage Outwards 18,250
To Rent and Insurance
1,35,750 1,35,750
Transfer of Net Loss : To Capital
a/c
 The P/L a/c shows a debit balance when there are losses.
 Transferring a debit balance from one account to a second would result in the second account
being debited and the first account being credited.
» Journal
The journal entry for transfer of the net loss from P/L a/c to the Capital a/c would be
Journal in the books of M/s _____ for the period ending 32st December 2005
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
1st to 30th – Capital a/c Dr – 1,35,750
To Profit and Loss a/c – 1,35,750
[For the transfer of the net loss to the capital

account.]
» Ledger
Dr Capital a/c Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
31/12/0 To Net Loss – 1,35,750 31/12/0 By Balance b/d – 2,50,000

5 To Bal c/d – 1,14,250 5
31/12/0
5
Total 2,50,000 Total 2,50,000
01/07/0 By Balance b/d – 1,14,250

5
» Trial Balance
Debit Credit
L/
F
(in Rs) (in Rs)
Cash a/c – 86,000

Bank a/c – 61,000
Total 3,74,600 3,74,600
» Balance Sheet

Capital 1,14,250 Cash 86,000
Debenture Loan 2,02,100 Furniture 24,000
Debtors 58,600
Land and Buildings 1,45,000
3,74,600 3,74,600

Transfer of Net Loss : To Profit and Loss Appropriation a/c
 The P/L a/c shows a debit balance when there are losses.
 Transferring a debit balance from one account to a second would result in the second account
» Journal
The journal entry for transfer of the net loss from P/L a/c to Profit and Loss Appropriation a/c would be
Journal in the books of M/s _____ for the period ending 32st December 2005
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
1st to 30th – Profit and Loss Appropriation a/c Dr – 1,35,750
To Profit and Loss a/c – 1,35,750
[For the transfer of the net loss to the profit and

loss appropriation account.]
» Ledger
J/ Amount J/ Amount
F (in Rs) F (in Rs)
31/12/0 To Net Loss – 1,35,750 31/12/0 By Balance c/d – 1,35,750

5 5
Total 1,35,750 Total 1,35,750
30/06/0
To Balance b/d – 1,35,750
5
» Trial Balance
Debit Credit
L/
F
(in Rs) (in Rs)
Cash a/c – 86,000

Bank a/c – 61,000
Profit and Loss Appropriation a/c – 1,35,750
Total 5,10,350 5,10,350
» Balance Sheet

Capital 2,50,000 Cash 86,000
Debenture Loan 2,02,100 Furniture 24,000
Debtors 58,600
P & L Appropriation 1,35,750
5,10,350 5,10,350
• Alternative

Capital 2,50,000 Cash 86,000
(Less:) P & L Appropr. 1,35,750 1,14,250 Bank 61,000
Creditors 2,02,100 Furniture 24,000
Debenture Loan Debtors 58,600
3,74,600 3,74,600
The basic purpose of accounting is derivation of information. Where the organisation feels that in addition to
having the information relating to the Capital a/c and the accumulated profits separately, it also needs to
know the total amount of capital available with it (including accumulations), the two accounts are clubbed
and shown in the Balance Sheet.
Since here both the accounts lie on different sides of the balance sheet, the two amounts are set off.
Showing an item on a particular side and deducting the item from another item on
the opposite side of the balance sheet would give the same effect.
Using the phrases Net Profit, Net Loss in Ledger
Postings
If we post the Journal entry for transferring

 The profit from the "Profit & Loss a/c"
i. To Capital a/c
The posting on
a. The debit side of Profit and Loss a/c should read "To Capital a/c"
b. The credit side of Capital a/c should read "By Profit and Loss a/c"
ii. To Profit and Loss Appropriation a/c
The posting on
a. The debit side of Profit and Loss a/c should read "To Profit and Loss
Appropriation a/c"
b. The credit side of Profit and Loss Appropriation a/c should read "By Profit and
Loss a/c"
 The loss from the "Profit & Loss a/c"
i. To Capital a/c
The posting on
a. The credit side of Profit and Loss a/c should read "By Capital a/c"
b. The debit side of Capital a/c should read "To Profit and Loss a/c"
ii. To Profit and Loss Appropriation a/c
The posting on
a. The credit side of Profit and Loss a/c should read "By Profit and Loss
Appropriation a/c"
b. The debit side of Profit and Loss Appropriation a/c should read "To Profit and
Loss a/c"
» Postings only indicate transfer of balances
These postings only give us an idea that there is a transfer from the "Profit and Loss a/c" to the "Capital
a/c" or "Profit & Loss Appropriation a/c". They do not indicate the reason (idea of why the posting is being
made) for the transfer and the direction of transfer.
Consider the journal entry for transfer of net profit from the profit and loss account to the capital account
Journal in the books of M/s Razmataz Chemicals for the period from __ to 31st December
2005
No. (in Rs) (in Rs)
To Capital a/c – 89,100
This can be interpreted as
 Transfer of Credit balance From Profit and Loss a/c To Capital a/c
Transferring a credit balance from one account to a second would result in the second account
 Transfer of Debit balance From Capital a/c To Profit and Loss a/c
Transferring a debit balance from one account to a second would result in the second account
• Deriving Additional Information

The basic purpose of accounting is derivation of information. The more the
Therefore, to give us the additional information relating to the reason and direction of transfer, we create
and use additional ledger accounts by name "Net Profit a/c" and "Net Loss a/c".
» To/By Net Profit

The Net Profit from the Profit and Loss a/c is transferred to the Net Profit a/c and from there to the Capital
a/c or the Profit and Loss Appropriation a/c.
By using this additional account we can ensure that the postings would read To Net Profit in the Profit and
Loss account and By Net Profit in the Capital or Appropriation accounts.
Journal/Ledger » Hide/Show
Journal in the books of M/s Razmataz Chemicals for the period from ___ to 31st December
2005
No. (in Rs) (in Rs)
To Net Profit a/c – 47,000
[For the transfer of the net profit to the Net

Profit account.]
1st to 30th – Net Profit a/c Dr – 89,100
To Profit and Loss Appropriation a/c – 89,100
(Or) Capital a/c
[For the transfer of the net profit from the Net

Profit account to the capital account or the profit
and loss appropriation account.]
Dr Net Profit a/c Cr

Amount Amount
(in Rs) (in Rs)
31/12/05 To Capital a/c – 89,100 31/12/05 By Profit & Loss a/c – 89,100
(Or)
To P/L Appropr. a/c

The Profit and Loss a/c would straight away reveal the information that there is Net Profit and has been
transferred. The Capital a/c or the Profit and Loss Appropriation a/c would reveal the information that Net
Profit has been received by transfer.
» To/By Net Loss

The Net Loss from the Profit and Loss a/c is transferred to the Net Loss a/c and from there to the Capital
a/c or the Profit and Loss Appropriation a/c.
By using this additional account we can ensure that the postings would read By Net Loss in the Profit and
Loss a/c and To Net Loss in the Capital or Profit and Loss Appropriation accounts.
Journal/Ledger » Hide/Show
Journal in the books of M/s Razmataz Chemicals for the period from ___ to 31st December
2005
No. (in Rs) (in Rs)
1st to 30th – Net Loss a/c Dr – 1,35,750
To Profit & Loss a/c – 1,35,750
[For the transfer of the net loss to the Net Loss

account.]
1st to 30th – Profit and Loss Appropriation a/c Dr – 1,35,750

To Net Loss a/c – 1,35,750
[For the transfer of the net loss from the Net

Loss account to the profit and loss appropriation
account.]
Dr Net Loss a/c Cr

Amount Amount
(in Rs) (in Rs)
31/12/05 To Profit & Loss – 1,35,750 31/12/05 By P/L Appropr. – 1,35,750

a/c a/c
Total 1,35,750 Total 1,35,750

The Profit and Loss a/c would straight away reveal the information that there is Net Loss and has been
transferred. The Capital a/c or the Profit and Loss Appropriation a/c would reveal the information that Net
Loss has been received by transfer.

Net Profit a/c, Net Loss a/c » Control accounts
• Control Accounts
Accounts which are created and closed instantaneously and whose sole purpose is to enable the derivation
of greater information are called "Control Accounts".
Use of Controlling accounts is a procedure that we adopt frequently in accounting.
• Manual Accounting
In manual accounting, we just assume the presence of such accounts and use the useful phrases wherever
needed. We do not record the journal entries relating to these and carry on posting as if we have recorded
the journal.
• Computerised Accounting
If you intend to make use of such a facility in computerised accounting, care should be taken to ensure that
all the relevant controlling accounts are created and the required journal entries are passed.
Profit & Loss Appropriation a/c » Special Nominal
account
• A Nominal Account
If Profit & Loss Appropriation a/c is maintained, the Net profit or loss revealed by the Profit and Loss a/c in
every accounting period is transferred to that account. Thus the accumulated balance in the Profit & Loss
Appropriation a/c also indicates either a profit or loss which qualifies it to be called a nominal account.
to either the Trading a/c or the Profit and Loss a/c as the case may be.
However, the Profit & Loss Appropriation a/c, though a nominal account is not closed. The balance in that
account is carried over to the subsequent accounting periods just like balances in the case of Real or
Personal accounts.
With regard to this characteristic, the Profit & Loss Appropriation a/c is a special account.
• Special Nominal Accounts

Nominal accounts which are not closed at the end of the accounting period and whose balances are carried
forward from one accounting period to another as "Special Nominal accounts". Balances of these accounts,
appear in the balance sheet along with the other Real and Personal account balances.

Trial Balance » What? Why? When?
• What is a Trial Balance
The Trial Balance is a statement of ledger account balances as on a particular instance.
Trial Balance of M/s Wearall Textlies as on 31st March 2006
Debit Credit
L/
F
(in Rs) (in Rs)
Opening Stock – 63,650

Textile Purchases – 22,56,000
Wages – 3,25,000
Octroi – 1,78,200
Salaries – 1,04,000
Rent – 1,26,000
Printing and Stationery – 74,650
Advertisements – 86,000
Cash – 26,000
Office Building – 4,23,450
Capital – 2,50,000
Bank – 1,19,000
Motor Vehicles – 2,10,000
Sundry Creditors – 1,80,000
Sales – 36,86,000
P/L Appropriation – 6,52,950
Sundry Debtors – 2,08,000
Machinery – 5,69,000
Total 47,68,950 47,68,950
• Why is a Trial Balance prepared?

The trial balance is prepared to check/ensure the arithmetical accuracy of accounting. Though not a
conclusive proof, the agreement of the trial balance is a prima facie evidence of the absence of
mathematical errors.
This is the most important purpose for which the trial balance is prepared.
» Isn't Trial Balance made for enabling preparation of Final Accounts?

