Generally a
business enterprise prepares books of account for many purposes among others:
- Statutory compliance
- Self-appraisal and reviews
- Determination of profit or loss position
- Payment of taxes and dividend etc
However, many SME have not been able to complete their business books accordingly on account of either knowledge or other reasons, hence they have resulted to rules of thumbs where compelled for the needful to meet any of the purpose above. To this end we are dedicating this edition to importance and basic financial reports/books of accounting for SME.
- Trading Accounts
The aim of preparing trading account is to find out gross profit or gross loss while that of second section is to find out net profit or net loss. The adequacy of information like income details, expenses analysis, purchases and receipts are very key; as understatement of expenses will lead to overstatement of profit and consequently pushed the entity to payment of taxes and dividend from borrowed fund or the business capital.
Preparation of Trading Account
Trading account is prepared mainly to know the profitability of the goods bought (or manufactured) and sold by the businessman. The difference between selling price and cost of goods sold is the gross earning of the business. Thus in order to calculate the gross earning, it is necessary to know: cost of goods sold and sales. Total sales can be ascertained from the sales ledger. The cost of goods sold is, however calculated.
In order to calculate the cost of sales it is necessary to know its meaning. The ‘cost of goods’ includes the purchase price of the goods plus expenses relating to purchase of goods and bringing the goods to the place of business. In order to calculate the cost of goods, we should deduct from the total cost of goods purchased the cost of goods in hand. We can study this phenomenon with the help of following formula:
Opening stock + cost of purchases – closing stock = cost of sales.
As already discussed, the purpose of preparing trading account is to calculate the gross profit of the business. It can be described as excess of amount of ‘Sales’ over ‘Cost of Sales’. This definition can be explained in terms of the equation:
Gross Profit = Sales-Cost of goods sold or (Sales + Closing Stock) – (Stock in the beginning + Purchases + Direct Expenses).
The opening stock and purchases along with buying and bringing expenses (direct exp.) are recorded on the debit side whereas sales and closing stock is recorded on the credit side. If credit side is greater than the debit side the difference is written on the debit side as gross profit, which is ultimately recorded on the credit side of profit and loss account. When the debit side exceeds the credit side, the difference is gross loss, which is recorded at credit side and ultimately shown on the debit side of profit & loss account. Usual Items in a Trading Account:
- A) Debit Side Opening Stock, purchases, buying expenses, manufacturing expenses,
- B) Credit Side Sales, Closing Stock,
Profit and Loss Account
The profit and loss account is opened by recording the gross profit (on credit side) or gross loss (debit side). For earning net profit, a businessman has to incur many more expenses in addition to the direct expenses. Those expenses are deducted from profit (or added to gross loss); the resultant figure will be net profit or net loss. The expenses, which are recorded in Profit and loss account, are called indirect expenses.
