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Introduction

In simple words, the term Sale of services means providing services to a customer in exchange for compensation. Various organizations offer services in various domains such as Education, Consultancy, Finance, Healthcare, Transportation, and many more.

A service is anything that provides value to the customer. It may be an experience, an advice, a solution, etc. Sometimes, services are also customized as per the specific requirements of the customer.

In the case of the sale of goods, the ownership of a tangible product is transferred to the purchaser. On the other hand, a service is an intangible offering and there is no transfer of ownership. The treatment of the sale of services is similar to the sale of goods in the books of accounts. Like goods, the sale of services may be by receipt of cash or on credit.

Journal Entry

Case1- Sale of service on credit

In this case, the service is provided on credit and the debtor would pay on a later date.

1. According to the Traditional rules of accounting:

(Being services sold on credit)

2. According to the modern rules of accounting:

(Being services sold on credit)

Case 2- Sale of Services on Cash

1. According to the Traditional rules of accounting:

(Being services sold on credit)

2. According to the modern rules of accounting:

(Being services sold on credit)

Example of the Accounting Entry

Mr. K availed the financial services of XYZ Ltd. in May amounting to 20,000 with an agreement to pay the same in the following month. The journal entry in the books of XYZ  for the month of May is as follows:

(Being services sold on credit)

1. The first aspect of the entry is that Mr.K’s account is debited by 20,000. This is because Mr.K is a debtor of the company and a debtor is an asset for the company. As per the modern rules of accounting, an increase in assets is debited.

2. The second aspect of the entry is that the Sales account is credited by 20,000. This is because sales are revenue for the business and as per the modern rules of accounting, an increase in revenue is credited in the books of accounts.

Impact on Financial Statements

In the Balance sheet of the business, the debtor account would increase under the Assets head. A debtor is the current asset of the business. In case the payment is received in cash, the cash account will increase which is also a current asset of the business.

In the Trading Account of the business, the sale of services is credited. The impact of the above Journal entry on the Trading account of the business is shown below:

Conclusion

The key points from the above article are summarised as follows:

• Sale of services means providing services to a customer in exchange for compensation.
• Services may be of various types including education, financial advice, consultancy, healthcare, etc.
• The sale of services may either be on a cash or a credit basis.
• In some cases, services are also customized according to the needs of the customers.
• In the Trading account of the business, the sales are credited as it is revenue for the business.

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Closing Stock refers to the unsold goods held at the end of the financial year. To ascertain the true financial position of a company it is necessary to adjust the closing stock at the end of an accounting year.

Closing stock is crucial for accurate financial reporting because it impacts the calculation of the cost of goods sold (COGS) and the determination of a company’s gross profit. It is typically valued at either its cost price or its net realizable value, whichever is lower, in accordance with generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS).

Closing stock is reported on the balance sheet under the current assets section, as it represents inventory that a company expects to sell in the near future. Properly managing and valuing closing stock is essential for correct financial reporting and assessment of a company’s financial health.

The valuation and management of closing stock directly impact a company’s profitability. Proper management ensures that inventory is neither overvalued nor undervalued, which can affect the calculation of profits and taxes.

Tracking closing stock helps businesses manage their inventory levels effectively. It provides insights into which products are selling well and which may be slow-moving, allowing businesses to adjust their purchasing and sales strategies accordingly.

In many cases, closing stock requires a physical count of inventory items to accurately determine their quantity and condition at the end of the accounting period.

The formula to calculate closing stock is:

Closing Stock = Opening Stock + Purchases – Cost of Goods Sold

Where:

• Opening Stock is the value of inventory at the beginning of the accounting period.
• Purchases represent the total value of inventory purchased during the accounting period.
• Cost of Goods Sold (COGS) is the total cost of inventory sold during the accounting period.

Adjustment entry of closing stock

The closing stock generally does not appear in the trial balance and is seen as an adjustment entry. We need to pass an adjusting entry before the preparation of final accounts. It is important to note that an adjustment entry is always recorded twice in the books of accounts therefore, the two ways of recording the same for closing stock are as follows:

1. Credit side of the trading account.

2. The asset side of the balance sheet.

Example

The closing stock of ABC Ltd. amounts to 40,000. The journal entries in the books of the company are as follows;

(being closing stock adjusted)

Placement of closing stock in the trading a/c

Placement of closing stock in the balance sheet

Note: Sometimes, adjusted purchases are given in the trial balance which indicates that the opening as well the closing stock have been adjusted through purchases. It is important to note here that the closing stock will only be recorded on the asset side of the balance sheet and will not appear in the trading a/c.

Hope this helps.

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Meaning of Net Current Assets

To understand net current assets, we need to understand current assets and current liabilities.

Current assets are those assets that are used for operating activities and it is used within a year. It is liquid and easily converted into cash. An example of the current asset will be inventory.

Current liabilities are those liabilities that need to be fulfilled by the company within a year. It is a short-term financial obligation. Usually, current assets are used to cover the current liabilities. An example of current liabilities will be short-term borrowing.

 Net Current Assets is the difference between total current assets and current liabilities. It is also called working capital. This shows the company’s liquidity position to cover short-term obligations.

There are different types of working capital: gross working capital, net working capital, positive and negative working capital, cyclical working capital, etc.

The Net Current Assets can have a positive or a negative value, wherein the two are an indicator of the well-being of a business. In case the current assets are greater than the current liabilities, the company possesses sufficient assets to pay off its indebtedness and is operating efficiently.

However, a company is said to be facing financial difficulty and is not in a position to pay off its debts when the value of net current assets is negative.

Calculation of Net Current Assets: Formula

The formula is as follows:

where;

Total current assets = Cash and Cash Equivalents + Stock + Marketable Securities +                                          Prepaid Expenses + Accounts Receivable + Other Liquid Assets

Total current liabilities = Current Portion of Long-term Debt + Notes Payable +                                                      Accounts Payable + Accrued Expenses + Unearned Revenue +                                          Other Short-term Debt

• On the balance sheet, the total current assets are listed under the heading current assets.
• On the other hand, the total current liabilities are shown on the balance sheet under the heading current liabilities.

On the balance sheet, components of net current assets i.e., current assets and current liabilities appear on the asset side and liability side respectively.

Current assets are directly proportional to net current assets whereas current liabilities are inversely proportional to net current assets.

Example

Calculate the Net Current Assets of ABC Ltd.

(Extract of Balance Sheet)

Solution:

Total current assets = 2,96,000

Total current liabilities= 93,000

Net Current Assets = Total Current Assets – Total Current Liabilities

= 2,96,000- 93,000

= 2,03,000

Key Takeaways

• Net Current Assets are also known as Net Working Capital.
• Net Current Assets is the difference between the total current assets and total current liabilities.

Net Current Assets Vs Current Assets

Conclusion

The net current asset or working capital helps with ratio analysis. This helps in showing the creditworthiness of the company, especially the company’s financial trust. This will help in the overall confidence of the shareholders and the creditors.

It also helps in funding growth initiatives, like research and development and starting a new line of products.

Working capital is also very useful for risk management.

Overview of Fees Earned

Fees earned signify the revenue generated by an entity that is engaged in rendering services to its clients. When an entity deals in both goods and services it charges fees for the part of services rendered and for the goods delivered it charges the predetermined price. It generally forms a major part of revenue in the service industry such as professions where consultancy fees are charged to its clients.

Few Instances wherein an entity record the amount earned as fees:

1. For Services Rendered

• Consultancy
• Consultancy on Taxation-Related Matters
• Auditing and Assurance
• Architectural Services
• Accountancy and Other Legal Services.