No, not at all.
Preparation of Trial Balance is not an act that forms a part of the activities involved in the regular
accounting cycle. Since Final Accounting can be completed without the preparation of the Trial Balance, we
can say that enabling the preparation of final accounts is not the purpose of the trial balance.
• When is a Trial Balance prepared?

The trial balance is generally prepared at a time when all the ledger accounts are balanced like at the end
of the accounting period.
Theoretically, the trial balance can be prepared as and when needed.
The practical difficulty in preparing the trial balance as and when needed is the requirement of the balances
of all the ledger accounts within the organisational accounting system. Different ledger accounts are
balanced at different time intervals based on the information needs of the organisation. Say in a typical
organisation Cash a/c is balanced daily, Expenses, Creditor and Debtor accounts are balanced on a monthly
basis, Asset accounts are balanced annually etc.
The ledger account balances relating to all ledger accounts would not be available ready hand at any given
instance. Year ending is one such instance when the balances are derived.
» Computerised Accounting
In mechanised (computerised) accounting systems, trial balance is a statement that can be automatically
derived as and when needed.
Accounting Cycle » Absence of Preparation of Trial
Balance
Preparation of a trial balance is not an act which forms a part of the activities involved in the accounting
cycle.
The Accounting Cycle (activities involved)
 Begins with opening the books of accounts for an accounting period by recording the opening
entry;
Journal in the books of M/s Amonaya Metals for the period from 1st January 2007 to
____
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
1st January – Assets a/c Dr – –
To Liabilities a/c – –
To Capital a/c – –
[For bringing the balances in the various

ledger accounts at the end of the previous
accounting period into books.]
 This is the journal entry that supports the posting To Balance b/d and By Balance b/d in the
various ledger accounts.
 Recording the various transactions all through out the accounting period;
 Balancing the ledgers as and when needed and finally at the end of the accounting period;
 Recording the transactions for making up the final accounts
1. Making the Trading a/c
2. Closing the Trading a/c by transferring the balance in it to Profit & Loss a/c
3. Making the Profit and Loss a/c
4. Closing the Profit and Loss a/c by transferring the balance in it to Capital a/c (or Profit
and Loss Appropriation a/c)
 Preparing the Balance sheet (A statement of balances in all the ledger accounts that remain after
making up and closing the Trading and Profit & Loss a/c.)
 The accounting cycle ends with recording the closing entry for closing the books of accounts.
Journal in the books of M/s Amonaya Metals for the period from 1st Jan to 31st Dec
2007
Debit Credit
V/R
Date Particulars L/F Amount Amount
No.
(in Rs) (in Rs)
31st – Liabilities a/c Dr – –
December Capital a/c – –
To Assets a/c – –
[For carrying the balances in the various

ledger accounts at the end of the
accounting period to the subsequent
accounting period.]
 This is the journal entry that supports the posting To Balance c/d and By Balance c/d in the
various ledger accounts.

Final Accounting : Use of Journal/Ledger
Final Accounting deals with all the ledger account balances at the end of the accounting period in one way
or the other.
 All the Nominal accounts that represent direct expenses and direct incomes are closed by transfer
to the Trading a/c.
For this at least two journal entries are recorded.
 The Trading a/c is closed by transferring its balance to the Profit and Loss a/c.
For this a journal entry is recorded.
 All the Nominal accounts that represent indirect expenses, losses and indirect Incomes are closed
by transfer to the Profit and Loss a/c.
For this at least two journal entries are recorded.
 The Profit & Loss a/c is closed by transferring its balance to either the Capital a/c or Profit & Loss
Appropriation a/c.
For this a journal entry is recorded.
 All the remaining accounts are listed out in the Balance Sheet.
A closing entry is recorded in relation to this, though it is not directly related to preparing the
balance sheet.
If the Final Accounting is to be done in a systematic manner, then all the journal entries mentioned above
are to be recorded and all the ledger accounts that are affected by those transactions are to be posted to
and updated. That would result in the making up of the Trading a/c and Profit and Loss a/c. The balance
sheet is prepared by drawing up a statement of ledger account balances carried forward through the
closing entry.
Final Accounting : Use of Trial Balance : Avoiding
Journal/Ledger
In manual accounting, the Trading a/c, Profit & Loss a/c and the Balance Sheets can also be prepared using
the information in the Trial Balance avoiding the act of journalising the transactions involved in final
accounting.
This is done by showing each item in the ledger accounts (Trading, P/L a/c) or the statement (Balance
Sheet) where it would be ultimately appearing had the actual procedure been adopted. This would have the
same affect as recording the journal and posting into the ledger.
» Example
The balance in the Carriage Inwards a/c (direct expenditure) is transferred to the Trading a/c by recording
a Journal entry. By this, the Carriage Inwards a/c would get closed (its balance becomes zero) and the
Trading a/c would get debited with that balance. In preparing the Trading a/c the balance in the Carriage
Inwards a/c can be ascertained from the Trial Balance and shown on the debit side of Trading a/c.
» Reduction of Work involved in Manual Accounting

Since not recording the related journal entries makes no difference as far as final accounting is concerned,
in almost all cases in manual accounting, the process of recording the journal entries required for final
accounting and updating the ledger is bypassed to reduce the burden of the work involved.

Information in Trial Balance » To be dealt with only once
In making up final accounts using the information in the Trial Balance, we should ensure that each item of
information (representing a ledger account balance) should be dealt with only once.
In final accounting each piece of information can appear either on the debit or credit sides of the Trading
a/c or "Profit & Loss a/c" or on the assets or liabilities side of the "Balance Sheet".
Each item from the Trial Balance should be dealt with only once in Final Accounting.
• Interpreting the items in the Trial Balance

A statement for interpretation of the various ledger account balances in the above trial balance
Trial Balance of M/s Wearall Textlies as on 31/03/06 » Statement of Analysis
Balanc
Account Which
Account Description e Where Amount
Type Side
Nature
Opening Stock Direct Expenses Nominal Debit Trading Debit 63,650

Textile Purchases Direct Expenses Nominal Debit a/c Debit 22,56,000
Wages Direct Expenses Nominal Debit Trading Debit 3,25,000
Octroi Direct Expenses Nominal Debit a/c Debit 1,78,200
Salaries Indirect Nominal Debit Trading Debit 1,04,000
Rent Expenses Nominal Debit a/c Debit 1,26,000
Printing and Indirect Nominal Debit Trading Debit 74,650
Stationery Expenses Nominal Debit a/c Debit 86,000
Advertisements Indirect Real Debit P/L a/c Assets 26,000
Cash Expenses Real Debit P/L a/c Assets 4,23,450
Office Building Indirect Personal Credit P/L a/c Liabilities 2,50,000
Capital Expenses Personal Debit P/L a/c Assets 1,19,000
Bank Asset Real Debit B/S Assets 2,10,000
Motor Vehicles Asset Personal Credit B/S Liabilities 1,80,000
Sundry Creditors Liability Nominal Credit B/S Credit 36,86,000
Sales Liability/Asset Spl. Nominal Credit B/S Liabilities 6,52,950
P/L Appropriation Asset Personal Debit B/S Assets 2,08,000
Sundry Debtors Liability Real Debit B/S Assets 5,69,000
Machinery Direct Incomes Trading
Accumulatd Profit a/c
Asset B/S
Asset B/S
B/S
• Making up the Final Accounts
Final Accounting using the information in a Trial Balance involves nothing more than putting the right items
in the right places i.e. on the appropriate side of Trading a/c, Profit and Loss a/c or the Balance Sheet.
Trading and Profit & Loss a/c [For the year ending
Dr Cr
31/03/06]
Amount Amount
(in Rs) (in Rs)

To Textile Purchases 22,56,000
To Wages 3,25,000
To Octroi 1,78,200
36,86,000 36,86,000
To Salaries 1,04,000 By Gross Profit 8,63,150

To Rent 1,26,000
To Printing and Stationery 74,650
To Advertisements 86,000
To Net Profit 4,72,500
8,63,150 8,63,150
Balance Sheet of M/s Wearall Textlies as on 31st March 2006

Capital 2,50,000 Cash 26,000
Sundry Creditors 1,80,000 Bank 4,23,450
P/L Appropriation 11,25,450 Office Building 1,19,000
[6,52,950 + 4,72,500] Motor Vehicles 2,10,000
Sundry Debtors 2,08,000
Machinery 5,69,000
15,55,450 15,55,450
Care in dealing with Profit and Loss Appropriation a/c (or
Capital a/c)
The balance in the "Profit & Loss Appropriation a/c" as shown in the Trial Balance represents the balance
carried forward from the previous accounting period (i.e. year ending 31st March 2005).
The Profit and Loss a/c relating to the current period is closed by transfer its balance to the "Profit & Loss
Appropriation a/c"

J/ Amount J/ Amount
F (in Rs) F (in Rs)
31/03/0 To Bal c/d – 11,25,450 31/03/0 By Bal b/d – 6,52,950

6 6 By Net Profit – 4,72,500
31/03/0
6
Total 11,25,450 Total 11,25,450
01/04/0
By Balance b/d – 11,25,450
6
Therefore, while showing the information (balance) relating to the Profit & Loss Appropriation a/c in the
Balance sheet, care should be taken to make appropriate adjustment to the balance on account of the
transfer of balance from the Profit and Loss a/c.
The balance that appears in the balance sheet is not the one that appears in the trial balance, but the one
that takes into consideration the adjustment on account of current periods profit or loss also.
If the balance in Profit and Loss a/c is transferred to the Capital a/c, then such a care should be taken with
regard to the Capital a/c balance.

Trial Balance used in Final Accounting : When Prepared?
The Trial Balance is a statement of ledger account balances as on a particular date (instance).
Final Accounting is done towards the end of the accounting period.
The trial balance that we consider in the preparation of final accounts is the one that is prepared towards
the end of the accounting period i.e. on the last day of the accounting period.

Transactions after the Trial Balance Date
There might be a number of accounting transactions which might not have been taken into consideration
by the time the Trial Balance has been prepared.
Some of the reasons for the presence of such transactions are
• Transactions which do not occur in the normal course of business

There are a number of transactions relating to the business which do not occur in the normal course of
business. These transactions unless deliberately recorded do not get into the books of accounts.
Examples for such transactions
i. Stock taken away by the proprietor for personal use

ii. Abnormal loss of stock
• Transactions which have to be recorded only towards the end

There are a number of transactions relating to the business which have to be recorded only at the end of
the accounting period. If the trial balance has been prepared before all such transactions into consideration
have been taken into consideration, then they stay unrecorded in the books of accounts.
i. Depreciation on Assets
ii. Expenses - Outstanding/Prepaid
iii. Incomes - Outstanding/Pre-received
• Transactions relating to Error Rectifications

The agreement of a Trial Balance is not a conclusive proof of absence of errors in accounting. Even in case
where the trial balance agrees, there may still be errors existing in the books of accounts.
These errors if identified subsequent to the preparation of the Trial Balance, need to be rectified which
needs journal entries to be passed for rectification.

