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What is the Journal Entry for Profit on Sale of Fixed Assets?

Ahuja Sahil
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Journal Entry for Profit on Sale of Fixed Assets

Nowadays, businesses sell their assets as part of strategic decision-making. Sale of an asset may be done to retire an asset, funds generation, etc. Such a sale may result in a profit or loss for the business. In the case of profits, a journal entry for profit on sale of fixed assets is booked.

It is very common that an asset may not be sold at current book value, hence if it is sold for more than its written down value it generates profit for the business and in a situation opposite to that i.e. when it is sold for less it incurs a loss.

Loss or profit on the sale of an asset is to be shown on the appropriate side of the profit and loss account.

 There are 3 different accounts that will be affected in this case;

  1. Asset being sold
  2. Cash being received
  3. Profit earned on the sale of an asset

Journal Entry for Profit on Sale of Fixed Assets

Cash A/c Debit Real Account Debit what comes in
 To Sale of Asset Credit Real Account Credit what goes out
 To Profit on Sale of Asset Credit Nominal Account Credit all gains

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 35 – Fixed Assets

>Read Journal Entry for Loss on Sale of Fixed Assets

 

What is the Journal Entry for Discount Allowed?

Ahuja Sahil
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Discount Allowed

Discounts are very common in today’s business world, they are generally provided in lieu of some consideration which can range from timely payments to market competition. While posting a journal entry for discount allowed “Discount Allowed Account” is debited.

Discount allowed acts as an additional expense for the business and it is shown on the debit side of a profit and loss account. Trade discount is not shown in the main financial statements, however, cash discount and other types of discounts are supposed to be recorded in the books of accounts.

In case of a transaction where both trade discount and cash discount are allowed, the trade discount is allowed first and then the cash discount is processed.

Related Topic – Journal Entry for Discount Received

 

Journal Entry for Discount Allowed

It is journalized and the balances are pushed to their respective ledger accounts.

Cash A/C Debit Real A/C Dr. What comes in
Discount Allowed A/C Debit Nominal A/C Dr. All expenses
 To Debtor’s A/C Credit Personal A/C Cr. The giver

Discount allowed ↑ increases the expense for a seller, on the other hand, it ↓ reduces the actual amount to be received from sales.

 

Simplifying the entry with the help of modern rules of accounting

Explanation and rules for journal entry for discount allowed

Discount allowed by a seller is discount received for the buyer. The following examples explain the use of journal entry for discount allowed in real-world events.

 

Examples – Journal Entry for Discount Allowed

  • Cash received for goods sold to Unreal Co. worth 50,000 along with a 10% discount. (Discount allowed in the regular course of business)
Cash A/C 45,000
Discount Allowed A/C 5,000
 To Unreal Co. A/C 50,000

 

  • Received 5,000 from Unreal Co. in full and final settlement of their account worth 10,000. (Discount allowed to settle an overdue payment)
Cash A/C 5,000
Discount Allowed A/C 5,000
 To Unreal Co. A/C 10,000

 

Short Quiz for Self-Evaluation

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>Read Journal entry for goods given as charity or free samples

 

What is the Journal Entry for Depreciation?

Ahuja Sahil
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  1. Overview
  2. Depreciation Journal Entry
    1. When charged directly to the asset
    2. When provision for depreciation or accumulated depreciation is maintained
  3. Example & Steps
  4. Journal Entry for Depreciation on Furniture
  5. Journal Entry for Depreciation on Machinery
  6. Journal Entry for Depreciation on Equipment
  7. Journal Entry for Depreciation on Building
  8. Journal Entry for Depreciation on Land
  9. Quiz

 

Overview

A reduction in the value of tangible fixed assets due to normal usage, wear and tear, new technology or unfavourable market conditions is called Depreciation. Whether you maintain the provision for depreciation/accumulated depreciation account determines how to do the journal entry for depreciation.

Assets such as plant and machinery, buildings, vehicles, furniture, etc., expected to last more than one year but not for an infinite number of years, are subject to depreciation.

Related Topic – Which Contra Account is used to Record Depreciation?

 

Depreciation Journal Entry

In the books of accounts, depreciation can be recorded by any of the following two methods,

1. When depreciation is charged to the ‘Asset’ account.

2. When provision for depreciation/accumulated depreciation is maintained.

More often than not, the second method is used.

Journal Entry for Depreciation

 

Method 1 – Depreciation Charged to the Asset Account

In this method, the asset account is charged (credited) with depreciation. There is one disadvantage of this method, which is that it is not possible to find out the original cost of an asset and the total amount of depreciation.

Depreciation A/c Debit
 To Asset A/c Credit

(Depreciation charged directly to the fixed asset)

Accounting rules applied in the above journal entry are;

Depreciation A/c – Debit the increase in expense

Asset A/c – Credit the decrease in assets

 

Golden rules of accounting applied in the above journal entry are;

  • Depreciation A/c – Nominal Account > Debit all expenses & losses
  • Asset A/c – Real Account > Credit what goes out

 

To Transfer Depreciation into P&L

Profit & Loss A/c Debit
 To Depreciation A/c Credit

(Being depreciation charged transferred to profit & loss account)

After the asset’s useful life is over and when all depreciation is charged, the asset approaches its scrap or residual value.

 

Method 2 – Entry when Provision for Depreciation or Accumulated Depreciation Account is Maintained

When using this method, depreciation is not credited to the asset account. A provision for depreciation or an accumulated depreciation account is maintained where depreciation is credited separately.

As a result of this method, the asset can be shown at its original cost, and the provision for depreciation (contra account) can be shown on the liabilities side. It helps counterbalance.

It is also possible to deduct the accumulated depreciation from the asset’s cost and show the balance on the balance sheet.

Depreciation A/c Debit
 To Provision for Depreciation A/c Credit

(Being depreciation charged accumulated in a separate account for the asset)

 

To Transfer Depreciation into P&L

Profit & Loss A/c Debit
 To Depreciation A/c Credit

(Being depreciation charged transferred to profit and loss account)

Depreciation accumulated over the life of an asset is shown in the accumulated depreciation account.

Related Topic – Is Accumulated Depreciation an Asset or Liability?