2. Both Goods and Services

• Manufacturing and repairs
• Trading in goods and consultancy
• Goods and transport

When a combined amount is received for the cases wherein both goods and services are rendered one has to record fees earned proportionately.

Since fees earned is a part of the revenue of the business, it is credited to the books of accounts.

As per the Modern Rule of Accounting

Fees Earned shall be credited as fees form a part of the revenue and as per modern rule of accounting, the increase in an income should be “Credited”.

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 example, an accounting firm conducts a quarterly audit for various organizations. The accounting firm charges audit fees to its clients so this fee forms the revenue for the accounting firm. The fee received increases the revenue for the firm, thus, an increase in fees is credited according to modern rules.

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

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

(Fees received from the clients.)

Step 2 – To transfer the income to the “Income and Expenditure Account”.

(Fees received are transferred to the income and expenditure account.)

As per the Golden Rules of Accounting

Fees earned (Income) are Credited (Cr.)

As per the golden rules of accounting for (nominal accounts) incomes and gains are to be credited. So, fees earned are credited to the financial books.

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. So, fees received being a nominal account are credited to the financial books.

Example

Suppose, you are a private tutor and student students pay your tuition fees on a monthly basis. The tuition fees are income for you and according to the golden rules, fees will be credited to your books of accounts.

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

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

(Monthly tuition fees received in the bank account.)

Step 2 – To transfer the income to the “Income and Expenditure Account”

(Fees received are transferred to the income and expenditure account.)

Fees Earned Inside the Trial Balance

Fees earned show a credit balance in the trial balance. A trial balance example showing a credit balance for fees earned is provided below.

If an entity follows the Cash System of Accounting entire amount received shall form part of the fees earned. One need not distinguish fees based on actual earnings in the accounting period.

Journal Entry for the same shall be:

The accounting treatment in an income statement is given below;

If an entity follows the Accrual System of Accounting only that part of the receipts shall form a part of fees earned which has been accrued in the reporting period.

The amount if received in advance shall be recorded as a liability and if received less, then such a difference shall be recorded as sundry debtors under current assets.

Journal Entry for the same shall be;

Out of the total revenue, a part of fees is received in advance-

It appears in the income statement and balance sheet as;

In case only part of fees earned is received in a reporting period:

It appears in the income statement and balance sheet as –

As it can be seen in all of the cases above fees earned being an income are credited.

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Debenture Suspense Account

It’s basically a temporary account prepared by an entity to record the transaction of debenture when such an entity issues or agrees to issue a certain amount worth debentures as collateral security. As soon as the entity repays the loan taken it shall nullify the earlier agreement in simple terms pass the reversal entry.

When a company issues debentures, it may receive applications from investors. These applications might come in various forms, such as checks or electronic transfers.

It takes time for the company to process these applications, verify the funds, and issue the debentures to the investors. During this period, the company may create a debenture suspense account to temporarily hold the funds received and record the pending issuance of debentures.

The debenture suspense account is a temporary account on the company’s balance sheet. It reflects the amount received from investors for debentures that have not yet been fully processed. This account helps in maintaining accurate financial records until the debentures are issued and properly accounted for.

Once the debentures are fully processed and issued to the investors, the amounts from the debenture suspense account are transferred out and recorded appropriately in the company’s books. This might involve transferring the funds to a different account and updating the company’s records to reflect the issuance of the debentures.

Issue of Debenture as Collateral Security

When an entity has to borrow funds from a bank or a financial institute such bank or financial institute shall not grant such loan amount until the entity provides some collateral security in order to safeguard its interest. Bank shall always prefer to have as collateral the physical assets than any alternative means.

But if such physical asset does not cover the amount of loan as collateral then the entity will issue the debentures as secondary security.

When an entity default in making payment of interest or principal amount of loan then the bank will first realize such amount outstanding by discharging the primary asset and if it does not cover the entire amount then the bank will have no choice but to claim its rights over the debentures so issued by the entity.

When the debentures are issued as collateral the entity has two options –

At the end of the accounting period the Debenture Suspense Account will be subtracted from Debentures Account on Equities and Liabilities side of the Balance Sheet.

At the time of repayment of the loan the entries passed above will be reversed.

The Debentures issued as collateral security shall be shown in the balance sheet if the company follows Option 1 as:

Extract of Balance Sheet as on 31/03/XXXX

Notes to Accounts:

The Debentures issued as collateral security shall be shown in the balance sheet if the company follows Option 2 as:

Extract of Balance Sheet as on 31/03/XXXX

Notes to the Accounts

It is preferable to use option 1 as the entity has some evidence and records of such transaction. Even though in actuality no amount was received by the entity at the time of transacting it.

I hope it was informative.

Aastha.

-This question was submitted by a user and answered by a volunteer of our choice.

Yes, it is possible for a company to show positive cash flows but still be in grave trouble.

To begin with, let me explain to you the meaning of positive cash flows.

Meaning of Positive Cash flows

Positive Cash flow is an indication that the cash balance of an entity has increased from its previous year. It also represents that the cash inflow is greater than the cash outflow during the period.

Positive Cash flow =
Closing Cash & Cash Equivalents > Opening Cash & Cash Equivalents; OR
Cash Inflow > Cash Outflow

Reasons why a company has positive cash flows but is still facing grave trouble

There might arise situations where you witness positive cash flows in the statement of cash flow but still, the company is facing hardships, owing to various reasons.

1. Increase in bad debts

Bad debts being a non-cash expense will never be reflected in the cash flow statement. However, a company may face plenty of hardships, if its bad debts increase over time, instead of reporting positive cash flows.

2. Increase in borrowings accepted

Positive cash flows can also arise because of the increase in the loans accepted by entities. Increase in borrowings will result in higher interest payments which could be troublesome. Also, repayment of the loan accepted could be challenging for an entity.

3. Delay in payments

In order to report positive cash flows during an accounting period, the company might delay the payment of the amount due to the creditors, moneylenders, etc.

However, this could prove to be adverse for the entity as it will have to anyway discharge all these amounts due in the future period. Also, it could be possible that the entity will have to settle these amounts due along with interest or penalties.

4. Sale of inventory at lower cost

Positive cash flows can even occur as a result of the entity selling its inventory at a price lower than its purchase price. This is done by companies to generate immediate cash to pay bills due, to avoid bankruptcy, and for its day to day operations.

So, despite having positive cash flow, the company might run into losses by selling its inventory at a loss.

5. Revenues earned not introduced back into the business

Earning revenue increases positive cash flow. But, it is of utmost importance for a company to bring back the revenue earned and utilize it for growth prospects, increase the production and sales of the business, and for further expansion. Positive cash flow arising from earning revenues but not directing it back for business purposes is worthless.

6. Disposing of long-term assets

Positive cash flow could also be a result of the cash inflow arising from the sale of long-term assets. Companies in need of cash might dispose off their assets primarily held for long-term purposes. This could land them in big trouble in the future as there would be a lack of assets generating future economic value to the entity.

I hope after reading this answer, you might have got an insight into the various reasons for companies facing trouble despite reporting positive cash flows.

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First, let me help you interpret the difference between Receipts & Income along with the help of an example.

Difference between Income & Receipts 

Examples of Receipts & Income

For instance, XYZ Inc. receives the following amount in the month of January 20×1. Let us differentiate the following transactions as receipts or income.

1. Borrowed 50,000 from a bank for establishing a new unit.
2. Amount of 10,000 received from the disposal of an old machine.
3. Amount of 600,000 received from the issue of new shares & debentures of XYZ Inc.
4. 500,000 received as consideration for the sale of goods or services.
5. Rent received 60,000 from the tenant.
6. Interest & Dividend received 15,000 from investments in Amazon Inc.