What are Adjustments?
The transactions which have not yet been journalised, appended to the trial balance are what we call
adjustments.
Thus we can say that Adjustments are transactions relating to the business which have not been
journalised by the end of the accounting period.
• Illustration
Trial Balance of M/s Azaya Traders" as on 30th June 2006.
Debit Credit
L/
F
(in Rs) (in Rs)

Purchases – 11,36,000
Wages – 18,000
Carriage Inwards – 26,900
Trading Charges – 64,000
Carriage Outwards – 52,500
Rent received – 1,78,300
Cash – 62,500
Capital – 3,44,700
Bank (Overdraft) – 37,980
Comission – 42,780
Creditors – 2,68,000
Sales – 15,48,700
Debtors – 2,56,000
Total 23,77,680 23,77,680
» Adjustments
The following additional information is available
1. A Machine purchased on credit from M/s Ramsay Machine Tools for Rs. 2,00,000 is not yet
recorded in the books.
2. Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
The additional information presented after the trial balance contains information relating to accounting
transactions, which are to be identified from the wordings.
Why are they called Adjustments? Why not Additional
Transactions?
Since adjustments are also transactions relating to the business, we need to bring them into the accounting
books by journalising them.
The trial balance is used for final accounting, so as to eliminate a lot of physical work (in manual
accounting) in the form of recording transactions for making up final accounts, posting them into respective
ledger accounts, balancing of ledger accounts effected by these transactions.
Therefore even for the purpose of bringing the transactions represented by the adjustments into books a
method has been designed which would not require us to record these transaction, post them and balance
the ledger accounts affected. This method incorporates the effect of the transactions into the final accounts
without having to go through the regular process of recording, posting, balancing etc.
• Accounting for the Transactions

Recording the transactions represented by adjustments normally would result in the existing balance in the
affected ledger accounts to either increase or decrease.
» Transaction
Wages to the extent of Rs. 43,000 are incorrectly recorded as Salaries.
This represents an error of principle whereby an expenditure that was to be debited in a particular account
has been debited to another account.
To bring the effect of this transaction into books, the journal entry to rectify this error has to be recorded.
» Journal/Ledger Hide/Show
Journal in the books of M/s Azaya Traders for the year ending 30th June 2006
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
30/06/06 – Wages a/c Dr – 2,00,000
To Salaries a/c – 2,00,000
[For the transfer of wages erroneously treated

as salaries from the "salaries a/c" to the "Wages
a/c".]
The transaction posted into the relevant ledger accounts
Dr Salaries a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/06 To Bal b/d – 1,53,000 30/06/06 By Wages – 43,000

– 30/06/06 Bal c/d 1,10,000
1,53,000 1,53,000
01/07/06 To Balance b/d – 1,10,000

Dr Wages a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/06 To Salaries a/c – 43,000 30/06/06 By Bal c/d – 43,000
43,000 43,000
01/07/06 To Balance b/d – 43,000

• The Method of Adjustment
This method involves identification of the effect and making mathematical adjustments in the figures that
we consider in final accounting (i.e. at the time of showing them in the Trading a/c or Profit & Loss a/c or
the Balance Sheet.).
» Effect of the Transaction

The effect of the journal entry to be recorded in the above case can be analysed as
A. (−) From Salaries on the debit side of P/L a/c

The Salaries a/c which already has a debit balance is credited which will result in a decrease
in the existing debit balance.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is
deducted from the Salaries a/c balance (Rs. 1,53,000) shown on the debit side of the "Profit
& Loss a/c".
B. (+) To Wages on the debit side of Trading a/c

The Wages a/c which already has a debit balance is debited resulting in an increase in the
existing debit balance.
To bring the effect of this transaction, the amount involved in the transaction (Rs. 43,000) is
added to the Wages a/c balance (Rs. 18,000) shown on the debit side of the "Trading a/c".
These are the adjustments to be made to bring the affect of the above transaction into the books of
accounts.
• Why call them Adjustment? Why not Additional Transactions?

Since the affect of these transactions is incorporated by mathematical adjustments, they are called
Adjustments rather than just Additional Transactions.

To make the Adjustment » Know the Journal Entry
Adjustments are transactions relating to business which have not yet been
journalised.
Therefore, to make the adjustments one should have an idea of the journal entry related to the transaction
indicated by the adjustment.
If we know the Journal entry, we can identify the effect of the same on the ledger accounts and thus be
able to identify the adjustments to be made.
The adjustments are made at the time of making up the final accounts within the three parts that make up
the final accounting, i.e. the "Trading a/c", "Profit & Loss a/c" and the "Balance Sheet".
Illustration »
Problem
Draw up the final accounts from the following trial balance and the additional information that follows it.
Trial Balance of M/s Azaya Traders" as on 30th June 2006.

Debit Credit
L/
F
(in Rs) (in Rs)

Purchases – 11,36,000
Wages – 18,000
Carriage Inwards – 26,900
Trading Charges – 64,000
Carriage Outwards – 52,500
Rent received – 1,78,300
Cash – 62,500
Capital – 3,44,700
Bank (Overdraft) – 37,980
Comission – 42,780
Creditors – 2,68,000
Sales – 15,48,700
Debtors – 2,56,000
Total 23,77,680 23,77,680
The following additional information is available
Illustration » Working
Notes
An analysis of the various ledger accounts in the trial balance would enable us to decide what to be done
with each item in the trial balance.
Trial Balance of M/s Azaya Traders as on 30/06/06 » Statement of Analysis
Balanc
Account What
Account Description e Where Amount
Type Side
Nature
Opening Stock Direct Expenses Nominal Debit Trading Debit 86,000

Purchases Direct Expenses Nominal Debit a/c Debit 11,36,000
Salaries Indirect Expenses Nominal Debit Trading Debit 1,53,000
Wages Direct Expenses Nominal Debit a/c Debit 18,000
Carriage Inwards Direct Expenses Nominal Debit P/L a/c Debit 26,900
Trading Charges Indirect Expenses Nominal Debit Trading Debit 64,000
Carriage Indirect Expenses Nominal Debit a/c Debit 52,500
Outwards Indirect Incomes Nominal Credit Trading Credit 1,78,300
Rent received Asset Real Debit a/c Assets 62,500
Cash Liability Personal Credit P/L a/c Liabilities 3,44,700
Capital Liability Personal Credit P/L a/c Liabilities 37,980
Bank (Overdraft) Indirect Expense Nominal Debit P/L a/c Debit 42,780
Comission Liability Personal Credit B/S Liabilities 2,68,000
Creditors Direct Incomes Nominal Credit B/S Credit 15,48,700
Sales Asset Personal Debit B/S Assets 2,56,000
Debtors Asset Real Debit P/L a/c Assets 4,80,000
Machinery B/S
B/S
B/SB/S
An analysis of the additional transactions would enable us to identify what is to be done to incorporate their
effect in accounting.
Entry Effect
1. (+) To Machinery a/c on the Assets side of the Balance Sheet
Dr. Machinery a/c
2. (+) To Ramsay Machine Tools a/c on the Liabilities side of the
Cr. Ramsay Machine Tools a/c
Balance Sheet
2. Detailed Explanation Hide/Show
Journal in the books of M/s Azaya Traders for the year ending 30th June 2006
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
30/06/06 – Machinery a/c Dr – 2,00,000
To M/s Ramsay Machine Tools a/c – 2,00,000
[For the value of machine purchased on

credit.]
Dr Machinery a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/06 To Bal b/d – 4,80,000 30/06/06 By Bal c/d – 6,80,000

To Ramsay – 2,00,000
Machine Tools
6,80,000 6,80,000
01/07/06 To Balance b/d – 6,80,000

Dr Ramsay Machine Tools a/c Cr
Amount Amount
(in Rs) (in Rs)
30/06/06 To Bal c/d – 2,00,000 30/06/06 By Machine a/c – 2,00,000
2,00,000 2,00,000
01/07/06 By Balance b/d – 2,00,000
Entry Effect
Dr. Wages a/c 1. (+) To Wages a/c on the Debit side of the Trading a/c
Cr. Salaries a/c 2. (−) From Salaries a/c on the Debit side of the Profit and Loss a/c
4. Detailed Explanation Above

Illustration »
Solution
Making up the final accounts would involve nothing more than putting the items from the trial balance in
the right places i.e. in either the "Trading a/c" or "Profit and Loss a/c" or the "Balance Sheet" and making
subsequent adjustments.
Trading and Profit & Loss a/c of M/s Azaya Traders for the year ending
Dr Cr
30/06/06
Amount Amount Amount Amount
(in Rs) (in Rs) (in Rs) (in Rs)

To Wages 18,000
(+) Salary (Tr) 43,000 61,000
To Carriage 26,900
Inwards 2,38,800
To Gross Profit
15,48,700 15,48,700
To Salaries 1,53,000 By Gross Profit 2,38,800

(−) Tr. to Wages 43,000 1,10,000 By Rent Received 1,78,300
To Trading Charges 64,000
Carriage Outwards 52,500
To Comission 42,780
To Net Profit 1,47,820
4,17,100 4,17,100
Balance Sheet of M/s Azaya Traders as on 30th June 2006

Capital 3,44,700 Cash 62,500
(+) Net Profit 1,47,820 4,92,520 Debtors 2,56,000
Bank (Overdraft) 37,980 Machinery 4,80,000
Creditors 2,68,000 (+) New Machine 2,00,000 6,80,000
(+) Due to M/s Ramsay 2,00,000 4,68,000
9,98,500 9,98,500
The effect of the additional transactions (adjustments) are incorporated into the accounts by mathematical
adjustments wherever needed.
Adjustments to be Dealt with at least
Twice
• Dual Entity Concept

Every transaction relating to business has its effect on two elements.
Adjustments are transactions relating to the business which are yet to be journalised. We call them
adjustments for the reason that they are dealt with by making mathematical adjustments to the figures of
ledger account balances instead of passing the regular journal entries.
Therefore, in making mathematical adjustments we have to ensure that we are adjusting the two elements
that are affected by the transaction.
Each item from the adjustments should be dealt with at least twice in Final Accounting.
Where an item appears in the trial balance it is to be dealt with only once and where an adjustment is
being dealt with it is to be dealt with at two or more places depending on the number of elements effected
by the transaction.
» Adjusting more than two accounts

In most of the cases, the journal entry for recording the transaction given as adjustments is a simple entry
involving two accounts (one being debited and the other being credited). However, in some cases, a
complex entry involving more than two elements (accounts) is needed to record the additional
transactions. In such cases more than two accounts may have to be adjusted.
Valuation of Assets » Direct
Expenses
• Asset Valuation Principle

The value of an asset includes all the expenses incurred before bringing the asset into usable condition.
• Direct Expenditure
In financial accounting, we use the term Direct Expense in relation to assets.
Any expenditure that goes into the value of an asset is identified as Direct Expenditure for that asset.
• Assets » Treatment of Direct Expenses

All the expenses incurred in relation to an asset before bringing the asset into usable condition would form
direct expenses for the asset
All the direct expenses in relation to an asset are to be made part of the value of the asset i.e. are to be
capitalised.
» Example
If a machine is purchased at Delhi and brought to Tenali for use, then all the expenses incurred before
bringing the machine into working mode (usable condition) like transportation charges from Delhi to Tenali,
Unloading Charges at Tenali, Installation Charges etc., should be considered to be part of the value of the
machine.
These expenses should not be debited to the respective expenditure accounts, but should be debited to the
Machinery a/c. The Machinery a/c balance which indicates the value of the asset would be the sum of the
cost of the machine, the transportation charges, unloading charges, installations charges, etc..

