Overview of Income

Income is the money received by a business in exchange for goods or services sold. It could be both, received or yet to be received. In other words, it is a monetary inflow received either in cash or kind. It includes the revenue from various sources like dividends and interest received, selling goods or services, the commission received, etc.

There are two types of income or revenue shown in the income statement:

• Operating income: The income that is generated from the ordinary course of business such as Sales revenue.
• Non-operating income: The income that is generated from sources other than ordinary business activities such as Dividends received.

In accounting terms, economic benefits increase due to inflows. An increase in income should be credited to the books of accounts.

Related topic – Is Income Received in Advance an Asset or Liability?

As per Modern Rules of Accounting

Income is Credited (Cr.) when increased & Debited (Dr.) when decreased.

Why is it like this?

This is a rule of accounting that is not to be broken under any circumstances.

How is it done?

For instance, you receive a commission for selling goods at the end of every month. The total amount of commission (income) would be added to the income statement for the current accounting year since this increases the total income of your business.

Below is the timeline of how it would be recorded in the financial books.

Step 1 – The following journal entry for commission received is recorded in the books of accounts when money is received. (Rule Applied – Cr. the increase in income or revenue)

(Commission received in cash)

Step 2 – To transfer the income to “Profit & Loss A/c”.

(Commission received is transferred to the income statement)

Related topic – Is Fees Earned a Debit or Credit?

As per the Golden Rules of Accounting

Income is Credited (Cr.)

As per the golden rules of accounting for (nominal accounts) incomes and gains are to be credited.

The account of expenses, losses, incomes, and gains are called Nominal accounts. Basically, nominal accounts are those accounts shown in profit and loss accounts or income statements. The balance of these accounts is always zero at the beginning of a financial year.

Example

Let’s say you rent out a premises and receive a monthly payment from the tenant. Consequently, this income (rent received) would be reflected on the income statement.

Below is the timeline of how it would be recorded in the financial books.

Step 1 – In the below example the journal entry for rent received is recorded and “Rent Received A/c” is credited. (Rule Applied – Cr. all incomes & gains)

(Monthly rent received in the bank account)

Step 2 – To transfer the income to “Profit & Loss A/c”

(Rent received is transferred to the income statement)

Any income received in advance is a liability for the receiver and it is shown on the liability side of the balance sheet.

Related topic – Capital is Debit or Credit?

Incomes Inside Trial Balance

Incomes show a credit balance in the trial balance. A trial balance example showing a credit balance for commission and interest received is provided below.

>Read Is Expense Debited or Credited?

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What is Income Received in Advance?

Income received in advance is the income received but not due. In other words, when a business receives an income for a service not yet rendered, it is considered as income received in advance. It may be commission, rent, or any other income which is received before it is due.

Why is Income Received in Advance treated as a current liability?

In simple words, income received in advance is treated as a current liability because the income that has been received by the company before its due date, is not yet earned and the company is obliged to deliver the purchased goods or services in the future.

Let us assume that you have received an amount from a customer, for the goods or services that you will provide in the future, therefore, in the current financial period it is a liability for your company. It can be referred to as Deferred revenue, Deferred income, or Unearned income.

Example

XYZ Ltd. has received 4,000 from a customer in March for goods that will be delivered in April.

XYZ Ltd. will debit the Cash a/c for 4,000 and credit the Deferred Revenue a/c for 4,000. On the 31st of March, the balance sheet of XYZ Ltd. shall include 4,000 in the cash of their company and record the deferred revenue of 4,000 under current liabilities.

The journal entries to be recorded are as follows:

(Being income received in advance)

The above Journal entry records the transaction of receiving the cash in advance in the month of March for the goods that are to be delivered in April.

(Being goods sold to the customer)

In the above Journal entry, the Deferred Revenue Account is debited and the sales revenue account is credited to show that the goods have been delivered and revenue has been earned.

Placement in the balance sheet

An extract of the balance sheet is given below to show the placement of income received in advance:

Conclusion

The key takeaways from the above article are as follows:

• Income received in advance is the income not yet due but received.
• Income received in advance is treated as a liability.
• This is because the business has yet to render the services for the income already received by it.
• It is shown as a current liability under the Liabilities side of the Balance Sheet.
• It is also referred to as Deferred revenue, Deferred income, or Unearned income.

>Related Long Quiz for Practice Quiz 22 – Current Liabilities

>Related Long Quiz for Practice Quiz 31 – Income received in Advance

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Firstly, Nancy, the question put up by you is a bit vague. As in it is difficult to identify whether you have an issue in understanding an accounting concept regarding a loan given or loan taken.

Moving ahead, I think I can answer the question stated below in two ways

Is Loan a Current Asset?

Case 1: If a Loan is Given

Firstly you have to be clear whether the loan is a Loan granted or a Debt. When an entity lends a certain amount to another person based on certain conditions agreed by the parties at the time of entering into such contract. Then such a lender will recognise this transaction as a case of Loan Given.

Case 2: If a Loan is Taken

When an entity or a person owes a certain amount to another person or an entity or simply put up he has borrowed a certain sum from such another person based on certain conditions agreed at the time of entering into the contract such a transaction is a case of Loan Taken for the borrower.

To classify such a loan as a Current Asset or a Current Liability, you will need to first identify the tenure of such loan given or taken i.e whether it’s a Short term Loan or a Long term Loan.

If you want to make an accurate classification pertaining to the head under which such loan would be presented it is very important to ascertain whether its a short term or a long term loan.

Short term Loan

It refers to a loan taken or given for a short duration of time roughly ranging between a month and a year these are generally repaid in monthly instalments. Such Short term Loans can be classified under the heads of Current Assets or Liabilities. If you are still unable to get the concept clear the below-mentioned table can be of great help –

Long term Loan

A loan Taken or Given shall be said to be a Long term Debt or Long term Loan Given if such a loan is not due to be repaid or received within a year. It can be classified as a Non-Current Asset or a Liability.

Similarly, refer to the table below for a better understanding of this concept

I am sure that after having a look at the image included below you will have a clear understanding of this concept;

>Related Long Quiz for Practice Quiz 20 – Current Assets

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Before I give you the examples of deferred revenue I would first like to explain what deferred revenue means.

Meaning of Deferred Revenue

Deferred revenue is the amount received by an entity in advance before delivering the goods or transferring the title to goods or before rendering the services.