 

Journal Entry for Depreciation Example & Steps

Let’s assume that a piece of machinery worth 100,000 was purchased on April 1st 2023, with a scrap value of nil and a depreciation rate of 10% (straight-line method). The company will close its accounts on 31st March.

Show entries for depreciation, all relevant accounts, and the company’s balance sheet for the next 2 years using both methods.

Method 1 – When no provision is maintained

31 Mar 2024 (end of year 1) – Depreciation charged on machinery

Depreciation A/c 10,000
 To Machinery A/c 10,000

(Being depreciation charged on the machine @ 10% for year 1 SLM)

 

31 Mar 2025 (end of year 2) – Depreciation charged on machinery

Depreciation A/c 10,000
 To Machinery A/c 10,000

(Being depreciation charged on the machine @ 10% for year 2 SLM)

 

Machinery A/c & Depreciation A/c for the next two years

Example of depreciation entry posted in Asset account and Depreciation Account when no provision is maintained

Balance Sheet for the next two years (extract)

Example of balance sheet when provision is not maintained

 

Method 2 – When provision for depreciation is maintained

Machinery A/c & Depreciation A/c for the next two yearsExample of depreciation entry posted in Asset account and Depreciation Account when provision is maintained

 

Balance Sheet for the next two years (extract)

Example of balance sheet when provision is maintained

Related Topic – How to show Accumulated Depreciation in Trial Balance?

 

Depreciation on Furniture Journal Entry

Office furniture is subject to depreciation. Depending on the local laws, fittings may also be included in the definition of ‘furniture’.

This may include wiring, switches, sockets, light fittings, fans, and other electrical fittings. Every country’s regulatory bodies determine how furniture and fittings are depreciated.

Entry to depreciate office furniture,

Depreciation A/c Debit
 To Furniture A/c Credit

(Assuming no provision/accumulated depreciation account is maintained)

The rules applied while charging depreciation on office furniture are,

  • Depreciation – Dr. the increase in depreciation expense.
  • Furniture – Cr. decrease in furniture value, which is an asset for the firm.

Related Topic – Can Depreciation be Charged in the Year of Sale?

 

Depreciation on Machinery Journal Entry

An expenditure directly related to making a machine operational and improving its output is considered a capital expenditure. In other words, this is a part of the machine cost that can be depreciated. For example, installation, wages paid to install, freight, upgrades, etc.

Entry to depreciate machinery,

Depreciation A/c Debit
 To Machinery A/c Credit

(Assuming no provision/accumulated depreciation account is maintained)

The rules applied while charging depreciation on machinery are,

  • Depreciation – Dr. the increase in depreciation expense.
  • Furniture – Cr. decrease in machine’s value, which is an asset for the firm. In this case, it is important to add any capital expenditure incurred on the machinery’s cost.

Related Topic – Examples of Contingent Assets

 

Depreciation on Building Journal Entry

When an asset is purchased, any expenses incurred on the purchase of the asset (except for goods) increase its cost. They are debited to the “Asset A/c” and not recognised as expenses.

It is important to note that all expenses incurred for the construction of the building are added to the cost of the building. These include purchasing construction materials, wages for workers, engineering, etc.

Entry to depreciate building,

Depreciation A/c Debit
 To Building A/c Credit

(Assuming no provision/accumulated depreciation account is maintained)

The rules applied while charging depreciation on machinery are,

  • Depreciation – Dr. the increase in depreciation expense.
  • Furniture – Cr. decrease in machine’s value, which is an asset for the firm. In this case, it is important to add any capital expenditure incurred on the machinery’s cost.

Related Topic – Can Assets have a Credit Balance?

 

Depreciation on Equipment Journal Entry

Sometimes referred to as PPE (Property, Plant & Equipment), they are physical items held for use to operate a business. They are intended for use beyond 12 months.

Spare parts, stand-by equipment, and servicing equipment are not considered to be PPE unless they comply with the standards defining the term. In the absence of such items, they are considered inventory.

Entry to depreciate equipment is,

Depreciation A/c Debit
 To Furniture A/c Credit

(Assuming no provision/accumulated depreciation account is maintained)

The rules applied while charging depreciation on office furniture are,

Depreciation – Dr. the increase in depreciation expense.

Furniture – Cr. decrease in furniture value, which is an asset for the firm.

Related Topic – 20 Journal Entry Examples with a PDF 

 

Depreciation on Land Journal Entry

Due to the fact that there is no estimated useful life associated with this asset, the land is not depreciated. It is not because “it is always appreciated”. In fact, in exceptional scenarios, land may depreciate as well. For these reasons, there is no journal entry for depreciation on land.

Related Topic – Reclassification Entries

 

Short Quiz for Self-Evaluation

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>Read Amortization with an example

 

What is the Journal Entry for Income Received in Advance?

Ahuja Sahil
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Journal Entry for Income Received in Advance

Also known as unearned income, it is income which is received in advance, however, the related benefits are yet to be provided. It belongs to a future accounting period and is still to be earned. Journal entry for income received in advance recognizes the accounting rule of “Credit the increase in liability”.

Examples of income received in advance – Commission received in advance, rent received in advance, etc. Such advances received are treated as a liability for the business.

Journal entry for income received in advance is;

Income A/C  Debit Debit the decrease in income
 To Income Received in Advance A/C  Credit Credit the increase in liability

As per accrual-based accounting unearned income must be recorded in the books of finance irrespective of when the related goods/services are provided.

Related Topic – What is the Journal entry for Accrued Income?

 

Simplifying with an Example

Question – On December 20th 2019 Company-A receives 1,20,000 (10,000 x 12 months) as rent in cash which belongs to the following year (Jan 2020 to December 2020).

Show all related rent entries including journal entry for income received in advance on these dates;

  1. December 20th 2019 (Same Day)
  2. December 31st 2019 (End of the period adjustment)
  3. January 1st 2020 to December 31st 2020 (Beginning of each month next year)

1. December 20th 2019 – (Money received for rent to be collected next year)

Cash A/c 1,20,000
 To Rent Received A/c 1,20,000

 

2. December 31st 2019 – (Rent receivable next year adjusted with rent received in advance account)

Rent Received A/c 1,20,000
 To Rent Received in Advance A/c 1,20,000

 

3. January 1st 2020 to December 1st 2020 – (Income matched to each period)

Rent Received in Advance A/c 10,000
 To Rent Received A/c 10,000

All 12 months from Jan’20 to Dec’20 will be consumed in each period against the rent received in advance account to reduce the advance account to zero by end of the year.