Is Stock an Asset?
• Dual nature of Stock

» Purchases : During the Accounting Period
Whenever we purchase stock/goods we debit the Purchases a/c (Nominal account). This implies that we
treat the amount spent on purchasing stock as an expenditure.
Such a treatment is adopted all throughout the year.
» Asset : At the end of the Accounting Period

At the end of the accounting period, while preparing the final accounts we treat stock an asset and show it
in the Balance Sheet on the assets side.
Thus we can say that stock has dual nature. All throughout the year the amount spent on it is expenditure
and only for the moment the balance sheet is prepared it is an asset.
• Valuation of Stock » Based on the Principle for Valuation of Assets

Since Stock is an asset, its valuation should also be made based on the principle for valuation of assets.
The value of stock should include all the expenses incurred before bringing stock into usable condition.
• Usable Condition for Stock » Being ready for Sale

Considering the Stock used in sale, the usable condition for stock would mean getting it ready for sale i.e.
it being finally set up in the show case or sale area.
• Value of Stock
All the expenses incurred on the stock till it is placed in the sales area would form direct expenses for the
stock and should be treated as a part of the value of stock.
In situations where it would be difficult/impossible to collect all the expenses in detail, this idea is modified
to mean the expenses incurred before that stage till which point it would be convenient to collect
information.
Direct Expenses for Stock used in Trading
Business
In relation to a trading business, the stock used for sale would be an asset.
The usable condition for that stock would be, it being placed ready for sale in the showroom.
Therefore, the direct expenses in relation to this stock would be all the expenses incurred before placing it
in the show room or any other relevant place ready for sale.
Conventionally, expenses like Wages, Carriage Inwards (carriage on purchases), Octroi, Excise, Duties etc.,
Stock purchased, etc. are treated as direct expenses apart from the actual cost of the goods purchased
which is revealed by the "Purchases a/c".
It is not a rule that only these form direct expenses. Any expenditure that would have been incurred in
relation to stock before it is made ready for sale would form direct expenditure for the stock.
Cost of Goods
Sold
• Cost of Goods Sold = Value of the Goods Sold
The cost of goods sold is a term used to indicate the value of the goods sold.
This value is needed to identify the amount of basic/core (gross) profit made by the organisation
» Gross Profit = Sales − Cost of Goods Sold
Consider the following data relating to an organisation.
1. Opening Stock at the beginning of the accounting period, Rs. 20,000.
2. Purchases of goods/stock during the accounting period : Rs. 2,48,000.
3. Direct expenses incurred :Rs. 54,000.
4. Unsold stock at the end of the accounting period valued at Rs. 36,000.
5. Value of Stock used for other purposes Rs. 14,000.
Opening Stock 20,000

(+) a) Purchases (Cost Value) 2,48,000
b) Direct Expenses 54,000 3,02,000
Total Value of Goods 3,22,000
(−) a) Closing Stock (Value) 36,000
b) Stock Unused for Trading 14,000 50,000
Cost of Goods Sold 2,72,000
The formula for calculating the value of Cost of Goods Sold based on the above calculations can be written
as
Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses

− Closing Stock − Stock Unused for trading
• Stock Unused for Trading

Stock with the organisation may have been used for purposes other than trading. The value of such stock
unused for trading purposes has to be deducted from the total value of stock so as to arrive at the value of
cost of goods sold.
Some such instances
 Goods being taken away by the proprietor for personal purposes;

 Stock used in building up an asset;
 Stock used for advertisement purposes;
 Normal loss of stock;
 Abnormal loss of stock;
 Stock used up for other types of businesses (like consignments, branches, joint ventures etc)

Do we need Cost of Goods Sold to find Gross Profit
• Gross Profit = Sales − Cost of Goods Sold

By definition Gross Profit = Sales − Cost of Goods Sold ← (1)
⇒ To obtain the value of gross profit we need the figures of cost of goods sold and sales.
• Bypassing finding Cost of Goods Sold

Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused for
trading
Substituting this in (1) we get,
• Gross Sales − (Opening Stock + Purchases + Direct Expenses − Closing Stock − Stock Unused for
=
Profit trading)
Sales − Opening Stock − Purchases − Direct Expenses + Closing Stock + Stock Unused for
=
trading
(Sales + Closing Stock + Stock Unused for trading) − (Opening Stock + Purchases + Direct
=
Expenses)
Thus we do not specifically need to calculate the value of cost of goods sold for finding gross profit, only its
affect is to be brought into account.
Such an ascertainment of Gross Profit is done in the Trading and Profit and Loss account.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Opening Stock – By Sales –

To Purchases – By Stock Unused –
To Direct Expenses – By Closing Stock –

 "Purchases a/c" is a nominal account with a debit balance and is a direct expenditure (for stock).
Since Purchases a/c is closed by transfer to the Trading a/c, it appears on the debit side of
Trading a/c.
Transferring a debit balance from one account to a second results in the

second account being debited and the first account being credited.
Thus, all the accounts representing the figures that are added to purchases appear on the debit
side
 "Sales a/c" is a nominal account with a credit balance and is a direct income.
Since Sales a/c is closed by transfer to the Trading a/c, it appears on the credit side of Trading
a/c.
Transferring a credit balance from one account to a second results in the

second account being credited and the first account being debited.
Thus, all the accounts representing the figures that are added to sales appear on the credit side
» Finding Cost of Goods Sold in such cases

Cost of goods sold is a figure that is not straight away available in the books of accounts used in financial
accounting. That figure can be obtained either from the "Trading a/c" or by preparing a separate ledger
account to specific account which gives the information relating to the cost of goods sold.

Ascertaining Cost of Goods Sold from Trading
a/c
Each ledger account serves one or more informational needs of the organisation. The Trading a/c gives the
information relating to the Gross Profit made by the organisation. It can also be used to derive the
information relating to the "Cost of Goods Sold".
» Ascertaining Cost of Goods Sold

Cost of Goods Sold = (Opening Stock + Purchases + Direct Expenses) − (Closing Stock + Stock Unused for
trading)
The "Trading a/c" with this information posted to it would be
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000 By Closing Stock 36,000

To Purchases 2,48,000 By Stock Unused 14,000
To Direct Expenses 54,000
sub-total 3,22,000 sub-total 50,000

The trading account before crediting sales would have a greater total on the debit side and thus has a debit
balance. That debit balance represents the cost of goods sold.
Thus, to ascertain the cost of goods sold, we need to balance the "Trading a/c" without crediting sales.
The Sales a/c can be subsequently transferred to the Trading a/c to ascertain the Gross Profit.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000 By Closing Stock 36,000

To Purchases 2,48,000 By Goods Unused 14,000
To Direct Expenses 54,000 By Cost of Goods Sold 2,72,000
c/d
3,22,000 3,22,000
To Cost of Goods Sold 2,72,000 By Sales 3,80,000

b/d 1,08,000
To Gross Profit
3,80,000 3,80,000
If such a two stage Trading a/c is prepared, we would be able to ascertain the Cost of Goods Sold as well
as Gross Profit from the Trading a/c itself.
» Ascertaining Cost of Goods Sold by Mathematical Calculations

The Trading a/c is generally prepared only as a single stage account as follows
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

To Purchases 2,48,000 By Goods Unused 14,000
To Direct Expenses 54,000 By Closing Stock 36,000
4,30,000 4,30,000
To obtain the value of cost of goods sold from this we use the definition for gross profit.
• Cost of Goods Sold = Sales − Gross Profit [Since Gross Profit = Sales − Cost of Goods Sold]
= Rs. 3,80,000 − Rs. 1,08,000
= Rs. 2,72,000
Finding Cost of Goods Sold using Goods Consumed
a/c
The value of Cost of Goods Sold can also be obtained specifically, by maintaining a separate account for the
purpose. This may be named "Goods Consumed a/c" (any other indicative name may be used).
The basic purpose of accounting is derivation of information and the

more the information we need, the more the accounting heads we
need to maintain.
The Goods Consumed a/c is nothing but the first part of the trading account where it was balanced twice.
Dr Goods Consumed a/c Cr

Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000 By Goods Unused 14,000

To Purchases 2,48,000 By Closing Stock 36,000
To Direct Expenses 54,000 By Trading a/c 2,72,000
3,22,000 3,22,000
The balance in the Goods Consumed a/c represents Cost of Goods sold. This account is closed by
transferring the balance to the Trading a/c.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Goods Consumed 2,72,000 By Sales 3,80,000

3,80,000 3,80,000
• Cost of Goods Consumed
If the balances in the ledger accounts representing direct expenses are not transferred to the "Goods
Consumed a/c" but are transferred to the "Trading a/c", then the balance from the "Goods Consumed a/c"
cannot be called cost of goods sold (value of goods sold).
It just represents the cost of goods consumed. To obtain the cost of goods sold from this, the direct
expenses have to be added to this.
Goods used within the Organisation have to be valued at
Cost
The stock that is used within the organisation (stock drawn by the proprietor for own purposes, stock used
for building an asset, stock used for advertisement purposes, etc.,) have to be valued at cost.
This is for the reason that if such usages are recorded at a value which includes an element of profit, the
transaction when recorded would generate a profit, which would amount to making a profit out of a
transaction with oneself.
Principle of Mutuality » One cannot make a profit out of a transaction with oneself
Consider the following data relating to an organisation which started its operations on 28th December
2006:
 Opening Stock :: Nil;
 Purchases :: Rs. 1,20,000;
 Direct Expenses :: Rs. 30,000
 Sales :: Nil
 Stock used by the organisation internally Rs. 20,000 (Valued at Cost).
Generally Sales are made by adding 25% profit to cost
 Closing Stock :: ?
The accounting period ends on 31st December 2006.
Value of Closing Stock with the Organisation = Total Value of Stock − Value of Stock used up internally
= Purchases + Direct Expenses − Rs. 20,000
= (Rs. 1,20,000 + Rs. 30,000) − Rs. 20,000
= Rs. 1,30,000
Sales value of the stock used within the organisation = Cost + 25% of Cost
= Rs. 20,000 + 25% of Rs. 20,000
= Rs. 20,000 + Rs. 5,000
= Rs. 25,000
• Stock used up internally recorded at Sales Value
Dr Trading a/c Cr
To Purchases 1,20,000 By Sales –

