All the nominal accounts are closed at the end of the accounting period by transfer to the Trading and Profit and Loss a/c.

Thus in the Trading and Profit and Loss a/c

• the debits are from nominal accounts with debit balances, representing expenses and losses.
• the credits are from nominal accounts with credit balances, representing incomes and gains.

The net balance in the Trading and Profit and Loss account would be the balance remaining after setting off these transferred balances which amounts to setting off expenses/losses against incomes/gains. The balance in the Trading and Profit and Loss account will be the profit or loss made during the accounting period relating to which the account is being prepared.

Information obtained from the Trading and Profit and Loss a/c

The Trading and Profit & Loss a/c gives us the information relating to the overall profit or loss made by the organisation during the accounting period at the end of which it is being prepared.

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	20_2	20_3	20_4	20_5
Purchases Salaries Rent Interest Sales	2,00,000 15,000 12,000 80,000 3,00,000	2,40,000 18,000 18,000 96,000 3,60,000	3,25,000 28,000 24,000 1,35,000 4,87,500	4,00,000 32,000 30,000 1,65,000 6,00,000

If we are making a combined Trading and Profit & Loss a/c the profits/losses made by the organisation would be:

Account Head	20_2	20_3	20_4	20_5
a) Incomes Sales	3,00,000	3,60,000	4,87,500	6,00,000
Total	3,00,000	3,60,000	4,87,500	6,00,000
b) Expenses Purchases Salaries Rent Interest	2,00,000 15,000 12,000 80,000	2,40,000 18,000 18,000 96,000	3,25,000 28,000 24,000 1,35,000	4,00,000 32,000 30,000 1,65,000
Total	3,07,000	3,72,000	5,12,000	6,27,000
c) Profit/Loss (a) − (b)	− 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 as 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

Trading and Profit & Loss a/c (for the year 20_3)

DrCr
Particulars	Amount	Particulars	Amount
To Purchases To Salaries To Rent To Interest	2,40,000 18,000 18,000 96,000	By Sales a/c By Balance (Loss)	3,60,000 12,000
Total	3,72,000	Total	3,72,000

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 the figures arrived at through a combined Trading and Profit and Loss account may be detrimental to the organisation.

Remedy : Segregate 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 segregated 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 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	20_2	20_3	20_4	20_5
a) Direct Incomes Sales	3,00,000	3,60,000	4,87,500	6,00,000
Total	3,00,000	3,60,000	4,87,500	6,00,000
b) Direct Expenses Purchases	2,00,000	2,40,000	3,25,000	4,00,000
Total	2,00,000	2,40,000	3,25,000	4,00,000
c) Core Profit (a) − (b)	1,00,000	1,20,000	1,62,500	2,00,000
d) Indirect Expenses Salaries Rent Interest	18,000 12,000 80,000	18,000 18,000 96,000	28,000 24,000 1,35,000	32,000 30,000 1,65,000
Total	1,07,000	1,32,000	1,87,000	2,27,000
e) Overall Profit (c) − (d)	− 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 a/c : Gross Profit

All the nominal accounts representing Direct expenses and Direct Incomes are closed at the end of the accounting period by transfer to the Trading a/c. Trading a/c thus gets debited with Direct Expenses and Credited with Direct Incomes.

The Trading a/c is prepared to ascertain the Profit from the core operations of the business. The balance in the account indicates either a profit (when it is a credit balance) called Gross Profit or a loss (when it is a debit balance) called Gross Loss.

The Trading a/c provides the information relating to the Gross Profit/Loss made by the organisation.

Gross Profit

The profit or loss revealed by the Trading a/c is called Gross Profit or Gross Loss respectively.

This 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

All the nominal accounts representing Indirect expenses, losses, indirect incomes and gains are closed at the end of the accounting period by transfer to the Profit and Loss a/c. Profit and Loss a/c thus gets debited with Indirect expenses and losses and credited with Indirect incomes and gains.

The Profit and Loss a/c is prepared to ascertain the overall Profit from the operations of the business. The balance in the account indicates either a profit (when it is a credit balance) called Net Profit or a loss (when it is a debit balance) called Net Loss.

The Profit and Loss a/c provides the information relating to the Net Profit/Loss made by the organisation.

Net Profit

The profit or loss revealed by the Profit and Loss a/c is called Net Profit or Net Loss respectively.

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.

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

Journal in the books of M/s ___ for the period from ____ to ____

Particulars		Amount (Dr)	Amount (Cr)
Trading a/c To Direct Expenses a/c	Dr	–	–
[For the transfer of debit balances in the direct expenses accounts to the Trading a/c.]
Direct Incomes a/c To Trading a/c	Dr	–	–
[For the transfer of credit balances in the direct incomes accounts to the Trading a/c.]
Trading a/c To Profit and Loss a/c	Dr	–	–
[For the transfer of Gross Profit to the Profit and Loss a/c.]
Profit and Loss a/c To Trading a/c	Dr	–	–
[For the transfer of Gross Loss to the Profit and Loss a/c.]
Profit and Loss a/c To Indirect Expenses/Losses a/c	Dr	–	–
[For the transfer of debit balances in the indirect expenses accounts and accounts indicative of losses to the Profit and Loss a/c.]
Indirect Incomes/Gains a/c To Profit and Loss a/c	Dr	–	–
[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 at the end of year 20_3 would therefore be

Trading a/c

DrCr
Particulars	Amount	Particulars	Amount
To Purchases To Profit & Loss a/c	2,40,000 1,20,000	By Sales	3,60,000
	3,60,000		3,60,000

Profit & Loss a/c

DrCr
Particulars	Amount	Particulars	Amount
To Salaries To Rent To Interest	18,000 18,000 96,000	By Trading a/c By Capital a/c	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.

