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I have answered this question on the assumption that “Trading Expenses are those expenses which are covered in the Trading Account”.

Meaning of Trading Expenses

Trading Expenses are direct expenses incurred for the purchase and production of goods. They are related to the core business operations of the business entity and directly related to the purchase and production of the finished goods.

So, all the expenses incurred from the time of purchasing raw materials/goods till the time the finished goods are brought to a saleable condition are referred to as trading expenses.

For example: carriage inward, manufacturing expenses, wages, etc.

Features of Trading Expenses

Presentation in Financial Statements

A snippet of the Trading account has been attached for better understanding.

Conclusion

Hence, trading expenses are debited to the trading account to accurately reflect the costs incurred in the process of buying and selling goods or financial instruments.

This helps in determining the gross profit derived from trading activities before other expenses are considered.

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What is Rent Received in Advance?

Rent Received in Advance is an amount received by the landlord from the tenant before the actual due date. It’s an income received in advance.

Income received in advance refers to the amount received by a person or an entity before rendering services or transfer of title to goods.

Rent received in advance is typically recorded on the landlord’s balance sheet as a liability until it is earned, at which point it is recognized as rental income on the income statement.

It’s important for landlords to accurately track and manage rent received in advance to ensure proper financial reporting and compliance with accounting standards.

For Example,

A landlord may have the policy to charge the last month’s rent in advance for his convenience to cover himself from loss of income on the expiry of the lease term. A lot of landlords across the globe follow this policy.

Whether it is Taxable?

The answer to this question is that it depends. It depends on the accounting policy an entity or a person follows.

If a person follows the accrual system of accounting then the rent received in advance shall be treated as a liability in the year of receipt and it will be taxable in the year of realization.

The image shown below is the perfect example of the same:

However, If a person follows the Cash System of Accounting then such rent received shall be treated as an income in the year of receipt and it would be taxable in the year of receipt itself.

The image shown below explains the same:

The accounting treatment in each of the cases shall be:

In the Accrual System of Accounting

In the above journal entry, it is reflected that rent will not be recorded in the income statement that is it will be taxable in the year of accrual and so it shall be the taxable income in the next accounting period.

 In Cash System of Accounting

In this case, it is reflected from the above journal entry since the cash system is followed the rent is recorded as an income and since it will be reflected in an income statement it is a taxable income in the year of receipt.

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

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To begin with, let me help you understand the meaning of the term Contingent Assets.

Meaning of Contingent Assets

Contingent Assets are possible assets or potential economic benefits because they do not currently exist but may arise in the near future. The shift from possible assets to real assets for the entity is dependent on the occurrence or non-occurrence of future events which are not under its control.

A tabular depiction of the recognition/disclosure principles for contingent assets has been presented below:

Examples of Contingent Assets

Example 1

ABC Ltd filed a legal suit against its supplier XYZ Ltd for compensation against damages on non-supply of contracted goods. There is a possibility of ABC Ltd winning the case, as it has concrete evidence of contract violation by XYZ Ltd. The lawsuit has not been settled till the accounting year-end.

–In this case, it is probable ( > 50% – 95% probability) that there would be an inflow of economic benefits (compensation for damages) to ABC Ltd in the near future. So, it will be disclosed as a contingent asset in the notes to accounts or board reports (as applicable).

Example 2

Suppose in the above example, the court orders XYZ Ltd to pay 100,000/- as compensation for damages. ABC Ltd has not yet received the money until the accounting year-end. Can it recognize this as a contingent asset?

–The court has ordered the payment for damages. Although ABC Ltd has not received the payment till the accounting year-end, it is virtually certain ( > 95% of probability) that it will receive the compensation amount in the near future.

ABC Ltd will now recognize the compensation amount as an asset in the financial statements and not disclose it as a contingent asset, as it is virtually certain.

Example 3.

Jute Ltd entered into a sale contract of 500,000 for the supply of jute during 20×2-20×3 with Textiles Ltd. During the transit, the truck carrying the jute for delivery met with an accident which destroyed the entire jute. The jute destroyed was covered under an insurance policy. The cost of the jute destroyed was 400,000. The policy prescribed acceptance of the amount of claim, amounting to 80% of the goods destroyed ie. 320,000 (80% * 400,000).