To Direct Exp. 30,000 By Stock used 25,000
To Gross Profit 5,000 By Closing Stock 1,30,000

1,55,000 1,55,000
There is no commercial activity (no sales), there is no scope for earning profits. But the Trading a/c reveals
a Gross Profit of Rs. 5,000 which is on account of the stock used up internally being recorded at sales
value.
Such profit generation is inappropriate for the reason that in using up stock within the organisation, the
organisation is not conducting a transaction with an outside party.
Thus to avoid profit generation in such cases, the stocks so used are to be valued at cost.
• Stock used up internally recorded at Cost

Dr Trading a/c Cr
To Purchases 1,20,000 By Sales –
To Direct Exp. 30,000 By Stock used 20,000
To Gross Profit Nil By Closing Stock 1,30,000

1,50,000 1,50,000
The Trading a/c would reveal no profit when the stock used up internally is valued at cost.
Finding Value of Closing Stock from
Sales
We may be able to ascertain what is left out if we know what has been sold. This logic may be applied in
finding the value of closing stock. However, to know this, we need to ascertain the value of cost of goods
sold.
i. Gross Profit = Sales − Cost of Goods Sold
ii. Cost of Goods Sold = Opening Stock + Purchases + Direct Expenses − Closing Stock
iii. Gross Profit = Sales − (Opening Stock + Purchases + Direct Expenses − Closing Stock) [From (i)
and (ii)]
= Sales − Opening Stock − Purchases − Direct Expenses + Closing Stock
iv. Closing Stock = Opening Stock + Purchases + Direct Expenses + Gross Profit − Sales [From (iii)]
To use this relation to obtain the value of closing stock, we need the information relating to Gross Profit. All
other information in this relation is readily available from the accounting records.

Gross Profit Ratio
• Ratio : Percentage
Ratio is a comparison between two numerical quantities of the same kind.
Ratio between two quantities is expressed in the form a : b a , where "a" and "b" do not have a common
or b factor.
Percentage = Ratio × 100
• Gross Profit Ratio

Gross Profit Ratio is the ratio of Gross Profit to Net Sales Value or Cost of Goods Sold.
» To Sales
Gross Profit
Gross Profit Ratio =
Net Sales
Gross Profit
Gross Profit as a % of Sales = × 100
Net Sales
(Or)= Gross Profit Ratio (to Sales) × 100
» To Cost of Goods Sold
Gross Profit
Gross Profit Ratio =
Cost of Goods Sold
Gross Profit
Gross Profit as a % of Cost of Goods Sold = × 100
Cost of Goods Sold
(Or)= Gross Profit Ratio (to Cost) × 100
• Inter-Relationship between the two Ratios
The Gross Profit Ratio (to Sales) and Gross Profit Ratio (to Cost of Goods Sold) are interrelated and one can
be obtained if the other is known.
» Finding GP Ratio (to Cost) when GP Ratio (to Sales) is known Show/Hide
The data relating to the Gross Profit as a % of Sales given can be considered in three different forms. The
formula used for conversion (expressing the interrelationship) varies depending on the form of the data
considered.
• Data on 1 Scale
Expressing the data on 1 scale, amounts to expressing the value either in decimals or as a fraction.
Consider the following data:
 Sales = x
 Gross Profit Ratio (to Sales) = y (one scale)
Gross Profit = Sales × Gross Profit Ratio (to Sales)

=x×y
= xy
Cost of Goods Sold = Sales − Gross Profit
= x − xy
= x (1 − y)
Gross Profit
Gross Profit Ratio (to Cost) =
Cost of Goods Sold
xy
=
x (1 − y)
y
=
(1 − y)
» Example
Given » Gross Profit Ratio (to Sales) is 0.25 ⇒ y = 0.25
y
Therefore, Gross Profit Ratio (to Cost) =
(1 − y)
0.25
=
(1 − 0.25)
0.25
=
0.75
1
=
3
= 0.33
Gross Profit (as a % to Cost) = Gross Profit Ratio (to Cost) × 100
= 0.33 × 100
= 33 1 %
3
• Data on 100 Scale
Expressing the data on 100 scale implies expressing the % without using the denominator 100.
[42% is taken as 42 for calculation purposes if it is taken on a 100 scale.]
m
Let the data on 100 scale be represented by 'm'. ⇒ y =
100
Substituting this value for 'y' in the above formula we get,
y
Gross Profit Ratio (as a % of Cost) = × 100
(1 − y)
m
100
= × 100
m
(1 − )
100
m
100
= × 100
100 − m
100
m 100
= × × 100
100 100 − m
m
= × 100
100 − m
» Example
Given » Gross Profit is 25% of Sales ⇒ m =25
m
Therefore, Gross Profit as a % of Cost = × 100
100 − m
25
= × 100
100 − 25
25
= × 100
75
100
=
3
1
= 33
3
• Data as a ratio with numerator 1
In some cases, for some common values that we use in problem solving, we use a formula based on the
Gross Profit Ratio expressed as a ratio with a numerator 1.
1 1
Let the data be represented by ⇒y=
a a
Substituting this value for 'y' in the formula in (1) we get,
y
(1 − y)
= 1
a
1
a
=
a−1
a
1 a
= ×
a a−1
1
=
a−1
» Example
1
Given » Gross Profit Ratio (to Sales) = ⇒a=4
4
1
a−1
1
=
4−1
1
=
3
Gross Profit (as a % to Cost) = Gross Profit Ratio (to Cost) × 100
1
= × 100
3
1
= 33 %
3
» Finding GP Ratio (to Sales) when GP Ratio (to Cost) is known Show/Hide
The data relating to the Gross Profit as a % of Cost of Goods Sold given can be considered in three different
forms. The formula used for conversion (expressing the interrelationship) varies depending on the form of
the data considered.
• Data on 1 Scale
Expressing the data on 1 scale, amounts to expressing the value either in decimals or as a fraction.
Consider the following data:
 Cost of Goods Sold = p

 Gross Profit (to Cost of Goods Sold) = q (one scale)
Gross Profit = Cost of Goods Sold × Gross Profit (to Cost of Goods Sold)
=p×q
= pq
Sales = Cost of Goods Sold + Gross Profit
= p + pq
= p (1 + q)
Gross Profit
Gross Profit Ratio (to Sales) =
Net Sales
pq
=
p (1 + q)
= q
(1 + q)
» Example
Given » Gross Profit Ratio (to Cost) is 0.2 ⇒ p = 0.2
q
Therefore, Gross Profit Ratio (to Sales) =
(1 + q)
0.2
=
(1 + 0.2)
0.2
=
1.2
1
=
6
Gross Profit (as a % to Sales) = Gross Profit Ratio (to Cost) × 100
1
= × 100
6
2
= 16 %
3
• Data on 100 Scale
Expressing the data on 100 scale implies expressing the % without using the denominator 100.
[35% is taken as 35 for calculation purposes if it is taken on a 100 scale.]
n
Let the data on 100 scale be represented by 'n'. ⇒ q =
100
Substituting this value for 'q' in the above formula we get,
q
Gross Profit as a % of Sales = × 100
(1 + q)
n
100
= × 100
n
(1 + )
100
n
100
= × 100
100 + n
100
n 100
= × × 100
100 100 + n
n
= × 100
100 + n
» Example
Given » Gross Profit is 20% of Cost ⇒ n =20
n
Therefore, Gross Profit as a percentage of Saes = × 100
100 + n
20
= × 100
100 + 20
= 20 × 100
120
1
= × 100
6
= 16 2/3%
• Data as a ratio with numerator 1
In some cases, for some common values that we use in problem solving, we use a formula based on the
Gross Profit Ratio expressed as a ratio with a numerator 1.
1 1
Let the data be represented by ⇒q=
b b
Substituting this value for 'q' in the formula in (1) we get,
q
(1 + q)
1
b
=
1
(1 + )
b
1
b
=
b+1
b
1 b
= ×
b b+1
1
=
b+1
» Example
1
Given » Gross Profit Ratio (to Sales) is ⇒b=5
5
1
b+1
1
=
5+1
1
=
6
Gross Profit Ratio (as a % to Sales) = Ratio × 100
1
= × 100
6
2
= 16 %
3
» Frequently used conversions
• Hundred Scale
As a % of 1 2
20 25 33 50 66 100
Cost 3 3
2 1
As a % of Sales 16 20 25 33 40 50
3 3
• One Scale
As a % of Cost 0.2 0.25 0.333 0.5 0.666 1
As a % of
0.166 0.20 0.25 0.333 0.4 0.5
Sales
• Inverse
1 1 1 1 2 1
As a % of Cost
5 4 3 2 3 1
1 1 1 1 2 1
As a % of Sales
6 5 4 3 5 2
Gross Profit is generally Non-
Uniform
The gross profit earned by an organsation is in almost all cases not a figure that can be easily derived
(without the availability of the value of closing stock). Deriving the value of closing stock would be far
easier than deriving the value of gross profit made (based on sales).
• Variety of Products being Sold

The organisation may be selling a number of products with different selling prices and different rates of
gross profits.
In such cases, if the gross profit figure is to be ascertained from the sales figure, sales records should be
maintained so as to give the sales details relating to each product with a distinct Gross Profit %. This would
involve a lot of work and would be impractical, more so where there are a large number of products being
dealt with.
• Variations in Sale Prices

The prices charged to customers are dependent on a number of factors like the market conditions, the
immediate competition existing in the market, the loyalty of the customers etc.
Depending on the market conditions, some times the prices may be varied instantaneously.
Depending on the customer to whom the product is being sold, the prices may be varied (a discount may
be given to loyal customers) etc.
In such a situations there would not be uniformity in the Gross profit percentage and it would be near to
impossible to ascertain the gross profit made using the sales figures.
Since using the figure of gross profit to ascertain the value of closing stock available in the organisation is
not a feasible idea, we look at other methods for finding out the value of closing stock.
How is the Value of Closing Stock
Ascertained?
• Physical Stock
Closing stock is the stock/goods unsold at the end of the accounting period.
The details relating to the physical stock would be readily available with the organisation only if the
inventory records are being maintained by the organisation. In other cases the physical stock would have
to be ascertained by stock taking.
• Stock Value
There is no specific ledger account in financial accounting that would give us the information relating to the
value of closing stock ready hand.
The value of closing stock is available ready hand only if inventory records are being maintained that too
from the inventory records.
The value of Closing Stock is ascertained by Physical Verification of Stock on the last day
of the accounting period and its valuation at Cost or Market Price (Net Realisable Value)
whichever is lesser
This is the most common method for valuing the closing stock.
The information relating to the value of closing stock is not regularly required by the organisation. It is
however required at the end of the accounting period for the purpose of evaluation of the Cost of Goods
Sold.
Convention of
Conservatism
• Net Realisable Value of Stock