Trading and Profit and Loss a/c

DrCr
Particulars	Amount	Particulars	Amount
To Purchases To Profit and Loss a/c	2,40,000 1,20,000	By Sales	3,60,000
	3,60,000		3,60,000
To Salaries To Rent To Interest	18,000 18,000 96,000	By Trading a/c By Capital a/c	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 and Profit and Loss a/c

DrCr
Particulars	Amount	Particulars	Amount
To Purchases To Profit and Loss a/c	2,40,000 1,20,000	By Sales	3,60,000
	3,60,000		3,60,000
To Salaries To Rent To Interest	18,000 18,000 96,000	By Trading a/c By Capital a/c	1,20,000 12,000
	1,32,000		1,32,00

Interpreting transfer of profits

The debit to the Trading a/c reading 'To Profit and Loss a/c' or the credit to the Profit and Loss a/c reading 'By Trading ac/' which is for transfer of gross profit to the Profit and Loss a/c can be interpreted as

• Transfer of a credit balance from the Trading a/c to the Profit and Loss a/c or

  Transfer of credit balance from one account to another results in the second account being credited and the first account being debited.

• Transfer of a debit balance from the Profit and Loss a/c to the Trading a/c

  Transfer of debit balance from one account to another results in the second account being debited and the first account being credited.

The posting just gives an idea of the fact that there is a transfer. The reason for transfer and the direction of transfer cannot be interpreted without ambiguity.

Similar ambiguity exists in interpreting the posting relating to transfer of Gross Loss, Net Profit and Net Loss.

To overcome ambiguity - use intermediary accounts

To overcome the ambiguity in the information provided through the posting, we route the transfer through an intermediary account thereby providing clearer information relating to the transfer. Gross Profit a/c and Net Profit a/c are such accounts. The sole purpose of these accounts is to provide greater information.

Gross Profit a/c, Gross Loss a/c, Net Profit a/c, Net Loss a/c

While transferring the gross profit from the Trading a/c to the Profit and Loss a/c, the use of term To Gross Profit in place of To Profit and Loss a/c is made possible by using an additional ledger account by name Gross Profit and transferring gross profit to the relevant account instead of to Profit and Loss a/c directly. .

Trading a/c

DrCr
Particulars	Amount	Particulars	Amount
To Purchases To Gross Profit  Profit & Loss a/c	2,40,000 1,20,000	By Sales	3,60,000
	3,60,000		3,60,000

Thereafter, the amount is transferred to the Profit and Loss account from the Gross Profit a/c.

Journal in the books of M/s ___ for the period from ____ to ____

Particulars		Amount (Dr)	Amount (Cr)
Trading a/c To Gross Profit a/c	Dr	1,20,000	1,20,000
[For the gross profit transferred from trading account.]
Gross Profit a/c To Profit and Loss a/c	Dr	1,20,000	1,20,000
[For the gross profit transferred to the profit and loss account.]

If there is a loss shown by the Trading a/c, then an account by name Gross Loss is used for such a transfer.

Journal in the books of M/s ___ for the period from ____ to ____

Particulars		Amount (Dr)	Amount (Cr)
Gross Loss a/c To Trading a/c	Dr	–	–
[For the gross loss transferred from trading account.]
Profit and Loss a/c To Gross Loss a/c	Dr	–	–
[For the gross loss transferred to the profit and loss account.]

Similarly the net profit from the Profit and Loss a/c would be transferred to Net Profit a/c.

Journal in the books of M/s ___ for the period from ____ to ____

Particulars		Amount (Dr)	Amount (Cr)
Net Profit a/c To Profit and Loss a/c	Dr	–	–
[For the net profit transferred from profit and loss account.]
Capital a/c To Net Profit a/c	Dr	–	–
[For the net profit transferred to capital.]

The net loss from the Profit and Loss a/c would be transferred to Net Loss a/c.

Journal in the books of M/s ___ for the period from ____ to ____

Particulars		Amount (Dr)	Amount (Cr)
Net Loss a/c To Profit and Loss a/c	Dr	12,000	12,000
[For the net loss transferred from profit and loss account.]
Capital a/c To Net Loss a/c	Dr	12,000	12,000
[For the net loss transferred to capital.]

The trading and profit and loss accounts on using these accounts would be

Trading a/c

DrCr
Particulars	Amount	Particulars	Amount
To Purchases To Gross Profit	2,40,000 1,20,000	By Sales	3,60,000
	3,60,000		3,60,000

Profit & Loss a/c

DrCr
Particulars	Amount	Particulars	Amount
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

This would enable giving a clear information regarding why the transfer is being made. This is helpful, since transfer of gross profit/loss is not the only reason why an amount is transferred from the trading a/c to the profit and loss a/c. Similarly transfer of net profit/loss is not the only reason why an amount is transferred from the profit and loss account to the capital account.

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 we intend to make use of such a facility in computerised accounting, care should be taken to ensure that all the relevant intermediary accounts are created and the required journal entries are passed.

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.

Since these two accounts are prepared by transferring the debit and credit balances in the nominal accounts, the total postings in these accounts having a nominal nature, these accounts would also be nominal accounts.