Lesson Notes By Weeks and Term v3 - Junior Secondary 3
Trading, Profit and Loss Account
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Trading, Profit and Loss Account
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Subject: Business Studies
Class: Junior Secondary 3
Term: 1st Term
Week: 9
Theme: Book-Keeping And Business Success
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State the purpose of trading, profit and loss accounts Calculate the cost of goods sold Determine net sales Determine net profit or loss and gross profit Out line the rules for the construction of a simple profit and loss account
The Trading, Profit and Loss Account (often shortened to Income Statement or Statement of Comprehensive Income in more advanced accounting) is a financial statement that summarises the revenues, costs, and expenses incurred during a specific period (e.g., a month, quarter, or year) to determine the net profit or loss for that period. It is typically prepared after the Trial Balance. Purpose of Trading, Profit and Loss Account: The main purposes include: Ascertaining Gross Profit/Loss: To show the profit or loss made purely from buying and selling goods.
Ascertaining Net Profit/Loss: To show the overall profit or loss of the business after all operating expenses and other incomes have been considered.
Performance Measurement: To evaluate the efficiency and effectiveness of the business operations.
Decision Making: Provides information for owners, managers, investors, and creditors to make informed decisions about the business's future.
Taxation: To calculate the taxable income of the business.
Components and Calculations: The Trading, Profit and Loss Account is divided into two main sections: the Trading Account and the Profit and Loss Account.
A. Trading Account Section: This section calculates the Gross Profit or Gross Loss.
1. Sales Revenue (or Turnover): This represents the total value of goods sold by the business.
Gross Sales: Total sales recorded before any returns.
Sales Returns (Returns Inwards): Goods returned by customers to the business. Net Sales = Gross Sales - Sales Returns
Example: If a supermarket in Abuja sells goods worth ₦500,000 but customers return damaged items worth ₦20,000, the Net Sales are ₦500,000 - ₦20,000 = ₦480,000.
2. Cost of Goods Sold (COGS): This is the direct cost attributable to the production or purchase of the goods sold by a business during a period.
Opening Stock: Value of unsold goods at the beginning of the accounting period (i.e., closing stock from the previous period).
Purchases: Value of goods bought by the business for resale during the period.
Purchases Returns (Returns Outwards): Goods returned by the business to its suppliers. Net Purchases = Purchases - Purchases Returns
Example: A textile dealer in Onitsha buys fabrics worth ₦300,000 but returns a faulty batch worth ₦15,
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0. Net Purchases = ₦300,000 - ₦15,000 = ₦285,
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0. Carriage Inwards (Freight In): Costs incurred to bring goods from the supplier's location to the business premises (e.g., transport costs, import duties). These are direct costs added to purchases.
Closing Stock: Value of unsold goods at the end of the accounting period.
Calculation of COGS: Cost of Goods Available for Sale = Opening Stock + Net Purchases + Carriage Inwards Cost of Goods Sold = Cost of Goods Available for Sale - Closing Stock
Example: A provision store starts with stock of ₦100,
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0. It buys goods worth ₦400,000 (after returns) and pays ₦10,000 for transport. At year-end, ₦50,000 worth of goods remain unsold. Cost of Goods Available for Sale = ₦100,000 + ₦400,000 + ₦10,000 = ₦510,000 Cost of Goods Sold = ₦510,000 - ₦50,000 = ₦460,000
3. Gross Profit or Gross Loss: Gross Profit = Net Sales - Cost of Goods Sold (when Net Sales > COGS) Gross Loss = Cost of Goods Sold - Net Sales (when COGS > Net Sales)
Example using previous data: Net Sales = ₦480,000 Cost of Goods Sold = ₦460,000 Gross Profit = ₦480,000 - ₦460,000 = ₦20,000
B. Profit and Loss Account Section: This section calculates the Net Profit or Net Loss.
1. Gross Profit/Loss (carried down): The figure obtained from the Trading Account section is brought down to this section. If it's a Gross Profit, it's an income; if a Gross Loss, it's an expense.
2. Other Incomes (Operating Incomes): Revenues earned from activities other than the primary sale of goods.
Examples: Rent received, discount received, interest received, commission received.
3. Operating Expenses (Overheads): All other expenses incurred in running the business that are not directly related to the cost of goods sold.
Examples: Salaries and wages, rent, electricity, telephone, advertising, depreciation, bank charges, general expenses, discount allowed, carriage outwards (cost of sending goods is brought down to this section. If it's a Gross Profit, it's an income; if a Gross Loss, it's an expense.
2. Other Incomes (Operating Incomes): Revenues earned from activities other than the primary sale of goods.
Examples: Rent received, discount received, interest received, commission received.
3. Operating Expenses (Overheads): All other expenses incurred in running the business that are not directly related to the cost of goods sold.
Examples: Salaries and wages, rent, electricity, telephone, advertising, depreciation, bank charges, general expenses, discount allowed, carriage outwards (cost of sending goods to customers).