 

Treatment of Income Received in Advance in the Financial Statements

After posting the journal entry for income received in advance a business records it the final accounts as follows;

  1. Reduces it from the concerned income head on the credit side of the income statement.
  2. Shows it as a liability in the current balance sheet under the head “Current Liabilities“.
Treatment of income received in advance in the books
Treatment of income received in advance in the books of finance

 

Example – Journal Entry for Rent Received in Advance

Let’s assume that in the month of March 10,000 are received in advance for rent, the rent actually belongs to the month of April.

Journal entry to record this in the current accounting period is;

Rent Received A/c 10,000
 To Rent Received in Advance A/c 10,000

(Assuming cash was debited and rent received was credited at the time of actual receipt)

 

Example – Journal Entry for Commission Received in Advance

Total of 2000 was received as commission earned in the current accounting year. Post the journal entry for income received in advance (commission earned) to include the impact of this activity.

Commission Received A/c 2,000
 To Commission Received in Advance A/c 2,000

(Assuming cash was debited and commission received was credited at the time of actual receipt)

 

Short Quiz for Self-Evaluation

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

>Read Top Accounting and Finance Interview Questions

 

What is the Journal Entry for Accrued Income?

Ahuja Sahil
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Journal Entry for Accrued Income

It is income earned during a particular accounting period but not received until the end of that period. It is treated as an asset for the business. Journal entry for accrued income recognizes the accounting rule of “Debit the increase in assets” (modern rules of accounting).

Examples of accrued income – Interest on investment earned but not received, rent earned but not collected, commission due but not received, etc.

 

Journal entry for accrued income is;

Accrued Income A/C Debit Debit the increase in asset
 To Income A/C Credit Credit the increase in income

As per accrual-based accounting income must be recognized during the period it is earned irrespective of when the money is received.

Accrued income is also known as income receivable, income accrued but not due, outstanding income and income earned but not received.

Related Topic – Journal Entry for Income Received in Advance

 

Simplifying with an Example

Question – On December 31st 2019 Company-A calculated 50,000 as rent earned but not received for 12 months from Jan’19 to Dec’19.

The same is received in cash next year on January 10th 2020. Show all related rent entries including the journal entry for accrued income on these dates;

  1. December 31st 2019 (Same day)
  2. January 10th 2020 (When the payment is received)

 

1. December 31st 2019 – (Rent earned but not received)

Accrued Rent Account 50,000
 To Rent Account 50,000

 

2. January 10th 2020 – (Received cash in lieu of accrued rent from 2019)

Cash Account 50,000
 To Accrued Rent Account 50,000

 

Treatment of Accrued Income in Financial Statements

After posting the journal entry for accrued income a business records it in the final accounts as follows;

  1. Shows it on the credit side of the income statement as it is an income for the current accounting period (just not received yet).
  2. Shows it on the asset side of the balance sheet under the head “Current Assets”.
Treatment of accrued income in the books1
Treatment of accrued income in the books of finance

 

Example – Journal Entry for Accrued Commission

Let’s assume that in March there was 30,000 as commission earned but not received due to business reasons.

At the end of the month, the company will record the situation into their books with the below journal entry.

Accrued Commission A/C 30,000
 To Commission Received A/C 30,000

(Commission earned but not received)

 

Example – Journal Entry for Accrued Interest

Total of 2000 was not received as interest earned on debentures in the current accounting year. Post the journal entry for accrued income (interest earned) to include the impact of this activity.

Accrued Interest A/C 2,000
 To Interest Received A/C 2,000

(Interest receivable on debentures)

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 14 – Accrued Income

> Read How to Prepare a Journal Entry (With Steps)

 

What is the Journal Entry for Prepaid Expenses?

Ahuja Sahil
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Journal Entry for Prepaid Expenses

Prepaid expenses are those expenses which are paid in advance for a benefit yet to be received. The perks of such expenses are yet to be utilised in a future period. Below is the journal entry for prepaid expenses;

According to the three types of accounts in accounting “prepaid expense” is a personal account.

Prepaid Expense A/C Debit Debit the increase in asset
 To Expense A/C Credit Credit the decrease in expense

It involves two accounts: Prepaid Expense Account and the related Expense Account.

They are an advance payment for the business and therefore treated as an asset. The accounting rule applied is to debit the increase in assets” and “credit the decrease in expense” (modern rules of accounting).

They are also known as unexpired expenses or expenses paid in advance. It is important to show prepaid expenses journal entry in the financial statements to avoid understatement of earnings.

 

Simplifying Prepaid Expenses Adjustment Entry with an Example

Question – On December 20th 2019 Company-A pays 1,20,000 (10,000 x 12 months) as rent in cash for next year i.e. for the period (Jan’2020 to Dec’2020).

Show all entries including the journal entry for prepaid expenses on these dates;

  1. December 20th 2019 (Same day)
  2. December 31st 2019 (End of period adjustment)
  3. January 1st 2020 to December 1st 2020  (Beginning of each month next year)

1. December 20th 2019 – (Payment made for rent due next year)

Rent Account 1,20,000
 To Cash Account 1,20,000

 

2. December 31st 2019 – (Rent payable in next year transferred to prepaid rent account)

Prepaid Rent Account 1,20,000
 To Rent Account 1,20,000

 

3. January 1st 2020 to December 1st 2020 – (Expense charged to each period)

Rent Account 10,000
 To Prepaid Rent Account 10,000

All 12 months from Jan’20 to Dec’20 will be charged in each period against the prepaid expense account to reduce the prepaid account to zero by end of the year.

 

Treatment of Prepaid Expenses in Financial Statements

Once the journal entry for prepaid expenses has been posted they are then arranged appropriately in the final accounts.

