3.3 The Second Year of a Business

Continuing with the example of G． John， at the end of his second year of trading， on 31 December 20×2， he draws up another trial balance （Exhibit 3.7）．

1.Adjustments Needed for Inventory

So far， we have been looking at new businesses only． When a business starts， it has no inventory brought forward． G． John started in business in 20×1.Therefore， when we were preparing John's statement of profit or loss for 20×1， there was only closing inventory to worry about．When we prepare the statement of profit or loss for the second year we can see the difference． If you look back to the statement of profit or loss in previous sections， you can see that there was closing inventory of ￡ 3，000.This is， therefore， the opening inventory figure for 20×2.We will need to incorporate it in the trading account． It is also the figure for inventory that you can see in the trial balance as at 31 December 20×2.

Remember：The closing inventory for one period is always brought forward as the opening inventory for the next period．

G．John checked his inventory at 31 December 20×2 and valued it at that date at ￡ 5，500.We can summarise the opening and closing inventory account positions for John over the two years as shown in Exhibit 3.8.

2.Ledger Accounting for Inventory

To enable you to understand the double entry aspect of inventory， both the inventory account and the trading account for G． John for the year ended 31 December 20×2 are shown below：

You can see that in 20×2 there is both a debit and a credit double entry made at the end of the period to the trading account． First， the inventory account is credited with the opening inventory amount of ￡ 3，000 and the trading account is debited with the same amount． The entries above show how this has been recorded using double entry：

Then， the inventory at 31 December 20×2 is ￡ 5，500 and had not been entered into the accounts previously． The entries above show how this has been recorded using double entry：

Thus， while the first year of trading only includes one inventory figure in the trading account， for the second year of trading both opening and closing inventory figures will be in the calculations． Let's now calculate the cost of goods sold for 20×2：

The gross profit can now be found by taking into consideration the effect the closing inventory has on the gross profit． Remember that sales less cost of goods sold equals gross profit，therefore：

Now the statement of profit or loss and the statement of financial position can be drawn up，as shown below in Exhibit 3.9 and Exhibit 3.10：

Financial statements is the term given to all the summary statements that accountants produce at the end of reporting periods． They are often called ‘ final accounts ’，but this term is quite misleading （as none of the financial statements are‘accounts’ in the accounting sense）．Nevertheless， some people do still refer to them as the ‘ final accounts’ or simply as the accounts of a business． You therefore， will， need to be aware of these terms， just in case you read something that uses these terms， or your teacher or lecturer， or an examiner， uses them at some time．

3.Other Expenses in the Trading Account

You already know that carriage inwards is added to the cost of purchases in the trading account． You also need to add to the cost of goods in the trading account any costs incurred in converting purchases into goods for resale． In the case of a trader， it is very unusual for any additional costs to be incurred getting the goods ready for sale．

For goods imported from abroad it is usual to find that the costs of import duty and insurance are treated as part of the cost of the goods， along with any costs incurred in repackaging the goods． Any such additional costs incurred in getting goods ready for sale are debited to the trading account．

Some of you often find it difficult to remember how to treat returns and carriage when preparing the statement of profit or loss． You need to be sure to learn and remember that all returns， inwards and outwards， and carriage inwards appear in the calculation of gross profit． All the costs of putting goods into a saleable condition should be charged to the trading account．Carriage outwards appears as an expense in the profit and loss account section of the statement of profit or loss．

Some students lose a lot of marks on the topics covered in this chapter because they assume that the topics are easy and unlikely to be things that they will forget． Unfortunately， they are fairly easy to understand， and that is why they are easily forgotten and confused． You would be wise to make sure that you have understood and learnt everything presented to you in this chapter before you go any further in the book．

Summary

·Returns inwards should be deducted from sales in the trading account．

·Returns outwards should be deducted from purchases in the trading account．

·Carriage inwards is shown as an expense item in the trading account．

·Carriage outwards is shown as an expense in the profit and loss account．

·Inventory account carries forward the balance from one period to the next．

·In the second and later years of a business， both opening and closing inventory are brought into the trading account．

·It is normal practice to show cost of goods sold as a separate figure in the trading account．

·A statement of profit or loss that includes the adjustments for carriage inwards and both opening and closing inventory in the trading section and carriage outwards as an expense in the profit and loss section．

·That expense items concerned with getting goods into a saleable condition are charged in the trading account．

·That where there is import duty or insurance charged on goods purchased， these costs are treated as part of the cost of goods sold． toltG6ap03Kh+EOBASKwlvvgU7bbrzMQXs8OIS1dJrBeSk2yRIGPNgzFI6j2w5GC