LESSON 4 THE TRIAL BALANCE; TRADING AND.PDF

LESSON 4: THE TRIAL BALANCE; TRADING AND PROFIT/LOSS ACCOUNTS AND THE BALANCE SHEET: MORE FEATURES The objectives: After carefully studying this lesson, you should be able to: recognise different forms of carriage recognise the structure of income, cost and profit prepare a Trial Balance, a Trading and profit and loss account & the Balance sheet distinguish between fixed and current assets, as well as between longer-term and current liabilities INTRODUCTION You will also learn about the purpose of the trial balance and how to prepare one Then, you will be introduced the different typeds of profits and how they are calculated in the Trading and Profit & Loss accounts You will learn how to transfer net profit and drawings to the Capital assount at the end of the period Finally, you will learn how to present the assets, liabilities and capital on the balance sheet in a more meaningful and informative format I THE TRIAL BALANCE Double-entry book-keeping is based on the matching principle: for every amount on the debit side there is an equivalent amount on the credit side If over a period of time – say, a month – all transactions have been entered correctly, then it follows that The sum of the debits = the sum of the credits Refer now to the example relating to James Meredith in Lesson and A Trial Balance at the end of May Year would appear like this: Trial Balance of James Meredith at 31 May Year Dr (£) Cr (£) Capital 5,000 Cash 100 Bank 4,305 Office furniture 350 Purchases 390 Sales 335 Returns Inwards 65 Returns Outwards 50 Rendell Supplies 50 Wages 40 Insurance 55 Drawings 130 5,435 5,435 Note that N Tibbs has not been included as there is a NIL balance at 31 May Year The heading should always include the name of the firm concerned and the date at which the Trial Balance is drawn up Knowing the side of the Trial Balance on which you would expect an account to appear will be of great help in drawing one subsequently in any check you might have to do: Debit balance Credit balance - cash - capital - asset accounts, e.g office - loan to the business furniture - creditors - debtors - sales - purchases - returns outwards - returns inwards - expense accounts, e.g wages, insurance - drawings Bank account may have either a debit or a credit balance Credit balances on the bank account, i.e where the account is ‘overdrawn’ If the trial balance agrees, this does not prove that all the transactions have been entered correctly A transaction may, for example, have been omitted completely from the books You shall consider this further in the later lessons The trial balance is important as a means of checking It is also a preliminary to the preparation of the ‘final accounts’ of a business – to which you shall be turning your attention in the next parts II TRADING AND PROFIT AND LOSS ACCOUNTS II.1 Methods of calculating different types of profit Gross profit The account by which sales income exceeds cost of goods sold (Sales Revenue – Cost of Goods sold) Net profit The remaining profit – after allowing for other costs (Gross profit + Other income – Running expenses) • In Trading account, you will calculate Gross Profit • In Profit and Loss account, you will calculate Net profit (a) income from sales = Sales Revenue Cost of goods sold (b) Other income, e.g rent receivable Running expenses Gross profit Net profit Income = (a) Income from Sales + (b) Other income II.2 Final accounts: More features II.2.1 Returns In Lesson 2, you studied Returns Inwards and Returns Outwards Therefore, in final accounts Returns are treated as below: Purchases – Returns outwards = Net Purchases Sales – Returns inwards = Net Sales II.2.2 Carriages Carriages include Carriage inwards and Carriage outwards a Carriage inwards: Payment for having purchases delivered Carriage inwards is deducted in amount of Purchases b Carriage outwards: A charge paid by the firm to carrier for delivering goods to customers: Cost of distribution Carriage outwards is treated as an expense; therefore, it is added into expenses column * Both carriage inwards and carriage outwards have debit balance II.3 Preparation of trading and profit and loss account II.3.1 Calculation of ‘Cost of goods sold’ A DOBBS TRIAL BALANCE AT 30 JUNE YEAR Dr (£) Purchases 22,500 Sales 67,310 Stock at July, year 1,200 Debtors 1,250 Creditors Cr (£) 2,210 Carriage inwards 410 Carriage outwards 730 Returns inwards 1,450 Returns outwards Office expenses Insurances 1,240 2,150 550 Wages 3,000 Premises 47,300 Furniture and fittings 26,540 Cash at bank 11,950 Cash in hand 1,750 Drawings 1,100 Capital 51,120 121,880 121,880 When the Trial balance shows agreement, you first draw up the trading account To this, it is necessary to calculate Cost of goods sold Opening stock + Purchases + Carriage inwards - Returns outwards - Closing stock = Cost of goods sold In this example, at the end of Year 5, A Dobbs still has £2,500 of goods left of his purchases These will be available for selling in year £ Cost of goods sold = £ Opening stock Purchases 1,200 22,500 Carriage inwards 410 22,910 - Returns outwards 1,240 21,670 22,870 - Closing stock 2,500 20,370 Note: Closing stock is not included in the list of balances in the Trial balance since it will appear as Opening stock for the next accounting period Closing stock should be valued in order to know the quantity of goods he had left II.3.2 Preparation of trading and profit and loss account It is most important to recognise that the trading and profit and loss account is part of the double-entry system, so that if you make a debit entry in it there must be an equivalent credit entry elsewhere in the system A DOBBS Trading and Profit and Loss Account for the Year ended 30 June Year £ £ £ Opening stock 1,200 Sales 67,310 Purchases 22,500 less Returns inwards 1,450 Carriage inwards 410 22,910 - Returns outwards 1,240 21,670 22,870 - Closing stock 2,500 Cost of goods sold 20,370 Gross Profit c/d 45,490 65,860 65,860 £ £ Carriage outwards 730 Gross Profit b/d 45,490 Office expenses Insurances 2,150 550 Wages Net Profit 3,000 39,060 45,490 Note: 45,490 - Purchases, Sales, Returns inwards, Returns Outwards and Carriages Inwards are closed off to Trading account - Expense accounts, together with other income accounts, will be closed off to Profit and