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What are Qualitative Characteristics of Accounting Information?

Ahuja Sahil
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Qualitative Characteristics of Accounting Information

There are some qualities of accounting that make it useful for both external and internal users of accounting. Without these qualities, accounting information wouldn’t be clear, and an orderly view of the business would not be visible. 4 qualitative characteristics of accounting information are;

Qualitative Characteristics of Accounting Information

 

Comparability

Comparison is a very important part of financial information as it helps the users of accounting information to differentiate, analyze, improve, and take important decisions.

The ability to do intra-firm comparisons (within the same company), inter-firm comparisons (with other companies), and market sector comparisons (comparisons within the same market sector) make accounting information easy to work with.

Example of Comparability – QoQ (Quarter on Quarter) & YoY (Year on Year comparisons) should be possible with the accounting information.

 

Understandability

The presentation of accounting information should be simple and understandable for the users of the information. All the data must be clear and concise, it can be easily understood by everyone, including parties who are not from an accounting background.

All relevant explanatory notes should be provided along with the financial statements. Method of valuation of inventory, method of depreciation, information on reserves and surplus, contingent liabilities, and any other extraordinary items.

Example of Understandability – It should be possible for bankers, investors, employees, etc., to understand the financial information of the business.

 

Reliability

One of the most important qualitative characteristics of accounting information is the reliability of data, i.e. all information provided must be traceable and verifiable with proper source documents.

In an internal or external audit, the information inside financial statements should be confirmable back to its source. Failure of an audit may lead to disbelief in the company’s financial data.

Example of Reliability – An auditor must be able to verify a transaction back to its origin with the help of invoices, memos, purchase orders, sales orders, etc.

 

Relevance

Relevance of accounting information means it should help the user of information with their decision-making process. The information provided should not be irrelevant and unnecessary. All information should be capable of monetary computation.

Example of Relevance – A firm is expected to provide the total amount owed by the debtors on the balance sheet, whereas the total number of debtors is unimportant.

 

Short Quiz for Self-Evaluation

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>Read 5 Principles of Accounting with Examples

 

 

What are Subsidiary Books?

Ahuja Sahil
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Subsidiary Books of Account

Also known as books of original entry, special purpose books, special purpose subsidiary books, and subsidiary books of accounts are various books recording financial transactions of a similar nature. They are the sub-division of the journal.

During the lifecycle of a business, the volume of transactions in a business may rise to the extent that a single journal may no longer be adequate to keep the books. This is when special purpose books or subsidiary books may be required for more efficient bookkeeping.

List of supporting books

Subsidiary Books of Accounting

Related Topic – How to treat return inwards in trial balance?

 

Types of Subsidiary Books

1.  Cash Book – A cash book is a book of prime entry that records all transactions made by a business in both cash and a bank instrument.

2. Purchase Book – A purchase book is one of the special purpose books where all the credit purchases are recorded by a business.

3. Sales Book – A sales book is one of the subsidiary books where all the credit sales are recorded by a business.

4. Purchase Returns Book – Also known as returns outward book, a purchase returns book is prepared to record goods returned by a business to its suppliers.

5. Sales Return Book – Also known as a returns inward book, a sales return book is prepared to record goods returned to a business by the customers.

6. Journal Proper – It is a book in which all miscellaneous transactions which are not recorded in any other subsidiary book are called a journal proper.

7. Bills Receivable Book – is a book that records all bills receivable to a business, the total of bills receivable book is posted on the debit side of the B/R account.

8. Bills Payable Book – is one of the subsidiary books that records all bills payable by a business, the total of bills payable book is posted on the credit side of the B/P account.

Related Topic – Is sales return a debit or credit?

 

Purpose of Subsidiary Books

For any business that grows large enough and the amount of transactions increases, it is no longer possible to record all transactions in one journal book, but rather in a number of journals. This is where subsidiary books play a crucial role and they can be seen as an extension of the journal book itself.

As a result, subsidiary books may be defined as books in which transactions are entered first, followed by ledger account preparation. They are also called day books or special journals.

In addition to overcoming the limitations of a journal book or journal entries, they have other benefits such as better organization of similar types of transactions.

Related Topic – Is cash book both a journal and ledger?

 

Short Quiz for Self-Evaluation

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Revision & Highlights Short Video

Highly Recommended!!

Do not miss our 1-minute revision video. This will help you quickly revise and memorize the topic forever. Try it :)

 

>Read Why are subsidiary books maintained in accounting?

 

What are Source Documents in Accounting?

Ahuja Sahil
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Source Documents or Source Vouchers

Source documents are the first document to record a transaction which works as an evidence containing details of a transaction. They are external documents or documents related to external activities which are first input in the accounting source systems.

Examples of source documents are invoice or bill, cash memo, cheque, sales order, purchase order, credit note, petty cash voucher, credit card sales voucher, etc.

Source documents arrive in a company through many different departments, mostly via sales and purchase departments. They are sometimes referred to as supporting documents.

Examples of Source Documents

Sales Order (SO) – is a document issued to the customer and generated by the firm itself. Nowadays sales orders are digitally transmitted soft copies over company’s internal network.

Purchase Order (PO) – is an official document generated by a buyer of goods/services as an offer for the seller. There are 4 different types of purchase orders Standard PO, Contract PO, Blanket PO and Planned PO.

Cash Memo – Cash memo is a document prepared by the seller when goods are sold in cash. It contains all details of the transaction such as quantity, amount, selling price, etc.

Invoice/Bill – It is an evidence prepared by the seller to document credit sales. It has all details about the credit sale such as the purchaser, date, price, quantity, etc.

Debit Note – A debit note is a document sent by a buyer to a seller while returning goods received on credit. This notifies that a debit has been made to their accounts.

Credit Note – A credit note is a document sent by a seller to the buyer notifying that a credit has been made to their account against the goods returned by the buyer.

Pay-in-Slip – It is a source document used for depositing cash and cheques into a bank. Pay-in-slip acts as an evidence of deposit

Cheque – It is an order in writing drawn on the bank to pay the mentioned amount payable to the bearer or the person specified on the cheque.

Petty Cash Voucher – It is used for petty cash expenses such as stamps, postage and handling, stationery, carriage, etc.

