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ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation PDF Download

3.1 TRADING ACCOUNT ITEMS

(a) In a trading firm like a wholesaler, the main business consists of buying and selling the same goods. In addition to the amount of the opening inventory, the trading account will also be debited with all expenses incurred in bringing the goods to the godown of the firm and in making them ready for sale. For example, freight paid on purchases, cartage, octroi, etc. will all be debited to the Trading Account. The rule is that this account will be debited with all expenses incurred in bringing the goods to their present location and condition.

We shall now consider individual items :

(1) Opening Inventory : Since this was closing inventory of the last year, it must have been entered in the opening inventory account, through the opening entry. Therefore, it will be found in the trial balance. This item is usually put as the first item on the debit side of the Trading Account. Of course, in the first year of a business there will be no opening inventory.

(2) Purchases and Purchase Returns : The purchases account will have debit balance, showing the gross amount of purchases made of the materials. The purchase returns account will have credit balance showing the return of materials to the suppliers. On the debit side of the trading account the net amount is shown as indicated (with assumed figures) :

ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation

It happens sometimes that goods are received but the relevant invoice is not received from the supplier. On the date of the closing of the account, an entry must be passed to debit the purchases account and credit the supplier with the cost of goods. One may also exclude such goods from the closing inventory and not pass any entry, but this course is not recommended.

 

(3) Carriage or Freight Inwards : This item should also be debited to the Trading Account, as it is incurred to bring the materials to the firm’s godown and make them available for use. However, if any freight or cartage is paid on any asset, like machinery, it should be added to the cost of the asset and not debited to the Trading Account.


(4) Wages : Wages paid to workers in the godown/stores, should be debited to the Trading Account. If any amount is outstanding, it must be brought into books so that full wages for the period concerned are charged to the Trading Account. However, if wages are paid for installation of an asset, it should be added to the cost of the asset.


(5) Sales and Sales Returns : The sales account will have a credit balance indicating the total sales made during the year. The sales return account will have a debit balance, showing the total amount of goods returned by customers. The net of the two amounts is entered on the credit side of the Trading Account.

Sometimes, goods which have been sold and for which invoice has been prepared may not have been dispatched. If the sale is complete, that is if the customer is liable to pay the amount, such goods should be kept aside and not included in the closing inventory. If however, the sale is not yet complete say, when sent to customers on approval basis, that is when the customer has the right to return the goods within the stipulated period, the cost of the goods should be included in the closing inventory and, if any entry was passed to record the “sale”, it should be reversed.


(6) Closing Inventory and its valuation : Usually there is no account to show the value of goods lying in the godown at the end of the year. However, to correctly ascertain the gross profit, the closing Inventories must be properly taken and valued.

The entry is

Closing Inventory Account

To Trading Account

 

Dr.

 

Alternatively, Closing Inventory can be adjusted with purchases : 

Closing Inventory Account

To Purchases Account

Dr.

 


The effect of this entry is to reduce the debit in the Purchases Account. It will then appear in the trial balance. The Closing Inventory Account is then not entered in the Trading Account and will be shown only in the Balance sheet.

To ascertain value of the closing inventory, it is necessary to make a complete inventory or list of all the items in the godown together with quantities. Of course, damaged or obsolete items are separately listed. To the list of finished goods, one should also add the goods lying with agents sent to them on consignment basis and also the goods sent on approval to customers.

The valuation principle is cost or net realisable value whichever is lower.

Taking inve ntory is quite a lengthy process. Strictly, immediately at the end of the year the taking of inventory should be completed. Sometimes, however this is done either a few weeks before or a few weeks after the closing. In such a case the value of the inventory thus taken must be adjusted to relate it to the closing date. The adjustment will be necessary because, in the meantime, purchases and sales must have been made. The main point to remember is that in respect of sales their cost has been established. Cost will be sales less gross profit.


(7) Sales Tax : Sales Tax is an indirect tax in the sense that it is collected by the seller from the customers and deposited in Government’s Account as per requirements of the Sales Tax Act. Sales tax is generally deducted from gross sales figures and sales tax liability (net of payments) is shown as current liability in the balance sheet.

The Trading Account is very useful; with its help the firm can see the relationship between the costs incurred and the revenues earned and also the level of efficiency with which operations have been conducted. The ratio of gross profit to sales is very significant. It is arrived as 

ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation

In the illustration given under para 3 of the unit, the rate of gross profit is 27.5%.