Loss account - Double-entry for the item ‘net profit’ is a credit to the capital account - Profit represents an increase of capital - The total of drawings for the year will be transferred to the debit of capital account III THE BALANCE SHEET Following completion of the trading and profit and loss account, you are left with the asset, liability and capital balances These you list in a statement termed the balance sheet The asset, liability and capital accounts are closed off to the balance sheet Each of these accounts retains its balance, and the balance sheet simply lists them without being part of the double-entry system Here is the layout of a two-sided balance sheet: A DOBBS BALANCE SHEET AT …… Fixed assets Premises capital …… Fixtures and fittings add Net profit …… ……… Machinery ……… Motor vehicle ……… ……… less Drawings…… ……… Amount due in more than year Current assets Loan from …… Stock ……… Amount due within 12 months Debtors ……… Creditors …… ……… Bank ……… Cash ……… ……… Following the Trading and Profit and Loss of A Dobbs in the previous part, his balance sheet was also made at that date as below: A DOBBS BALANCE SHEET AT 30 JUNE YEAR £ Fixed assets £ Capital Premises 47,300 Furniture and fittings 51,120 add Net profit 39,060 26,540 less Drawings 1,100 73,840 Current assets 37,960 89,080 Amount due within Stock 2,500 12 months Debtors 1,250 Creditors Cash at bank 11,950 Cash in hand 1,750 17,450 91,290 Note: £ 2,210 91,290 - In two-sided balance sheet, the practice is to show assets on the left-hand side and capital together with liabilities on the right-hand side - If entries have been correctly made to the point of obtaining the net profit figure, the recording in the balance sheet of the remaining balances should result in agreement between the two sides of the balance sheet - Assets are groups into headings: Fixed assets and current assets III.1 Fixed assets Fixed assets are those which are expected to have a long or relatively long life in the business and were not brought primarily with the purpose of reselling them ‘Life in the business could mean 2-3 years for, say, motor vehicles or indefinite life, as with premises Examples of fixed assets are land and buildings (or premises), fixtures and fittings, machinery, office equipment and motor vehicles III.2 Current assets Current assets are those which at least appear to make more direct contribution to the income of the firm They are more obviously involved in the trading activities of the firm and are expected to have a short life: e.g stocks, debtors, cash at bank or cash in hand With each of the above two groups, the assets are listed with the most permanent assets and work through to the most easily turned into cash as in the sample layout above The right-hand side of the balance sheet is normally laid out in the following sequence: • Capital • Long-term liabilities or amounts payable in more than year (e.g a loan repayable in year’s time) • Short-term liabilities or amounts due within 12 months (e.g creditors, bank overdraft or short-term bank loan) SUMMARY The trading and Profit & Loss account is used to calculate profit (or Loss) for a specific period of time, usually a year It has two sections: the trading account and the profit & Loss account Returns inwards is deducted from sales in the trading account Returns outwards is deducted from purchases in the trading accounts Carriage inwards is the cost of transporting goods from duppliers into the business It is added to purchases in the trading account Carriage outwards is the cost of delivering goods to customers It is shown as an expense in the profit and loss account Gross profit is the amount by which sales exceed cost of goods sold If cost of goods sold is more than sales this is a gross loss Gross profit/ loss is calculated in the trading account Net profit is the amount by which the gross profit or loss, plus any revenue other than sales, exceeds total operating expenses incurred during the period Where expenses incurred exceed the gross profit or loss, plus other revenues, this is a net loss Net profit/ loss is calculated in the profit and loss account The trading and profit & Loss account is part of the double entry system To show the effect of profit/loss on capital, the net profit is transferred to the capital account on the credit side Drawings are also transferred to the capital account on the debit side 10 Net current asset is the difference between current assets and current liabilities 11 The balance sheet is not part of double entry system 12 The balance sheet show assets on the left-hand side and capital and liabilities on the right hand side 13 Assets are grouped as fixed assets or current assets Fixed assets are listed in descending order of permanence and current assets are listed in increasing order of liquidity 14 Liabilities are grouped as either long-term liabilities or current liabilities Current liabilities are those that are due for payment within one year and longterm liabilities are those amounts payable in more than one year I hope you will be successful! GLOSSARY Carriage (n) Phí vận chuyển carriage inwards (n) Phí vận chuyển hàng hóa mua vào carriage outwards (n) Phí vận chuyển hàng hóa bán closing stock (of goods) (n) Hàng tồn cuối kỳ cost (n) Chi phí cost of goods sold (n) Giá vốn hàng bán current asset (n) Tài sản lưu động current liability (n) Nợ ngắn hạn Exceed (v) Vượt fixed asset (n) Tài sản cố định Income (n) Thu nhập long-term liability (n) Nợ dài hạn Loss (n) Thua lỗ opening stock (of goods) Hàng tồn đầu kỳ profit (n) Lợi nhuận Gross profit Lợi nhuận gộp Net profit Lợi nhuận ròng sales revenue (n) Doanh thu bán hàng trading (n) Kinh doanh Trial balance (n) Bảng cân đối thử/ kết toán kiểm tra ... included as there is a NIL balance at 31 May Year The heading should always include the name of the firm concerned and the date at which the Trial Balance is drawn up Knowing the side of the Trial. . .The sum of the debits = the sum of the credits Refer now to the example relating to James Meredith in Lesson and A Trial Balance at the end of May Year would appear like this: Trial Balance... completely from the books You shall consider this further in the later lessons The trial balance is important as a means of checking It is also a preliminary to the preparation of the ‘final accounts’