All the above examples can be termed as receipts but all of them cannot be termed as income. Only examples 4, 5, & 6 can be referred to as income for XYZ Inc.

Eg. 1, 2, & 3 are capital receipts and will not affect the statement of profit & loss of XYZ Inc. Therefore they are termed only as receipts & not income.

Whereas eg. 4, 5, & 6 are revenue receipts and will affect the profit & loss statement. Therefore, they can be referred to as income for XYZ Inc.

Now moving forward, let me help you understand the difference between payments & expenditure, with the help of an example.

Difference between Payments & Expenditure

Examples of Payments & Expenditure

For instance, ABC Inc. incurs the following payments in the month of January 20×1. Let us differentiate these transactions as payments or expenditures.

1. Paid 40,000 for the acquisition of new machinery.
2. Paid 200,000 for the redemption of shares and debentures issued by ABC Inc.
3. Repaid 45,000 amount of loan taken from the financial institution.
4. Salary & Wages paid 100,000.
5. Purchase of Raw materials 30,000.
6. Professional fees paid 15,000.

All the above examples can be referred to as payments by ABC Inc. but all of them cannot be termed as expenditures. Only examples 4, 5, & 6 can be referred to as expenditures for ABC Inc.

Eg. 1, 2, & 3 are capital expenditures and will not affect the statement of profit & loss of ABC Inc. Therefore they are termed only as payments and not expenditures.

Whereas eg. 4, 5, & 6 are revenue expenditures and will affect the profit & loss statement. Therefore, they can be referred to as expenditure for ABC Inc.

Conclusion

1. All cash incomes are receipts. But all cash receipts are not income.
2. All cash expenditures are payments. But all the cash payments are not expenditures.

Overview of Purchase Ledger Control Account

Purchase Ledger Control Account (PLCA) is a summarized ledger of all the trade creditors of the entity. This Control Account typically looks like a “T-account” or a replica of an Individual Trade Payable (Creditor) account. But instead of containing transactions of invoices, returns, and payments related to one creditor, it contains summarized transactions of invoices, returns, and payments related to all the creditors in the business.

Purchase Ledger Control Account is also referred to as a “Trade Creditors Control Account”. It indicates the total amount a business entity owes to its suppliers at a particular point in time. Therefore, it is a “short-term liability” for the business entity and forms part of the balance sheet.

Thus, Purchase Ledger Control Account is credited if its balance increases & debited if its balance decreases. The balance of the PLCA should equal the sum of the balances of the individual supplier accounts. If discrepancies arise, then they should be investigated.

As per the Modern Rules of Accounting

Purchase Ledger Control Account (liability) is Credited (Cr.) when increased & Debited (Dr.) when decreased.

Why is it like this?

Since it indicates the total trade payables, it shows a credit balance and the modern rule of accounting cannot be broken under any circumstances.

How is it done?

Suppose the following were the transactions during the year with the Creditors ABC Inc. & XYZ Inc. along with the outstanding balance as of 31/12/20×2.

Purchase Ledger Control Account for the year 01/01/20×2 to 31/12/20×2 will be presented as follows:

The balance of PLCA i.e. 400,000 is equal to the sum of the balance of individual outstanding creditors i.e. 150,000 + 250,000 = 400,000.

You can see that the transactions which increase the balance of PLCA are credited & decrease the balance are debited. Also, it is depicting a credit balance.

As per the Golden Rules of Accounting

Purchase Ledger Control Account (liability) is credited as per the Golden Rules.

The individuals and other organizations that have direct transactions with the business are called personal accounts. PLCA indicates total trade payables at a given point in time, and since trade payables are personal accounts, PLCA also operates according to the golden rule for personal accounts.

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

The following were the transactions during the year with the Creditors ABC Inc. & XYZ Inc. along with the outstanding balance as of 31/12/20×2.

Purchase Ledger Control Account for the year 01/01/20×2 to 31/12/20×2 will be presented as follows:

The balance of PLCA i.e. 450,000 is equal to the sum of the balance of individual outstanding creditors i.e. 200,000 + 250,000 = 450,000.

You can see that PLCA is depicting a credit balance.

Purchase Ledger Control Account in Trial Balance

PLCA shows a credit balance in the trial balance. A trial balance example showing a credit balance for PLCA is provided below.

Read

Meaning & Definition

Set-off means discharging reciprocal monetary obligations by counterbalancing debt or claim. The set-off is carried out by debiting one account against a credit on another. The word “set-off” gives us the idea that it is related to writing off or reducing the value.

In simple accounting terms, when a debtor can decrease the amount of one’s debt by the amount owed by the creditor to the debtor, it is known as setting off. The creditor’s claim on the debtor is reduced by the amount of the debtor’s claim on the creditor. It is important to note that the claims are unrelated or separate transactions.

To set off a debit on one account against a credit on another, you deduct the debit from the credit. The balance you receive is the difference between the two amounts, either payable or receivable.

Set-off is crucial as all the accounts are reconciled to show a true and fair image of the financial position of the business.

Key Features of set-off : (with the exception of contractual set-off)

• both claims must be for the non-payment of money
• there must be mutuality of debts

Types of Set-off in Accounting

In commercial transactions, contractual set-off, banking set-off, and insolvency set-off are important. A set-off in terms of accounting is of the following types and applies accordingly:

1. Contractual set-off – Many times, a debtor agrees to exclude the right to set off based on a contract or business relations. In this case, although the creditor owes some amount to the debtor, it is considered nil, and the debtor is obliged to pay the entire amount of debt.

2. Banking set-off – The bank gets the right to set off a credit balance against another debit balance when a person has more than one account, i.e. combining two or more accounts held by the same entity.

3. Insolvency set-off – An insolvent debtor of the company may set-off its claims against its creditor.

4. Legal set-off (also known as independent set-off or statutory set-off) – Under legal proceedings, mutually exclusive unsettled debts between the two parties, arising from transactions unrelated to each other can be set off.

5. Equitable set-off (also known as transaction set-off) – It is an independent provision where the set-off is given at the discretion of the court. Here, the amount of set-off is according to the decision of the court.

6. Intercompany set-off – A company may have various subsidiaries. There are many transactions that happen between such entities. A set-off of the amounts owed by the entities to each other may help in determining an accurate financial position of the entities.

Example 1

Mr A purchased goods from XYZ Ltd. amounting to 40,000. However, XYZ owes an amount of 10,000 to Mr A as per past unrelated transactions. The working of the amount owed by Mr A (the debtor) to XYZ (the creditor) as per their agreement is as follows:

Solution:

Mr A originally owes a sum of 40,000 to XYZ Ltd. Also, XYZ owes a sum of 10,000 to Mr A on the basis of prior transactions. So, Mr A is allowed to set off by paying only a sum of 30,000 (40,000 – 10,000) to XYZ as a settlement of the claim.

Here, XYZ Ltd. A/c is debited with 10,000, which represents the amount set off. The ledger account of XYZ in the books of Mr A is provided below.

The main benefit of using set-off in accounting is that it ensures payment security and hassle-free settlement of disputes at both ends.

Let us take another example to understand this concept better:

Example 2

ABC Ltd. and XYZ Ltd. are two companies. ABC has to pay XYZ 1,000 for goods purchased. On the other hand, XYZ has to pay 500 to ABC Ltd. for marketing services rendered by it. The companies mutually decide to set-off this amount.

On set-off, ABC has to now pay 500 (1,000 – 500) to XYZ in full and final settlement.