 

3.2 CLOSING ENTRIES IN RESPECT OF TRADING ACCOUNT

The following entries will be required :

(i) For opening Inventory : Debit Trading Account and Credit inventory Account.

(ii) For purchases returns : Debit Returns Outward Account and Credit Purchases Account.

For returns inward : Debit Sales Account and Credit Returns Inwards Account. (In the trading account information is usually given both in respect of gross sales; and purchases and the respective returns).

(iii) For purchases account : Debit Trading Account and Credit Purchases Account, the amount being the net amount after return.

(iv) For expenses to be debited to the Trading Account, for example wages etc; Debit Trading Account and credit the concerned expenses accounts individually.

(v) For sales : Debit Sales Account with the net amount after returns, and Credit Trading Account.

The student will see that all the accounts mentioned above will be closed with the exception of the Trading Account.

(vi) For closing Inventory : Debit Inventory Account and Credit Trading Account. The  inventory Account will be carried forward to the next year.

Except entries mentioned in (ii) above, the other entries are usually summarised as follows :

(1) Trading Account

To Opening Inventory Account

To Purchases Account

To Wages Account

To Freight on Purchases Account, etc.

Dr.

 

 

 

 

(2) Sales Account

Closing Inventory Account

To Trading Account

At this stage Trading Account will reveal the gross profit, if the credit side is more, or gross loss 

if the credit side is less. The gross profit will be transferred to the Profit and Loss Account by the entry:

Dr.

Dr.

 

Trading Accou nt

To Profit and Loss Account

The entry for gross loss, if there be any is :

Profit and Loss Account

To Trading Account

Dr.

 

 

Dr.

 

 

Illustration 1 

From the following information, prepare a Trading Account of M/s. ABC Traders for the year ended 31st March, 2011 :

ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation

Solution 

 In the books of M/s. ABC Traders  

Trading Account for the year ended 31st March, 2011

ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation

 

Illustration 2 

From the information given in illustration 1, pass necessary closing entries in the journal proper of M/s. ABC Traders.

Solution
 In the Books of M/s. ABC Traders Journal Proper

ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation
ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation
            ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation

 

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FAQs on ICAI Notes 6.2: Final Accounts of Non Manufacturing Entities - 2 - CA Foundation

1. What are final accounts of non-manufacturing entities?
Ans. Final accounts of non-manufacturing entities are the financial statements prepared at the end of an accounting period, such as a year, to provide a summary of the organization's financial performance and position. These entities, which may include service providers, retailers, and other non-manufacturing businesses, prepare final accounts to present information about their income, expenses, assets, liabilities, and equity.
2. What is the purpose of preparing final accounts for non-manufacturing entities?
Ans. The purpose of preparing final accounts for non-manufacturing entities is to assess their financial performance and position. These accounts provide valuable information to the stakeholders, such as investors, creditors, and management, to make informed decisions. The final accounts help in evaluating the profitability, liquidity, and solvency of the non-manufacturing entity and serve as a basis for tax calculations, loan applications, and financial analysis.
3. What are the components of final accounts for non-manufacturing entities?
Ans. The components of final accounts for non-manufacturing entities typically include the following: 1. Trading Account: It shows the gross profit or loss from buying and selling goods or services. 2. Profit and Loss Account: It summarizes the indirect expenses, such as salaries, rent, and administrative costs, and calculates the net profit or loss. 3. Balance Sheet: It provides a snapshot of the organization's financial position by listing its assets, liabilities, and equity. 4. Cash Flow Statement: It outlines the cash inflows and outflows during the accounting period, helping to evaluate the entity's cash management and liquidity.
4. How do you calculate the net profit in the final accounts of non-manufacturing entities?
Ans. To calculate the net profit in the final accounts of non-manufacturing entities, you need to subtract the indirect expenses from the gross profit. Indirect expenses include salaries, rent, administrative costs, depreciation, and other operating expenses. The resulting figure represents the net profit before tax. If there are any additional income or gains, they are added to the net profit before tax to arrive at the net profit after tax.
5. Why is the balance sheet important in the final accounts of non-manufacturing entities?
Ans. The balance sheet is important in the final accounts of non-manufacturing entities as it provides a snapshot of the organization's financial position at a specific point in time. It lists the assets owned by the entity, its liabilities, and the equity of the owners or shareholders. The balance sheet helps in assessing the entity's solvency, liquidity, and financial stability. It is also used by investors, creditors, and management to evaluate the entity's ability to meet its obligations, make investment decisions, and plan for future growth.
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