Treatment after journal entry for prepaid expenses

Related Topic  – Treatment of Prepaid Expenses in Final Accounts (Detailed)

 

Example – Journal Entry for Prepaid Insurance

Company-A paid 10,000 as insurance premium in the month of December, the insurance premium belongs to the following calendar year hence it doesn’t become due until January of the next year.

At the end of December the company will record this into their journal book using the below journal entry for prepaid expenses;

Prepaid Insurance Premium A/C 10,000
 To Insurance Premium A/C 10,000

(Insurance premium related to next year transferred to prepaid insurance premium account)

 

Example – Journal Entry for Prepaid Salary or Wages

Journalize the prepaid items in the books of Unreal Corp. using the below trial balance and additional information provided along with it.

  • Prepaid Salaries – 25,000
  • Prepaid Wages – 10,000
Account Dr. Cr.
Salaries 50,000
Wages 20,000

 

Journal entry for prepaid expenses in the books of Unreal Corp.

Prepaid Salary A/C 25,000
 To Salary A/C 25,000

(Salaries related to next year transferred to prepaid salary account)

 

Prepaid Wages A/C 10,000
 To Wages A/C 10,000

(Wages related to next year transferred to prepaid wages account)

 

Example – Journal Entry for Prepaid Rent

Company-B paid 60,000 rent (5,000 x 12 months) in the month of December which belongs to the next year and doesn’t become due until January of the following year.

Using the concept of the journal entry for prepaid expenses below is the journal entry for this transaction in the books of Company-B at the end of December.

Prepaid Rent A/C 60,000
 To Rent A/C 60,000

(Rent related to next year transferred to prepaid rent account)

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 36 – Prepaid Expenses

>Read Income Received in Advance

 

What is the Journal Entry for Outstanding Expenses?

Ahuja Sahil
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What is the Journal Entry for Outstanding Expenses?

There are expenses that are due but have not been paid as of the end of the current accounting period. Such expenses are called outstanding expenses. The benefits of such expenses have been consumed although due to some reason they are not paid. We’ll explain how to pass a journal entry for outstanding expenses in this article.

Outstanding expense is a “personal” account as per the traditional classification of accounts and a “liability” as per the more recent way of accounting.

 

Journal Entry for Outstanding Expenses

Expense A/C Debit Debit the increase in expense
 To Outstanding Expense A/C Credit Credit the increase in liability

The outstanding expenses journal entry involves two accounts: the “Outstanding Expense Account” and the related “Expense Account”.

They are an obligation for the business and therefore treated as a liability. The accounting rule applied is “credit the increase in liability” and “debit the increase in expense” (modern rules of accounting).

They are also known as expenses due but not paid and should be shown in the financial books to avoid overstatement of earnings.

Journal Entry for Outstanding Expenses

Related Topic – Journal Entry for Outstanding Subscription

 

Simplifying Outstanding Expenses Entry with an Example

Question – On December 31st 20YY Company-A recognised rent due for 100,000 related to the same year. The period has ended and the payment has not been made.

The same is paid in cash next year on January 10th. Show all financial recordings including the journal entry for outstanding expenses on these dates;

  1. December 31st 20YY (Same day)
  2. January 10th (Next year, when it is actually paid)

 

1. December 31st 20YY – (Overdue expense recorded as outstanding)

Rent Expense A/c 100,000
 To Outstanding Rent A/c 100,000

 

2. January 10th – (Payment made towards outstanding rent in next year)

Outstanding Rent A/c 100,000
 To Cash A/c 100,000

 

Treatment of Oustanding Expenses in Financial Statements

Once the journal entry for outstanding expenses has been posted they are then placed appropriately in the final accounts.

Treatment after journal entry for outstanding expenses

Related Topic – Journal Entry for Prepaid Expenses

 

Journal Entry for Outstanding Rent

A rent which is past its due date is called outstanding rent. Such an obligation is included in the list of current liabilities for a business and the account is treated as a representative personal account. 

Let’s assume that in the month of March there was 30,000 past due as a rent amount that wasn’t paid for some reason.

When rent is overdue, here is the outstanding rent journal entry that is recorded,

Rent Expense A/c Debit Dr. the increase in expense
 To Outstanding Rent A/c Credit Cr. the increase in rent liability

(Being unpaid rent recorded)

Related Topic – How to Show Outstanding Expenses in Trial Balance?

 

Journal Entry for Outstanding Salary or Wages

Salaries and wages differ slightly. Part-time jobs, assignments with variable hours, and jobs with repetitive duties are commonly referred to as wages instead of salaries.

Wages are generally paid on a weekly, biweekly, or monthly basis. Generally, the difference between salary and wage is that salary is a fixed amount and wage is based on the number of hours that an employee works.

Pass outstanding salary journal entry in the books of Unreal Corp. using the below trial balance and supplementary information provided along with it.

  • Outstanding Salaries – 30,000
  • Outstanding Wages – 20,000

Extract from Trial Balance of Unreal Corp.

Account Dr. Cr.
Salaries 70,000
Wages 80,000

 

Outstanding Salaries Journal Entry in the Books of Unreal Corp.

Salary A/c 30,000
To Outstanding Salary A/c 30,000

(Salaries due in the previous year are transferred to “Outstanding Salary A/c”)

 

Journal Entry for Outstanding Wages in the Books of Unreal Corp.

Wages A/c 20,000
 To Outstanding Wages A/c 20,000

(Wages related to the previous year transferred to outstanding wages account)

Related Topic – Example of a Service Center

 

Journal Entry for Outstanding Interest

It is also known as accrued interest. An outstanding interest journal entry is required to record the amount of interest owed by the business on a loan obligation. It refers only to the portion of the interest that is currently due but not paid by the borrower. It is a “receivable” for the lender.

Suppose in the month of December, interest on a bank loan taken from ABC bank was due at 24,000. Pass the accounting entry for outstanding interest at the end of the year i.e. 31st Dec.

Interest Expense A/c 24,000
 To Outstanding Interest A/c 24,000

(Recording interest overdue at 24,000)

Related Topic – Difficult Adjustments in Final Accounts

 

Are Outstanding Expenses Debited or Credited?