Before the end of the accounting year, Jute Ltd received informal information from the insurance company that their claim had been processed and the payment had been dispatched for the claim amount.

–In this scenario, there exists a possible asset (claim amount). Also, the inflow of economic benefits is probable ( > 50% – 95% probability) because Jute Ltd. has received informal information from the insurance company about the processing of the claim.  Therefore, Jute Ltd can treat and disclose this as a contingent asset in the notes to accounts or board reports (as applicable).

Example 4.

A Road & Highway Developer enters into a contract with the Road & Highway Authority of India to complete a highway project. The agreed cost of the total project was 10 million, but the actual cost turned out to be 15 million. As per the terms of the contract, the Authority was mandatorily required to hand over the land within a specific time period. But the Authority failed to do so. On account of the delay in handing over of land, an excess cost of 5 million was incurred by the Developer.

To recover the incremental cost incurred, the Developer filed litigation against the Authority for reimbursement of 5 million. The court has not yet given its final verdict. However, the Developer is sure that he will win the case.

In this example, the Developer will disclose 5 million as a contingent asset in the notes to accounts or board report (as applicable) till the court does not give its final verdict. This is because there is a probability of the Developer winning the case as there has been a violation of terms by the Authority.

Once the litigation is announced in favour of the Developer by the court, this will be recognized as an asset in the balance sheet of the Developer.

Hope these examples have made your understanding of contingent assets very clear.

>Related Long Quiz for Practice Quiz 18 – Contingent Assets

Prepaid rent includes the word rent. Therefore, one might think that it is an expense, right? But, Prepaid rent is a current asset and not an expense. Let us break it down for you.

What are Current Assets?

Current assets are the assets that a business owns and expects to realize within 12 months or the operating cycle. Some examples of current assets are Bills Receivables, Cash, Cash at Bank, Inventories, etc.

What are Prepaid Expenses?

You can think of prepaid expenses as the costs that have been paid but are yet to be utilized. For example, prepaid rent, prepaid insurance, prepaid salaries, etc.

In the balance sheet, all the prepaid expenses that have not yet been consumed are recorded as current assets.

Accrual Vs Cash Basis

In the accrual basis of accounting, the expenses and revenues are recorded in the books when they are incurred or earned irrespective of the cash has been paid or received.

When you make the payment of rent before its due date, it is known as prepaid rent. Rent is usually paid in advance for multiple reasons, such as availing a discount, the landlord demanding a prepayment, etc.  For a better understanding of the concept, let us have a look at the example given below.

Example of Prepaid Rent

Company X signs an agreement to rent a warehouse for 1,000 per month from March for 7 months. The landlord demands payment of the total amount in February. The journal entries to be recorded are as follows:

(Being rent paid before the due date)

(Being prepaid rent adjusted as it expires)

Note: The total amount of rent 7,000 (1,000 x 7) is initially recorded in the balance sheet under current assets as prepaid rent. The reason for recording it as a current asset is that the rent which will be due at the end of each month is already paid for and the benefit is yet to be availed.

Each month the prepaid rent account is reduced by the amount of rent paid for that month. The prepaid rent (asset account) will be reduced by 1,000 (7,000/7) each month and the amount shall be debited to rent (expense account) for each month.

Prepaid Rent Expense or Asset?

Prepaid rent is recorded under current assets in the balance sheet because businesses often pay the rent before the due date, and it is utilized within a few months of its payment, usually within the same financial period. The benefits of the payment in advance are realised later on.

Prepaid Rent Shown in the Balance Sheet

In the Balance Sheet, the Prepaid expense is shown as a Current Asset under the Assets head of the Balance Sheet.

Conclusion

The key takeaways from the above article are:

• Prepaid rent is a current asset and not an expense.
• Prepaid expenses are the costs that have been paid but are yet to be utilized.
• Prepaid rent is recorded under current assets in the balance sheet.

>Related Long Quiz for Practice Quiz 20 – Current Assets

>Related Long Quiz for Practice Quiz 36 – Prepaid Expenses

>Read

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Meaning of Closing Stock

Closing stock refers to the value of the goods or products that remain unsold and are held by a business at the end of a specific accounting period, such as a month, quarter, or year. It represents the final inventory of goods that have not yet been sold but are ready for sale.

Accounting Treatment of Closing Stock

According to accounting concepts and principles, every accountant should record closing stock/inventory and other current assets (say- short-term investments, marketable stocks and securities) as per the conservatism (or) prudence concept.