 

Short Quiz for Self-Evaluation

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>Read What is a Voucher?

 

What is an Accounting Period?

Ahuja Sahil
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Accounting Period

Also known as a financial period, period of account, accounting year, financial year, etc. the period for which a business prepares its accounts is called the accounting period for that firm.

As per the going concern concept, when a business is started, it is assumed that it will not be dissolved in the near future and will continue to operate for a foreseeable future. Therefore it is required that the lifespan of a business should be divided into equal parts. It is used for financial reporting by the business.

Internally, the company may decide to maintain accounting records monthly, quarterly, etc. However, for external users of accounting information, the financial statements are produced for a period of 12 months. There may be exceptions to this when a business is newly set up or is being dissolved.

 

Key Features of Accounting Period

  • Period of measurements should be equal.
  • Maximum 12 months after the start date.
  • It may be different from the calendar year.
  • It is uniform and consistent.

 

Financial Period of Various Countries

Accounting Period in Major Countries

Note – Fiscal year, accounting year & calendar year may be different for a company.

 

Short Quiz for Self-Evaluation

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>Read Accounting Cycle

 

What is Creditor’s Turnover Ratio?

Ahuja Sahil
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Creditor’s Turnover Ratio or Payables Turnover Ratio

Creditor’s turnover ratio is also known as Payables Turnover Ratio, Creditor’s Velocity and Trade Payables Ratio. It is an activity ratio that finds out the relationship between net credit purchases and average trade payables of a business.

It finds out how efficiently the assets are employed by a firm and indicates the average speed with which the payments are made to the trade creditors. The inverse of this ratio, when multiplied by 365, gives the average number of days a payable remains unpaid.

 

Formula to Calculate Creditor’s Turnover Ratio

Formula for Creditor's Turnover Ratio

Net Credit Purchases = Gross Credit Purchases – Purchase Return

Trade Payables = Creditors + Bills Payable

Average Trade Payables = (Opening Trade Payables + Closing Trade Payables)/2

 

Example – Payables Turnover Ratio

Ques. Calculate creditor’s turnover ratio from the information provided below;

Total Purchases – 5,00,000

Cash Purchases – 2,00,000

Creditors (Beginning of period) – 50,000 & Creditors (End of period) – 1,00,000

Ans. 

Creditor’s turnover ratio or Accounts payable turnover ratio = (Net Credit Sales/Average Trade Receivables)

Net Credit Purchases = Total Purchases – Cash Purchases

= 5,00,000 – 2,00,000

Net Credit Purchases = 3,00,000

Average Trade Payables = (Opening Trade Payables + Closing Trade Payables)/2

= (50,000 + 1,00,000)/2

= 75,000

Ratio = (3,00,000/75,000) => 4/1 or 4:1

 

High and Low Creditor’s Turnover Ratio

A high ratio may indicate

• Low credit period available to the business or early payments made by the business.
• The company may operate majorly on the cash basis.
• The company is not availing full credit period.

A low ratio may indicate

• Creditors are not paid in time.
• Increased credit period is allowed to the business.

 

Short Quiz for Self-Evaluation

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>Read Debtor’s Turnover Ratio

 

 

What is the Journal Entry for Credit Purchase and Cash Purchase?

Ahuja Sahil
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Journal Entry for Credit Purchase and Cash Purchase

To run successful operations a business needs to purchase raw material and manage its stock optimally throughout its operational cycle. Accounting and journal entry for credit purchase includes 2 accounts, Creditor and Purchase. In case of a journal entry for cash purchase, ‘Cash’ account and ‘Purchase‘ account are used.

The person to whom the money is owed is called a “Creditor” and the amount owed is a current liability for the company. Purchase orders are commonly used in large corporations to order goods on credit.

 

Accounting and Journal Entry for Credit Purchase

In case of a credit purchase, “Purchase account” is debited, whereas, the “Creditor’s account” is credited with the equal amount.

Purchase Account Debit
 To Creditor’s Account Credit

Journal entry for credit purchase

 

Golden rules of accounting applied (UK Style)

  • Purchase A/C (Type – Nominal) > Rule – Dr. all Expenses and Losses
  • Creditor’s A/C (Type – Personal) > Rule – Cr. the Giver

Modern rules of accounting applied (US-Style)

  • Purchase A/C (Type – Expense) > Rule – Dr. the Increase in Expenses
  • Creditor’s A/C (Type – Liability) > Rule – Cr. the Increase in Liability

 

Example – Journal Entry for Credit Purchase

Post a journal entry for – Goods purchased for 5,000 on credit from Mr Unreal

Example - Journal Entry for Credit Purchase

Related Topic – Journal Entry for Credit Sales and Cash Sales

 

Accounting and Journal Entry for Cash Purchase

Cash Purchase, on the other hand, is simple and easy to account for. In case of cash Purchase, the “Purchase account” is debited, whereas “Cash account” is credited with the equal amount.

Purchase Account Debit
 To Cash Account Credit

Journal entry for cash purchase

 

Golden Rules applied (UK Style)

  • Purchase A/C (Type – Nominal) > Rule – Dr. all Expenses and Losses
  • Cash’s A/C (Type – Real) > Rule – Cr. What Goes out

Modern Rules applied (US-Style)

  • Purchase A/C (Type – Expense) > Rule – Dr. the Increase in Expenses
  • Cash A/C (Type – Asset) > Rule – Cr. the Decrease in Asset

 

Example – Journal Entry for Cash Purchase

Post a journal entry for – Goods purchased for 5,000 in cash from Mr Unreal

Example - Journal Entry for Cash Purchase

 

Short Quiz for Self-Evaluation

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What is the Journal Entry for Credit Sales and Cash Sales?

Ahuja Sahil
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Journal Entry for Credit Sales and Cash Sales

Sales are a part of everyday business, they can either be made in cash or credit. In a dynamic environment, credit sales are promoted to keep up with the cutting edge competition. Accounting and journal entry for credit sales include 2 accounts, debtor and sales. In case of a journal entry for cash sales, a cash account and sales account are used.

The person who owes the money is called a “debtor” and the amount owed is a current asset for the company. Companies are careful while extending credit as it may lead to bad debts for the business.

 

Accounting and Journal Entry for Credit Sales

In the case of credit sales, the respective “debtor’s account” is debited, whereas “sales account” is credited with the equal amount.