Conclusion

On a concluding note, we may say that:

• Set-off is a process of writing off a debit on one account against a credit on another.
• These two claims are separate transactions.
• Both the claims are for non-payment of money.
• There are various types of set-offs including Equity set-offs, Intercompany set-offs, Contractual set-offs, Banking set-offs, Insolvency set-offs and Legal set-offs.
• Set-off is crucial as all the accounts are reconciled which helps to show the true financial position of the entity.
• It helps in determining the actual amount receivable from or payable to an entity.

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Meaning of Outstanding Subscriptions

In the context of non-profit organizations, a subscription is an amount paid by every member of the organization as membership fees. It is the main source of income of a non-profit entity.  It is usually collected monthly from all the ordinary members.

Outstanding subscription is the amount of subscription which was to be paid by the members during the course of an accounting period but is due for payment i.e. the payment for it has not been made.

Understanding Outstanding Subscriptions is important for investors, financial analysts and company management as they assess the financial health and potential future growth of a company.

High level of Outstanding Subscriptions indicate strong investor interest in the company’s offerings, which can be a positive signal for its future prospects.

Example

For example, XYZ Club has 1200 members, each paying a monthly subscription of 100. As of 31st March, the Subscription due (or) outstanding subscription amounted to 25,000. Journalize the following transactions for subscriptions due and received in the books of XYZ Club.

In the books of XYZ Club

(Being Subscription due as of 31st March)

At the time of receipt

(Being Subscription received)

Modern Accounting Approach

We will record the same transaction by following the modern rules of accounting.

In the books of XYZ Club

(Being Subscription due as of 31st March)

At the time of receipt

(Being Subscription received)

Outstanding Subscriptions in Financial Statements

Accounting Treatment

• It is added to the subscription and recorded on the income side of the Income and Expenditure account. It is also termed as Subscription in areas (or) Subscription due.
• An outstanding subscription is treated as an asset to the organization and shown on the asset side of the balance sheet.

O/s Subscription at the end of the Accounting Year Represents

An outstanding subscription at the close of the financial year is considered an asset and, therefore, appears on the Assets side of the closing balance sheet as a result (being the closing balance of the subscription).

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Introduction

In simple words, provision for doubtful debts refers to the amount set aside as a provision from the profits of the business for the amount that is doubtful to be received in the future.

The provision for doubtful debts is usually provided for credit sales. This is because it is doubtful whether the customer might not be able to make the payment completely or partially.

Why is it necessary to maintain provision for doubtful debts?

It is necessary to maintain provision for doubtful debts due to the prudence principle. According to this principle, the company needs to be cautious and conservative when recording financial statements and reports. The company needs to identify potential losses from the events and transactions of the company.

It is a proactive step taken to safeguard the accurate financial position of the firm & to ensure the year-end reporting is done accurately. The accountant views the past trends of a business and then determines the approximate amount of doubtful debts every year and creates a provision for the same.

This shows how a company can manage risk related to credit sales when the company is on the receivable end. This will also increase the confidence of investors and stakeholders as this principle ensures transparency by showing how the potential risks are treated.

Example

A customer has purchased goods on credit for 50,000 from Kumar company. Provide provision for doubtful debts of 10%.

The Journal entry for the above example for the provision of doubtful debts will be

The journal entry is recorded in the books for the provision for doubtful debts of 50,000.

As per the modern rules, since there is a decrease in profit, the profit and loss account will be debited. The provision for doubtful debts will be credited since there is an increase in liability.

The company’s (receivables) debtors is 50,000.

As per the prudence principle, after the potential losses, the amount receivable from debtors will be 45,000.

Treatment of provision for doubtful debts

The provision for doubtful debts can either appear in the trial balance or as an adjustment entry.

When provision for bad debts is shown in the trial balance:

Provision of doubtful debts appears on the credit side of the trial balance. The provision for bad debts is created out of profits. This is done to not overestimate the profits.

In the trial balance, the Provision for doubtful debts has a credit balance as it is an accounts receivables contra account. A Contra account is an account that acts against the asset account.

According to the example, we can see that debtors is an asset, and the provision for doubtful debts has been deducted from the total debtors.

The trial balance of Kumar Ltd. is as follows:

In the Profit and loss a/c

In the profit and loss account, the provision for doubtful debts will be debited as this will lead to a decrease in net profit.

Conclusion

• Provision for doubtful debts is an account made based on the amount that might not be receivable from the debtors
• This account follows the prudence principle.
• It appears on the credit side of the trial balance as it is a contra account as it is reduced from debtors (asset).
• It appears on the debit side of the profit and loss account since it is an expense for the company.

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Before answering this question you should first have a glance over the concept of interest on capital.

Interest on Capital

An organisation or an entity is considered separate from its partners or proprietor or shareholders for that matter.

Since the capital brought in by the partners and proprietor is an obligation for an entity thus the interest payable to the partners or proprietor for that matter is considered as an expense of the firm or an entity. Had not the partners or sole owner brought in the capital the firm or the organisation would have borrowed such amount externally and so, it would have to incur a certain financial charge.

Adjustment of Interest on Capital in the Financial Statement

Where the capital is introduced by the sole proprietor the transaction will be journalised as

Interest when due;

Interest on capital transferred to profit and loss statement

Thus, ultimately the profit of the firm is reduced as such interest is treated as an expense and hence debited in the profit and loss statement and it is shown in the balance sheet by increasing the capital on the liability side of the balance sheet by that amount.

For Example;

Mr John is a dealer in the smartphone has introduced capital worth 1,00,000 and the firm shall pay interest @ 6% p.a. at the end of the year.

It will be displayed in the profit and loss statement as;

It will be displayed in the balance sheet as;

Interest on capital is provided out of profits only. Thus in case of loss, no interest is provided.

In the case of a partnership firm – 

If the firm maintains Fluctuating Capital i.e all entries in respect of salary, interest, profit earned and drawings of partners are transacted through the partner’s capital A/c.

Thus, where an entity maintains only partners capital account the interest on capital shall be journalised as;

Interest on capital due;

Interest on capital transferred to profit and loss appropriation statement;

Some entities prefer showing the partner’s capital accounts with the same old figures i.e no entries in respect of salary, interest, profit earned and drawings of partners are transacted through the partner’s capital A/c.

A separate account is to be opened for the same called “Partner’s Current Account”. The interest on capital here shall be calculated only on fixed capital.

In this case, such a transaction shall be journalised as;

Interest due on capital

Interest on capital transferred to profit and loss appropriation statement;

Thus, ultimately the profit of the firm is reduced as such interest is treated as an expense and hence debited in the profit and loss appropriation statement and it is shown in the balance sheet by increasing the partner’s capital/ current a/c on the liability side of the balance sheet by that amount.

The example given below will be of some help to interpret the above paragraph.

An entity has 2 partners – Alex and Anna at the beginning of the year both have introduced a capital of 100,000  each and it was agreed in the partnership deed that the partners will charge interest @ 12% p.a. every year at the end of the year.

Hence, the interest of 24,000 (100,000 x 12% p.a x 2 partners) shall be transacted in the balance sheet and Profit and loss statement as;

If the firm maintains partners capital account only;
Adjustment in profit and loss appropriation statement

Extract of Profit and Loss Appropriation Account;

Adjustment in a balance sheet

A snippet of the balance sheet is given below

If the firm maintains partners capital account and partners current account

Adjustment in profit and loss statement

Extract of Profit and Loss Appropriation Account;

Adjustment in a balance sheet

A snippet of the balance sheet is given below

I have tried simplifying it as much as I could. I hope this helps.

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Meaning of Prepaid Expenses

Prepaid expenses refer to the advance payment of goods or services the benefits of which shall be received in the future. Prepaid expenses are considered assets on the balance sheet because they represent items paid for in advance that will become expenses over time as they are used or consumed.