For the purpose of Valuation of closing Stock, Market Price implies Net Realisable
Value/Rate and not the Selling Price.
Net Realisable Value of stock is the net sale realisation excluding all the expenses directly
and exclusively relatable to the sale (Sale commission, Brokerage etc) from the Sale
Realisation.
Therefore, in trying to ascertain the Market Price to be used for valuation, care should be
taken to ensure that such expenses are deducted from the sales price to ascertain the net
realisable value of stock.
• Convention of Conservatism
By the Convention of Conservatism we take into
consideration all those expenses and losses of which we
are aware, even if they relate to the subsequent
accounting periods.
The act of valuing closing stock at cost or market price is based on the "Convention of
Conservatism".
Convention of Conservatism : Valuation of
Closing Stock : Illustration
Following is the "Trading a/c" relating to an organisation, wherein the Closing Stock has been recorded at
cost.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

To Gross Profit 94,000
4,16,000 4,16,000
» Closing Stock details

The closing stock is made up of
 Batch N :: 600 units valued at Rs. 36/unit with a total value of Rs. 21,600
 Batch M :: 600 units valued at Rs. 24/unit with a total value of Rs. 14,400
 Total 1,200 units with a total value of Rs. 36,000
Value here implies cost + direct expenses
The selling prices and the related expenses are
 Batch N :: Rs. 50/unit

 Batch M :: Rs. 50/unit [Regular price]
Batch M :: Rs. 25/unit [Current price]
This stock represents an outdated model of the product and the present market conditions
would enable the stock to be sold only at a price of Rs. 25 per unit.
 The sales of all stocks are made through a dealer who would charge a commission of 10% of the
sale proceeds.
» Cost and Net Realisable Values of Closing Stock

From the available data, Closing stock can be valued at two different rates. Cost and Market Price (Net
Realisable Rate).
 600 units [Batch N]

i. Cost = Rs. 36/unit.
ii. Market Price = Rs. 50/unit.
iii. Expenses directly relatable to sale = Rs. 5/unit
(10% of selling price = Rs. 50/unit × 10%).
iv. Net Realisable Value = Rs. 45/unit
[Market Price (Rs. 50/unit) − Expenses relatable to sale (Rs. 5/unit)]
 600 units [Batch M]

i. Cost = Rs. 24/unit.
ii. Market Price = Rs. 25/unit.
iii. Expenses directly relatable to sale = Rs. 2.50/unit
(10% of selling price = Rs. 25/unit × 10%).
iv. Net Realisable Value = Rs. 22.50/unit
[Market Price (Rs. 25/unit) − Expenses relatable to sale (Rs. 2.50/unit)].
» Valuation of Closing Stock based on Convention of Conservatism
 600 units [Batch N]

Cost = Rs. 36/unit. Net Realisable Rate = Rs. 45/unit.
Since Cost < Net Realisable Value, the goods are to be valued at cost.
⇒ Value of 600 units is Rs. 21,600 (600 units × Rs. 36/unit)
 600 units [Batch M]

Cost = Rs. 24/unit. Net Realisable Rate = Rs. 22.50/unit.
Since Net Realisable Value < Cost, the goods are to be valued at the net realisable value.
⇒ Value of 600 units is Rs. 13,500 (600 units × Rs. 22.50/unit)
Value of Closing stock if valued at cost = Rs. 14,400 (600 units × Rs. 24/unit)
The Closing Stock should be valued therefore at Rs. 35,100 (Rs. 21,600 + 13,500).
» Trading a/c
If value of Closing Stock is taken based on the Convention of Conservatism, the Trading a/c would be
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

4,15,100 4,15,100
The Gross profit has gone down by Rs. 900 since closing stock is considered at a lesser value.
Role of Convention of
Conservatism
The convention of conservatism asks us to take into consideration all those expenses and losses relating to
the subsequent periods of which we are aware.
» Future Losses
Where the Net realisable value of stock is less than its cost, the organisation may incur a loss.
In the above case, the organisation may have to incur a loss of Rs. 900 [Rs. 14,400 (cost) − Rs. 13,500
(net realisable value)].
• When?
This loss would have to be borne by the organisation if it sells the stock at the net realisable rate.
Since it is the end of the accounting period, such a sale at such a price, if at all it takes place, would be in
the subsequent accounting period.
Thus, the organisation may have to incur this loss in the future.
• Is the loss for sure?

The loss may have to be incurred in the future only if the stock has to be sold at Rs. 25 per unit (which
gives a net realisation of Rs. 22.50).
We may consider such a loss a certainty in cases where the stock is required to be sold at the lower price
on account of it becoming obsolete, losing demand etc.
Bu where the lower market rate is on account of normal market fluctuation and if the rates go up in the
subsequent period and the product can be sold at a higher price, this loss need not be incurred.

How is the loss absorbed?
Based on the Convention of Conservatism, the loss though it may have to be incurred in the future period,
is absorbed in the current period itself, since its information is known.
This will be the case where the lower valuation is on account of conditions which are certain (obsolete
goods, demand going down etc).
» Crediting a Nominal a/c implies gain

The value of closing stock is credited to the "Trading a/c". By the principle of credit in relation to nominal
accounts (Credit all Incomes and Gains), we can assume the value to indicate a gain.
Reducing the value of closing stock would therefore amount to reducing the credit made to the Trading a/c,
which would be reducing the gain. Debiting an amount is an equivalent of deducting the amount from the
opposite side i.e. the credit side. Therefore, reducing the gain is the same as taking in additional loss.
Therefore, the loss is absorbed by considering the value of closing stock at a lesser value i.e. the net
realisable value. [In the above example, by considering the closing stock at the lower value, the estimated
loss of Rs. 900 relating to the subsequent accounting periods has been absorbed in the current period
itself.]
Value of Closing Stock = Value of Opening Stock of the
Subsequent Period
The Closing Stock a/c relating to an accounting period and the Opening Stock a/c relating to the
subsequent accounting period represent the same account. Therefore, the value of the closing stock at the
end of the accounting period and the opening stock at the beginning of the subsequent accounting period
are the same.
• Closing Stock a/c

The "Closing Stock a/c" is a real account and is created at the last moment of the accounting period.
It represents Stock as an asset. The balance in the "Closing Stock a/c" is carried forward to the next
accounting periods.
• Opening Stock a/c

The account that we name "Closing Stock a/c" is renamed "Opening Stock a/c" at the beginning of the next
accounting period while bringing the values of assets and liabilities into the books of accounts with the help
of an "Opening Entry".
This "Opening Stock a/c" is treated as an equivalent of a Nominal account.
Like other nominal accounts it is closed at the end of the accounting period. It is closed by transfer to the
"Trading a/c" since it goes into the value of cost of goods sold.
» Note
The value of Opening and Closing stocks relating to a particular accounting period do not mean the same.
They are two indicated by distinct ledger accounts - Opening stock by "Opening Stock a/c" which is a
nominal account and Closing stock by "Closing Stock a/c" which is a Real account.
They may or may not have the same values.

Recording the Value of Closing Stock
The valuation of closing stock and recording of the value of closing stock in the books are two different
aspects.
After ascertaining the value of the closing stock, it is to be brought into the books of accounts.
The basic purpose of accounting is derivation of information and the more information we
need the more the accounting heads we need to maintain.
For each additional piece of information that we intend to derive from the books of accounts, we create and
use an additional ledger account.
Thus, to derive the information relating to Closing Stock we maintain a real account by name "Closing
Stock a/c".
The "Closing Stock a/c" gives the information relating to the value of the stock (as an asset) unsold at the
end of the accounting period.
• Recording
The value of closing stock is not available ready hand in the books of accounts. It is specifically ascertained
at the end of the accounting period by physical verification of stock and its valuation at cost or market price
whichever is lower.
Thus, by recording the journal entry for Closing Stock, we are in effect bringing the value of Closing Stock
into books.
» Debit : Closing Stock a/c

Accounts representing assets are real accounts and show a debit balance. Since by recording the journal
entry for bringing the value of closing stock into books, we are creating an asset by name "Closing Stock
a/c" we debit that account.
[Closing Stock a/c – Real a/c – Debit what comes in.]
» Credit :
There are three possible variations in the account to be credited for recording the value of closing stock.
i. Trading a/c
ii. Goods Consumed a/c
iii. Purchases a/c
The ledger account to be credited is dependent on which account is used to reflect the value of cost of
goods sold as well as the time of recording the entry.

Recording Closing Stock » Crediting Trading a/c
Total value of goods = Opening Stock + Purchases + Direct Expenses.
Opening Stock 20,000

(+) a) Purchases (Cost Value) 2,48,000
b) Direct Expenses 54,000 3,02,000
Total Value of Goods 3,22,000
(−) a) Closing Stock (Value) 36,000
b) Stock Unused for Trading 14,000 50,000
Cost of Goods Sold 2,72,000
» Direct Incomes/Expenses transferred to Trading a/c

At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent
expenses which go into the value of goods/stock (direct expenses), are closed by transfer to the "Trading
a/c".
This would result in the "Trading a/c" being debited with the total value of goods/stock. Show/Hide
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000

3,22,000 3,22,000
» Revealing/Reflecting Cost of Goods Sold

To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of
goods.
Thus the value of closing stock has to be credited to the "Trading a/c" which has the total value of
goods/stock existing in it as a debit balance. Show/Hide
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000 By Cost of Goods Sold 2,86,000

To Purchases 2,48,000 c/d 36,000
To Direct Expenses 54,000 By Closing Stock
3,22,000 3,22,000
To Cost of Goods Sold 2,86,000

b/d
• Journal/Ledger
The Journal entry for recording the value of closing stock in such a case would be
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
31st Dec – Closing Stock a/c Dr – 36,000
To Trading a/c – 36,000
[For recording the value of Closing Stock in the

books.]
Dr Closing Stock a/c Cr

Amount Amount
(in Rs) (in Rs)
To Trading a/c 36,000 By Bal c/d 36,000
36,000 36,000
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

4,16,000 4,16,000
Recording Closing Stock » Crediting Goods Consumed
a/c
Where the organisation intends to specifically identify the cost of goods consumed, a separate ledger
account by name "Goods Consumed a/c" may be created and used for that purpose.
» Direct Expenses transferred to Goods Consumed a/c

At the end of the accounting period, the balances (amounts) in all the ledger accounts which represent
expenses which go into the value of goods/stock (direct expenses), are closed by transfer to the "Goods
Consumed a/c".
This would result in the "Goods Consumed a/c" being debited with the total value of goods/stock.
Show/Hide

Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000

3,22,000 3,22,000
» Revealing/Reflecting Cost of Goods Sold
To reflect/reveal the cost of goods sold, the value of closing stock is to be deducted from the total value of
goods.
Thus the value of closing stock has to be credited to the "Goods Consumed a/c" which has the total value
of goods/stock existing in it as a debit balance. Show/Hide

Amount Amount
(in Rs) (in Rs)
To Opening Stock 20,000 By Trading a/c (?) 2,86,000

3,22,000 3,22,000
The amount transferred to the Trading account represents the Cost of Goods Sold
• Journal/Ledger
The Journal entry for recording the value of closing stock in the books would be
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
To Goods Consumed a/c – 36,000

books.]