Journal Entry for Credit Sales
Debtor’s Account Debit
 To Sales Account Credit

Golden rules of accounting applied (UK Style)

  • Debtor’s A/C (Type – Personal) > Rule – Dr. the Receiver
  • Sales A/C (Type – Nominal) > Rule – Cr. all Incomes and Gains

Modern rules of accounting applied (US Style)

  • Debtor’s A/C (Type – Asset) > Rule – Dr. the Increase in Assets
  • Sales A/C (Type – Revenue) > Rule – Cr. the Increase in Revenue

 

Example – Journal Entry for Credit Sales

Post a journal entry for – Goods sold for 5,000 on credit to Mr Unreal.

Related Topic – Journal Entry for Credit Purchase and Cash Purchase

 

Accounting and Journal Entry for Cash Sales

Cash sales, on the other hand, are simple and easy to account for. In the case of cash sales, the “cash account” is debited, whereas “sales account” is credited with the equal amount.

Journal Entry for Cash Sales
Cash Account Debit
 To Sales Account Credit

Golden Rules applied (UK Style)

  • Cash A/C (Type – Real A/C) > Rule – Dr. What Comes in
  • Sales A/C (Type – Nominal) > Rule – Cr. all Incomes and Gains

Modern Rules applied (US Style)

  • Cash A/C (Type – Asset) > Rule – Dr. the Increase in Assets
  • Sales A/C (Type – Revenue) > Rule – Cr. the Increase in Revenue

 

Example – Journal Entry for Cash Sales

Post a journal entry for – Goods sold for 5,000 in cash to Mr Unreal.

 

Short Quiz for Self-Evaluation

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>Read Accounting Concepts with Examples

 

Difference Between Bill of Exchange and Promissory Note

Ahuja Sahil
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Bill of Exchange Vs Promissory Note

To pay for credit sales a buyer may make a written promise in form of a promissory note or a bill of exchange. Below is a compilation of the major points of difference between a bill of exchange and a promissory note.

Definition (Bill of Exchange) – It is a financial instrument in writing containing an unconditional order signed by the maker, directing another person to pay a specific sum of money. It is paid to the bearer of the instrument (or) to the order of a particular person (or) to a particular person.

Format

Format - Bills of Exchange

 

Definition (Promissory Note) – It is a financial instrument, in which one party promises in writing to pay a pre-determined sum of money to the other party subject to agreed terms. It can either be payable on demand or at a specific time. It may be paid to the bearer of the instrument (or) to the authorized party (or) to the order of the authorized party.

Format

Promissory Note Template

 

Difference (Table Format)

Bill of Exchange Promissory Note
1. A bill of exchange is an order to pay. 1. A promissory note is a promise to pay.
2. The creditor is the drawer in this case. 2. The debtor is the drawer in this case.
3. There are 3 parties involved in a bill of exchange; the Drawer, the Drawee, and the Payee. 3. There are 2 parties involved in a promissory note; Promisor and the Payee.
4. Acceptance is mandatory by the drawee. 4. Acceptance is not mandatory by the drawee.
5. Liability of the drawer is only recognized when the acceptor fails to pay. 5. Promisor has the primary liability to make a payment.
6. Noting a bill of exchange is advisable in case of non-payment. 6. Noting a promissory note is compulsory in case of non-payment.
7. Stamping is necessary for a bill of exchange except for “bills payable on demand”. 7. Stamping is necessary for promissory notes without any exceptions.
8. A single copy is prepared, except in the case of foreign bills. (3 copies are made) 8. One copy is prepared in all cases.

 

>Read Bookkeeping Vs accounting

 

What is Profit and Loss Appropriation Account?

Ahuja Sahil
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Profit and Loss Appropriation Account

In case of a sole proprietorship, there is a single owner and any addition in the capital in form of net profit or reduction in form of drawings is directly done from the firm’s capital account. However, in case of a partnership, “Profit and Loss Appropriation Account” is created to demonstrate the change in each partner’s individual capital as a result of profit or loss incurred by the firm.

P&L Appropriation account helps to show a clear distinction between the capital contribution of each partner and the changes thereafter. Profit and Loss Appropriation Account is used for allocation of net profit among different partners. It is seen as an extension of the profit and loss account itself.

 

Template and Method of Preparation

It includes items such as interest on capital, interest on drawings, interest on partner’s loan, salaries to partners, commission, reserves, and profit share. (It doesn’t include drawings made by partners)

Credit

Net Profit (From the income statement) & Interest on drawings (charged to partners)

Debit

Interest on capital, salaries to partners, commission to partners, transfer to reserve, profit share, etc.

Profit and Loss Appropriation Account Format - 2

Note – Except rent if there are any funds payable to a partner for e.g. interest on capital, salaries, commission, etc. they should be treated as appropriation and are not supposed to be charged against profits.

 

Short Quiz for Self-Evaluation

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>Read Difference Between Profit and Loss & Profit and Loss Appropriation

 

What are Modern Rules of Accounting?

Ahuja Sahil
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American or Modern Rules of Accounting

There are a couple of ways to approach the art of accounting, traditional and modern. Classification of accounts under both traditional and modern rules of accounting is done very differently.

The UK or traditional style of accounting classifies all accounts of a business into 3 main types i.e. Real, Personal & Nominal. On the other hand, American or modern rules of accounting classify all accounts into 6 different types i.e. Asset, Liability, Capital, Revenue, Expense & Drawings.

Traditional or Golden rules of accounting are applied with real, personal, and nominal accounts, however, American or modern rules of accounting are applied with the modern classification of accounts.

 

Classification of Accounts and Modern Rules

The first step is to identify the type of account from either of the 6 categories shown in the below table. Once the account is determined correctly, apply modern rules of accounting to prepare a perfect journal entry.

Type of Accounts Debit Credit
Asset Increase Decrease
Liability Decrease Increase
Capital Decrease Increase
Revenue Decrease Increase
Expense Increase Decrease
Drawings Increase Decrease

 

Tip – Memorize the word (CRADLE) which means “small bed for a baby” in the English language.