Examples of prepaid expenses are insurance premiums, rent, subscriptions, utilities, etc.

Type of Account

Prepaid expenses are considered a current asset since it will benefit in the future.  The prepaid expenses will be adjusted in the next couple of months within the operating year hence it is a current asset.

Expenses such as prepaid rent, insurance, etc. are shown in the trial balance on the debit side as they are initially an asset for the business, however, once the benefit is received, the value of the asset falls.

Journal entry for prepaid expenses

As per modern rules, 

The prepaid expenses are leading to an increase in current assets. It will be debited. The cash account will be credited since it leads to a decrease as it is used to make payments for prepaid expenses.

As per traditional rules,

Prepaid expenses are coming in into the firm as it is debited as per the real account rule. As cash is used to make the payment for the prepaid expenses it is credited since cash is going out of the firm.

Expenses such as prepaid rent, insurance, etc. are shown in the trial balance on the debit side as they are initially an asset for the business, however, once the benefit is received, the value of the asset falls.

Example

The trial balance of Amar Ltd. shows the rent amounting to 4,500 as a prepayment for April.

This prepaid rent of 4,500 is shown in the trial balance as follows:

Trial Balance as of 31st March, Kumar Ltd 

Note

• If the prepaid expenses are already shown in the trial balance it means that an adjusting entry has already been recorded in the books of accounts and they shall be further recorded only in the balance sheet of the company.
• It shall be shown in the balance sheet of the company under current assets.
• However, if prepaid expenses are not shown in the Trial Balance, then they shall be added to their respective accounts and recorded on the debit side in the Profit and Loss A/c.

Conclusion

• Prepaid expenses are debited since it leads to an increase in assets. The cash account is credited since the money is used to pay for the prepaid expenses.
• Prepaid expenses are considered as a current asset since it is used up within the operating year.
• This helps in reducing administrative burden since it is already paid. It reduces administrative processes related to procurement and payment. This shows the operational efficiency of the company related to cash management.
• Prepaid assets are recorded as assets on the balance sheet until it is utilized. This can improve the financial statement of the company related to liquidity ratios and asset turnover ratios, which is important for investors and creditors.

related Long Quiz for Practice Quiz 36 – Prepaid Expenses

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What is Petty Cash Book?

A petty cash book is a specialized accounting ledger used to record small and miscellaneous expenditures that are typically paid for in cash. It helps in maintaining a record of all such expenses in an organized manner.

The petty cash book helps in tracking small expenditures efficiently and provides accountability for cash transactions that might otherwise be difficult to monitor. It also simplifies the process of auditing and ensures that small expenses are properly documented for financial reporting purposes.

Features of Petty Cash Book

Petty Cash Book allows for the systematic recording of minor expenditures, ensuring that even the smallest transactions are documented and accounted for.

The petty cash book helps maintain control over cash disbursements by providing a clear record of who authorized the expenses and for what purpose.

It provides a detailed record of cash expenditures, which is essential for accurate financial reporting and budgeting.

The petty cash fund can serve as a readily available source of cash for unforeseen or emergency expenses, providing liquidity when needed.

The petty cash book is usually maintained by a petty cash custodian or administrator within an organization.

The petty cash book typically follows a simple format, often divided into columns for date, description of expense, amount spent, and columns for various expense categories.

Balance of Petty Cash Book

Balance of the petty cash book is an asset and not income. The logic behind the answer is that petty cash book is one of the types of cash book and petty cash book records expenses and incomes which is similar to cash book. Since a cash account is considered an Asset, a petty cash book which is a part of a cash book is also an asset.

The balance of petty cash book is never closed and their balances are carried forward to the next accounting period which is considered as one of the most significant qualities of an asset whereas Income doesn’t have any opening balance and their balances get closed at the end of every accounting year.

Petty cash book is placed under the head current asset in the balance sheet. The Closing Balance of the petty cash book is computed by deducting Total expenditure from the Total cash receipt (as received from the head cashier).

Example Problem

Prepare Petty Cash Book of Alex & Max Co. from the following information as provided below

Petty Cash Book of Alex & Max Co.

Conclusion

Thus, the balance of the petty cash book is an asset and not income.

the balance of the petty cash book is classified as an asset because it represents the remaining cash available for small expenses within the organization and is essential for maintaining liquidity and facilitating day-to-day operations.

It is not considered income or revenue because it does not result from the organization’s primary revenue-generating activities.

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Return Inwards

Return inwards is also called sales returns or sales allowances, it refers to the customers returning their products to the company. These returns happen when the customer is dissatisfied with the product or receives a defective product.

In layman’s language, return inwards refers to the goods returned by the buyer (customer) to the seller (i.e., selling entity) due to various issues.

The amount of return inwards (or) sales returns is deducted from the total sales of the firm. This is treated as a contra-revenue transaction meaning deducted from the revenue itself.

Why are sales returns books important to maintain?

• It helps in keeping track of the financial records and helps in ascertaining the financial accuracy.
• Maintaining sales returns books helps in understanding customers’ returns their dissatisfaction, and potential issues with the product. This will help the company in taking corrective measures.
• Tracking return inwards helps in adjusting the inventory and helps in providing the accurate amount of stocks.

Journal Entry

As per modern rules,

When there is a sales return the journal entry will be

As per modern rules, an increase in revenue is credited, and a decrease in revenue is debited. As the products are returned to the company it leads to a decrease hence, the sales return account is debited since there is a decrease in income or revenue.

This will lead to a decrease in the trade receivables account. Trade receivables is an asset account where the company needs to receive money in the future. As the goods are being returned, trade receivables decrease, leading to decreased assets.

As per traditional rules,

When there is a sales return the journal entry will be

As per traditional rules, the sales returns are debited since it is a loss for the company. Most importantly it is a contra revenue meaning a decrease from the total revenue.

The trade receivables are credited since he is returning it back to the company which makes him the giver as it is a personal account.

Example

 On 1st May, Max Ltd. (a dealer in refrigerators) sold 20 refrigerators for 5,00,000 on credit to Alexa Ltd. On 25th May they returned all the refrigerators to Max Ltd. due to the serious defects in the model of the refrigerators. Pass journal entries for the above transaction in the books of Max Ltd.
In the books of Max Ltd (Modern Approach)

a) As per traditional rules

(Being goods returned by Alexa Ltd due to serious defects)

As the goods are being returned to the firm, it is debited since it is a loss for the company. The Alexa Ltd is credited since it is a personal account and the giver is returning to the company.

b) Entry for the return of goods sold to Alexa Ltd.

(Being goods returned by Alexa Ltd due to serious defects)

Sales returns are debited since there is a decrease in revenue and Alexa Ltd is credited since there is an increase in the asset.

Placement in Trial Balance

Return inwards or sales returns hold the debit balance and are placed on the debit side of the trial balance as it will be reduced from the total sales.

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Provision for Depreciation in the Trial Balance

A trial balance shows provision for depreciation as a “credit item”. The value of most of the assets reduces over a period of time. It’s a common practice to record the assets at their historical cost but over a period of time, does the value of the asset remain the same as at the time of its purchase?

Obviously “Not”. So, if the asset has a debit balance then the provision for depreciation can not have a debit balance i.e it is bound to have a credit balance.

The below-given image would also be of great help to understand the above para.

What is Provision for Depreciation?

The fixed assets are depreciated over a period of time. Depreciation while is deducted from an income statement every year it is not deducted from an asset rather it is recorded on the liability side as accumulated depreciation or provision for depreciation. It’s a contra asset.