Examples of Deferred Revenue

• Yearly Subscription to a Magazine: An entity engaged in publishing magazines generally charges a yearly subscription for sending the magazines at predetermined time intervals to the subscribers. Such an entity charges a yearly subscription the amount received is a perfect example of deferred revenue. The Accounting Treatment for the Same is –
  The entity will first record deferred revenue as

At the time of actual accrual of revenue i.e at the time of recording earned revenue-

• Other Subscriptions: another example is the subscription charged by Amazon, Netflix, Hotstar etc. for getting access rights to download or watch the content on the website or such app. The charges are generally on a yearly or quarterly or monthly basis and thus in case if the customer buys a quarterly or a yearly plan such revenue is a deferred revenue since the services are not yet availed by the users. The company shall account for such receipts and revenue as:
  when it receives such subscription amount-

and when such revenue is accrued i.e customer has availed such service-

• Software license Fees: A software company generally charges the software license fees for using the entity’s software on a yearly or semi-annually or quarterly basis. Such fees are charged even before giving access rights. Hence, the company defers revenue. Accounting Treatment in the books of software companies shall be:
  At the time of receipt of the license fee

At the time of recognising revenue which may be monthly or quarterly or such other basis as per the entity’s policy;

• Educational Institute: Coaching centres or the universities for higher education generally charge the course fee before the commencement of each term. Thus the amount is received by such institute even before the services of imparting education has been rendered, This is a perfect example of deferred revenue. Such Educational Institute shall account this transaction as:
  At the time of receipt of such fee;

and at the time of revenue recognition;

What is Suspense account?

A suspense account is a general ledger account prepared in the following situations;
1. Transactions are unidentified or unclassified at the time of occurrence, or
2. Differences arises between the total debit side & the credit side of the trial balance.

When the right account is determined or the error is rectified, the amount shall be moved from the suspense account to its proper account.

Features Suspense account?

Here are some key features of a suspense account:

1. Temporary Holding: A suspense account serves as a temporary holding place for transactions that cannot be immediately classified into the appropriate permanent accounts.
2. Resolution: The purpose of a suspense account is to provide a means to temporarily record transactions until their proper classification or resolution can be determined.
3. Corrective Action: Transactions in a suspense account often require further investigation or correction to resolve discrepancies or uncertainties in the accounting records.
4. Balance Sheet Impact: Transactions recorded in a suspense account may impact the balance sheet temporarily until they are properly classified or adjusted.
5. Income Statement Impact: Depending on the nature of the transactions, entries in a suspense account may also affect the income statement temporarily until they are resolved.
6. Clearing Account: Once the discrepancies or uncertainties are resolved, the entries in the suspense account are typically cleared by transferring them to their appropriate permanent accounts.
7. Audit Trail: A suspense account provides an audit trail, allowing auditors and accountants to track transactions that required further investigation or correction.
8. Disclosure: In financial statements, any transactions recorded in a suspense account are typically disclosed in the notes to the financial statements to provide transparency to stakeholders.
9. Common Use: Suspense accounts are commonly used in situations where there are timing differences, errors, or missing information in accounting records.
10. Control Mechanism: Maintaining a suspense account helps in maintaining control over the accounting process by ensuring that all transactions are eventually properly classified and recorded.

Presentation of Suspense account in Financial Statements

In case Suspense A/c is not closed at the end of the accounting period, the balance in the Suspense A/c is presented in the Balance Sheet.

Extracts of the balance sheet have been attached for better understanding.

Example of Suspense A/c

A customer of ABC Ltd makes an online payment of 50,000 but he did not specify against which open invoice (out of the 20 open invoices) the amount needs to be settled. In this case, the accountant will pass the initial entry in the suspense account till he identifies the correct open invoice.

Journal entry to park the unidentified amount in the suspense account

The accountant identifies the open invoice against which the amount of 50,000 is to be settled.

Journal entry to close the suspense account and post the amount received against the appropriate invoice and proper account-

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Fixed Assets

Fixed assets are those assets that can be in the firm for a long period and it is tangible. These assets provide benefits for more than one accounting period for the firm. These provide support for the production or delivery of goods or services.

Current Assets

Current assets are those assets that are used within the operating year. These assets are used for the company’s day-to-day operations. This shows the firm’s liquidity and its ability to meet short-term obligations.

List of Fixed Assets and Current Assets

Presentation in the balance sheet

The balance sheet of ABC Ltd. is as follows;

This is an example of a balance sheet. The liabilities are recorded first and later assets are recorded. Assets and liabilities must balance out each other.

It is important to record all the liabilities as the company needs to pay them back responsibility on time. The assets also need to be recorded to know what kind of assets the company owns.

The fixed assets are recorded first since they stay for more than one accounting period. Later, the current assets are recorded since they will be used up within an operating year. All of the assets need to be mentioned in the company and should be organized based on the category it belongs to like fixed assets and current assets.

Conclusion

It is important and necessary for the company to be transparent about its assets and liabilities to the public.

>Related Long Quiz for Practice Quiz 20 – Current Assets

>Related Long Quiz for Practice Quiz 35 – Fixed Assets

Overview of Liabilities

From a business perspective, a liability is defined as money owed to third parties. It may be external (3rd parties) or internal (promoters). It is a debt or financial obligation that is settled by an exchange of economic benefits at a future date. For example, long-term loans, bonds payable, trade payables, bills payable, short-term loans, bank overdraft, etc.

Classification of Liabilities

• Internal & External Liabilities – Internal liabilities include all obligations that a business has to pay back to internal parties. For e.g. promoters (owners), employees, etc.
• Current liabilities: The liabilities that are payable within one year. For Example- Creditors, bank overdraft
• Non-current liabilities: The liabilities that are payable after a period of more than one year. For Example- long-term loans, debentures
• Contingent liabilities: The liabilities that are payable depending on the occurrence of a particular event. For Example- lawsuit proceedings, guarantee for loans

In accounting terms, liabilities are the funds payable to outsiders. Thus, an increase in liability should be credited to the books of accounts.

Related topic – Where is Amortization Shown in Financial Statements?

As per the Modern Rules of Accounting

Liability is Credited (Cr.) when increased & Debited (Dr.) when decreased.

Why is it like this?

This is a rule of accounting that cannot be broken under any circumstances.

How is it done?

For instance, a local business borrowed a sum from the bank for expanding its operations. As a result, this loan would be a liability and would be shown on the balance sheet for the current accounting year since the borrowed money increases the liability of the business.

Given below is the journal entry to be recorded at the time of borrowing the loan: (Rule Applied – Cr. the increase in liability)

(Sum borrowed from the bank for expansion)

The balance in the loan account decreases when payment is made towards amortization.

Related topic – Are Bad Debts Recorded in the Income Statement?

As per the Golden Rules of Accounting

Liability is credited as per the Golden Rules

The individuals and other organizations that have direct transactions with the business are called personal accounts. Liabilities such as creditors, outstanding expenses, income received in advance, loans taken, etc. are classified as personal accounts. Personal accounts are recorded on the balance sheet of the organization.

As per the golden rules of accounting (for personal accounts), liabilities are credited. In other words, the giver of the benefit is a liability to the one who receives it.