Outstanding expenses are obligations yet to be paid by the firm. They are “credited” as per two rules of accounting,

  1. Personal A/c – Cr. the giver
  2. Treated as a Liability – Cr. the increase in liability

Such past due expense is debited to Profit & Loss A/c because it is prepared as per the accrual basis of accounting which says that “irrespective of when the payment is made, all expenses and incomes should be recorded in the period when they occurred.

An outstanding expense is one that has been incurred but has not yet been paid. Despite the fact that it has not been paid, it belongs to the same accounting period. Therefore, it is added to the debit side of a profit & loss account.

Related Topic – Is an Expense Debit or Credit?

 

Are such Outstanding Expenses Debts?

Debt is typically in the form of money, that is due or owed. However, in day-to-day accounting vocabulary, a “debt” may be referred to as long-term debt i.e. an obligation that is payable beyond 12 months.

Outstanding expenses are a liability for the firm but they are not considered a debt for the company. Due to the fact that outstanding expenses are expected to be paid within 12 months, they are treated as current liabilities.

Related Topic – Are Bad Debts Liabilities?

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 34 – Outstanding Expenses

>Read Top Accounting and Finance Interview Questions

 

What is the Difference Between Debit Note and Credit Note?

Ahuja Sahil
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Debit Note Vs Credit Note

Debit and credit notes are an important part of today’s business culture as corporations have grown large and so have their credit sales and purchases.

Accounts payable management and accounts receivable management including dealing with credit and debit notes on a daily basis. Therefore, knowing the difference between a debit note and credit note is important.

 

 Debit Note

1. When a buyer returns goods to the seller, he sends a debit note as an intimation to the seller of the amount and quantity being returned and requesting the return of money.

2. A debit note is sent to inform about the debit made in the account of the seller along with the reasons mentioned in it.

3. The purchase returns book is updated on the basis of the debit note. (In case of return of goods)

4. It is often used to return goods on credit.

5. A debit note is generally prepared like a regular invoice and shows a positive amount.

6. Journal entry to record a debit note in the books of seller

 Sales Returns A/C  Debit
   To Debtor’s A/C  Credit

 

Template for Debit Note
Sample Format of a Debit Note

Related Topic – Accounts Payable with Journal Entries

 

Credit Note

1. When a Seller receives goods (returned) from the buyer, he prepares and sends a credit note as an intimation to the buyer showing that the money for the related goods is being returned in the form of a credit note.

2. A credit note is sent to inform about the credit made in the account of the buyer along with the reasons mentioned in it.

3. The sales return book is updated on the basis of the credit note. (In case of return of goods)

4. It is generally sent by the seller if the goods are found incomplete, damaged or incorrect.

5. A credit note generally shows a negative amount.

6. Journal entry to record a credit note in the books of buyer

 Creditor’s A/C  Debit
   To Goods Returned A/C  Credit

 

Template for Credit Note
Sample Format of a Credit Note

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 19 – Credit Note

>Related Long Quiz for Practice Quiz 25 – Debit Note

>Read Top Accounting and Finance Interview Questions

 

What is the Difference Between Income Statement and Balance Sheet?

Ahuja Sahil
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Income Statement vs Balance Sheet

An Income statement and a Balance sheet are two significant financial statements in accounting, and both statements have their own individual purpose and identity. They are important, yet very different. Below, you will find few points showing the difference between the income statement and balance sheet.

 

Income Statement (Profit and Loss Account)

1. The income statement is an important final account of a business that shows the summarized view of revenues and expenses of a particular accounting period.

2. An income statement is prepared for an entire accounting period.

3. All income and expense accounts are closed and not carried forward.

4. An income statement shows how profits/gains are earned and expenses/losses are incurred.

5. It consists of income and expenses.

6. The balance of an account is transferred to the capital account in the balance sheet.

Related Article – Difference between Trial Balance and Balance Sheet

 

Balance Sheet

1. The balance sheet is a statement that shows a detailed listing of assets, liabilities, and capital showing the financial condition of a company on a given date.

2. A balance sheet is prepared on the last day of the accounting period.

3. All asset and liability accounts are left open and carried forward to the next period.

4. Balance sheet, on the other hand, shows the financial position of a business.

5. It consists of assets, liabilities, and capital.

6. The balance derived from a balance sheet is transferred to the capital account.

7. The balance of the statement becomes the opening balance for the next period.

 

Example of Income Statement (Profit and Loss Account)

The income statement is prepared to determine the profit earned or loss sustained by the business enterprise during a period of time. As a custom in practice, profit is ascertained in three stages,

  • Ascertainment of gross profit
  • Calculation of operating profit
  • Ascertainment of net profit

The above three figures can be determined by analyzing the income statement.

Following is the income statement of ABC Ltd for the year ending 31st March, YYYY,

Income Statement or Profit and Loss Account Example

 

Example of Balance Sheet

In order to know the position of assets and liabilities of the business, a statement is prepared which is called the Balance sheet. It is a summary of the complete accountancy records. The balance sheet represents the financial position of a business on a specific day.

Following is the Balance sheet of Unreal Corp. on 31st March, YYYY,

Balance Sheet Example

 

What comes first and should they match?

What comes first?

The income statement and the balance sheet are both parts of the accounting cycle. The cycle starts with identifying the economic transaction and recording them and then ends with the analysis of financial statements. The financial statements consist of the income statement and the balance sheet. It is a custom as well as practical to prepare the income statement before preparing the balance sheet,

  • The income statement provides required inputs for the preparation of the balance sheet and the statement of retained earnings.
  • The first critical piece of information for the users of accounting information is generally the net profit/loss, salary figures, amount of sales turnover, etc.

 

Should they match?

Another important observation is that the balance of the income statement and the balance sheet should not and will probably not match. The income statement balancing figure is either the net profit or the net loss. On the other hand, if the balance sheet is accurately prepared, the assets total will match the liabilities total.

  • The income statement contains all the revenue and expenditure figures of the business. These items are of recurring nature and relate to the current year while the balance sheet items are of a fixed nature. Both these statements use different items from the trial balance.
  • The income statement provides the net profit/loss figure for the statement of retained earnings. Retained earnings will then form part of ‘reserves and surplus’ in the balance sheet. Hence, the balance sheet will on one hand rely on the income statement for a lot of critical inputs. On the other hand, it will show the observable position of assets and liabilities with the business, that is completely unrelated to the income statement.