C – Capital, R – Revenue, A – Assets, D – Drawings, L – Liability, E – Expense

Another way to look at modern rules of accounting is,

American or Modern Rules of Accounting

 

Example Journal Entries

  • Example I – Purchased furniture for 20,000 in cash, prepare the journal entry
Accounts Involved Amount Rule Applied
Furniture A/C 20,000 Asset – Dr. the increase
To Cash A/C 20,000 Asset – Cr. the decrease

 

  • Example II – Received 1,00,000 in the bank as a loan, prepare the journal entry
Accounts Involved Amount Rule Applied
Bank A/C 1,00,000 Asset – Dr. the increase
To Loan A/C 1,00,000 Liability – Cr. the increase

 

  • Example II – Received 5,00,000 via a cheque from Mr. Unreal as a trade receivable, prepare the journal entry
Accounts Involved Amount Rule Applied
Bank A/C 5,00,000 Asset – Dr. the increase
To Mr. Unreal A/C 5,00,000 Revenue – Cr. the increase

 

Short Quiz for Self-Evaluation

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>Read Step by Step Accounting Process

 

10 Tips to Follow for Freshers Before an Accounting Interview

Ahuja Sahil
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3
10 Tips to Follow for Freshers Before an Accounting Interview

Last updated on Jun 20th 2023

Tips to Follow for Freshers Before an Accounting Interview

Initial finance and accounting interviews can be hard-hitting and you don’t want to be caught off-guard. Here, we’ve compiled top 11 tips to follow for freshers before an accounting interview.

For obvious reasons we have not added the must-haves such as “hard work” & “dedication”. This list has been curated from real-life experiences and hopes to help you to achieve more out of your accounting interviews.

 

10. Revise your basics

Top grades in academics do not guarantee success in accounting and finance interviews. This is the main reason why we strongly suggest that you revise fundamentals of accounting and finance before your next encounter with an interviewer.

The idea is to avoid taking it for granted and never be complacent with yourself. You can subscribe and receive a free eBook with top 40 accounting interview questions asked by major companies around the world.

Revise Finance and Accounting Fundamentals

 

9. Know Your Job Profile – Don’t Be Trapped

This is one of the most important tips to follow for freshers before an accounting interview. A lot of freshers are prone to getting into the WRONG type of jobs because of not being able to handle the anxiety of starting a professional career.

A finance student getting into marketing, human resources, customer care, operations, and other unrelated work profiles is not the best way to kickstart a career.

It is highly advisable that you research your role & job profile. What are you expected to do 9 to 5? how are you going to spend a regular day at work? etc. Trust us, you don’t want to feel trapped and be sorry for your decision later on. It is also important because it allows you to anticipate questions and prepare precisely for the technical rounds.

 

8. Exhibit Stability

You may not have applied for the exact role you’ve always wanted, however, this isn’t something you need to convey to the interviewers. Talking about IJPs (Internal Job Postings), future plans, anything which shows that you’re not going to stay in this role for long is a strict NO!

Be careful about revealing your future plans, a lot of students get excited and start talking about fancy courses such as CPA, CA, CMA, ACCA, CFA, etc. that they are pursuing. Don’t get amazed to know that this is only a red flag in the eyes of the interviewer. There are however exceptions to this scenario where a specific course may be a plus for your role. Only reveal if you’re 100% sure about it.

 

7. Stay Motivated

You may have the best preparation and extraordinary educational background but on the day of the interview, you still need the unseen & intangible forces to work in your favour.

add motivation to the right attitude and the see the magic happen!

To reduce nervousness, stress, and anxiety related to an interview, we recommend that you try to watch motivational videos or do anything that makes you feel confident and positive.

 

6. MS-Excel

Most finance and accounting roles require you to work extensively with MS-Excel. Therefore, most of the accounting and finance interviews have at least one round related to Microsoft Excel.

Few functions we recommend every fresher should be comfortable with are Sort, Filter, Concatenate, Vlookup, Hlookup, Pivot (basics), Conditional Formatting, Text to Column, Charts, Sumif, Countif, Left, Right, Mid, Trim, etc.

The above is not an exhaustive list but covers most of the major functions. Also, consider learning some basic excel shortcuts.

 

5. Journal Entries

For accounting students, this is your holy grail. There is almost no way that an accounting interview can exist without journal entries. Not only are you expected to be good with accounting fundamentals but you are also required to display superior journal entry skills.

We have a list of journal entries here that can help you prepare. Along with basic entries, the operations manager love to ask accrual related entries don’t forget to prepare them.

 

4. Don’t Overtalk & Embrace Smartwork

Overtalking rarely helps, more often than not we end up saying things that we didn’t want to or we reveal more than required. Please avoid this.

Staying Quiet at the right time is an uncommon tact

Nothing beats a combination of Smart Work and Hard Work. For example, if you are anticipating a group discussion in your interview make sure you’ve researched the best practices, to-dos, etc. related to a GD. Don’t be shy to Google and learn something new.

 

3. Communication Skills

More than 70% of rejections happen in the preliminary rounds where the people from the human resource department churn out the applicants. The biggest reason for rejection in Non-English speaking countries still remains “Poor Communication Skills”.

Few resources for improvement we recommend are; watching movies, reading, youtube channels, online courses on UDEMY, online certifications at COURSERA, etc. This is one area that requires persistence and constant practice.

 

2. Research About the Company

Don’t forget to research about the company, mainly, its main line of business, history & top management. The best way to do this is through Wikipedia or the company’s own website.

Be ready with a crisp and natural answer to this question “Why do you want to join our organization?”

 

1. Rejection isn’t the end of World

Last in our list of tricks and tips to follow for freshers before an accounting interview is related to handling rejection. There is always a chance that your entire interview experience may have been really awesome and all your answers were perfect, but, you will still be rejected.

Accept that you can’t control everything and sometimes the reason for failure isn’t you at all. There are numerous behind the scene management-related decisions that can impact your success in an accounting interview. A few of them are – reduction in no. of positions, the job is filled up by an IJP, budget constraints, hiring manager’s personal choice, etc.

Jack Ma, Alibaba Group’s founder was REJECTED! by KFC. 

~Goodluck~

 

>Read Accounting Interview Questions for Freshers

 

What is Debtor’s Turnover Ratio?

