As per the Golden Rules As per the golden rules of accounting, a trading account is a nominal account. To ensure that financial statements accurately reflect a business's financial position and performance, the golden rules of accounting guide the preparation of financial statements. The point to noRead more
As per the Golden Rules
As per the golden rules of accounting, a trading account is a nominal account. To ensure that financial statements accurately reflect a business’s financial position and performance, the golden rules of accounting guide the preparation of financial statements.
The point to note is that it is almost impossible to apply the rules of debit and credit with certain accounts such as Trading A/c, Profit & Loss A/c, etc.
As per the Modern Rules
The purpose of a trading account is to record transactions related to the purchase and sale of goods for a business. In other words, it serves as a recording and reporting mechanism for business income and expenses.
An accounting period, like a month, quarter, or year, is the time when a trading account is prepared. It is used to calculate the business’s net profit or loss. Other financial statements, such as the balance sheet, are prepared using the information in a trading account.
In summary, a trading account is a type of income statement account that is used to track and report on the income and expenses from a business’s buying and selling activities
Rules of Debit and Credit
There are three main types of accounts according to the legacy rules of debit and credit: personal accounts, real accounts, and nominal accounts. A personal account is one that is related to an individual or entity owing the business money (e.g. a customer), or owing the business money (e.g. a supplier).
A real account is one that relates to assets such as cash, inventory, and property.
Nominal accounts are accounts that relate to income and expenses, such as a “trading account”.
To summarize, a trading account is a nominal account used to record and report the business’s income and expenses resulting from its buying and selling activities.
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Preliminary expenses are those expenses that are incurred before the company’s business commences. These expenses are written off annually which does not involve any flow of cash. Therefore, in the cash flow statement, preliminary expenses are added back to net profit before tax and extraordinary itRead more
Preliminary expenses are those expenses that are incurred before the company’s business commences. These expenses are written off annually which does not involve any flow of cash. Therefore, in the cash flow statement, preliminary expenses are added back to net profit before tax and extraordinary items under the head operating activities (indirect method).
A cash flow statement is a financial statement that summarises the cash and cash equivalents entering and leaving the company. They can be classified into operating activities, investing activities and financing activities.
Reason for Treatment
Operating activities refer to those sources or usage of cash that relates to business activities.
As per the indirect method, the cash flow statement for operating activities begins with net profit before tax and extraordinary items. Since the company records non-cash expenditures also, they should add these back to net profit to find out the true cash flows. This is why preliminary expenses are added to net profit in the indirect method.
As per the direct method, all cash receipts are added and all cash expenses are subtracted to get cash flow from operating activities. Since preliminary expenses are a non-cash activity, they do not require any treatment in the direct method.
Preliminary expenses do not fall under the head investing activities as investing activities involve the acquisition or disposal of long term assets or investments. They do not fit in financing activities either as financing activities relate to change in capital or borrowings of the company.
Example
If the balance in preliminary expenses for the year 2019 was Rs.5,000 and its balance in 2020 reduced to 3,000, then its treatment in the cash flow statement would be:
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