This concept states that closing inventory (or) other current assets must be recorded at Cost (or) Net Realizable Value (NRV) whichever is the least. Conservatism concept follows a rule that “never anticipate for future profit but the record for all possible losses occurring in an organization”.

Example- At the end of the financial year, if the value of closing stock in the books appears to be 45,000 but, its market value is 60,000. Then the surplus amount of 15,000 (60,000-45,000) will be treated as an anticipated profit that will be obtained when the stock is sold in the next accounting period.

According to the principle of conservatism, the closing stock must be valued at cost or Net Realizable Value (NRV) whichever is least. Hence Closing stock must be valued at 45,000 in the books of accounts.

Reason for showing closing stock on the credit side of trading account

Closing stock is shown on the credit side (revenue side) of the trading account but closing stock is not revenue. It is just shown on the revenue side because of the application of the matching concept which states that “all expenses must match with the revenues of the current period”.

The value of opening stock, purchases and direct expenses is charged as an expense to the trading account by showing them on the debit side. The income produced by selling them is matched by showing it as sales, direct revenue on the credit side of the trading account.

Hence, if there are any unsold units left with the organization, then their cost should not be charged to the trading account. Further, their value must be reduced by recording them on the credit side of the trading account to find true or genuine gross profit.

I would further like to add an example to make the above explanation easy and understandable.

Example- ABC Co. purchased 150 units of goods for 50 per unit. After a few months, they sold 100 units for 100 per unit. Calculate the value of Gross Profit based on the given two cases.

Case 1- If the Closing stock is not shown on the trading account

Case 2- If the Closing stock is shown on the trading account.

Case 1- If the closing stock is not shown on the credit side

In case 1, total revenue of the firm = 10,000 (sales) is matched with total expenses of the firm = 7,500 (purchases) then the gross profit will be 2,500 (10,000-7,500). This gross profit is untrue because the accountant has violated the matching principle of accounting by not recording 50 unsold units as closing stock.

Case 2- If the closing stock is shown on the credit side

In case 2, total revenue of the firm = 15,000 (sales + closing stock) is matched with total expenses of the firm = 7,500 (purchases) then the gross profit will be 7,500 (15,000-7,500). This gross profit is true (or) genuine because the accountant has followed the matching principle of accounting by recording 50 unsold units as closing stock.

A snippet of the trading account will help you to develop a better understanding of the concept

Overview of Expenses

The costs paid by a business in order to generate revenue are called expenses. In other words, it is an outflow of funds in exchange for the acquisition of a product or service. For example, rent payments, interest payments, electricity bills, administration expenses, selling expenses, etc.

There are different types of expenses based on their nature and the term of benefit received.

• Direct & Indirect Expenses – All expenses related to the direct cost of goods and services produced are called direct expenses. Whereas, expenses that do not form part of direct costs are called indirect expenses.
• Capital Expense – Expenses incurred for acquiring capital assets, like building, machinery, etc., are called capital expenses.
• Revenue Expense – expenses incurred for day-to-day business operations are revenue expenses.

In accounting terms, expenses tend to increase productivity while decreasing owner’s equity. Thus, an increase in expenses should be debited in the books of accounts.

Related Topic – Capitalized Expenditure

As per the Modern Rules of Accounting

Expense 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.

How is it done?

Suppose, you rent a local shop that sells apples & you make a yearly payment towards the shop’s rent (in cash). As a result, this expense would be added to the income statement for the current accounting year because due to this payment the total expenses of your business have increased.

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

Step 1 – While making the payment the below journal entry is recorded in the books of accounts. (Rule Applied – Dr. the increase in expense)

(Payment in cash for shop’s rent)

Step 2 – At the time when the expense is transferred to “Profit & Loss A/c”.

(Shop’s rent expense is transferred to the income statement)

Related Topic – Liability is Debited or Credited?

As per the Golden Rules of Accounting

Expense is Debited (Dr.)

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

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 opposed to personal and real accounts, nominal accounts always start out with a zero balance at the beginning of a new accounting year.