Ahuja Sahil
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0

Debtor’s Turnover Ratio or Receivables Turnover Ratio

Debtor’s turnover ratio is also known as Receivables Turnover Ratio, Debtor’s Velocity and Trade Receivables Ratio. It is an activity ratio that finds out the relationship between net credit sales and average trade receivables of a business.

It helps in cash budgeting as cash flow from customers can be computed on the basis of total sales generated by a business. It is to be noted that provision for doubtful debts is not subtracted from trade receivables.

 

Formula to Calculate Debtor’s Turnover Ratio

Formula for Debtor's Turnover Ratio

Net Credit Sales = Gross Credit Sales – Sales Return

Trade Receivables = Debtors + Bills Receivable

Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables)/2

 

Example – Receivables Turnover Ratio

Ques. Calculate debtor’s turnover ratio from the information provided below;

Total Sales – 5,00,000

Cash Sales – 2,00,000

Debtors (Beginning of period) – 50,000 & Debtors (End of period) – 1,00,000

Ans. 

Debtor’s turnover ratio or Accounts receivable turnover ratio = (Net Credit Sales/Average Trade Receivables)

Net Credit Sales = Total Sales – Cash Sales

= 5,00,000 – 2,00,000

Net Credit Sales = 3,00,000

Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables)/2

= (50,000 + 1,00,000)/2

= 75,000

Ratio = (3,00,000/75,000) => 4/1 or 4:1

 

High and Low Debtor’s Turnover Ratio

A high ratio may indicate

• Low collection period allowed to customers.
• The company may operate majorly on the cash basis.
• Company’s collection of accounts receivable is efficient.
• A high proportion of quality customers pay off their debt quickly.
• The company is conservative with regard to the extension of credit.

A low ratio may indicate

• High collection period allowed to customers.
• Good credit period availed by the company from its suppliers.
• The company may have a high amount of cash receivables for collection.

 

Short Quiz for Self-Evaluation

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>Read Creditor’s Turnover Ratio

 

Accounting and Journal Entry for Bill of Exchange

Ahuja Sahil
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0

Journal Entry for Bill of Exchange

Bill of exchange is an instrument in writing signed by the maker which contains an order without any conditions. It directs another person to pay a specific sum of money to the bearer of the instrument (or) to a particular person (or) to the order of a particular person. Journal entry for bill of exchange is posted differently in the books of both drawee and the drawer.

A valid bill of exchange acts as a bill receivable for the drawer (Issuer) and a bill payable for the drawee (Acceptor).

 

Journal Entry in the Books of Drawer

Accounting in the books of drawer at different stages is shown as follows;

  • When the sale of goods on credit is recorded in books of the drawer.

When credit sales are recorded in the books of drawer

  • When a valid and accepted bill of exchange is received against the above credit sale.

Journal entry when bill is received from drawee

  • When payment is received, journal entry for bill of exchange is;

Journal entry when payment is received after maturity of a bill of exchange

 

Journal Entry in the Books of Drawee or Acceptor

Accounting in the books of drawee/acceptor at different stages is shown as follows;

  • When the purchase of goods on credit is recorded in the books of the drawee/acceptor.

Journal entry in books of drawee - purchase of goods on credit

  • When a valid and accepted bill of exchange is provided for the above credit purchase.

Journal entry in books of drawee - when bill is given to drawer

  • When payment is made, the journal entry for bill of exchange is;

Journal entry when payment is made at maturity of a bill of exchange

 

Short Quiz for Self-Evaluation

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>Read Bill of Exchange – with Template and Example

 

Accounting and Journal Entry For Provident Fund

Ahuja Sahil
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Journal Entry For Provident Fund (PF)

Provident fund or PF is a compulsory retirement savings plan managed by the government where employees contribute a fixed percentage of their monthly pay-out and the same amount is contributed by the employer. Accounting and Journal entry for provident fund is a 3 step process.

When salaries are paid to employees, the employer deducts the employee’s contribution from it and only the net amount is paid. Employer’s own contribution along with the employee’s share is later on deposited with the proper authority.

 

1. When salaries are paid, the below entry is posted.

Journal entry for provident fund when salary is paid

2. For employer’s own contribution to provident fund, the below entry is posted.

Journal entry for employer's own contribution to provident fund

3. When both the amounts are deposited, the below entry is posted.

Journal Entry when both PF amounts are deposited

If the amount has not been deposited within the accounting period, it is to be shown on the balance sheet as a current liability.

Related Topic  – Journal Entry for Income Tax Paid

 

Example of Accounting for Provident Fund

Show accounting and journal entry for provident fund deposits and deductions for the below information.

Total salaries – 1,00,000, PF deduction (employees) – 12,000, Employer share – 12,000

 

1. When salaries are paid (employee’s share is deducted)

Example - journal entry for PF when salary is paid

2. For employer’s own contribution to PF account (employer’s contribution journalized as salary)

Example - journal entry for employer's own contribution to PF

3. When both employee’s and self-contribution to PF account is deposited with the required authority.

Example - journal entry for PF when both the amounts are deposited

 

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What is a Bill of Exchange?

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Meaning

Bill of exchange is a financial instrument in writing containing an unconditional order signed by the maker, directing another person to pay a specific sum of money. The amount may be paid in any of the following ways;

  • to the bearer of the instrument, (or)
  • to the order of a particular person, (or)
  • to a particular person

 

Features of BOE

  • Bill of exchange is a written order.
  • Signed both by the drawer and the acceptor.
  • It is accepted by the drawee and doesn’t have any conditions attached.
  • Unlike a promissory note which is only a promise, a BOE is an order of payment on a specific date.
  • It is payable either on-demand or after a fixed period.

 

Parties Involved

Drawer – is the seller or the creditor who issues the instrument and is entitled to receive the money-back from the person to whom the credit is extended. Drawer signs the BOE.

Acceptor or Drawee – is the purchaser or the debtor who accepts the instrument and to whom credit has been extended. Drawee is required to pay the amount back to the seller. A bill of exchange is signed and accepted by the acceptor/drawee.

Payee – The person to whom the amount is supposed to be paid is called a payee. The drawer himself or a third party may be made a payee.

 

Template for Bill of Exchange

Sample Format - Bill of Exchange

 

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What is Stock Turnover Ratio?