Therefore, these statements are very much linked and interdependent. But, they do not match.

 

Short Quiz for Self-Evaluation

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>Read Balance Sheet Accounts

 

 

What is the Difference Between Fixed Assets and Current Assets?

Ahuja Sahil
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Fixed Assets Vs Current Assets

Basis Fixed Assets Current Assets
Definition Fixed assets are assets that last for a long time and are acquired for continuous use by an entity. They are resources held for a short period of time and are mainly used for trading purposes.
Timeframe The assets of this type are held for a long period of time. (>1 year) The assets of this type are held for a short period of time. (<1 year)
Purpose The purpose to spend on fixed assets is to generate income over the long term. Their purpose is to manage day-to-day trading activities over the short term.
Valuation A fixed asset is valued by (the cost of the asset – depreciation). A current asset is valued as per its current market value or cost value, whichever is lower.
Funding Source Fixed assets are acquired with long-term funds. Current assets are acquired with short-term funds.
Sale At the time of sale, there is a capital gain or capital loss. At the time of sale, there is an operating gain or operating loss.
Collateral They can be used as collateral. They can not be used as collateral.

 

Fixed Assets

1. Also called long-term assets, fixed assets are held by a business with the intention of continuous use and not to be resold in a short period of time.

2. Fixed assets would usually last for more than a year or 1 complete accounting cycle of a business.

3. They are bought from long-term funds deployed within a business.

4. These assets are used to keep a business running and earn profits out of operations.

5. If and when required, fixed assets are not easy to convert into cash.

6. Examples of fixed assets include Machinery, Building, Furniture etc.

Related Topic – What is Chart of Accounts?

Difference between fixed assets and current assets

 

Current Assets

1. On the contrary, current assets are kept for resale, and can be converted into cash or an equivalent in a short period of time.

2. Current assets are likely to be realized within a year or 1 complete accounting cycle of a business.

3. They are bought out of short-term funds deployed within a business.

4. These are assets which are converted to cash or exhausted during the regular accounting cycle of a business.

5. Current assets are easy to liquidate as compared to fixed assets.

6. Examples of current assets include Cash in hand, Cash at the bank, Stock, Debtors etc.

 

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>Related Long Quiz for Practice Quiz 20 – Current Assets

>Related Long Quiz for Practice Quiz 35 – Fixed Assets

>Read Difference between Current Assets and Current Liabilities

 

What is the Difference Between Balance Sheet and Trial Balance?

Ahuja Sahil
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Balance Sheet Vs Trial Balance

Balance Sheet

1. It is a statement that shows a detailed listing of assets, liabilities, and capital demonstrating the financial condition of a company on a given date.

2. The purpose of preparing a balance sheet is to show the financial position of a business.

3. A balance sheet is mandatory to be prepared by law and to complete the accounting cycle.

4. Closing stock is shown on the balance sheet as an asset.

5. A balance sheet is mainly divided into two heads: Assets and Liabilities.

6. It accommodates only personal and real accounts, nominal accounts are not included.

7. A balance sheet can only be made when all accrual entries (prepaid and outstanding) have been adjusted.

Related Topic – What is Balance B\F and Balance C\F?

 

Trial Balance

1. It is a statement of debit and credit balances that are extracted from ledger accounts on a specific date.

2. The purpose of preparing a trial balance is to ascertain the accuracy of the books of accounts.

3. A trial balance is not mandatory to be prepared according to the law.

4. .Closing stock is not usually shown in the trial balance.

5. A trial balance is divided into two-column heads: Debit and Credit.

6. It accommodates all accounts: real, personal and nominal.

7. A trial balance can be prepared without making any adjustments.

The above-mentioned differences between Balance Sheet and Trial Balance are related to their purpose, format, content, stage in accounting, exceptions, etc.

 

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What is the Difference Between Journal and Ledger?

Ahuja Sahil
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Journal vs Ledger

During the accounting cycle, there are two important steps to be followed; recording journal entries & preparing ledger accounts. They are related, however, there is a difference between journal and ledger which can be summarized as follows;

 

Journal

1. Journal is a book of accounting where daily records of business transactions are first recorded in a chronological order i.e. in the order of dates.

2. It is known as the primary book of accounting or the book of original/first entry.

3. It is prepared out of transaction proofs such as vouchers, receipts, bills, etc.

4. A journal is not balanced like a ledger.

5. The procedure of recording in a journal is known as journalizing, which performed in the form of a Journal Entry.

6. It may be subdivided into a cash book, a sales day book, sales return day book, purchases day book, purchases return day book, B/R Book, B/P Book, Petty Cash Book.

7. The format of a journal;

Sample format of a journal

Related Topic – What is a Compound Journal Entry?

 

Ledger

1. A ledger is an accounting book in which all similar transactions related to a particular person or thing are maintained in a summarized form.

2. It is known as the principal book of accounting or the book of final entry.

3. It is prepared with the help of a journal itself, therefore, it is the immediate step after recording a journal.

4. Except for nominal accounts, all ledger accounts are balanced to find the net result.

5. The procedure of recording in a ledger is known as posting.

6. It may be sub-divided into general ledger, debtors/sales ledger, creditors/purchases ledger.

7. The format of a ledger account;

Sample format of a ledger

 

>Read How to Make a Trial Balance from Ledger Balances?

 

What is the Difference Between Trade Discount and Cash Discount?

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Trade Discount vs Cash Discount

Discounts play an important role in business transactions. They have has been part of business transactions since the beginning of time. Buyers offer discounts and sellers receive it, either implicitly or explicitly. The purpose of this article is to explain the difference between trade discount and cash discount in detail.

 

Trade Discount

1. Trade discount is a reduction granted by a supplier of goods/services on the list or catalogue prices of the goods supplied.

2. It is provided due to business considerations such as trade practices, large quantity orders, market competition, etc.

3. Trade discount is not separately shown in the books of accounts; all net amounts after discount are recorded in the subsidiary books of accounting.

4. It is allowed on both credit and cash transactions.

5. Trade discount is given on the basis of purchase.

6. There is no separate journal entry for trade discount allowed or received as it is not recognized as an expense for the business.