To find the net book value at the time of disposal of the asset or year-end or revaluation etc. one needs to subtract the provision for depreciation account balance from the historical cost of the asset. Such provision being a contra asset has a credit balance.

The illustrative example given below in the form of a problem might be of some help.

Prepare a trial balance of Ms Julie from the data given below;

Solution:

I hope that your question now has been answered.

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Cash is commonly received by the business under the following situations:

1. Receipt of payment by a debtor in cash.

2. Sale of goods by the business on a cash basis.

3. Withdrawal of cash from the bank.

4. Cash received from other income.

5. Additional capital introduced by the partner, etc.

It is important to note that the receipt of cash in any of the above-mentioned scenarios is always debited in the books of accounts because it is an asset for the business.

The journal entries for receipt of cash in different scenarios as discussed above are as follows;

1. Journal entry for cash received from the debtor

When an organisation sells goods or services on credit, it becomes eligible to receive future payments. As an obligation, the debtor pays cash to the organisation. The journal entry for cash received from the debtor is as follows;

(Being cash received from the debtor)

As per the modern rules of accounting;

2. Journal entry for cash received from the sale of goods

When an entity sells goods or services on a cash basis, it receives cash at the time of sale only. The journal entry for cash received from the sale of goods is as follows;

(Being goods sold in cash)

As per modern rules of accounting;

3. Journal entry for cash received from withdrawal

When cash is withdrawn from the bank, it results in an increase in cash a/c and a decrease in bank a/c. The journal entry for cash received from withdrawal is as follows;

(Being cash received from withdrawal)

As per modern rules of accounting;

4. Journal entry for cash received from other income

Other than sales, there are other sources of income through which cash can be received such as rent received, interest income, the commission received, etc. The journal entry for cash received from other income is as follows;

(being cash received from other incomes such as commission, rent, interests, etc)

As per modern rules of accounting;

5. Journal entry for additional capital introduced by the partner

Capital is introduced by the partners or proprietors of a business, resulting in an increase in cash flow. The journal entry for additional capital introduced by the partner is as follows;

(Being additional capital introduced)

As per modern rules of accounting;

Conclusion

As a result of cash receipts by an organization, the amount of cash inflow increases, which has an impact on the cash flow statement. However, whenever cash is received, it results in a double entry on either the asset or liability side of the balance sheet.

As an example, when cash is received from the debtor, the cash will increase, while at the same time, the number of debtors will decrease.

In the case of the introduction of capital, cash will be increased but with that, the liability will also be increased.

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Purchase Order

Purchase Order is a commercial document issued by a buyer to the seller specifying the quantity, price, description, quality of goods required, the payment terms, etc. It is the first step and a very integral part of an organization’s procurement process. Purchase Order precedes the Purchase Invoice.

Now, the question arises whether a purchase order is legally binding, and once issued can it be cancelled by any of the parties to a transaction.

So, let me help you address the first question-Whether a purchase order is legally binding or not?

Purchase Order – Legally binding or not?

The issue of a purchase order by the buyer does not itself result in a legally binding contract. A legally binding contract gets executed between the parties to a transaction only on the acceptance of the purchase order by the seller. It provides legal protection to the buyer and seller.

1. From the buyer’s perspective-

So, let me help you understand how does a purchase order legally protects the buyer.

On the acceptance of the purchase order, the vendor or supplier is obligated to deliver the requested goods as stated in the order. He is also compelled to consider the other conditions in the order specifying the description, type, and quality of goods.

Example
Let’s say you order 10 computers for your company from a well-known vendor, paid for the same, but on the delivery date you end up receiving only 8 computers.

In this case, if you have an acknowledged purchase order with you, you will certainly be able to prove that you received less quantity than what you paid for. The purchase order will serve as an on-record legal document for your purchase.

Had you not possessed an acknowledged purchase order, you would have certainly landed up in big trouble.

2. From the seller’s perspective

Purchase Order can be used as a legal document in the court of law by a seller to sue the buyer in case he refuses to pay the agreed amount for the goods supplied. This is possible only because of the legally binding contract status of the purchase order.

3. Trade Finance

Banks and financial institutions facilitate domestic and international trade transactions and provide financial assistance based on purchase orders issued.

Example
To produce the goods as requested by the buyer, the supplier can approach a bank for funds based on the acknowledged purchase order.

In case the supplier does not provide credit terms for payment to the buyer and the buyer does not possess the requisite funds for payment. Then in such a situation, banks or financial institutions accept the purchase order as a legal document for providing financial assistance to the buyer.

Now, let me help you understand the next question asked – Can the Purchase Order be cancelled?

Cancellation of a Purchase Order

To help you understand, whether the cancellation of a purchase order is possible or not, we must consider various situations related to the acceptance and cancellation of the purchase order-

• Situation 1

Can a purchase order be cancelled before its acceptance?

The question to this scenario is yes. As the purchase order has not been accepted by the seller, it can be easily cancelled by the buyer, because it has not yet attained a legally binding status.

• Situation 2

Can the buyer cancel a purchase order after the goods have been delivered to him by the supplier?

–In this scenario, goods have been dispatched and delivered ie. the purchase order has already been acknowledged by the vendor. In such a case, the vendor might not accept a cancellation request as desired by the buyer. Or the vendor may accept your request but may charge some fees for the same.

• Situation 3

Can the purchase order be cancelled by the supplier or the buyer after it is acknowledged as a legal binding contract?

–The purchase order gets a legal binding status only after its acknowledgement by the seller. So, in this case, we will have to consider the terms and conditions laid out in the order.

If the purchase order allows cancellation without fulfilment of any additional terms and conditions, and both the parties mutually decide to terminate the order. Then in such a case, no party shall be liable to sue or be sued in the court of law.

But, if the purchase order does not allow cancellation after its acceptance, it becomes legally binding on the parties to fulfil the requirements stated in the order. If one party does not obey the terms detailed in the order, the other party certainly has the right to sue. The order will be considered to be an on-record legal document if such a situation arises.

Conclusion

As discussed with examples, it is evident that;

1. A purchase order is legally binding.
2. It can be cancelled considering the terms and conditions listed in the order.

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Introduction

There are certain accounts that are not closed at the end of an accounting year and their balances are carried forward to the next year. These may be Permanent accounts or Real accounts depending on the approach of accounting being followed. To understand the concept better, both Traditional and Modern approaches are explained below:

• Traditional Approach- According to the traditional accounting perspective, personal accounts (say- creditors, debtors, capital, etc) and real accounts (say- land, machinery, patents, etc) are not closed and their balances are carried forward for the next accounting period.
• Modern Approach– According to the modern accounting perspective, permanent accounts (say- Land, Machinery, Creditors, etc.) are not closed and their balances are brought forward to the next accounting year.

The purpose behind classifying accounts as Permanent and Temporary accounts is the process of closing the accounts at the end of the accounting period. Permanent accounts are not closed as they help in providing a consistent and continuous financial position of the business.

On the other hand, temporary accounts are closed at the end of the period and their balances are not carried forward to the next accounting period.

Permanent Accounts

Permanent accounts are those accounts that appear at the time of preparation of the Balance Sheet. These accounts are measured cumulatively and their balances never get closed until the organization is legally wound up. These accounts include asset accounts, capital account, and liabilities accounts.

Permanent or real accounts provide a historical perspective which is crucial in presenting the organization’s true financial position. These help in providing consistency in the financial reporting of the organization from one accounting period to the next

Example – As of 31st March, YYYY if ABC and Co. had Cash amounting to 500,000, then that amount will be carried forward (c/f) as the opening cash balance in the next accounting year. If the cash balance increased by 400,000 during the year, then at the end of the accounting year Cash balance would become 900,000. This amount will be again carried forward onto the next accounting period and the cycle keeps going on.

