Trading account is prepared to find out the amount of Gross Profit or Gross Loss in a particular period of time. Gross Profit or Gross Loss is the amount of difference between the cost of goods sold and the price of goods sold. Gross profit or loss can be ascertained with the help of the following equation.
Gross Profit = Sales – Cost of goods sold.
Gross Loss = Cost of goods sold – Sales
If the amount of sales is more than the cost of goods sold, the result will be Gross Profit but if the amount of sales is less than the cost of goods sold, the result will be Gross Loss. Cost of goods sold may be ascertained by adjusting the figures of opening and closing stock to the amount of purchases made during the year and adding direct expenses into it. Cost of goods sold = Purchasing during the year of opening stock – Closing stock = Production expenses. Thus trading account simply tells about the gross profit or loss, made by a business on purchasing and selling of goods. It does not take into account the other opening expenses incurred by him during the course of running the business. The balancing figure of trading account – Gross Profit or Gross Loss is transferred to Profit and Loss Account. That is why trading account is treated as sub-section of the Profit and Loss account and it is prepared before the preparation of Profit and Loss Account.