 

Example for Trade Discount

10 vehicles were purchased by Unreal Pvt Ltd with a 5% trade discount on the list price of 1,00,000 each.

Total List Price = 10 x 1,00,000 = 10,00,000

Total Discount = 5% of 10,00,000 = 50,000

Final Invoice Price after TD = 10,00,000 – 50,000 = 9,50,000

Related Topic – How to Show Trade Discount in Purchase Book?

 

Cash Discount

1. Cash discount is a deduction allowed by a supplier of goods or by a provider of services to the buyer from the invoice price.

2. It is provided as an incentive or a motivation in return for paying a bill within a specified time.

3. Cash discount is shown separately in the books It is shown as an expense in the Profit and Loss A/C.

4. It is only allowed on cash payments.

5. Cash discount is given on the basis of payment.

6. Journal entry for cash discount received by a business;

Journal entry for cash discount received

Also, journal entry for cash discount allowed by a business;

Journal entry for cash discount allowed

 

Example for Cash Discount

Let’s continue the example above for the trade discount. Assuming that the supplier, in addition, extended a cash discount of 2% 10 Net 30 days.

This means that if the buyer pays within 10 days of delivery, they can avail extra 2% discount on the invoice price.

So, Invoice Price = 9,50,000

2% of 9,50,000 = 19,000

Net amount to be paid within 10 days = 9,50,000 – 19,000 = 9,31,000

 

Difference in Table Format

Difference between trade discount and cash discount in table format

 

How to calculate a cash discount and trade discount?

Trade Discount

A trade discount is calculated on the list price itself before any transaction takes place. In other words, it will be calculated on the list price and then deducted from the same. Eventually, the remaining amount becomes the sale price or the invoice price for the items. The records will be kept on the basis of this final amount only.

It is usually unconditional and benefits all buyers. It may vary according to the quantity being purchased.

 

Cash Discount

A cash discount, on the other hand, is calculated on the invoice price of the items. Suppliers or wholesalers usually provide their buyers with a credit period. If the buyer makes a quick payment within the mentioned credit period, the seller offers an additional discount on the pre-decided invoice price (that may or may not be net of existing trade discount). This will be termed as a cash discount.

It works under certain conditions and is not available for all buyers. It may vary according to the time of payment.

 

Example

Z is a regular customer of ABC Ltd who is a wholesale dealer of television sets. Z wants to purchase some sets from ABC Ltd. Listed price of a television set is 11,000.

Following conditions are being specified:

  • ABC Ltd. offers to sell one television set for 10,000 if Z makes a purchase of at least 100 sets, which amounts to a trade discount of 9.09%.
  • Z agrees and places an order of 100 sets at a rate of 10,000 per set. ABC Ltd further specifies that the credit period provided is 15 days.
  • Payment within the credit period will benefit Z with an additional cash discount of 2%. Z makes the payment on the 10th day of the purchase.

Price of goods = 100 * 11,000 = 1,100,000

Less trade discount 9.09% = 100,000

Amount payable by Z = 1,000,000

When Z makes payment on the 10th day, he will have to pay only 980,000 (1,000,000 – 2% of 1,000,000).

 

Journal Entry

  • There is no journal entry for trade discount provided as in the above case. The discounted price of 1,000,000 becomes the sale price of the items.
  • The cash discount of 2% amounting to 20,000 will be an expense for the business and will be recorded in the books of accounts.
  • A cash discount is not mentioned in the catalogue and is provided over and above the trade discount. Hence, it is important to keep a track of such expenses in the books of accounts.

The final entry at the time of payment, in the books of ABC Ltd, will show the cash worth 980,000 as debit as this is the amount being received. The cash discount of 20,000 will also be a debit since it is an expense for the business. The total accounts receivable worth 1,000,000 will be credited as total assets (receivables) are being reduced.

A ledger account for “cash discount” will also be opened in the general ledger. This will further reflect in the income statement as an expense.

 

>Read Journal Entry for Cash Discount

 

 

How to Prepare a Trial Balance from Ledger Balances?

Ahuja Sahil
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Prepare Trial Balance from Ledger Balances

Preparing a trial balance from ledger balances is the next step of posting and balancing ledger accounts. The trial balance is a statement of debit and credit balances that are extracted from ledger accounts on a specific date.

The trial balance is prepared with two different techniques: Total Method and Balance Method.

According to the Total Method, the sum of debits and credits of every account is shown in the trial balance, i.e. both debit and credit totals are recorded in the trial balance. On the other hand, according to the Balance Method, only the Net balance which is the difference between credit and debit total is transferred and recorded.

Related Topic – What is Adjusted Trial Balance?

Prepare a trial balance as on 31st Dec 2013 by filling in the debit and credit columns accordingly for each ledger balance mentioned below.

 Account  Balance  Account  Balance
 Capital  70,000  Carriage Inwards  1500
 Opening Stock  20,000  Carriage Outwards  2000
 Salaries  10,000  Plant & Machinery  17,000
 Returns Inward  500  Investments  7000
 Returns Outward  6000  Sales  70,000
 Purchases  80,000  Patents  10,000
 Sales Ledger Control  7000  Furniture  8000
 Purchase Ledger Control  40,000  Discount Allowed  1000
 Cash in Hand  15,000  Misc. Receipts  4000
 Cash at Bank  11,000  Closing Stock   9000

 

Ans.

Trial Balance From the Above Ledger (31st Dec 2013)

 Particulars  Debit  Credit
 Capital    70,000
 Opening Stock  20,000  
 Salaries  10,000   
 Returns Inward  500  
 Returns Outward     6000
 Purchases  80,000  
 Sales Ledger Control  7000   
 Purchase Ledger Control    40,00 
 Cash in Hand  15,000  
 Cash at Bank  11,000   
 Carriage Inwards  1500   
 Carriage Outwards  2000   
 Plant & Machinery  17,000   
 Investments  7000  
 Sales    70,000
 Patents  10,000  
 Furniture  8000  
 Discount Allowed  1000   
 Misc. Receipts    4000
  
 Total  1,90,000  1,90,000

The way a balance is transferred to either debit or credit side of a trial balance depends on the nature of that account, below is the table showing the relationship between types of accounts and their usual balances.