Example

Suppose, you rent a local shop that sells apples & you make a monthly payment towards the shop’s electricity bill (by the bank). Consequently, this payment 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 of a journal entry for electricity bill payments “Electricity Charges A/c” is debited. (Rule Applied – Dr. all expenses & losses)

(Payment by the bank for the shop’s electricity bill)

Step 2 – At the time when the expense is transferred to “Profit & Loss A/c”.

(Shop’s rent expense is transferred to the income statement)

If the expense is prepaid, it is an asset to the business and is shown on the asset side of the balance sheet.

Related Topic – Is Income Debit or Credit?

Expenses Inside Trial Balance

Expenses show a debit balance in the trial balance. A trial balance example showing a debit balance for salaries and rent expenses is provided below.

>Read Contra Accounts

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Principles of Accounting

I would like to share with you the five basic principles of accounting, followed by an example each. I hope this answer enhance your basic accounting knowledge.

Business-Entity Principle

This principle states that the organization has a separate entity apart from its owner. Every accountant should consider business as distinct from its owner. This means business transactions must be recorded in business books of accounts and the owner’s transactions in his books of accounts.

For Example- Company A started a watch business by investing 1,00,000 with which he purchased raw materials for 40,000 and maintained balance in hand. He further withdrew in 8,000 for his personal use from the business.

As per the business entity principle, his capital invested will get reduced by 8,000 and these expenses should not be treated as business expenses. Now the business owes 92,000 to the owner.

Accrual Principle

The accrual principle states that the effects of transactions and events are identified at the time when they occur (say mercantile basis) and not on cash or cash equivalent either received or paid. The accrual principle records total revenue generated. Revenue includes gross inflow of cash, receivables and other consideration arising out of business activities.

For Example- Mr Alex started a Jute business. He invested 10,00,000, bought raw materials for the manufacturing of Jute bags for 6,00,000. He manufactured 50,000 Jute bags and sold the same for 8,00,000 to ABC Ltd. ABC Ltd. paid in 5,00,000 in cash and assured him to pay the rest of the amount in future.

As per the accrual principle, the total revenue of Alex is 8,00,000 (say 5,00,000 from cash and 3,00,000 by way of receivables).

Going Concern Principle

Going concern principle states that the business has a long fair life and it continues its operations until it is legally wound up in the foreseeable future. Hence it is presumed at the organization has neither the intention to shut nor the need to liquidate.

For Example- Standard Chartered Bank will close one of its bank branches in the middle east for the sake of improving its profitability and performance.

As per the going concern principle, Standard Chartered Bank will keep continuing its operations because closing down of a small portion of the business doesn’t affect the capability of the bank.

Cost Principle

The cost principle states that assets must be valued at historical cost (say the acquisition cost). If the machinery is acquired by paying 1,00,000 then the acquisition cost of the machinery is 1,00,000. It is highly objective and free from all biases.

For Example- Company B purchases a motor van for 3,00,000. The market value of the motor van is 2,50,000. At the time of preparation of the balance sheet, the motor-van must be valued at 3,00,000.

As per the cost principle, it is clear that motor van must be valued at cost and not at market value.

Conservatism Principle

Conservatism principle states that never anticipate future income and should account for all the possible losses. When there are various alternatives available for the valuation of the closing stock then the accountant should opt for that method that provides lesser value.

For Example- At the time of preparation of final accounts, the value of closing inventory shown in the books is 5,00,000. Net realisable value is 2,50,000.

As per the conservatism principle, closing inventory must be valued at cost price or net realisable value whichever is lower. Therefore, Closing stock must be shown at 2,50,000 in the books of accounts.

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Meaning of Petty Cash Book

A petty cash book is like a ledger account that records small day-to-day expenses. Once the set amount for the petty cash book is used up for minor expenses it is replenished with the same amount.

Petty cash book follows an imprest system of accounting. This means that a fixed amount of money is set aside to cover small and routine expenses.

Examples of petty cash books include office supplies, refreshments, postage, transportation, small repairs, etc.

Why is the petty cash book important?

• A petty cash book is important since it helps in tracking the small expenses that might be unnoticed or not recorded. This helps in keeping the company organized in its expenses. This shows the company’s responsibility and accountability.
• It helps the company run within its budget rather than spending too much as the minor expenses are being monitored by recording them.
• It is a convenient way to handle small expenses rather than the formal process of issuing cheques etc.

Type of Account

“Petty cash” is an asset and is shown under the category of current assets in the balance sheet. It is a current asset since the petty cash expenses occur within the operating year.

