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     Total Direct Expenses:     Purchases     Total Core Profit:     Direct Income − Direct Exp. Indirect Expenses:     Salaries     Rent     Interest     Total Overall Profit:     Core Profit − Indirect Expenses. 3,00,000 3,00,000 2,00,000 2,00,000 1,00,000 18,000 12,000 80,000 1,07,000 − 7,000 3,60,000 3,60,000 2,40,000 2,40,000 1,20,000 18,000 18,000 96,000 1,32,000 − 12,000 4,87,500 4,87,500 3,25,000 3,25,000 1,62,500 28,000 24,000 1,35,000 1,87,000 − 24,500 6,00,000 6,00,000 4,00,000 4,00,000 2,00,000 32,000 30,000 1,65,000 2,27,000 − 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 ____ Date V/R No. Particulars L/F Debit Amount (in Rs) Credit Amount (in Rs) 31st Dec – Trading a/c       To Direct Expenses a/c Dr – – xxxx xxxx [For the transfer of debit balances in the direct expenses accounts to the Trading a/c.] 31st Dec – Direct Incomes a/c       To Trading a/c Dr – – xxxx xxxx [For the transfer of credit balances in the direct incomes accounts to the Trading a/c.] 31st Dec – Trading a/c       To Profit and Loss a/c Dr – – xxxx xxxx [For the transfer of Gross Profit to the Profit and Loss a/c.] 31st Dec – Profit and Loss a/c       To Trading a/c Dr – – xxxx xxxx [For the transfer of Gross Loss to the Profit and Loss a/c.] 31st Dec – Profit and Loss a/c       To Indirect Expenses/Losses a/c Dr – – xxxx 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       To Profit and Loss a/c Dr – – xxxx 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 Particulars Amount (in Rs) Particulars Amount (in Rs) To Purchases To Gross Profit 2,40,000 1,20,000 By Sales a/c 3,60,000   3,60,000   3,60,000 Dr Profit & Loss a/c [For the year 2003] Cr Particulars Amount (in Rs) Particulars Amount (in Rs) To Salaries To Rent To Interest 18,000 18,000 96,000 By Gross Profit By Net Loss 1,20,000 12,000   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 Particulars Amount (in Rs) Particulars Amount (in Rs) To Purchases To Gross Profit 2,40,000 1,20,000 By Sales a/c 3,60,000   3,60,000   3,60,000 To Salaries To Rent To Interest 18,000 18,000 96,000 By Gross Profit By Net Loss 1,20,000 12,000   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.

Author Credit : The Edifier

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