Example

For instance, you own a stationery shop and you purchased pens from the manufacturer on credit. You agreed to make the payment for pens after 30 days. Thus, the amount payable to the supplier is a liability to you and is credited to your books of accounts.

Given below is the example of a journal entry to be recorded at the time of credit purchase: (Rule Applied – Credit the giver )

(Pens purchased on credit)

Related topic – List of Liabilities in Accounting

Liabilities Inside Trial Balance

Liabilities show a credit balance in the trial balance. A trial balance example showing a credit balance for reserves, trade payables, and loans is provided below.

>Read What is the Meaning of Assets have Debit Balance and Liabilities have Credit Balance?

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Meaning of Income received in advance

It refers to an income received in advance by the entity for goods or services which have not been rendered in the current accounting period. The advance income received relates to the future accounting period. It is a personal account and presented on the liability side of the balance sheet.

Income received in advance includes;

1. Commission received in advance
2. Rent received in advance
3. Professional fees received in advance
4. Premium received in advance

Taxable or not?

Taxability of Income received in advance depends on the method of accounting (Accrual method or Cash method) followed by an entity.

So, let me help you understand the taxability considering both approaches with an example each.

1. Entity follows the accrual method

If the accrual system of accounting is followed then income received in advance will be not be taxed in the period of receipt. It will be taxed in the accounting period to which it relates.

For Example,

In the month of December 20×1, Mr Michael received professional fees in advance 50,000 which relates to the month of January 20×2.

So, in this case, professional fees received in advance 50000 will not be taxed in the accounting period Jan-Dec 20×1. It will be taxed in the period Jan-Dec 20×2, as it belongs to January 20×2.

2. Entity follows cash method

If the cash system of accounting is followed then income received in advance will be taxed in the period of receipt itself.

For Example,

Ms Alexa received the commission in advance 25,000 in the month of December 20×5, but the same relates to the month of January 20×6.

So, in this case, the commission received 25,000 will be taxed in the accounting period Jan-Dec 20×5 itself. Even though it relates to a future accounting period ie. Jan-Dec 20×6, it is of no concern here, as the cash system of accounting is followed.

Conclusion

We can conclude,

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Objectives of Bank Reconciliation Statement

Bank Reconciliation statement refers to the statement that reconciles the difference between the balances as per the bank column of cash-book and pass-book.  The following are the objectives of the bank reconciliation statement. BRS Stands for Bank Reconciliation Statement.

1. The primary objective for preparing BRS is to check the accuracy in the bank column of both cash book and passbook. Accountants generally prepare BRS based on transactions recorded in the cash book and bank book (passbook) at a particular time.

2. BRS is prepared to check the cash inflows and outflows in the business and they must tally with the bank statements (or) passbook. This helps the users to easily detect the non-uniformity in cash book balance and passbook balance.

3. BRS provides us information on the various aspects of banking transactions such as it gives information on the position of cheques, payment made by the bank on standing instructions, direct payment by debtors, bank charges, bank interest, dividends received etc.,

4. BRS helps the accountant to keep track of the funds available in the bank account. Hence it becomes comfortable for the company to issue a cheque for making payments to its various creditors in some future agreed date.

5. Another main objective of preparing BRS is to control the internal management of the organization on cash inflow and outflow. BRS acts as a mechanism to keep track of cash embezzlement, bank drafts and misuse of the company’s funds by dishonest employees.

Impact of Bank Reconciliation Statements

The following impact may occur if companies do not prepare bank reconciliation statements.

1. If the bank reconciliation statements are not prepared by the companies then there will be a difference in the bank column of cashbook and passbook. Hence, there will not be any accuracy in amounts of cashbook and passbook.

2. If the bank reconciliation statement is not prepared then the company will not have adequate information relating to the various banking transactions such as payment made to various creditors, bank interest, bank charges, dividends received etc.,

3. If the bank reconciliation statement is not prepared then it will be very difficult for an accountant to keep track of available funds in the bank account as per the passbook. This may result in the delay of future payment to suppliers, creditors and other agents.

4. If the bank reconciliation statement is not prepared by the companies then cash embezzlement, fraudulent transactions, misuse of company funds by dishonest employees will increase and it cannot be easily traced by the company.

I would like to add an example for a clear understanding of the above explanation

Example for Bank Reconciliation Statement

ABC Ltd furnishes you the following information prepare a Bank Reconciliation Statement to find out the Debit Balance of Pass Book.

Bank Reconciliation Statement of ABC Ltd.

Impact of Transaction if bank reconciliation statement not prepared

If the cheque is deposited but not collected,

CashBook– The accountant will record the transaction and it will show an increase in the bank balance of the cashbook (15,000+4,000 = 19,000).

PassBook– If the same is not recorded by the bank at the same time. Then the bank passbook will show the same balance (say- no increase and no decrease).

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In layman’s language, a trade discount refers to a reduction/fall in the original price of a commodity being sold. This type of discount is usually granted on the list price of the products by the supplier or wholesaler to the retailer for considerations such as buying goods in bulk, trade relations, etc.

No journal entry is recorded separately in the books of accounts for trade discounts. The entries that are shown in the sales or purchase books are recorded as the net amount.

This type of discount is simply utilized to determine the net amount for a customer. Since the trade discount is deducted before any exchange takes place, it does not have any accounting entry.

Example

Mr.A sells goods to Mr U amounting to the list price of 8,000 and offers a trade discount of 10% as the customer purchased goods in bulk. Pass the necessary journal entries for this transaction.

Solution:

The net price will be calculated as follows:

List price = 8,000
Trade discount = 10%

Net amount = 8,000 – (8,000 x 10%)
= 8,000 – 800
= 7,200

The journal entry in the books of the seller (Mr. A) is as follows;

(Being goods sold)

While recording in the journal entry, the discount amount will be deducted from the total amount, hence the net amount will be recorded.

Rules as per the Modern Approach

As cash is coming into the company due to sales, it leads to an increase in assets hence it is debited. This is leading to an increase in revenue hence it is credited.

Rules as per the Traditional Approach

As the cash is coming into the company due to sales, it is debited. The sales are credited since it is the reason leading to an increase in income hence they are credited as per the nominal account rule.

The journal entry in the books of Mr. U is as follows:

As the goods are being purchased with a discount of 10%, it is debited and as the cash is going out it is credited. The discount amount of 800 is subtracted from the total 8,000 the net amount of 7,200 is recorded as it is being bought in bulk and a trade discount is being provided. (Being goods purchased)

Rules as per the Modern Approach

The purchases account is debited since there is an increase in expenses. The cash account is credited since there is a decrease in assets as payment is made for the purchases.

Rules as per the Traditional Approach

The purchases account is debited since its an expense for the company. As the cash is going out from the company for the payment it is credited as per real account rule.