Petty cash book has a debit balance (or) positive balance since the amount is transferred from cash to petty cash and the amount being spent on petty cash expenses is reduced from the debit balance and later replenished.

Received 250 from the head cashier for all petty cash expenses. Journalise the following transaction.

As per the Modern  Approach,

According to modern rules whenever there is an increase in the value of the asset then the particular asset account is debited and when there is a decrease in the value of the asset it is credited.

The amount of petty cash will increase when debited as this leads to an increase in petty cash as an asset. This also leads to a decrease in cash account. The cash account will be credited since there is a decrease in assets.

As per the traditional approach,

As per the traditional rules, the petty cash expenses are coming in hence it is debited. As the cash is being spent on these expenses, the cash is going out, it is credited.

Example

Prepare a Petty Cash Book on the imprest system from the following data as provided below-

Petty Cash Book

The normal opening balance of cash will be placed on the Left-Hand Side under the cash receipts column. Total payments are shown on the Right Hand Side of the petty cash book.

This example shows the total amount in cash is 450 and is credited in the petty cash book amount. Later, as the expenses occur it is recorded and finally subtracted from the total cash.

Conclusion

• The petty cash book is important because it helps companies maintain financial health, manage their budget, and ensure transparency and accountability.
• It is a current asset, as it can be converted into cash, sold, or consumed within the normal operating cycle of the business, usually within one year.
• The normal balance of petty cash will show a positive balance (or) debit balance.

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To understand the calculation for Provision for Bad and Doubtful Debts, one should first be familiar with the meaning of the term Provision for doubtful debts and why it is maintained by an organization.

Provision for Bad and Doubtful Debt

Provision for bad and doubtful debt is a contra asset which means it reduces the balance of an asset specifically the receivables.

When an entity executes transactions of sales on a credit basis it creates and adds on to the amount due from sundry debtors.  These sundry debtors, as per the agreed terms are liable to make a payment for such goods purchased before the end of the credit term.

If such debtor continuously makes a default such debtor shall be considered as a bad debt for the organization. When an entity remains doubtful regarding the recovery of its revenue i.e. it has a reason to believe that such an amount due to be received may not be realized, the entity shall create a reserve or a provision for doubtful debts.

As per the Prudence Concept of accounting, an entity must not anticipate profits, but prepare for all possible future losses. By maintaining this provision, an entity prepares itself for any future losses due to bad debts.

How is it calculated?

The table given below will help you to understand step-by-step calculations to compute provision for doubtful debts

For Example,

An extract of the Trial Balance of ABC Ltd. is given below:

Adjustment: Provide a 2% reserve for bad and doubtful debts on the debtors. It was realized that our debtor worth 1000 proved to be bad and has been written off.

Hence, the company should create a new provision of 200 for the current financial year.

Generally, the provision for doubtful debts is created based on the entity’s experience in the business and various other factors. An organization must assess the risk associated with each customer. It should analyze the previous payment patterns of the debtors, their credit ratings, financial conditions, etc.

The organization may conduct an aging analysis of the receivables. In simple terms, it means to analyze the receivables based on how long the invoice has been outstanding. For example, the invoices may be current, 30-45 days past the due date, 45-60 days past the due date, 120 days past, or so on. On the basis of this analysis, the organization may determine which debtors are more likely to default and prepare the Provision for doubtful debts accordingly.

Conclusion

The above discussion may be summarised as follows:

• When a debtor does not pay the debt owed by him to the organization, it becomes a bad debt for the business.
• To prepare for such future losses, the business must maintain a Provision for Bad and Doubtful debts.
• The provision is created based on the entity’s experience in the business and various other factors.
• Generally, a percentage of the total amount due from debtors is kept aside as Provision for doubtful debts.

Meaning of Capital

Capital refers to the financial resources of a business that are used to pay for its operations. The financial assets invested in the business by the owners form a part of the capital. It includes cash or cash equivalents, plant, machinery, etc.

Generally, there are four types of capital:

• Debt Capital: The capital that is acquired by borrowing from banks or other financial institutions is called debt capital. It is to be repaid along with interest at a certain percentage of the loan.
• Equity Capital: It is the capital collected from the owners in exchange for a common or preferred stock (shares). It is to be paid only when the company goes under liquidation.
• Working Capital: The capital that is used to fund day-to-day operations is called working capital. It is calculated as the current assets minus the current liabilities.
• Trading Capital: The capital available to the business to buy and sell securities in the financial markets is called trading capital. This type applies exclusively to the financial industry.

