Preparing the Trading Account, Profit & Loss Account and Balance Sheet

At the end of an accounting year, a business turns its trial balance into three things

every owner, lender and tax authority actually cares about: how much gross profit it made

on trading, how much net profit remains after running expenses, and what it owns and owes

on the closing date. These three questions are answered by two accounts and one statement,

prepared together as the "final accounts."

1. Trading Account — finds Gross Profit

The Trading Account isolates the profit earned purely from buying and selling goods,

before any office/administrative expenses are considered.

Direct expenses are the costs of bringing goods into a saleable condition and location —

wages (factory/godown labour), carriage inward (freight on purchases), and similar costs

incurred before the goods reach the sales counter. The Trading Account's balancing figure,

Gross Profit (or Gross Loss), is carried down to the Profit & Loss Account.

2. Profit & Loss Account — finds Net Profit

Starting from Gross Profit, every indirect (office, selling, administrative, financial)

expense is deducted, and every indirect income (commission received, interest received,

discount received) is added.

The resulting Net Profit (or Net Loss) belongs to the owner and is transferred to the

Capital Account in the Balance Sheet — it is not left sitting in the Profit & Loss Account.

3. Balance Sheet — shows the financial position

The Balance Sheet is not an account at all — it is a statement, prepared as on a

particular date, listing:

• Liabilities (left, in the traditional format used in India): Capital (opening capital + net profit − drawings, or − net loss), and outside liabilities such as Bills Payable, Sundry Creditors and loans.
• Assets (right): Fixed assets (Machinery, Building, Furniture), Current assets (Bank, Cash, Sundry Debtors, Closing Stock).

Because of the double-entry system's dual-aspect concept, the two sides of a correctly …