Note:

• The seller and the buyer will record the transactions in the books of accounts after subtracting the trade discount allowed from the original amount.
• As shown in the example above, the distributor and Mr. U shall record the transaction at 7,200.
• No separate entry shall be shown for a trade discount.

Conclusion

The key takeaways from the above article are as follows:

• A trade discount is a reduction/fall in the original price of a commodity being sold.
• It is usually granted on the list price of the products by the supplier to the buyer for reasons such as buying goods in bulk, trade relations, etc.
• No journal entry is recorded separately in the books of accounts for trade discounts.

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Posting Reference

A posting reference column is used to indicate that the entry is posted in the respective ledger accounts and it links the journal with the respective ledger account. The abbreviation used for posting reference is “PR”. It is also called a folio.

Purpose of PR Column

When an entity transacts in a large number on daily basis it becomes a troublesome task then for the bookkeeper to ascertain whether the entries are posted in appropriate ledgers. And it may so happen that the entry is posted twice. Later on, tracking that transaction and correcting the same becomes a tedious and time-consuming job.

Hence, to avoid these issues it’s recommended to maintain a posting reference column. Thereby simplifying the job of a bookkeeper.

It can be seen in the third column of the journal book generally. You can also see the same in the image inserted below;

Example

When an entity purchases an immovable property for an amount of 100,000 it shall be recorded in the books of accounts as;

The reference of the page number of the journal book shall be given in the respective ledger accounts to interlink the same. The ledger given below indicates the same;

Similarly, Cash Account shall also have a PR column wherein the reference of the page consisting of the primary journal entry shall be given. The below-given image presents the same

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In the business world, the terms “Debt” and “Liability” are used interchangeably and are understood to be the same. But in reality, they differ.

Debt

Debt refers to the money that a company borrows from external sources, typically in the form of loans, bonds, or lines of credit and it represents funds that the company owes to creditors or lenders with a promise to repay the borrowed amount along with interest over a specified period.

In other words, debt is the money borrowed by a business entity that is to be repaid to the moneylenders at a future specified date.

Examples of debt include bank loans, corporate bonds, mortgages, and other forms of borrowing used by businesses to finance operations, investments, or expansion.

Liability

Liabilities are a broader category of financial obligations that a company owes to external parties or stakeholders that include debt and other obligations such as accounts payable, accrued expenses, deferred revenue, and other liabilities that arise from past transactions or events.

Liabilities can be both short-term and long-term.

In other words, liability is an obligation to render goods or services or an economic obligation to be discharged at a future date.

For Example,

• Outstanding payment to suppliers of raw materials
• Outstanding Expenses – accrued rent, outstanding professional fees, outstanding electricity expenses, unpaid salary, etc
• Income received in advance – rent received in advance, the commission received in advance, etc
• Bills payable
• Debts accepted by an entity

Key differences between Debt and Liability

Now, let me help you understand the differences between the two terms discussed above, debt and liability.

Conclusion

All debts are liabilities, but not all liabilities are debts.

Debt is under liabilities, it refers to the portion of liabilities that represents borrowed funds. Liabilities are a broader range of financial obligations, including both debt and other types of liabilities arising from various business activities.

Debt and liabilities are essential components of a company’s balance sheet and are crucial for assessing its financial health and stability.

Meaning of Contra Assets

The word contra means “opposite”. So, contra assets have a credit balance, whereas assets normally have a debit balance. A contra-asset account stores a reserve which reduces the balance of the paired account. The reason to show this information separately in a contra-asset account is to see the extent to which the corresponding asset should be reduced.

A contra asset is used to offset or reduce the balance of the corresponding asset account in the balance sheet. Reducing or offsetting the gross value of the asset with the corresponding contra asset will give us the net value of the asset. A contra asset can also be referred to as a negative asset account.

Examples of Contra Assets

1. Accumulated Depreciation
2. Accumulated Amortization
3. Obsolete Inventory Reserve
4. Reserve/Provision for Doubtful Debts

Importance of Preparing the Contra Assets

• This helps in the accurate valuation of assets on the balance sheet. It helps in showing the present value of the assets after using them.
• It enhances financial transparency. The accuracy of financial documents is important for investors, creditors, and other stakeholders in making informed decisions.
• Contra assets help in eliminating risks relating to assets. For example, accumulated depreciation is a common contra asset that is used to indicate the depreciating nature of fixed assets, which may require maintenance or replacement and reduce the value.
• Contra assets help in making management decisions related to asset management and its maintenance.

Presentation in the Balance Sheet

Contra assets are to be stated in separate line items on the balance sheet of the company. The following contra assets can be presented on the balance sheet as given below:

Given below are the examples of Accumulated Depreciation & Reserve/Provision for Doubtful Debts. The calculation and posting in the extract of the balance sheet are also provided.

Example 1.

Suppose ABC Ltd. acquires new computer software for 600,000 in the month of January 20×1. The expected useful life of the software is 3 years with no scrap value.

As per the straight-line method, 200,000 will be written off or reduced from the amount of computer software each year for 3 consecutive years.

Example 2.

The outstanding balance of debtors was 50,000 as of 31/12/20×2. Entity ABC Ltd anticipates doubtful recovery from some debtors based on the previous year’s experiences. Therefore, it decides to provide a reserve for doubtful debts at 5% on its debtors.

So, 2,500 (50,000*5%) will be reduced from the number of debtors as a reserve or provision for doubtful debts as of 31/12/20×2. Hence, the net amount of debtors will be 47,500 at the end of the year.

Presentation of Accumulated Depreciation & Reserve/Provision for Doubtful Debts in the extract of the balance sheet as of 31/12/20×2

Conclusion

Adjusting asset values will help reflect their true worth and accounting like depreciation, and contra assets contribute to the reliability and integrity of financial reporting. These are asset quality indicators, that help assess financial health, and influence strategic decisions regarding asset management.

Overview of Prepaid Insurance

Prepaid Insurance is the amount of insurance premium which has been paid in advance in the current accounting period. However, the related benefits corresponding to the insurance amount prepaid will be received in the next accounting period. In other words, the insurance premium is paid before it is actually incurred.

Prepaid Insurance is an example of Prepaid Expenses. It is a current asset since its benefit will be received within a year. The actual amount pertaining to the next accounting period is recorded on the asset side of the balance sheet of the current year. Thus, prepaid insurance has a debit balance just like any other asset and it is debited in the books of accounts.

As the benefits of prepaid insurance are realized over time, the asset value decreases, and the amount is shown as an expense in the income statement of the organization. The adjustment related to prepaid insurance in the financial statements is carried out at the appropriate time i.e. both in the current period and in the future period (when it becomes due).

As per the Modern Rules of Accounting

Prepaid Insurance (Asset) is Debited (Dr.) when increased & Credited (Cr.) when decreased.

Why is it like this?