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Stock Turnover Ratio

The inventory turnover ratio or stock turnover ratio indicates the relationship between “cost of goods sold” and “average inventory”. It indicates how efficiently the firm’s investment in inventories is converted to sales and thus depicts the inventory management skills of the organization.

It is both an activity and efficiency ratio. This ratio helps to determine stock-related issues such as overstocking and overvaluation. The stock turnover ratio is calculated as;

Stock Turnover Ratio Formula

In some cases, the numerator may be “Cost of Revenue from Operations” which is calculated as “Revenue from operations – Gross profit”.

COGS – It can be calculated with either one of these formulas;

  • Opening Stock + Purchases + Direct Expenses (*if provided) – Closing Stock
  • Net Sales – Gross Profit

Average Inventory – Average of stock levels maintained by a business in an accounting period, it can be calculated as;

  • (Opening Stock + Closing Stock)/2
  • Stock to include = Raw material + Work in Progress + Finished Goods

 

Example

Calculate the stock or inventory turnover ratio from the below information.

Cost of Goods Sold – 6,00,000

Stock at beginning of period – 2,00,000, Stock at end of period – 4,00,000

Average Inventory = (2,00,000 + 4,00,000)/2 = 3,00,000

Stock Turnover Ratio = (COGS/Average Inventory)

= (6,00,000/3,00,000)

=2/1 or 2:1

 

High Ratio – If the stock turnover ratio is high it shows more sales are being made with each unit of investment in inventories. Though high is favourable, a very high ratio may indicate a shortage of working capital and a lack of sufficient inventories.

Low Ratio – A low inventory turnover ratio may indicate unnecessary accumulation of stock, inefficient use of investment, over-investment in inventories, etc. This is a concern for the company as inventory could become obsolete and may result in future losses.

 

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What is the Journal Entry for Interest on Drawings?

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Accounting and Journal Entry for Interest on Drawings

Cash or Goods withdrawn by a proprietor from the business for their personal use is labelled as drawings. Interest may be charged by the business at a fixed rate when a business owner draws funds or assets. Journal entry for interest on drawings includes two accounts; Drawings A/C & Interest on Drawings A/C.

Interest on drawings is an income for the business, hence, it is added to the interest account of the firm thereby increasing the total income of the business.

In common scenarios where interest on capital is charged by the owner, interest on drawings is also charged by the business.

Journal entry for interest on drawings is;

Drawings A/C Debit Debit the increase in drawings
 To Interest on Drawings A/C Credit Credit the increase in income

 

Example

Charge 10% interest on drawings at the end of the year to Maya, her total drawings from the business are valued at 1,00,000.

Maya’s Drawings A/C 10,000
To Interest on Drawings A/C 10,000

(Interest charged to Maya on drawings at 10% of 1,00,000 at the end of the year)

Maya’s withdrawals from the business at the end of the year are at 1,00,000 and she is charged interest on drawings at the rate of 10%, consequently, this increases the firm’s income by 10,000.

 

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>Related Long Quiz for Practice Quiz 24 – Drawings

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What is the Journal Entry for Interest on Capital?

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Accounting and Journal Entry for Interest on Capital

Owners may seek a return on investment in the form of a fixed rate of interest to the extent of the amount employed by them in the business. In order to ascertain a true picture of the business’s profitability, it is a common practice to provide interest on capital. Journal entry for interest on capital includes two accounts; Capital A/c & Interest on Capital A/c

Interest on capital is an expense for the business and is added to the capital of the proprietor thereby increasing his total capital in the business. It is not paid in cash or by the bank.

Journal entry for interest on capital is;

Interest on Capital A/c Debit Debit the increase in expense
 To Capital A/c Credit Credit the increase in capital

 

Example

Provide 10% interest on capital at the end of the year to Sam. His contribution to the business is 100,000.

Interest on Capital A/c 10,000
 To Sam’s Capital A/c 10,000

(Interest provided at 10% on 100,000 at the end of the year)

This shows that the company’s interest to be paid on capital has been increased by 10,000 consequently Sam’s capital has also been increased equally because of the interest earned by him on capital.

This will not be paid in cash or deposited in his bank account, although, it will increase his total capital investment in the business by 10%.

 

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What are the Three Types of Personal Accounts?

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Three Types of Personal Accounts

Real, Personal and Nominal accounts are the traditional classification of account types in accounting, however, personal accounts are further distinguished under three categories such as Natural, Artificial, and Representative.

Golden rule of accounting for personal accounts is – Debit the Receiver & Credit the Giver

Three types of personal accounts by Accounting Capital

 

Natural Personal Accounts

These accounts are related to human beings i.e. natural persons who are created by God. They possess a physical existence.

Examples

Sam’s A/C, Maya’s A/C, Capital A/C, Drawings A/C, Debtor’s A/C, Creditor’s A/C, etc. come under the category of natural personal accounts.

Journal entry using natural personal account – 5,00,000 cash brought in as capital.

Journal Entry - Natural Personal Account

 

Artificial Personal Accounts

Second among three types of personal accounts is “Artificial” personal account. These accounts do not have a physical existence however, they are recognized as persons in business dealings. Most often they are legal entities created by human beings.

Examples

Any Public or Private company A/C, Bank A/C, Club A/C, Insurance company A/C, NGO A/C, Cooperative society A/C, etc. would fall under this category.

Journal entry using both natural and artificial personal accounts – 5,00,000 brought in as capital via bank cheque.

Journal Entry with Artificial Personal Account

 

Representative Personal Accounts

This account is different as compared to the other two types of personal accounts as it refers to accounts which represent a person or a group. (It is not directly their account but it represents & is linked to them)

Examples

Outstanding expense A/C, Prepaid expense A/C, Accrued Income A/C, Income received in advance A/C, Unearned commission A/C, etc.

Journal entry using representative personal account – 5,00,000 due to be paid for rent but not disbursed until the end of the period.

Journal Entry with Representative Personal Account

 

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Accounting and Journal Entry for Credit Card Sales

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Journal Entry for Credit Card Sales

Digitization and modernization have made credit cards a very common mode of payment. Credit cards allow customers to shop without cash and make swift hassle-free payments. Frequent credit card payments mean businesses have to deal with the aspect of accounting and posting journal entry for credit card sales.