Amount Amount
(in Rs) (in Rs)

3,22,000 3,22,000
The balance in the "Goods Consumed a/c" represents the cost of goods sold and is transferred to the
"Trading a/c" to ascertain the Gross Profit.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Goods Consumed 2,86,000 By Sales 3,80,000

3,80,000 3,80,000
Balance in Goods Consumed a/c not representing Cost of
Goods Sold
The balancing figure in the "Goods Consumed a/c" transferred to the "Trading a/c" does not represent cost
of goods sold, in the following cases
• Direct Expenses Transferred to Trading a/c

Where the direct expenses have been transferred to the Trading a/c instead of the Goods Consumed a/c,
the balancing figure in Goods Consumed a/c does not represent cost of goods sold.
Particulars Amount Particulars Amount
(in Rs) (in Rs)

2,68,000 2,68,000
Cost of Goods Sold implies the total value of goods sold which includes both cost of the goods (represented
by purchases a/c balance) and direct expenses related to the goods.
Since Direct Expenses have not been debited to Goods Consumed a/c, the balancing figure represents the
value of goods sold excluding direct expenses thereon.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Direct Expenses 54,000 By Sales 3,80,000

To Goods Consumed 2,32,000
3,80,000 3,80,000
» Recording Closing Stock
Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to
either the Trading a/c or the Goods Consumed a/c.
The only precaution to be taken would be in interpreting the balancing figure value. It should not be
considered as Cost of Goods Sold.
However, in such cases, it would be more appropriate to record the value of closing stock through the
Trading a/c where the value includes both cost and direct expenses.
• Exception
Recording Closing Stock through Goods Consumed a/c would be rational if its value does not include any
part of the direct expenses incurred during the current period which have been debited to the Trading a/c.
• Opening Stock transferred to Trading a/c

Where the balance in "Opening Stock a/c" has been transferred to the Trading a/c instead of the Goods
Consumed a/c, the balancing figure in Goods Consumed a/c may not represent Cost of Goods Sold.
Amount Amount
(in Rs) (in Rs)
To Purchases 2,48,000 By Trading a/c (?) 2,66,000

To Direct Expenses 54,000 By Closing Stock 36,000
3,12,000 3,12,000
The balance in the Goods Consumed a/c transferred to the Trading a/c represents the value of goods that
have been purchased and sold away during the current period.
This does not include the value of opening stock that might also have been sold away. Thus this balance,
cannot be called "cost of goods sold" though it represents value.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

To Goods Consumed 2,66,000
3,80,000 3,80,000
» Recording Closing Stock
Valuation of closing stock is independent of the accounting treatment. Closing Stock can be credited to
either the Trading a/c or the Goods Consumed a/c.
The only precaution to be taken would be in interpreting the balancing figure value. It should not be
considered as Cost of Goods Sold.
However, in such cases, it would be more appropriate to record the value of closing stock through the
Trading a/c where the total value is debited ultimately.
• Exception
Recording Closing Stock through Goods Consumed a/c would be rational closing stock includes only that
stock which has been purchased during the current accounting period.
This would be the case where the quantity of closing stock is less than the quantity purchased during the
current period and stock is being used up on FIFO basis.
Recording Closing Stock » Crediting Purchases
a/c
Where the following conditions exist, we can credit "Purchases a/c" with the value of closing stock.
 Closing stock is physically relatable to the stock that has been purchased during the current
period.
[This would be the case where FIFO method is adopted for physical usage of stock]
 There are no direct expenses in relation to the stock purchased during the current period
(Or)
The value of closing stock does not include the direct expenses incurred during the current period
• Journal/Ledger
The Journal entry for recording the value of closing stock in the books would be
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)

books.]
Dr Purchases a/c Cr
J/ Amount J/ Amount
F (in Rs) F (in Rs)
1st- To Cash/Bank/Crs – 2,48,000 31/12/0 By Closing Stock – 36,000

31st 5 By Trading a/c – 2,12,000
31/12/0
5
2,48,000 2,48,000

Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

3,80,000 3,80,000
• Conventional use
Technically we can credit the value of closing stock to Purchases a/c only when the above conditions are
satisfied.
The use of "Trading a/c" or "Goods Consumed a/c" for crediting the value of closing stock, is possible only if
the journal entry for brining the value of closing stock into books is being recorded at the time of
preparation of final accounts.
Where we are recording the value of closing stock in the accounting books before the preparation of final
accounts, it is a convention that we credit "Purchases a/c" (on account of the absence of "Trading a/c" or
"Goods Consumed a/c" for use).

Closing Stock a/c : Opening Stock a/c
The "Closing Stock a/c" and the end of an accounting period and the "Opening Stock a/c" at the beginning
of the subsequent accounting period represent the same account.
• At the End of an Accounting Period

The closing balances in all the ledger accounts are carried forward to the subsequent accounting periods.
Every ledger posting should have a journal support.
The journal entry that supports the carry forward of balances in ledger accounts is called the "Closing
Entry".
» Closing Entry
The journal entry for closing the books of accounts during an accounting period
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
31st Dec – Creditors a/c Dr – 48,000
Bank Loan a/c Dr – 63,000
Profit & Loss Appropriation a/c Dr – 54,000
Capital a/c Dr – 1,00,000
To Closing Stock a/c – 36,000
To Debtors a/c – 1,26,000
To Furniture a/c – 61,000
[For the balances in the ledger accounts carried
forward to the next accounting period.]
» Closing Balance Sheet

The closing Balance Sheet is a statement of balances that are carried forward to the subsequent accounting
periods.
Balance Sheet of M/s ______ as on the Last Day

Capital 1,00,000 Cash 42,000
Profit & Loss Appropriation 54,000 Closing Stock 36,000
Creditors 48,000 Debtors 1,26,000
2,65,000 2,65,000
• At the beginning of the Subsequent Accounting Period

The opening balances in all the ledger accounts are brought forward from the previous accounting periods.
Every ledger posting should have a journal support and the journal entry that supports the brining forward
of balances in ledger accounts is called the "Opening Entry".
» Opening Balance Sheet

The opening balance sheet of an accounting period and the closing balance sheet of the previous period are
the same. This is something that is not specifically prepared.
Balance Sheet of M/s ______ as on the First Day

Capital 1,00,000 Cash 42,000
Profit & Loss Appropriation 54,000 Closing Stock 36,000
Creditors 48,000 Debtors 1,26,000
2,65,000 2,65,000
» Opening Entry
The opening entry is based on the opening balance sheet.
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
31st Dec – Cash a/c Dr – 42,000
Opening Stock a/c Dr – 36,000
Debtors a/c Dr – 1,26,000
Furniture a/c Dr – 61,000
To Capital a/c – 1,00,000
To Profit & Loss Appropriation a/c – 54,000
To Bank Loan a/c – 63,000
To Creditors a/c – 48,000
[For the opening balances in the various ledger

accounts brought forward into the books of
accounts from the previous accounting period.]
Where the Opening Entry is being recorded, the phrase "Closing Stock" is replaced by the phrase "Opening
Stock".
Closing Stock » Adjustment during Final
Accounting
The value of closing stock is ascertained through physical verification of the stock and its valuation at cost
or market price whichever is lesser.
Thus recording the entries for brining in the value of closing stock into books may not be complete by the
time trial balance is drawn up.
If the value of closing stock is not available (or is not recorded) by the time of making up the trial balance
at the end of the accounting period, it would appear as a part of the transactions appended to the trial
balance which are to be adjusted.
Adjustment is bringing in the effect of the transactions through mathematical operations of addition and
subtraction. The adjustments to be made can be found out by ascertained the net effect of the journal
entries to be recorded.
In adjusting the value of closing stock we consider the entry for recording the same to be the one where
the Trading a/c or Purchases a/c is credited.
 Where the closing stock is recorded by crediting its value to the Trading a/c
Entry Effect
Dr. Closing Stock a/c 1. (+) Show the Value of Closing Stock on the Assets side of the Balance
Sheet
Cr. Trading a/c 2. (+) Show the Value of Closing Stock on the Credit side of Trading a/c
 Where the closing stock is recorded by crediting its value to Purchases a/c
Entry Effect
1. (+) Show the Value of Closing Stock on the Assets side of the Balance Sheet
Dr. Closing Stock a/c
2. (−) Deduct the Value of Closing Stock from Purchases on the Debit side of
Cr. Purchases a/c
Trading a/c
 Where the closing stock is recorded by crediting Goods Consumed a/c
Entry Effect
1. (+) Show the Value of Closing Stock on the Assets side of the Balance
Sheet
Cr. Goods Consumed
2. (+) Show the Value of Closing Stock on the Credit side Goods Consumed
a/c
a/c
 This assumption is generally avoided, where the value of closing stock has to be dealt with as an
adjustment.
Closing Stock in Trial Balance »
Interpretation
Where "Closing Stock a/c" is present in the Trial Balance, it is an indication of the Journal entry for
recording the value of closing stock has already been recorded.
• Dealing with Closing Stock a/c

The "Closing Stock a/c" represents an asset and is thus a Real account.
Since an item appearing in the "Trial Balance" has to be dealt with only once based on its nature, the
Closing Stock a/c appearing in the trial balance is shown on the assets side of the Balance Sheet.
The balance in all the real accounts is carried forward to the subsequent accounting periods. All such
accounts whose balances are carried forward to the subsequent accounting periods are listed in the Balance
Sheet as at the end of the accounting period. Thus all the real account balances are shown on the assets
side of the balance sheet.
• What was the Journal Entry used?