A snippet of the cash account given below will help to develop a better understanding of all personal and real accounts whose balances are carried forward to the next accounting period.

For an enhanced insight, accounts that get closed at the year-end are also explained below:

Accounts that get closed at the year-end

• Traditional Approach – According to the traditional accounting perspective, Nominal accounts (say- factory expenses, salary & wages, depreciation, discount received, interest received, etc.,) get closed at the end of the accounting year.
• Modern Approach – According to the modern accounting perspective, the temporary account gets closed at the end of the accounting period. They are closed so that the previous year’s income and expenses do not get mixed with the current year’s income and expenses. This would help the users of financial statements to know the true net profit.

Temporary Accounts

Temporary accounts are those accounts that appear at the time of preparation of the Income Statement (i.e., trading and profit & loss account). These accounts get settled by either debiting or crediting them yielding Gross profit/loss and Net profit/loss. The temporary account includes expense accounts, income accounts and withdrawals.

Example- Salary paid to the employees amounting to 200,000 for the previous year gets closed in the previous accounting period itself and their balances are not carried forward in the next accounting year as the Salary account is a temporary account. 

Conclusion

On a concluding note, we may say the following:

• There are certain accounts that are not closed at the end of an accounting period.
• The balance at the end of the accounting period of such accounts is carried forward as opening balance for the next period.
• As per the Modern approach of accounting, permanent accounts are not closed and their balances are brought forward to the next accounting year.
• Permanent accounts include Accounts receivable, Accounts payable, Investments, Liabilities, and Capital account among others.
• As per the traditional accounting perspective, personal accounts and real accounts are not closed and their balances are carried forward for the next accounting period.
• Personal accounts include creditors, debtors, capital accounts, etc., and real accounts are Land, Plant and machinery, etc.
• Permanent or Real accounts help in providing a better perspective of the financial position to all the stakeholders of the organisation.

Profit and Loss Suspense Account

An entity prepares a profit and loss suspense account when either the partner is retired or in case of the death of a partner at any time before the end of the reporting period. It is a temporary account created to record the estimated profit for the current financial year during the ‘Reconstitution of the Partnership firm’.

It is used to record some fictitious profits during the year. The profit of the current year is calculated either on the basis of the last year’s profit or the average profit. The proportionate profit thus found is recorded in the Profit and Loss Suspense A/c.

The balance of the Profit and Loss Suspense account is transferred to the balance sheet of the new firm i.e. after the reconstitution of the partnership.

Why do we Prepare the Profit and Loss Suspense Account?

Generally, an organization prepares its financial statements at the end of its reporting period. The financial statements of a partnership firm typically include the following –

• Trading and Profit and Loss Account or
• Income and Expenditure account
• Balance Sheet

As stated above these financial statements are prepared at the end of an accounting period. The partner may die or decide to retire on any given date. In the case of the retirement or death of a partner in the middle of the year or on any given date, it shall be a tedious task for an entity to distribute the profits.

Hence to eliminate the hardships, the “Profit and Loss Suspense Account” is created and the share of profit of such deceased or retired partner is calculated through the Profit and Loss Suspense Account.

Calculation of Profit and Loss Suspense A/c

Proportionate profit for the part of the year is calculated from the date of the opening Balance Sheet to the date of retirement or death. Share of Retiring/Deceased partner is calculated on the basis of proportionate profit.

Proportionate profit can be calculated on the basis of the previous year’s profit or average profits in the past years. The estimated profit for the entire year is proportioned till the date of retirement/death of the partner and their share of the profit is settled in cash, loan, or their current account.

Let us understand this better with the help of an example:

Mr. Alex, Ms. Anna, and Mr. John are in partnership sharing profits and losses in the ratio of 2:2:1. Mr. Alex died on 15th April, YYYY. The firm closes its books of account on 31st December every year. So the executor of Mr. Alex is entitled to 3 and 1/2 months’ profit. Ms. Anna and Mr. John decided to pay the profit immediately to the executor of Mr. Alex. The profit of the previous accounting period was 1,20,000.

Here, The proportionate profit for 3 and 1/2 months

= 1,20,000 x 3.5months/12months

= 35,000

Mr. Alex’s share of the profit

= 35,000 x  2/5 (his share in the partnership)

= 14,000 (for 3 and 1/2 months)

For the transfer of such Profit or Loss the following journal entries are drafted in the books of the firm:

Extract of Balance Sheet as of 15th April YYYY is given below:

Profit and Loss Appropriation Account vs Profit and Loss Suspense Account

A Profit and Loss Appropriation Account is prepared to show the distribution of profits or losses of a partnership firm. It is an extension of the Profit and Loss Account. It shows the share of each partner in the profits and losses of a partnership firm during the financial year.

On the other hand, the Profit and Loss Suspense account is prepared to ascertain the profits or losses when either the partner retires or in case of the death of a partner at any time before the end of the financial year.

Conclusion

The following points may be concluded from the above discussion:

• A Profit and loss suspense account is prepared in order to distribute the profits and losses for a period shorter than the reporting period in a case where a partner is leaving the firm.
• It is a temporary account prepared during the ‘Reconstruction of the firm.’
• The Current year’s profit is calculated either based on the last year’s profit or the average profit.
• Share of Retiring/Deceased partner is calculated on the basis of the proportionate profit.

Overview of Rent Paid in Advance

Rent paid in advance means the payment of any rent obligation prior to the rental period in which it is due. It is an example of prepaid expense. Since the prepaid rent does not relate to the current accounting period, it is recorded on the asset side of the balance sheet.

Rent paid in advance is a current asset, thus the Rent Paid in Advance A/c is debited in the financial books of the organization. It is to be charged as an expense later when the benefit is received i.e. during the respective period to which the rent relates.

Journal entry as per Modern Rules of Accounting

When such rent is paid in advance it can be called an asset since it will generate some economic value for an organization or an entity in the future. According to the modern rules of accounting, an increase in an asset is debited in the books of accounts.

Cash and bank are current assets and when an entity makes an advance payment of rent, the cash-in-hand balance with an entity reduces. Hence, as per the Modern Rules of Accounting, we credit the decrease in cash balance.

The journal entry for recording Rent paid in Advance is provided below: (Rule Applied: Debit the increase in asset, Credit the decrease in asset)

The journal entry for recording Rent expenses incurred is provided below: (Rule Applied: Debit the increase in expenses, Credit the decrease in assets)

Example

Mr. Max pays a rent of 10,000 every month. Thus, the landlord and Mr. Max entered into an agreement that Mr. Max will pay rent at the beginning of each quarter for the entire quarter. So, Mr. Max pays at the beginning of every quarter the amount of 30,000.

The journal entries for the above shall be:

(Being rent paid in advance)

And at the end of every month, the journal entry to be passed shall be –

(Being rental expense incurred at every month’s end)

Journal entry as per the Golden Rules of Accounting

Payment towards rent is classified as a “nominal account”. A nominal account represents any accounting event that involves expenses, losses, revenues, or gains. It is what you would call a profit and loss or an income statement account. As per the golden rule of accounting for a nominal account, rent expenses are debited to the books of accounts.

When nominal accounts (expenses and incomes) become prepaid or outstanding, they are classified as Representative persons and the golden rule of personal accounts is applied. Thus, prepaid rent is debited as per the golden rules of accounting.