This is a rule of accounting that cannot be broken under any circumstances. Prepaid insurance is an asset to the entity. Therefore, as per the modern rules of accounting for assets an increase in assets will be debited.

How is it done?

For instance, HP Inc. paid the insurance premium for its equipment’s amounting to 50,000 on 10/12/20×1. This insurance policy covers the next 12 months. The amount paid towards insurance increases the assets of the business hence it is debited in the books of accounts.

Given below is the journal entry for recording prepaid insurance in the financial books. (Rule Applied – Dr. the increase in Asset)

(Insurance premium for next year paid in cash.)

The balance at the end of the year is shown on the asset side of the balance sheet and the amount is carried forward to the next year.

As per the Golden Rules of Accounting

Prepaid Insurance is debited as per the golden rules.

Prepaid Expenses are referred to as representative personal accounts (accounts that represent a certain person or group of people). According to the rule for personal accounts, we have to debit the receiver of the benefit and credit the giver of the same.

As per the golden rules of accounting (for personal accounts), prepaid insurance is debited.

Example

J P Morgan Inc. paid the insurance premium for all its furniture amounting to 100,000 on 31/12/20×2. However, the entire amount of premium paid relates to the year 20×3 (Accounting period-Jan 20×2 to Dec 20×2).

Given below is the example of the journal entry for prepaid insurance, for which the Prepaid Insurance Account is debited. (Rule Applied – Dr. the receiver.)

(Insurance premium for next year paid through the bank.)

The debit balance at the end of the year is shown on the asset side of the balance sheet and the amount is carried forward to the next year.

Prepaid Insurance Inside Trial Balance

Prepaid insurance shows a debit balance in the trial balance. A trial balance example showing a debit balance for prepaid insurance is provided below.

Here, only the amount for 3 months is prepaid and it is recorded on the asset side of the balance sheet.

Read

>Related Long Quiz for Practice Quiz 36 – Prepaid Expenses

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Balance Sheet is a statement showing the financial position of a business entity on a particular day. It shows the liabilities and assets of the business. It consists of items from the trial balance.

Trial balance is the third step after passing journal entries and posting in ledgers. The trial balance is the summary of all the accounts based on the ledger balance. It is an account prepared to check the athematic accuracy of the debit and credit balances are equal and accurate.

Steps to Prepare Balance Sheet from Trial Balance

All the debit side items related to assets listed in the trial balance shall be posted on the assets side of the balance sheet. All the credit side items related to capital and liabilities listed in the trial balance shall be posted on the liabilities side of the balance sheet.

1. Post the amount of capital on the liabilities side of the balance sheet under the head “capital & reserves”.

2. Then, the net profit or net loss ascertained while preparing the income statement shall be added or reduced respectively from the amount of capital.

3. Now, post all the “non-current liabilities” such as long-term bank loans, long-term debentures issued, etc. on the balance sheet’s liabilities side.

4. Then, post the “current liabilities” such as sundry creditors, bills payable, etc. Incorporate necessary adjustments related to outstanding expenses and pre-received income.

5. Moving to the asset side, start with the head “non-current assets”.

6. First, post the tangible assets under the head “non-current assets” such as plant & machinery, land & building, etc. Calculate depreciation/accumulated depreciation on the tangible assets and deduct the same to arrive at the net value.

7. Second, post the intangible assets under the head “non-current assets” such as software, goodwill, etc. Calculate amortization/accumulated amortization on the intangible assets and deduct the same to arrive at the net value.

8. Now, post all the long-term investments acquired such as bonds and debentures under the head “non-current assets”.

9. After posting all the non-current assets move forward to posting the “current assets” on the asset side of the balance sheet,

10. Post “current assets” such as cash in hand, cash at the bank, sundry debtors, bills receivable, etc. Incorporate necessary adjustments related to provisions for doubtful debts, prepaid expenses, and outstanding income,

11. Post the amount of closing stock given in the adjustments under the head “current assets”.

12. The final step is totaling both the liability and asset sides. Both sides of the balance sheet should be of an equal amount.

These steps complete the preparation of the balance sheet from the trial balance.

Illustration

A snippet of the trial balance and balance sheet has been attached for better understanding.

Adjustments

1. Closing stock as on 31st March yyyy is 2,00,000.
2. The salary outstanding for March yyyy is 60,000.
3. Depreciation @10% to be charged on Plant and machinery.
4. Amortization @10% charged on computer software.

Prepare a Balance Sheet from the above-given trial balance. Net Profit for the year ended 31/03/YYYY is 610,000.

Conclusion

• It is important to record the balances of ledger posts of different accounts in the trial balance since it helps the company know if their postings are right or wrong when there is a match or mismatch in the debit or credit side of the trial balance.
• The trial balance is later used to make the balance sheet, which is the most important financial statement as it determines the business’s financial position.
• All the credit sides of the trial balance are treated as liabilities and posted in the balance sheet based on the headings such as debt and equity, reserves and surplus, long-term borrowings, short-term borrowing, and current liabilities.
• All the debit side of the trial balance is treated as assets and posted on the asset side of the balance sheet based on the heading like tangible, intangible assets, current assets etc.

Every year or after a certain period, the ledger accounts are balanced after posting the transactions. The difference in the totals of the two sides of an account is written on the side with the smaller total. The debit balance of a trading account means the company has incurred a gross loss for that period. Let us break this down for you,

Debit Balance

While preparing an account, if the debit side of an account is greater than the credit side, the difference is called “Debit Balance”. In short, if Dr. Side > Cr. Side, it is said to have a debit balance.

Assets have a debit balance, and Liabilities have a credit balance. Similarly, Expenses have a debit balance, and Revenues have a credit balance.

Due to the fact that they are the balancing figures, a debit balance appears on the credit side while a credit balance appears on the debit side.

Related Topic – Debit Balance and Credit Balance in Accounting (Detailed)

Meaning in Trading Account and What it Indicates

A trading account is a financial statement which records all the trading activity (buying and selling) of the firm’s main products/services during an accounting period. As part of the preparation of final accounts, this is the first financial statement prepared.

The debit side shows “opening stock” + “expenses“, whereas the other side has “closing stock” + “revenues“.

As a result, if the left side (Dr.) is greater than the right side (Cr.), expenses will exceed revenues, resulting in a loss.

Note: Direct expenses are shown in the trading account, whereas indirect expenses are shown in the income statement.

The debit balance of a trading account means gross loss. However, a credit balance of the trading account indicates a gross profit. This signifies that the company lost more money than it made. This number is transferred to the debit side of a profit & loss account to further calculate net profit or a net loss.

Related Topic – What are Sales Returns and Allowances?

Example Showing Gross Loss

Prepare a trading account for the year ending 31 Mar YYYY from the following balances. This example has deliberately been chosen to show the debit balance of the trading account.

Closing stock is valued at 30,000 at the year-end.