The Journal entry used for recording the value can be identified/assumed depending on what ledger
accounts are present in the Trial Balance
» Trading a/c appears in the Trial Balance
Trial Balance of M/s ___ " as on 30th June 2005
Debit Credit
L/
F
(in Rs) (in Rs)
Opening Stock a/c — 20,000

Purchases a/c — 2,48,000
– —
Closing Stock a/c — 36,000
– —
Trading a/c — 36,000
– —
– —
Total xxx xxx
Where Closing Stock a/c and Trading a/c appear in Trial Balance
← The entry used for recording the value of closing stock.
Cr. Trading a/c
» Trading a/c does not appear, but Purchases a/c appears in the Trial
Balance
Debit Credit
L/
F
(in Rs) (in Rs)
Opening Stock a/c — 20,000

Purchases a/c — 2,12,000
– —
– —
– —
– —
– —
Total xxx xxx
Where Closing Stock a/c and Purchases a/c appear in Trial Balance
Dr. Closing Stock a/c ← The entry used for recording the value of closing stock.
Cr. Purchases a/c
» Both Trading a/c and "Purchases a/c" do not appear in the Trial Balance
Debit Credit
L/
F
(in Rs) (in Rs)
—
Goods Consumed — 2,32,000
– —
– —
– —
– —
– —
Total xxx xxx
Where Purchases a/c and Trading a/c do not appear in the Trial Balance and
Where Closing Stock a/c and Goods Consumed a/c appear in Trial Balance
← The entry used for recording the value of closing stock
Cr. Goods Consumed a/c

Purchases and Sales » Return a/c's
Each ledger account provides one or more pieces of information. To enable derivation of additional
information relating to returns of goods/stock, we record the transactions relating to purchase returns as
well as sales returns using Purchase Returns a/c and Sales Returns a/c respectively.
• Purchases Returns a/c

Purchase Returns a/c is a nominal account. It provides the information relating to the value of goods/stock
returned to the seller from whom the stock has been purchased.
Being a nominal account, this account is closed at the end of the accounting period.
• Sales Returns a/c

Sales Returns a/c is a nominal account. It provides the information relating to the value of goods/stock
returned by the buyers to whom the stock has been sold.
Being a nominal account, this account is closed at the end of the accounting period.
• Gross Purchases and Gross Sales

The Purchase Returns a/c and the Sales Returns a/c provide information relating to returns only.
Since returns are recorded separately using these accounts, the Purchases a/c and Sales a/c give the
information relating to the Gross Purchases and Gross Sales.
• Need for information relating to Net Values
Along with the information relating to the returns and the gross values, the organisation needs the
information relating to the net values i.e. the net purchases and net sales made by it.
There are two methods adopted for deriving the information relating to Net Purchases and Net Sales.
 By Setting off related Ledger account balances.

 By Transferring the balance in the returns accounts to Trading a/c and making adjustments
thereon.
This information is generally derived at the end of the accounting period. However, it can be derived as and
when needed, by deducting the balance in the returns account from the balance in the main account.
Finding Net Purchases/Sales by Setting off related Ledger
Account Balances
SET OFF » Setting off of ledger accounts is clubbing two accounts with opposite
balances. In setting off ledger account balances, we close the account with the lower
balance by transferring it to the account with a higher balance.
• Finding Net Purchases

The Purchases a/c carries a debit balance and the Purchase Returns a/c carries a credit balance. At the end
of the accounting period, the two accounts are set off i.e. the Purchase Returns a/c is closed by transfer to
the Purchases a/c.
Transfer of a credit balance from one account to a second would result in the second
account being credited and the first account being debited.
The balance remaining in the Purchases a/c would thus represent net purchases. While closing the
purchases account at the end of the accounting period, this balance is transferred to the Trading a/c
• Journal/Ledger Show/Hide
The journal entry for recording the transfer would be

Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
March 31st – Purchase Returns a/c Dr – 80,000
[For transferring the balance in the purchase

returns account to the purchases account to
derive the net purchases]
Dr Purchase Returns a/c Cr

Amount Amount
(in Rs) (in Rs)
By – –
To Purchases a/c 80,000 By – –
80,000 80,000
Dr Purchases a/c Cr
Amount Amount
(in Rs) (in Rs)
To – – By Purchase Returns a/c 80,000

To – – By Trading a/c 5,00,000
5,80,000 5,80,000
• Finding Net Sales

The Sales a/c carries a credit balance and the Sales Returns a/c carries a debit balance. At the end of the
accounting period, the two accounts are set off i.e. the Sales Returns a/c is closed by transfer to the Sales
a/c.
Transfer of a debit balance from one account to a second would result in the second
account being debited and the first account being credited.
The balance remaining in the Sales a/c would thus represent net sales. While closing the Sales account at
the end of the accounting period, this balance is transferred to the Trading a/c
• Journal/Ledger Show/Hide
The journal entry for recording the transfer would be

Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
March 31st – Sales a/c Dr – 72,500
To Sales Returns a/c – 72,500
[For transferring the balance in the sales

returns account to the sales account to derive
the net sales]
Dr Sales Returns a/c Cr

Amount Amount
(in Rs) (in Rs)
To – –
To – – By Sales a/c 72,500
72,500 72,500
Dr Sales a/c Cr
Amount Amount
(in Rs) (in Rs)
To Sales Returns a/c 72,500 By – –

To Trading a/c 7,51,500 By – –
8,24,000 8,24,000
• Information in Trading a/c
If this method is adopted for deriving the value of net purchases and sales, the Trading a/c would not
display information relating to returns and would contain postings as To Purchases a/c on the debit side
and the By Sales a/c on the credit side.
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)
To Purchases 5,00,000 Closing Stock 76,000
To Wages 45,000
To Octroi 32,000
To Carriage Inwards 15,000
8,27,500 8,27,500
Transferring balances in Purchases/Sales Returns a/c to
Trading a/c
The Purchase Returns a/c and the Sales Returns a/c being nominal accounts are closed at the end of the
accounting period by transfer to the Trading a/c (instead of to the Purchases a/c and Sales a/c
respectively).
The Purchase Returns a/c carries a credit balance and the "Sales Returns a/c" carries a credit balance.
• Journal
The journal entries for closing these accounts by transfer to the trading account would be
Credit
V/R Debit Amount
No. (in Rs)
(in Rs)
March 31st – Purchase Returns a/c Dr – 80,000
To Trading a/c – 80,000
[For transferring the balance in the purchase

returns account at the end of the accounting
period to the trading account]
March 31st – Trading a/c Dr – 72,500

To Sales Returns a/c – 72,500
[For transferring the balance in the sales

returns account at the end of the accounting
period to the trading account]
• Posting in Trading a/c

The "Trading a/c" with these journal entries posted:
Dr Trading a/c Cr
Amount Amount
(in Rs) (in Rs)

To Purchases 5,80,000 By Purchase Returns 80,000
To Sales Returns 72,500 Closing Stock 76,000
To Wages 45,000
To Octroi 32,000
To Carriage Inwards 15,000
9,80,000 9,80,000
We cannot derive the information relating to Net Purchases and Net Sales by just Posting the entries to the
Trading a/c.
Adjustment in Trading a/c : Information relating to Net
Purchases/Sales
Since the information relating to Net Purchases and Net Sales is not revealed by just transferring the
balances in the returns accounts to the Trading a/c we need to make adjustments to derive that
information.
• Net Purchases
Posting (showing) an amount on the credit side of an account is an equivalent of
deducting the amount from an item on the debit side.
Thus the Purchase Returns a/c balance instead of being shown on the credit side is deducted from
Purchases a/c balance on the debit side of the Trading a/c, thereby giving the figure of Net Purchases in
the Trading a/c itself.
• Net Sales
Posting (showing) an amount on the debit side of an account is an equivalent of
deducting the amount from an item on the credit side.
Thus, the Sales Returns a/c balance instead of being shown on the debit side would be deducted from Sales
a/c on the credit side of the Trading a/c, thereby giving us the figure of Net Sales in the Trading account
itself.
• Deriving from the Trading a/c

Dr Trading a/c Cr

To Purchases 5,80,000 (−) Sales 72,500 7,51,500
(−) Pur. Returns 80,000 5,00,000 Returns 76,000
To Wages 45,000 Closing Stock
To Octroi 32,000
To Carriage 15,000
Inwards 2,40,500
To Gross Profit
8,27,500 8,27,500
Such an adjustment would not affect the figure of gross profit.

Nominal Accounts: - Information Relating To Profits

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• Information relating to Profits

» Trading and Profit and Loss Accounts

• The Position of the organisation

Debtors (Assets) and Creditors

» Debtors represent Assets

» Creditors represent Liabilities

When is the information relating to profits & position

» Period for which profits are ascertained

» Day on which position is ascertained

For example, where the accounting period of an organisation is stated as

 From 1st July to 31st December,

• What Accounting Period to Follow?

Ascertaining the how much of

• Profit = Total (Incomes + Gains) − Total (Expenses + Losses)

• Math of Ascertainment of Profit/Loss

» Nominal Accounts with Debit balances

» Nominal Accounts with Credit balances

Thus the relation to ascertain the profit or loss can be written as

Profit = Sum of balances in Nominal accounts with a Credit Balance

Preparation of Trading and Profit and Loss account

• Transactions making up the Trading and Profit & Loss a/c

Consider the above formula for ascertaining the profit or loss,

Profit = Sum of balances in Nominal accounts with a Credit Balance

» For Ascertaining the sum of balances in Nominal Accounts with a Debit

Therefore the Journal Entry would be

[For the debit balances in the nominal accounts

» For Ascertaining the sum of balances in Nominal Accounts with a Credit

Therefore the Journal Entry would be

[For the credit balances in the nominal accounts

• Trading and Profit and Loss Account (a/c)

31/03/0 – xxx 31/03/0 By Nominal a/c 1 – xxx

sub-total 3,24,000 sub-total 5,80,000

Total 5,80,000 Total 5,80,000

When are the entries

What happens to the Nominal

 Started business with Capital Rs. 1,00,000

Illustration » Solution [Journal and

Journal Entries » Hide/Show

[For the amount brought in by the proprietor

1st to 30th – Bank a/c Dr – 10,000

[For the amount paid into bank.]

1st to 30th – Furniture a/c Dr – 25,000

[For the amount paid towards purchase of

1st to 30th – Purchases a/c Dr – 50,000

[For the amount paid towards purchase of

1st to 30th – Purchases a/c Dr – 15,000

[For the value of goods bought from Ram on

1st to 30th – Bank a/c Dr – 75,000

[For the sales made for cash and the proceeds

1st to 30th – Rahim a/c Dr – 50,000

[For the value of goods sold on credit to Rahim.]

1st to 30th – Salaries and Wages a/c Dr – 5,000

[For the amount paid in cash towards salaries

1st to 30th – Rent Paid a/c Dr – 8,000

[For the amount paid towards rent by cheque.]

Ledger Accounts » Hide/Show

1st-30th To Capital a/c – 1,00,000 1st-30th By Bank a/c – 10,000

Total 1,00,000 Total 1,00,000

30/06/05 To Balance b/d – 10,000

30/06/05 To Bal c/d – 1,00,000 01/06/05 By Cash a/c – 1,00,000

Total 1,00,000 Total 1,00,000

30/06/05 By Balance b/d – 1,00,000