4. Net Profit or Net Loss: Net Profit = Gross Profit + Other Incomes - Operating Expenses (when total incomes > total expenses) Net Loss = Operating Expenses - (Gross Profit + Other Incomes) (when total expenses > total incomes)
Example (continuing from above): Gross Profit = ₦20,000 Other Income (e.g., Discount Received) = ₦5,000 Operating Expenses (e.g., Salaries ₦10,000, Rent ₦3,000, Electricity ₦2,000) = ₦15,000 Total Incomes = ₦20,000 + ₦5,000 = ₦25,000 Total Expenses = ₦15,000 Net Profit = ₦25,000 - ₦15,000 = ₦10,000 Rules for Construction of a Simple Trading, Profit and Loss Account (T-Format):
1. Heading: The account must have a clear heading: "Trading, Profit and Loss Account for the Year Ended [Date]".
2. Debit and Credit Sides: It follows the T-format, with a debit side (left) and a credit side (right).
3. Opening Stock: Appears on the debit side of the Trading Account.
4. Purchases and Returns: Net Purchases (Purchases less Returns Outwards) appear on the debit side of the Trading Account.
5. Carriage Inwards: Appears on the debit side of the Trading Account.
6. Sales and Returns: Net Sales (Sales less Returns Inwards) appear on the credit side of the Trading Account.
7. Closing Stock: Appears on the credit side of the Trading Account.
8. Gross Profit/Loss: Calculated in the Trading Account. Gross Profit is recorded on the debit side to balance, then carried down (transferred) to the credit side of the Profit and Loss Account. Gross Loss is recorded on the credit side to balance, then carried down (transferred) to the debit side of the Profit and Loss Account.
9. Other Incomes: All other revenue accounts (e.g., Rent Received, Discount Received) appear on the credit side of the Profit and Loss Account.
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0. Operating Expenses: All other expense accounts (e.g., Salaries, Rent, Electricity, Discount Allowed, Carriage Outwards) appear on the debit side of the Profit and Loss Account.
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1. Net Profit/Loss: Calculated in the Profit and Loss Account. Net Profit is recorded on the debit side to balance, then transferred to the Capital Account. Net Loss is recorded on the credit side to balance, then transferred to the Capital Account.
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2. Double Entry Principle: Remember that each figure is obtained from a ledger account balance (e.g., Sales, Purchases, Expenses) which has already followed the double-entry principle.
Format Example (T-Format): Trading, Profit and Loss Account for the Year Ended 31st December 20XX | Debit Side (₦) | Credit Side (₦) | | :----------------------------------------- | :----------------------------------------- | | Trading Account Section | | | Opening Stock | Sales | | Purchases | Less: Returns Inwards | | Less: Returns Outwards | Net Sales | | Net Purchases | Closing Stock | | Carriage Inwards | | | Cost of Goods Sold | | | Gross Profit c/d | | | Total | Total | | | | | Profit and Loss Account Section | Gross Profit b/d | | Salaries and Wages | Discount Received | | Rent and Rates | Rent Received | | Electricity Expenses | Commission Received | | Depreciation | Total Incomes | | Discount Allowed | | | Carriage Outwards | | | Other Expenses | | | Total Operating Expenses | | | Net Profit (transferred to Capital) | | | Total | Total | | Or | Or | | | Net Loss (transferred to Capital) | Teacher Activities: Introduction and Recap: Begin by asking students what they understand by "profit" and "loss" in business. Recap the concept of a Trial Balance from previous lessons, explaining that the Trading, Profit and Loss Account is prepared from the nominal accounts (revenues and expenses) listed in the Trial Balance.
Explanation of Purpose: Clearly explain the reasons for preparing this account using local examples (e.g., a small shop owner needing to know if they are making money). Use charts or a whiteboard to list and explain the purposes.
Step-by-Step Breakdown: Introduce the Trading Account section.
Explain each component: Sales, Sales Returns, Purchases, Purchases Returns, Carriage Inwards, Opening Stock, Closing Stock. Demonstrate the calculation of Net Sales and Cost of Goods Sold with simple, realistic figures relevant to Nigerian contexts (e.g., a small kiosk selling provisions). Guide students to calculate Gross Profit/Loss. Introduce the Profit and Loss Account section. Explain Gross Profit/Loss b/d, Other Incomes (Discount Received, Rent Received), and Operating Expenses (Salaries, Rent, Electricity, Discount Allowed, Carriage Outwards, Depreciation). Guide students to calculate Net Profit/Loss.
Account Format: Display a sample T-format of the Trading, Profit and Loss Account on the board or chart. Go through each item, indicating its position (debit or credit side) and why.
Rules for Construction: Present and explain the rules for preparing the account, linking them to the format just shown. Worked
Examples: Work through 1-2 comprehensive examples on the board, inviting student participation at each step. Emphasize neatness and clear presentation.
Question and Answer Session: Encourage students to ask questions and provide clear answers to clarify any misconceptions.
