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Nature of Trading Businesses
Chapter 5

 Would you please tell me three most common

type of businesses?

Accounting for
Trading Business

Manufacturing

Services

Trading

Objectives

Nature of Trading Businesses

 Distinguish the activities of a service business from those of a

 Which type of business has the most complex

trading business

accounting system?

 Journalise the entries for trading transactions

 Prepare a profit and loss statement for a trading business

Contents
1. Nature of Trading Businesses
2. Accounting for Purchases
3. Accounting for Sales
4. Trade Discounts
5. Transportation Costs
6. Profit and loss statement for a trading
business

Manufacturing

Nature of Trading Businesses
 Why?
Service Business
Fees

X

Expenses

(X)

Net Profit

X

Trading Business
Sales

COGS
Gross Profit
Operate Expenses
Net Profit

X
(X)
X
(X)
X

COGS in a manufacturing business: Material, Labour and
Overhead

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Nature of Trading Businesses

Accounting for Purchases
2. Periodic Inventory System

COGS

Purchase
Goods

Re-sale

Inventory is accounted for at the end of the period
COGS = Opening Balance + Purchase – Closing Balance

Goods on hand at the end of the month or the
year (Inventory)

Accounting for Purchases
1. Perpetual Inventory System
2. Periodic Inventory System
3. Purchase

Stocktaking

Accounting for Purchases
3. Purchase
 Could be made:

4. Purchases discounts

- By Cash

5. Purchases Returns and Allowances

- On Credit
- By Mixture (Cash + Credit)

Accounting for Purchases
1. Perpetual Inventory System
Each purchase and sale of goods is recorded in an

Inventory Account. The amount of goods available for
sale and the amount sold are continuously (perpetually)
shown in the inventory records.

Accounting for Purchases
 Purchase by Cash
 Debit Inventory


Credit Cash

 Purchase on Credit
 Debit Inventory


Credit Trade Payable

Closing Balance = Opening Balance + Purchase - Sale
 Purchase on Mixture
 Debit Inventory



Credit Cash
Credit Trade Payable

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Accounting for Purchases
 Purchase discounts: reduced amount when making early

payment

 Credit terms: Terms for when payments for goods are to be

made

 Not allowed an amount of time to pay: Cash or Net Cash
 Allowed an amount of time to pay: Credit

 Credit period: Amount of time allowed before a payment is

required (begin with the date of the sale as shown on the
invoice) (30 days, 45 days, 90 days, etc)

Accounting for Purchases
5. Purchases Returns and Allowances
Debit Trade Payable
Credit Purchases Returns and Allowances
 When goods are returned or price is adjusted,

buyer usually sends the seller a letter – called
debit note or debit memorandum

Accounting for Purchases

Accounting for Sales

Credit terms: Cash or Credit

1. Sales

Could be express:

n/30
n/eom
2/10

2. Sales Discounts
3. Sales Returns and Allowances
4. Goods and Services Tax
5. Trade Discounts

Could use more than 1 term together

2/10, n/30

Accounting for Purchases
4.

Purchases discounts

Purchase good (assume on credit)
Debit Purchase
Credit Trade Payable
When making early payment (enjoy purchases discounts)
Debit Trade Payable

Credit Cash/Bank Account
Purchases Discounts

Accounting for Sales
1. Sales:
 Could be made:
- By Cash
- On Account
- By Mixture (Cash + Credit)

Note: These discounts reduce the cost of the goods purchased

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Accounting for Sales

Accounting for Sales

 Sales by Cash

2. Sales Discount

 Debit Cash


Credit Sales/Sales Revenue

Debit Cash
Debit Sales Discounts
Credit Account Receivable

 Sales on Account
 Debit Trade Receivable


Credit Sales/Sales Revenue

 Sales on Mixture
 Debit Trade Receivable
 Debit Cash


Credit Sales/Sales Revenue

Accounting for Sales

Accounting for Sales

 Sales made with the use of credit cards? (Master cards, VISA,

3.

etc)
 Will create a receivable with the card companies. These
companies will charge a service fee.

Sales on credit cards:

Debit Account Receivable (Card Company)
Credit Sales
Receive money from card company:
Debit Cash
Debit Credit Card Expenses
Credit Account Receivable (Card Company)

Sales Returns and Allowances
Goods sold be returned to seller (sales return)
The seller may reduce the initial price because of defects
(sales allowance)

The seller usually issues the buyer a credit note or credit
memorandum
This will reduce sales. However, manager may want to know
the amount of returns and allowances for a month or a year
 open contra sales accounts

Accounting for Sales
2. Sales Discounts

Accounting for Sales
4. Goods and ServicesTax (GST)

Seller may offer the buyer credit terms that include
a discount for early payment.

In some countries, this type of tax could be also
known under the name Value Added Tax (VAT)

In theory, discount for early payment will reduce
Sales/Sales Revenues (Debit it!!!). However,
managers may want to know the amount of sales
discount for the period  Open Sales Discounts
Account (Contra Sales Account)

Businesses are authorised to charge and collect GST
(or VAT) on behalf of the Controller of GST (Tax
Authority)

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Accounting for Sales

Transportation Costs

4. Goods and Services Tax (GST)

 Sale is determined when ownership (title) of the

In some countries, this type of tax could be also known
under the name Value Added Tax (VAT)

good passes to the buyer.

GST Payable (When sale is made)
GST Receivable (When purchase is made)

At the end of each quarter, business pays the net amount of
tax (ie GST Payable – GST Receivable)

Trade Discounts

 This point determines which party (buyer or

seller) must pay the transportation costs.

Transportation Costs

 Businesses may offer special discounts for large quantities

Buyer Pays

Shipping
Point

FOB (Free On Board)

Destination
Seller Pays

Trade Discounts

Transportation Costs

 Sellers and buyers do not normally record the list

 FOB Shiping point

prices of goods and the related trade discounts in
their accounts.
 In order words, the recorded amount is already

reflected the trade discount.

 Debit Transportation In
 Credit Cash/Bank/Payable

Buyer

 FOB Destination
 Debit Transportation Out
 Credit Cash/Bank/Payable

Seller

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Profit and loss statement for a trading
business
Revenue from Sales

X

Cost of Goods Sold

(X)

Gross Profit

X

Other Revenue

X

Operating Expenses
Net Profit

(X)
X

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