Trading Account for the year ending 31 Mar YYYY

Related Topic – Is Purchase Return a Debit or Credit?

Short Quiz for Self-Evaluation

Related Topic – Treatment of Closing Stock in Trading Account

Frequently Asked Questions Related to this Topic

A question that is commonly asked around this topic is,

Question – 1 – Select the most appropriate alternative from those given below:

Debit balance of Trading Account means _____?

1. Gross Loss
2. Net Loss
3. Net Profit
4. Gross Profit

Answer – The answer is A. The reason is clearly explained in the above text in this article.

Question – 2 – What is debit side of trading account?

Answer – The debit side of a trading account shows a combination of Opening Stock, Purchase & Return Outwards, and Direct Expenses.

Question – 3 – Trading Account is a _____ account?

1. Personal
2. Real
3. Nominal
4. Valuation

Answer – The answer is C. It is a nominal account prepared at the end of an accounting period.

Related Topic – Trading Expenses in Final Accounts

Conclusion

A trading account is an important indicator used by various internal and external parties to know the overall business performance and efficiency.

• To summarize, a trading account is a type of financial statement that is utilised by companies in order to keep track of the buying and selling activities that take place during an accounting cycle.
• The reason why it is so crucial is that it helps to determine whether the company made a profit or a loss during the year.
• A debit balance of the trading account represents that it has a greater debit side as compared to the credit. It shows that the company has suffered a loss from trading activities, which is an indication that more money has been lost than earned.
• A gross loss is then transferred to the debit side of the profit and loss account in order to further calculate net profit or a net loss.

The ability of a company or individual to meet its financial goals can be negatively affected by a gross loss. If a company suffers a gross loss, it may have difficulty paying its bills in the future. Therefore, it may need to borrow or dissolve its assets to stay operational.

>Read Accounting Fundamentals Quiz – Level Intermediate (#3)

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Meaning of Bad debts

As we can see, the term ‘Bad Debt’ comprises of the word ‘bad’, which gives us a fair idea that it is something about the debtors who are not good for the business.

So basically, Bad Debt is the amount owed by the customer to the business which is now irrecoverable. It is an expense for the business and it may arise due to reasons such as fraud, insolvency of the debtor, etc. We can also refer to it as Uncollectible Accounts Expense and Irrecoverable Debts.

Yes, bad debts are recorded in the Income statement. The Income statement shows the aggregate financial position of a business during a specified period by displaying the amount of revenue generated and expenses incurred by a business. Bad debts being an expense are recorded under operating expenses in the Income Statement or on the debit side in the Profit & Loss a/c.

Example

ABC Ltd. sells goods to a retailer for 40,000 at 50 days credit. However, after 50 days, the company realizes that the retailer has been declared insolvent and the amount is no longer recoverable. This amount of 40,000 is an expense for ABC Ltd and leads to a fall in the accounts receivable.
The journal entries to be recorded in the books of ABC Ltd are as follows:

(being amounts written off as bad debts transferred to bad debts account)

(being bad debts transferred to profit and loss a/c)

Bad debts as shown in the Income statement

(Extract of Income Statement)

What are Retained Earnings?

Retained Earnings are the accumulated net income of an entity at the end of an accounting period that is retained by it to meet any future contingencies, invest in expansion activities, pay dividends to its shareholders, share buybacks, or issue bonus shares.

Retained Earnings are a part of “Shareholders Equity” presented on the “Liabilities side” of the balance sheet as it indicates the company’s liability to the owners or shareholders.

The company cannot utilize the retained earnings until its shareholders approve it. Thus, retained earnings are credited to the books of accounts when increased and debited when decreased. If the balance of retained earnings is negative, then it is referred to as accumulated losses/deficit, or retained losses.

As per the Modern Rules of Accounting

Retained Earnings (liability) are Credited (Cr.) when increased & Debited (Dr.) when decreased.

Why is it like this?

According to this rule, an increase in retained earnings is credited and a decrease in retained earnings is debited. This is a rule of accounting that cannot be broken under any circumstances.

How is it done?

1. Retained Earnings are credited with the Net Profit earned during the current period. Crediting the retained earnings will increase its balance.

Example

Samsung Inc. earned a net profit of 500,000 during the accounting period Jan-Dec 20×1. The company decided to retain the profits for that year and invest the retained earnings in expanding the business. This increase in retained earnings is credited to Retained Earnings Account.

Given below is the journal entry to be recorded: (Rule Applied – Cr. the increase in liability)

(Transferring net profit earned to retained earnings.)

2. Some instances which reduce the balance of retained earnings are-

a. Net loss during the current period
b. Dividend payable
c. Bonus Shares issued, etc.

Retained Earnings will be debited with these transactions.

Example

Shareholders of Apple Inc. approve the dividend declared by the board of directors amounting to 100,000. The dividend payable reduces the balance of retained earnings so it is debited in the financial books.

Given below is the journal entry to be recorded: (Rule Applied – Dr. the decrease in liability)

(Dividend to be paid from retained earnings.)

As per the Golden Rules of Accounting

Retained Earnings (Liability) are credited as per the Golden Rules

Since retained earnings are a part of shareholders’ equity, it is an obligation of the company to pay it back to the owners. Thus, it is a liability of the company and it is credited as per the golden rules of accounting for personal accounts.

Example

HP Inc. earned a net profit of 500,000 during the accounting period Jan-Dec 20×1. The company decided to retain the earnings for that year and utilize them for further growth. This is a liability (shareholders’ fund) of the company to pay the earnings back to the shareholders. Thus, the retained earnings are credited to the Retained Earnings Account.

Given below is the journal entry to be recorded: (Rule Applied – Cr. the giver)

(Transferring net profit earned to retained earnings.)

Retained Earnings inside the Balance Sheet

Retained earnings show a credit balance and are recorded on the balance sheet of the company. A balance sheet example showing retained earnings is provided below.

Conclusion

The key takeaways from the above discussion are:

• Retained earnings are the incomes retained by a business for future contingencies, reinvestment, expansion, or any other purpose.
• Retained Earnings are a part of “Shareholders Equity” presented on the “Liabilities side” of the balance sheet.
• If the balance of retained earnings is negative, then it is referred to as accumulated losses/deficit, or retained losses.

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Direct and Indirect expenses-

Direct expenses include all those expenses which have a direct connection with the manufacture of the goods (i.e., conversion of raw materials into finished products). Such expenses are direct expenses and are placed on the debit side of the trading account. These expenses are also called as manufacturing expenses.

Indirect expenses include all those expenses that are incurred to run business activities. These expenses have no direct connection with the manufacturing of goods. Such expenses are indirect expenses and are placed on the debit side of the profit & loss account. These expenses are also known as office expenses.