The journal entry for recording Rent paid in Advance is provided below: (Rule Applied: Debit the receiver)

The journal entry for recording Rent expenses incurred is provided below: (Rule Applied: Debit all expenses and losses)

Example

Ms. Jane rented office space and she paid 4 months of rent to the landlord in advance. Therefore, ‘Prepaid rent A/c’ is debited and when the rent is incurred, the balance of prepaid rent is written off. The journal entry for the same is given below.

(Being rent paid in advance)

And at the end of every month, the journal entry to be passed shall be –

(Being rental expense incurred at every month’s end)

Rent paid in Advance in Trial Balance

The rent paid in advance shows a debit balance. A trial balance example showing a debit balance for prepaid rent is provided below.

Overview of Sales Return

When the customer returns the goods purchased back to the seller, the transaction is referred to as a sales return. It is also known as Return Inwards. The buyer may return the goods to the seller due to excessive purchases, defective goods, or any such reason. For recording this transaction, adjustments can be made to the Sales A/c or a separate Sale Return A/c can be created in the books of the business.

The sales account has a credit balance, so when a sales return occurs, it decreases the sales, which is why the sales return account is debited and the respective accounts receivable are credited.

When the customer returns the goods to the business, it reduces the Accounts Receivable and is a ‘loss’ or ‘expense‘ for the organization, hence sales return is a nominal account and is debited in the books of the organization.

As per Modern Rules

Sales Return is Debited (Dr.) when increased & credited (Cr.) 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 example, ABC Corporation sold goods to their customer on credit. Upon delivery of the goods, the customer found a few defective items which they returned to the organization. In the financial books, the Sales return account will be debited since it is an increase in expense for the organization.

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

Step 1 – The following journal entry is recorded in the books of accounts when the defective items are returned. (Rule Applied – Dr. the increase in expense)

(Goods returned by the customer.)

Step 2 – To transfer the expense to “Trading A/c”.

(Goods returned by the customer are transferred to the trading account)

As per the Golden Rules of Accounting

Sales Return (Expense) is Debited (Dr.)

As per the golden rules of accounting for (nominal accounts) expenses and losses are to be debited.

The account of expenses, losses, incomes, and gains are called Nominal accounts. The balance of these accounts is always zero at the beginning of the financial year. Since the sales return is an expense for the business, it is to be debited.

Example

For example, XYZ Corporation sold goods to their customer on credit. Upon delivery of the goods, the customer found a few defective items which they returned to the organization. In the financial books, the Sales return account will be debited since it is an expense for the organization.

Step 1 – For the above example, the journal entry for the goods returned, “Sales Return A/c” is debited. ( Rule Applied – Dr. all incomes and gains)

(Goods returned by the customer.)

Step 2 – To transfer the expense to the “Trading Account”

(Goods returned by the customer are transferred to the trading account)

Sales Return Inside Trial Balance

Sales returns show a debit balance in the trial balance. A trial balance example showing a debit balance for sales return is provided below.

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Return Outwards

In layman’s language, return outwards refers to the goods returned by the customer to the supplier (or) manufacturer due to various issues found in the goods (say- quality, defects, or damages). Return outwards is also known as purchase returns.

The amount of return outwards (or) purchase returns is deducted from the total purchases of the firm. It is treated as a contra-expense transaction. A Contra expense account is a ledger account where the expenses are deducted from gross revenue or sales.

Return outwards holds the credit balance and is placed on the credit side of the trial balance.

Journal Entry for Return Outwards

As per modern rules, 

a) Entry for the purchase of goods

This journal entry is passed when the goods are being purchased. The purchases account is debited since it is an increase in expenses. The supplier’s account is credited since this is leading to an increase in liability.

b)Entry on the return of goods purchased

This journal entry is passed for purchase returns or return outwards. As there is a returns taking place, it is reducing the expenses hence the purchases account is credited. The supplier’s account is debited since there is decrease in liability as he is returning the goods.

As per traditional rules, 

a) Entry for the purchase of goods

As purchases are an expense it is a nominal account, hence it is debited. The supplier’s account is a personal account, hence the account is credited since he is the giver.

b)Entry on the return of goods purchased

As the purchases are being sent back to the supplier, the supplier account is debited as per the personal account rule. The purchase account is credited since it is being sent back to the supplier.

Example

Mr Alex purchases 10 washing machines for 1,00,000 from Amazon on a credit period of 30 days. On 20th April he returns all the washing machines to Amazon due to the serious defects in all of its models. Pass journal entries for the above transaction in the books of Mr. Alex.

In the books of Mr Alex 

a) As per traditional approch

(Being goods returned to Amazon due to serious defects)

b) As per modern approch

(Being goods returned to Amazon due to serious defects)

Placement in Trial Balance

Return outwards appears on the credit side of the trial balance because it will be used to decrease total purchases (contra expense). Secondly, this will reduce inventory leading to a decrease in current assets.

A trading account consists of direct expenses and revenue. As purchases are a direct expense for the company, the purchase returns or returns outwards will be subtracted from the total purchases on the debited side.

Benefits of Returns Outwards subsidiary book

• It helps in keeping track of purchase returns accurately and shows better inventory management.
• This shows the company’s transparency while maintaining the books and their accountability to clear disputes related to returns. This also shows the company’s responsibilty.

Overview of Sales Ledger Control Account

A sales Ledger Control Account (SLCA) is a summarized ledger of all the trade debtors of the entity. This Control Account typically looks like a “T-account” or a replica of an Individual Trade Receivable (Debtor) account. But instead of containing transactions of invoices, returns, and receipts, etc related to one debtor, it contains summarized transactions of invoices, returns, and receipts, etc related to all the debtors of the business.

A sales Ledger Control Account is also referred to as a “Trade Debtors Control Account”. It indicates the total amount the debtors owe to the business entity at a particular point in time. Therefore, it is a “short-term asset” for the business entity and forms part of the balance sheet.

Thus, the Sales Ledger Control Account is debited if its balance increases & credited if its balance decreases. The balance of the SLCA should equal the sum of the balances of the individual customer accounts. If discrepancies arise, then they should be investigated.

As per the Modern Rules of Accounting

Sales Ledger Control Account (asset) is Debited (Dr.) when increased & Credited (Cr.) when decreased.

Why is it like this?

Since it indicates the total trade receivables, it shows a debit balance and the modern rule of accounting cannot be broken under any circumstances.

How is it done?

Suppose the following were during the year transactions with the Debtors Sugar Inc. & Chocolate Inc. along with the outstanding balance as of 31/12/20×2.

Sales Ledger Control Account for the year 01/01/20×2 to 31/12/20×2 will be presented as follows-

The balance of SLCA ie. 535,000 is equal to the sum of the balance of individual outstanding debtors ie. 265,000 + 270,000 = 535,000.

You can see that the transactions which increase the balance of SLCA are debited & decrease the balance are credited. Also, it is depicting a debit balance.

As per the Golden Rules of Accounting

The Sales Ledger Control Account (asset) is debited as per the Golden Rules.

The individuals and other organizations that have direct transactions with the business are called personal accounts. SLCA indicates total trade receivables at a given point in time, and since trade receivables are personal accounts, SLCA also operates according to the golden rule for personal accounts.

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

Example

Suppose the following were during the year transactions with the Debtors Tea Inc. & Coffee Inc. along with the outstanding balance as of 31/12/20×2.

Sales Ledger Control Account for the year 01/01/20×2 to 31/12/20×2 will be presented as follows-

The balance of SLCA ie. 565,000 is equal to the sum of the balance of individual outstanding debtors ie. 275,000 + 290,000 = 565,000.

You can see that SLCA is depicting a debit balance.

Sales Ledger Control Account in Trial Balance

SLCA shows a debit balance in the trial balance. A trial balance example showing a debit balance for SLCA is provided below.