There are majorly four credit card issuers in the world Visa, Master, Discover & American Express. For accounting and journal entry for credit card sales there are 2 scenarios;

Scenario 1 – When cash is received at a later date.

Scenario 2 – When cash is received immediately.

 

1. Accounting for Credit Card Sale when Money is Received at a Later Date

In case if the company’s bank account is not linked to the payer bank (issuer of swipe machine) then the business receives cash at a later date. The seller needs to submit all receipts of credit card sales as prescribed by the payer bank. Money is credited to the company’s account after deducting the commission on credit card sale.

  • Journal entry when the amount is due

When the amount is due it is shown as accounts receivable in the books of the business.

  • Journal entry when dues are settled at a later date

Following journal entry is posted in the ledger accounts when the amount is settled and the company’s bank account is credited with the net amount; i.e. after adjusting commission.

Journal entry for credit card sales when money is recevied at a later date - II

 

Example

Unreal Corp. has 5,00,000 as credit card sales on 10th of January which is due to be settled on the 30th of January. Commission rate charged by the issuer bank is 2% on total sales.

Journal entry on the date of transaction (10th January)

Example - Accounting for credit card sales - I

(Accounts Receivable account is used to show the amount due)

 

Journal entry on the date of settlement (30th January)

Example - Accounting for credit card sales - II

 

2. Accounting for Credit Card Sale when Money is Received Immediately

Nowadays payer banks issuing credit card machines (also known as Point of Sale terminals) automate the entire process. This means that the cash is credited automatically to the firm’s current account and no manual settlement is required. In this case, it is treated as an ordinary cash sale.

Journal entry for credit card sales when cash is recevied immediately

 

Example – When cash is received immediately

Unreal Corp. has a total of 5,00,000 as credit card sales on 10th January which is directly credited to the company’s account. Commission rate charged by the issuer bank is 2% on total sales.

Example when amount is settled immediately

(Sales account is credited as there is no requirement of accounts receivable account in this case)

 

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What are Revenue Receipts?

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Revenue Receipt

Revenue receipts are funds received by a business as a result of its core business activities. It leads to an overall increase in the total revenue of the company. These funds are generated from a firm’s operating activities hence they are shown inside trading and profit and loss account and not in a balance sheet.

They are recurring in nature which means that they can be seen quite often and can also be used for distribution of profits. Unlike capital receipts which can not be used to create reserves, revenue receipts are used to create reserve funds.

They have no effect on liabilities or assets of a company. Receipts of this kind affect the overall profit and loss of an organization & are booked on accrual basis which means as soon as the right of receipt is established.

 

Examples of Revenue Receipts

Few common examples are receipts from sale of good and services, discount received from creditors or suppliers, interests earned, dividends received, rent received, commission received, bad-debts recovered, income from other sources, etc.

An elaborated example of revenue receipts is interest earned – money received via earned interest is classified as revenue receipts as it is generated from regular business activities, doesn’t reduce assets or increase liabilities and & is a result of recurring business activity.

Sample view in a company

Examples of revenue receipts

 

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What are Capital Receipts?

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Capital Receipts

Capital receipts are funds received by a business which are not revenue in nature & lead to an overall increase in the total capital of a company. These are funds generated from non-operating activities of a business hence are not shown inside the income statement instead they are shown inside a balance sheet.

They are non-recurring in nature which means that they don’t occur regularly and can’t be used for distribution of profits. Unlike revenue receipts which can be used to create reserves, capital receipts are not used to create reserve funds.

They end up increasing liabilities or reducing assets in a company. Receipts of this kind do not affect the overall profit or loss of an organization & are booked on accrual basis which means as soon as the right of receipt is established.

 

Examples of Capital Receipts

Few common examples are funds received from issue of shares or debentures, cash from sale of fixed assets, borrowings such as loans, insurance claims, disinvestments, additional capital introduced by the proprietor(s), etc.

An elaborated example of capital receipts is sale of equipment – money received via sale of equipment is classified as capital receipts as it reduces the asset of the company, is an occasional & non-routine activity.

Another example explained is insurance claim received for loss of machinery – this is also a relevant illustration as sum of money received is due to reduction of an asset of the firm.

Sample view in a company

Example of capital receipts

 

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What is the Difference Between Depreciation and Amortization?

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Depreciation Vs Amortization

One of the main principles of accrual accounting is that an asset’s cost is proportionally expensed based on the period over which it is used. Both depreciation and amortization (as well as depletion and obsolescence) are methods that are used to reduce the cost of a specific type of asset over its useful life. This article describes the main difference between depreciation and amortization.

Depreciation is for tangible fixed assets whereas amortization is for intangible assets, however, in a way they are similar yet different at the same time. We have compared depreciation and amortization in 5 distinct points below;

 

Depreciation

1. Reduction in the value of a tangible asset due to normal usage, wear and tear, new technology, or unfavourable market conditions is called depreciation. Assets such as plant and machinery, buildings, vehicles, etc. which are expected to last more than one year, but not for an infinite number of years are subject to depreciation.

2. It only applies to fixed tangible assets.

3. Straight line, Diminishing value, etc. are a few of the various methods to charge depreciation.

4. Journal entry for depreciation

Depreciation Journal Entry*without using accumulated depreciation account

 

5. Example of Depreciation

Machinery cost  = 10,000, Depreciation Rate = 20%

= 20/100*10,000

Depreciation charge (1st year) = 2,000

 

Amortization

1. The process of spreading the cost of an intangible asset such as patent, copyright, trademark, etc. over a specific period i.e. equal to the course of its useful life is called Amortization.

2. It only applies to intangible assets.

3. Only the Straight-line method is used for the amortization of intangible assets.

4. Journal entry for amortization

Amortization Journal Entry*without using an accumulated amortization account

 

5. Example of Amortization

Patent cost = 10,000, Useful life of patent = 10 years

Amortization rate/year = 10%

1st year = 10/100*10,000

Amortization expense (1st year) = 1,000

Demonstrated above are the major points of difference between depreciation and amortization along with their respective examples.

Related Topic – Asset Disposal Account

 

Difference Between Depreciation & Amortization (Table Format)

Depreciation vs Amortization

 

Related Topic – Difference between Tangible and Intangible Assets

 

Types of Depreciation and Amortization

Types of Depreciation

These types of depreciation are mandated by law and enforced by professional accounting practices all over the world.