Difference between Direct Expenses and Indirect Expenses

The following are the differences between Direct Expenses and Indirect Expenses:

1. Direct Expenses:
   • Direct expenses are specifically tied to the production of goods or services.
   • They can be directly allocated to a particular product, service, or department.
   • Examples include raw materials, direct labor, manufacturing supplies, and shipping costs for goods sold.
   • Direct expenses vary with the level of production or output; as production increases, direct expenses also increase.
2. Indirect Expenses:
   • Indirect expenses are not directly associated with the production of goods or services but are necessary for the overall operation of the business.
   • They are often incurred for the benefit of multiple departments or the entire organization.
   • Examples include rent, utilities, administrative salaries, depreciation, and insurance.
   • Indirect expenses typically remain relatively constant regardless of the level of production or output.

List of Direct & Indirect Expenses

The following are the Direct Expenses and Indirect Expenses:

Conclusion

Direct expenses are directly related to the production process and can be allocated to specific products or services, while indirect expenses are more general and support the overall operation of the business.

>Related Long Quiz for Practice Quiz 23 – Direct and Indirect Expenses

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Yes, the cash book is both a journal and a ledger. 

To make the concept simpler, let us first be familiarized with the meaning of journals and ledgers, which shall help in determining the reasons for a cashbook to be both a journal as well as a ledger.

What is a Cashbook?

A Cashbook is a book of original entries that records all the cash and bank transactions. It may be a single-column, double-column, or triple-column cash book.

• Single-column Cash Book: In a single-column cash book, there is only one column and it records the cash transactions.
• Double-column Cash Book: In a double-column cash book there is one column each for cash and bank transactions.
• Triple-column Cash Book: In a triple-column cash book there are three columns, one each for cash transactions, bank transactions, and discounts allowed and received.

What is a Journal?

A Journal is a descriptive financial record of a business that is used for future reconciling as well as a transfer to other books of accounts such as the ledger. It is a book of original entries.

Cashbook is considered to be a journal because all the cash/bank receipts and payments are recorded in this book in a descriptive form similar to journal posting.

What is a Ledger?

In simple words, a ledger refers to recording individual accounts in a summarized form that are posted from a journal. It is a book of principal entries.

A cashbook is considered to be a ledger because all the cash transactions that are made during a particular financial period are recorded in this book in chronological order.

When a cashbook is prepared there is no need for a cash a/c as the book serves the same purpose and therefore, it can be used as a substitute.

What is the Format of a Cashbook?

The format of a Cash book is given in the image below:

Note: We may observe from the above image that the format and posting of a cashbook are similar to that of journal and ledger accounts. Therefore, it is right to say that a Cash book is both a Journal and a Ledger.

Conclusion

The above article may be summarised as follows:

• A Cashbook is a book of original entries that records all the cash and bank transactions.
• It is both a Ledger and a Journal.
• It may be a single-column, double-column, or triple-column cash book.
• It is a book of original entries, hence, it is considered a Journal.
• All the transactions of a year are recorded in the cash book and therefore, it is also a ledger.

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Every business organization uses inventory to generate sales. Inventory includes the raw material used to produce the goods, the goods which are yet to be completed (work-in-progress), and the finished goods which are ready to be sold.

If an organization manufactures products using raw materials or offers services that may require some raw materials, it must prepare accounting records for inventory.

Inventory can be purchased in two ways- on cash (or) credit.

In this question, we would like to explain both inventories purchased on credit and cash.  Starting with its meaning followed by Journal Entries and simple practical problems.

Purchased Inventory on Credit

When an organization purchases raw materials for manufacturing finished products from another organization on agreed terms that consideration (price or value) of raw materials (Inventory) will be paid on some future date then it is called Credit Purchase of Inventory.

Journal Entry for Inventory purchased on credit

1. Modern Accounting Approach

2. Traditional Accounting Approach

Practical Example

On 1st May Alexa Co., a manufacturer of sofa sets purchased hardwood from Anna Co. for 500,000 on a credit period of 2 months. Journalise the following transaction in the books of Alexa Co.

                                             In the books of Alexa Co.

1. When Inventory is purchased on credit from Anna Co.

(Being Inventory purchased on credit).

2. When the consideration (price or value) of Inventory is duly paid,

(Being consideration duly paid on the due date).

Purchased Inventory on Cash

When an organization purchases raw materials for manufacturing finished products from another organization on payment of cash, it is known as Purchase of Inventory on Cash.

Journal Entry for Inventory purchased on credit

1. Modern Accounting Approach

2. Traditional Accounting Approach

Practical Example

On 1st June, John and Co., a manufacturer of chairs purchased wood from Tom Co. for 200,000 on a credit period of 2 months. Journalise the following transaction in the books of John and Co.

                                             In the books of John and Co.

(Being Inventory purchased on Cash).

Conclusion

The above discussion may be summarised as follows:

• Inventory includes the raw material used to produce the goods, the goods which are yet to be completed (work-in-progress), and the finished goods which are ready to be sold.
• It is a current asset used in the production of goods.
• Inventory may be purchased either on Cash or on credit.

>Related Long Quiz for Practice Quiz 21 – Inventory

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Examples of Bank Reconciliation Statement

Illustration 1,

From the following particulars prepare a Bank Reconciliation Statement on 31^st January XXXX

1. Debit Balance as per Cash Book 48,000.
2. A cheque of 37,000 was deposited and collected by the bank but not recorded in Cash Book.
3. Purchased Furniture and payment by the debit card 25,000, was not recorded in Cash Book.
4. A cash deposit of 26,000 was recorded in the cash column of Cash Book.

Solution:

Illustration 2

From the following particulars prepare a Bank Reconciliation Statement on 31^st October XXXX

1. Pass Book of Ms Jane shows an overdraft of 50,000.
2. Cheques issued but not presented for payment to bank 40,000.
3. Payment side, bank column of Cash Book was undercast by 500.
4. Interest on overdraft charged by the bank was 1,500.

Solution:

Examples of Cash Book

Illustration 1,

Solution:

Illustration 2,

Prepare a 2 column cash book

Solution:

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Zero Working Capital

Before diving into the concept of Zero Working Capital, let me help you understand the meaning of Working Capital.

Working Capital is the term used to demonstrate whether the company possesses adequate current assets to discharge off its current liabilities. It is calculated as follows:

Working Capital = Total Current Assets – Total Current Liabilities

Now, taking this forward let us interpret the theory of Zero Working Capital.

The Working Capital of a company can be positive or negative, i.e. the total current assets may exceed the total current liabilities or vice-versa. However, there can be a situation when the total current assets are equivalent to the total current liabilities of the company. Such a situation is referred to as Zero Working Capital. Zero Working Capital is when,

Total Current Assets = Total Current Liabilities, or

Total Current Assets – Total Current Liabilities = Zero

Example

Using the data given in the balance sheet above, let us calculate the zero working capital.