Monitoring and Feedback: Circulate around the classroom during student activities, observing their work and providing immediate feedback.
Student Activities: Active Listening and Note-Taking: Students will listen attentively to explanations and take comprehensive notes on definitions, formulas, and rules.
Participation in Discussions: Students will respond to questions, share their understanding of profit/loss, and contribute to class discussions on the relevance of the topic.
Guided Calculations: Students will follow the teacher's examples, performing calculations for Net Sales, COGS, Gross Profit, and Net Profit/Loss individually or in small groups as guided.
Drawing Account Format: Students will practice drawing the T-format of the Trading, Profit and Loss Account.
Problem Solving: Students will attempt guided practice questions, applying the learned concepts and rules to prepare simple accounts.
Peer Learning: Students may discuss problems and solutions with their classmates in small groups.
Instructions for Teacher: Present these questions one by one. Allow students to attempt each, then reveal and explain the solution.
Question 1: Calculating Net Sales A fashion designer in Lagos had gross sales of ₦750,000 for the month of October. During the same month, customers returned clothes worth ₦35,000 due to wrong sizes. Calculate the Net Sales for the month.
Solution 1: Net Sales = Gross Sales - Sales Returns Net Sales = ₦750,000 - ₦35,000 Net Sales = ₦715,000
Commentary: This calculation is crucial as it represents the actual revenue from sales after accounting for customer dissatisfaction or errors.
Question 2: Calculating Cost of Goods Sold A small bookstore in Enugu had the following details for the year ended 31st December 20XX: Opening Stock: ₦80,000 Purchases: ₦320,000 Returns Outwards: ₦15,000 Carriage Inwards: ₦5,000 Closing Stock: ₦95,000 Calculate the Cost of Goods Sold (COGS).
Solution 2: Calculate Net Purchases: Net Purchases = Purchases - Returns Outwards Net Purchases = ₦320,000 - ₦15,000 = ₦305,000 Calculate Cost of Goods Available for Sale: Cost of Goods Available for Sale = Opening Stock + Net Purchases + Carriage Inwards Cost of Goods Available for Sale = ₦80,000 + ₦305,000 + ₦5,000 = ₦390,000 Calculate Cost of Goods Sold (COGS): COGS = Cost of Goods Available for Sale - Closing Stock COGS = ₦390,000 - ₦95,000 COGS = ₦295,000
Commentary: This is a foundational calculation for the Trading Account, showing the direct cost of the items that were actually sold during the period.
Question 3: Calculating Gross Profit Using the Net Sales from Question 1 (₦715,000) and the Cost of Goods Sold from Question 2 (₦295,000), calculate the Gross Profit.
Solution 3: Gross Profit = Net Sales - Cost of Goods Sold Gross Profit = ₦715,000 - ₦295,000 Gross Profit = ₦420,000
Commentary: Gross profit indicates the profitability of a business's core trading activities before considering other operating expenses.
Question 4: Determining Net Profit or Loss Following from Question 3, the bookstore had additional incomes and expenses: Gross Profit: ₦420,000 Discount Received: ₦10,000 Salaries: ₦150,000 Rent: ₦60,000 Electricity: ₦25,000 Carriage Outwards: ₦12,000 General Expenses: ₦18,000 Determine the Net Profit or Net Loss for the year.
Solution 4: Total Incomes: Gross Profit + Discount Received = ₦420,000 + ₦10,000 = ₦430,000 Total Operating Expenses: Salaries + Rent + Electricity + Carriage Outwards + General Expenses = ₦150,000 + ₦60,000 + ₦25,000 + ₦12,000 + ₦18,000 = ₦265,000 Net Profit/Loss: Net Profit/Loss = Total Incomes - Total Operating Expenses Net Profit = ₦430,000 - ₦265,000 Net Profit = ₦165,000
Commentary: Net profit is the ultimate measure of a business's overall profitability after all revenues and expenses have been considered. It shows the true financial success of the business.
Small Business Management: This knowledge is directly applicable to managing any small business in Nigeria, from a local okada (motorcycle taxi) repair shop to a roadside food vendor. Owners can use basic records of sales and expenses to calculate their gross and net profit, helping them understand if their business is viable and make decisions on pricing, purchasing, and cost control. For instance, a tailor can track fabric costs, tailoring fees, and rent to know their profit margin on each garment.
Entrepreneurship and Financial Literacy: For students aspiring to become entrepreneurs, understanding the Trading, Profit and Loss Account is fundamental. It enables them to predict profitability for a business idea, prepare a basic business plan, and effectively manage their startup's finances. It also fosters general financial literacy, allowing them to critically evaluate the financial performance of businesses they encounter or read about.
Investment Decisions: Although JSS3 students might not be directly investing, this topic lays the groundwork for understanding how profitability affects investment decisions. When they see news reports about Nigerian companies' profits or losses, they will have a foundational understanding of what those figures represent and their implications for shareholders and the economy. This connects to themes of national economic development and capital formation in Nigeria.