The different types of capital help the firm in different ways to improve its business.

In accounting terms, capital is a liability for the business, i.e. it is to be repaid in the future.

Journal Entry for Capital

As per the Modern Rules of Accounting

Capital is Credited (Cr.) when increased and Debited (Dr.) when decreased.

As capital is brought into the firm, the business is obliged to pay it back to its shareholders and lenders. Therefore when more capital is brought into the firm it is credited.

Suppose cash is brought into the business as capital, it leads to an increase in assets. As per the modern rules of accounts, increases in assets are debited.

(The additional capital is credited to the capital account.)

As per the Golden Rules of Accounting

Capital is credited as per the Golden Rules.

An account is said to be personal when it is related to firms, companies, individuals, etc. Capital is a liability for the firm/company/business because it is obliged to repay its owner, hence, it is a personal account. A personal account is recorded on the balance sheet of the organization.

As per the golden rules of accounting (for personal accounts), capital is credited since the company needs to pay it back.

Example

Sam has started a new business and brought in capital in the form of cash of 30,000.

The cash account is debited since Sam brings in cash leading to an increase in assets. The capital account is credited since this leads to increase in capital and capital is a personal account.

Capital Inside Trial Balance

Capital is shown on the credit side of the trial balance. Below is an example of capital recorded inside the trial balance.

Conclusion

• The capital is credited since it’s a contribution given by the shareholders, corporate banks, etc. It needs to be returned back. It is treated similarly to a liability.
• As more capital is bought in it is credited since it increases. The cash account has been debited since there is an increase in assets as the money is coming into the firm.

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Meaning of Provision for Doubtful Debts

Almost every business entity has some debtors. Debtors are the entities that owe money to the business. In some cases, the debtors may or may not pay the money owed by them. To prevent loss in such a situation, Provision for Doubtful Debts is maintained.

It is usually provided on credit sales. As per the Prudence concept of accounting, a business must not anticipate future profits, but rather, prepare for all possible losses. Provision for doubtful debts helps the business prepare for future losses that may occur due to non-payment of dues by the debtor.

Generally, a percentage of the total amount owed by the debtors is kept aside as a Provision for doubtful debts. This amount may change from year to year. It is a proactive step taken to safeguard the firm’s financial position.

Journal Entry for Provision for Doubtful Debts

The Journal Entry for Provision for Doubtful debts is given below:

(Being Provision for Doubtful debts created)

An example of the Journal entry is given below:

ABC Ltd. has Sundry debtors amounting to 51,000. Out of these, 10,000 are written off as bad debts in the current year. Create a Provision for doubtful debts at 5%.

Solution:

The amount of Provision for Doubtful Debts is calculated below :

5% of (Sundry Debtors – Bad Debts)

= 5%*(51,000 – 10,000)

= 5%*41,000

= 2,050

Journal Entry:

(Being Provision for Doubtful debts created)

Treatment of Provision for Doubtful Debts in Balance Sheet

An example below shows the treatment in the Balance Sheet to understand this concept better.

Example

An extract of the Trial Balance of ABC Ltd. is given below:

Show the treatment of Provision for Doubtful Debts in the Balance Sheet of ABC Ltd.

Solution:

The Balance Sheet of ABC Ltd. after the above adjustment is given below:

Calculation of Provision for Doubtful Debts:

5% of (Sundry Debtors – Bad Debts)

= 5%*(51,000 – 10,000)

= 5%*41,000

= 2,050

Further, 2,050 is deducted from the total amount of sundry debtors. Debtors are shown on the assets side under the current assets head of the Balance Sheet of the business.

Conclusion

The above discussion may be summarised as follows:

• Debtors are a current asset of the business as they owe money to the business.
• A Provision for Doubtful debts must be created for any loss due to non-payment by the debtors.
• Generally, a percentage of the total amount of debtors is kept aside as a provision.
• The amount of provision for doubtful debts is deducted from the total debtors in the Balance sheet.
• Debtors are shown on the assets side under the current assets head of the Balance Sheet of the business.

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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.

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

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.

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

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.