1. Total Current Assets = Cash in hand/bank + Sundry Debtors + Bills Receivable + Inventory
= 15,000 + 1,80,000 + 1,00,000 + 55,000
= 3,50,000

2. Total Current Liabilities = Sundry Creditors + Bills Payable + Outstanding Expenses
= 1,95,000 + 85,000 + 70,000
= 3,50,000

As there is no excess of Total Current Assets over the Total Current Liabilities, this situation is referred to as Zero Working Capital.

Benefits and Approach of Zero Working Capital

Zero Working Capital is one of the latest techniques in working capital management. Let us now understand the benefits and approach of zero working capital in a real-life scenario.

1. Reduction in the level of investments in working capital

Zero Working Capital is a strategy to reduce the level of investment in the working capital and thereby increase the investments in the long term assets. Following this strategy, companies avoid excess investments in current assets and prefer paying off their current liabilities using the existing current assets only.

2. Savings in Opportunity Cost of Funds

Working Capital earns a very low rate of return as compared to long term investments. Also, maintaining zero working capital will help save the opportunity cost of funds as the company can now use the excess funds to exploit various other opportunities.  So, owing to its benefits, the management would certainly prefer zero working capital.

3. Just-in-Time Methodology

Zero Working Capital approach will be possible only if the Just-in-Time methodology is adopted by the company. Following the demand-based production and distribution system is advised. Very low or zero inventory is emphasized. Everything should be produced and supplied as and when the demand for the same arises.

To keep in pace with the Just-in-Time practice, the receivable and payable terms should also be modified. Payable time granted by the supplier should be extended and the credit terms granted to the debtors should be cut back. This will ensure that you have the cash required to fund the supplier’s payment.

Conclusion

Zero Working Capital eventually helps in better management of the current assets and current liabilities but is still considered to be a difficult scenario to be implemented in practical business life.

>Related Long Quiz for Practice Quiz 33 – Working Capital

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What is a Suspense Account?

A Suspense account is maintained by a business to record transactions that are doubtful and unidentifiable for the time being. It is a temporary account that records certain transactions that have occurred, but there is uncertainty as to which ledger such entries may be posted.

Accounting Process of Suspense Account

If the suspense account is shown in the trial balance then it will be directly shown in the statement of financial position (say- Balance Sheet).

If the suspense account appears on the debit side of the trial balance, it will be shown on the Asset side of the balance sheet. If the suspense account appears on the credit side of the trial balance, it will be shown on the Liabilities side of the balance sheet.

A suspense account appears in the trial balance if either side of the trial balance doesn’t agree (or) if any error occurs during the trial balance preparation. A suspense account is a temporary account and it gets closed once the particular error is found and rectified.

A Suspense account never appears in the Income Statement because income statements are prepared to ascertain gross profit (or) net profit. If the income side exceeds the expenses side then it is gross profit or vice-versa.

A practical example and a snippet of the balance sheet are added below for a better explanation and a clear understanding.

Example

ABC Enterprises furnishes you with the following information. They have maintained a Suspense Account and the balance is given here. Prepare the financial statements with the Trial Balance of ABC given below:

Trial Balance of ABC Enterprises

From the above Trial Balance of ABC Enterprises, we may observe a Suspense Account with a Debit Balance of 20,000. This is shown on the Assets Side of the Balance Sheet under the head Current Assets.

The Balance Sheet of ABC showing the presentation of the Suspense Account is given below:

Extract of Balance Sheet of ABC Enterprises

Conclusion

The above discussion may be summarised as follows:

• A suspense account makes the trial balance agree and facilitates the further preparation of financial statements.
• A suspense account can be placed on either side of the balance sheet depending on the placement of the Trial Balance.
• A Suspense account never appears in the Income Statement because income statements are prepared to ascertain gross profit (or) net profit.
• A suspense account is a temporary account and it gets closed once the particular error is found and rectified.

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What is a Debit balance?

While preparing a ledger account (T-account), if the sum of the debit side is greater than the sum of the credit side, then we say that the account has a “debit balance“.

Debit side > Credit side

Assets have a debit balance

Let us understand this concept by correlating it with the golden and modern rules of accounting and with an example.

1. The golden rule of accounting for a real account (i.e. assets like plant & machinery, furniture & fixtures, etc) is

                             Debit what comes in, Credit what goes out

2. On the other hand, the Modern rule of accounting states-

                    Debit the increase in asset, Credit the decrease in asset

Keeping this in mind, we will move forward to an example.

Example for Asset A/c

Samsung Inc. acquired 2 plants & machinery for 2,50,000. Out of the 2, it sold 1 for 1,00,000. Also, 20,000 depreciation was charged. So, the ledger account for plant & machinery will be presented as follows in the books of Samsung Inc.,

With the purchase of 2 plants & machinery, there will be an increase in the overall assets of Samsung Inc. So, we will have to debit the purchase/increase in the asset. And on the sale of any asset purchased before, you need to credit the asset account.

Therefore, in general, the debit side of an asset account will be > than the credit side, resulting in a debit balance.

In this example, the above ledger shows the debit balance (debit side > credit side) in plant & machinery A/c (By Balance c/d – 1,30,000).

What is a Credit balance?

While preparing a ledger account (T-account), if the sum of the credit side is greater than the sum of the debit balance, then we say that the account has a “credit balance“.

Credit side > Debit side

Liabilities have credit balance

Again, let’s just interpret this concept by correlating it with the rules along with an example.

1. The golden rule of accounting for personal accounts (eg. creditors) is;

                  Debit the receiver, Credit the giver

2. Modern rule of accounting states-

                 Credit the increase in liability, Debit the decrease in liability

Keeping these rules in mind, let us now understand why liabilities have a credit balance with an example.

Example for Liabilities A/c

ABC Ltd purchased raw materials from its supplier XYZ Ltd for 5,00,000. During the month it could only make payments of 25,000 and 40,000 to the supplier. The remaining amount is still outstanding. So, the ledger account for XYZ Ltd (Creditors A/c) in the books of ABC Ltd will be presented as follows;

XYZ Ltd has been credited with 5,00,000 because he is the supplier of raw materials (credit the giver). Also, ABC Ltd is now liable to pay 5,00,000 (credit the increase in liability). Then as and when we pay XYZ Ltd, there will be a decrease in the liability, therefore debit. The liability account will show a credit balance until we discharge the dues completely.

So, in general, you will always see the credit side of the liability account to be > than the debit side.

In this example, the above ledger shows the credit balance (credit side > debit side) in XYZ Ltd A/c (To Balance c/d – 4,35,000).

Conclusion

The key points from the above discussion are given below:

• If the sum of the debit side is greater than the sum of the credit side in a ledger, then we say that the account has a “debit balance.
• If the sum of the credit side is greater than the sum of the debit balance in a ledger, then we say that the account has a “credit balance“.