  • Straight-line method: Under this method, depreciation is calculated on the original cost of the asset after deducting the scrap value. Depreciation is charged every year and at the end of the life of the asset, the value of the asset becomes zero. The amount of depreciation is the same every year.
  • Written down value method: The rate of depreciation is fixed in this method, but depreciation at this rate is calculated on the balance of the asset standing in the books on the first day of each accounting year. It is suitable for assets with high repair charges. It is also known as
  • Annuity method: Under this method, the amount of depreciation includes some portion of the expected amount of interest also. This interest is the forgone expected interest that the purchaser would have earned had he invested the cost of the asset somewhere else.
  • Depreciation Fund Method: Under this method, an amount equal to the annual depreciation is charged against the profits every year and accumulated in the form of a sinking fund. This amount is invested to earn interest and used to replace the asset after the end of its useful life.
  • Group Depreciation: Under this method, the value of homogeneous assets is totalled up and from this total, the residual value of all the assets is deducted and the balance is found. This balance is divided by the average of the estimated lives of all these assets and the result is the depreciation for one year.

 

Types of Amortization

Types of amortization usually refer to the various methods of amortization of a loan schedule. This finds more use in finance management than general accounting.

  • Straight-line amortization: A constant amortization method where the principal remains constant, but the interest changes with the outstanding obligation. The instalment amount keeps changing.
  • Mortgage style amortization: Also known as a constant payment method. The instalment amount does not change, but the principal and the interest keep changing.
  • Interest-only amortization: A different kind of setup where the principal is paid in a lump sum after the amortization schedule expires.
  • Line of credit amortization: It works like a revolving letter of credit. The amount is withdrawn in the draw period and repaid in the repayment period.

Related Topic – Adjustments in Final Accounts

 

Is goodwill depreciated or amortized?

Goodwill is an intangible fixed asset. It is created through a process that carries a certain value but can not be seen or touched. It is an attractive force that results in additional profits and/or value creation. Its value depends on factors like popularity, image, prestige, honesty, fairness, etc.

Nonetheless, it is an asset and hence its cost has to match up with the revenue it generated in a particular accounting year. Since goodwill is an intangible asset, its value has to be amortized. But, in a disruptive decision of 2001, the Financial Accounting Standards Board (FASB) disallowed the amortization of goodwill as an intangible asset.

The reason was that most companies use the purchase method to evaluate and record the amount of goodwill in their books since goodwill comes into the picture when a new business is purchased, or a new asset is purchased. This happens when a company pays more than the fair value of an asset.

FASB allowed the evaluation for impairment, annually for goodwill. Impairment evaluation is a complex and costly process, so the FASB reallowed the amortization of goodwill as an intangible asset over 10 years in 2014, only for private companies.

Goodwill can be amortized in the following way:

ABC Ltd is purchasing a smaller company X that has a net worth of 450 million. But, X enjoys a reputation in the niche local market so the purchase consideration was fixed at 500 million. After doing a thorough revaluation, the accountants found the fair value of X assets to be 470 million.

ABC Ltd records goodwill as (purchase consideration – net worth) = 50 million

The amortization amount is (book value of assets – fair value of assets) = 30 million

Now, goodwill in the books of ABC Ltd will be recorded at (50 million – 30 million) = 20 million

While the amortized goodwill of 30 million will be spread over 10 years at 3 million per year. This amount will be charged to the profit & loss account for 10 years.

 

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>Related Long Quiz for Practice Quiz 39 – Depreciation

>Read Difference between Depreciation, Depletion and Amortization

 

What is Interest Coverage Ratio?

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Interest Coverage Ratio

Interest Coverage ratio is a type of solvency ratio (long-term solvency) which is derived by dividing “Earnings before Interest and Taxes” of a company with its “Interest on Long-Term Debt“. Ideal number for this ratio is 1.5 or above, anything less than that shows the company doesn’t earn enough w.r.t its interest payments.

The ratio helps lenders and debenture holders to measure the capacity of a company to pay the interest liability on its long-term borrowings; higher the ratio greater the ability of the company to service its interest and hence lesser the risk of a financial default.

Interest Coverage ratio is also known as Times-Interest-Earned ratio.

 

Formula to Calculate Interest Coverage Ratio

Interest Coverage Ratio

EBIT: Earnings before Interest and Taxes

Interest on Long-Term Debt:  Total interest obligation of the company on its long-term borrowings

 

Explanation with an Example

From the below information of Unreal Corp. calculate its interest coverage ratio

Long Term-Loans = 1,00,000

Total Interest on Loans = 5,000

EBIT = 1,00,000

Interest Coverage Ratio = EBIT/Interest Expenses

= 1,00,000/5,000

= 20 (In this case the company’s earnings before interest and taxes are 20 times that of their interest expenses in an accounting period)

 

High Ratio – High coverage ratio depicts good financial condition & shows that the company earns enough profit before taxes and interest payments to pay off its interest expenses. The ability to pay interest obligations is critical for a company to stay in business as per going concern concept.

Low Ratio – Low coverage ratio shows the company is burdened by debt expenses and doesn’t earn enough EBIT relatively to its interest expenses. Banks and NBFCs would hesitate extending credit to such an organization.

 

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How to Show Trade Discount in Purchase Book?

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Trade Discount in Purchase Book or Purchase Journal

A discount granted by a seller of goods or services on the retail price is called a trade discount. It is provided as a business consideration such as trade practices, large quantity orders, etc. Trade discount in the purchase book is shown in a separate row as a reduction and thus arriving at a final net amount to be recorded.

Trade discount is not shown in a ledger account, the net amount thus calculated after deducting trade discount from the cost of goods purchased is posted to the debit side of the purchase account in the ledger.

Cost of Goods Purchased – Trade Discount = Net Amount to Record

 

Example Showing Trade Discount in Purchase Book

Prepare the purchase book of Unreal Pvt Ltd. from the following details.

Jan 7 – Purchased 10 Keyboards from ABC Co. for 300 each (for resale, invoice # 60)

Less: Trade discount @ 10%

 

Purchase Journal for Unreal Pvt Ltd.

Trade discount in purchase book

 

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