The trading and profit and loss account

The income statement has two parts. The trading account gives the gross profit, the profit made on the goods themselves. The profit and loss account then takes off the costs of running the office and selling, and gives the net profit.

Trading account. On the debit side: opening stock, purchases less purchases returns, and the direct expenses. On the credit side: sales less sales returns (net sales), and closing stock (next lesson). Sales of ₹3,00,000 with returns inwards of ₹5,000 give net sales of ₹2,95,000.

Direct expenses are everything spent to bring the goods to the point of sale: from buying them until they are finished. Wages for factory workers, carriage inwards (freight to bring goods in), cartage, octroi, factory rent, fuel and power for the machines, coal and gas.

Indirect expenses are the costs of running the business: office rent, salaries of office staff, advertising, carriage outwards (sending finished goods to buyers), bad debts, depreciation. They go to the debit side of the profit and loss account. Other incomes, like commission or interest received, go to its credit side. A plain "rent" in a question means office rent; only "factory rent" is direct.

So: Gross profit = Net sales − (Net purchases + Direct expenses), adjusted for stock. Net profit = Gross profit + Other incomes − Indirect expenses. In the book, Ankit's gross profit is 1,25,000 − 83,000 = ₹42,000, and his net profit is 42,000 + 5,000 − 42,500 = ₹4,500. Gross profit is not the whole revenue of the business; it is only the margin on the goods.

These accounts are made with closing entries: every expense and income account is closed into them. Trading A/c Dr, To Purchases, To Wages...; Sales A/c Dr, To Trading A/c; Profit and Loss A/c Dr, To Salaries, To Rent... The final net profit is transferred to the owner's capital account.