 

 Type of Account  Usual balance
 Assets  Debit
 Liability  Credit
 Capital  Credit
 Revenue  Credit
 Expenses  Debit
   
 Drawings  Debit
 Contra Asset  Credit
 Contra Liability  Debit

 

 

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>Read What is a Contra Account?

 

Why is Depreciation Not Charged on Land?

Ahuja Sahil
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Charging Depreciation on Land

If you’re an accounting student or executive you might have been often asked: “Why is depreciation not charged on land?”. The reason why depreciation is not charged on land is that the useful life of land can’t be found. A necessity for an asset to be depreciated is that it needs to have an estimated useful life, which, in case of land, can’t be determined.

We can’t decide what the estimated life of land (in years) we live or work on is.

 

Example

To explain it more clearly, let us say a company, which is still operational today, acquired a piece of land in 1910.

The company built its HQ on the land in 1910, the building has been rebuilt and renovated many times since 1910, but the piece of land is still there and no one can say for how many more years it is going to exist (possibly, infinite).

So, just because there is no useful life of land there was no depreciation charged on that. In fact, with time the value of land must have appreciated.

 

Also, Let us look at the formula for calculating annual depreciation (SLM)

= (Cost of Fixed Asset – Scrap Value)/Useful Life of Fixed Asset

With no useful life or “infinite” useful life the above formula can’t be fulfilled, this is the reason why depreciation is not charged on land.

 

>Read Tips to Follow for Freshers Before an Accounting Interview

 

How to Calculate Depreciation Rate % From Depreciation Amount?

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Calculation of Depreciation Rate %

The reduction in value of an 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 and other assets which are expected to last more than one year but not for infinity are subject to depreciation.

Formula of Depreciation Rate

Annual Depreciation rate = (Cost of Asset – Net Scrap Value)/Useful Life

 

There are various methods to calculate depreciation, one of the most commonly used methods is the straight-line method, keeping this method in mind the above formula to calculate depreciation rate (annual) has been derived.

Related Topic – Why is Depreciation not Charged on Land?

Example

Cost of machine = 10,000, Scrap value of machine = 1,000

Machine’s estimated useful life = 5 years

Annual Depreciation = (Cost of Asset – Net Scrap Value)/Useful Life

Annual Depreciation = (10,000-1,000)/5

= 9,000/5

= 1,800/year (Annual Depreciation)

Rate % = Annual Depreciation/Cost of Asset

(Annual Depreciation in %ge) 1,800/10,000 = 18%

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 39 – Depreciation

>Read Journal Entry for Depreciation

 

What is Return Inwards?

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Return Inwards

Return inwards are goods returned to a business by its customer(s). They are goods which were once sold to external third parties, however, because of being unsatisfactory, they were returned by the customer. They are also called “Sales Returns”.

Inward returns reduce the total accounts receivable for the business. It is a sales return and on the other, it is a purchase return. The transaction in both cases is reversed and the related sale or purchase is nullified.

This reversal reduces the total sales of a company and the deduction is shown in the trading account. A subsidiary book called Sales returns book is prepared to record all such entries.

 

Journal Entry for Return Inwards

Return Inwards A/C Debit Debit the decrease in revenue
 To Customer’s A/C Credit Credit the decrease in assets

Return Inwards – This is a reduction in revenue for the business.

Customer – This is a reduction in receivables for the business.

 

Shown in Trading Account (Deducted from Sales)

Return Inwards or Sales Returns

Related Topic – What is Purchase Returns Book?

 

Example

Let’s suppose a customer “Star Pvt Ltd.” returned goods worth 5,000 to “Unreal Corp.”. The journal entry to record these sales returns in the books of Unreal Corp. will be as follows;

Return Inwards A/C 5,000
 To Star Pvt Ltd. A/C 5,000

 

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>Read Return Outwards

 

What is Days Sales Outstanding (DSO)?

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Meaning

Days sales outstanding or DSO is also known as days receivables, it measures the average number of days that a company takes to collect the payment after a credit sale has been recorded.

It is used for the estimation of the average collection period and helps to determine the efficiency with which the company’s accounts receivables are being managed.

Days sales outstanding or DSO is usually a monthly activity and it may fluctuate every month. This can be due to multiple business scenarios such as seasonality, change in business policies, economics, etc. It is useful to determine the liquidity, however, it is not one of the most accurate indicators.

 

Formula to Calculate Days Sales Outstanding (DSO)

Formula for Days Sales Outstanding DSO

HIGH DSO – The company is lenient with its credit terms and allows more days for its customers to pay for sales. It may also indicate;

  • Company’s customers have difficulty with repayment.
  • Inefficient collection exercises by the company.

LOW DSO – The company has strict control over its credit terms and takes fewer days to collect its receivables.

Related Topic – What are Different types of Purchase Orders?

 

Example

Below are the details of a trading business.

Average AR for April 60,000
Net credit sales for April 3,00,000
No. of days in the month 30
DSO (60,000/3,00,000)*30

Days Sales Outstanding = 6 Days

It means the number of days on average that customers take to pay back to this company are 6 days.

 

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What is the Journal Entry for Goods Given as Charity or Free Samples?

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Journal Entry for Goods Given as Charity or Distributed as Free Samples

Charity generally refers to the voluntary giving of help, typically in the form of money or goods to those in need. Goods given as free samples are however a way of advertising. Both acts when performed by a company are required to be recorded in the books of accounts.

Goods given to charity or goods distributed as free samples are not to be accounted for as sales. Instead, they are accounted for as expenses, simply because, in this case, the outflow of goods happen without any consideration.

 

Journal Entry for Goods Given as Charity

When accounting for goods given as charity, purchases are reduced with the exact cost of goods contributed.

Charity A/C Debit
 To Purchases A/C Credit

 

Example

A company, Unreal Pvt Ltd. gave goods to a charity which cost them 20,000. Journal entry for charity, in this case, will be posted as,

Charity A/C 20,000
 To Purchases A/C 20,000

 

Treatment of Charity in Final Accounts

  • The amount is reduced from purchases in the trading account.
  • It is shown as an expense on the debit side of the income statement.

Related Topic – What is the Journal Entry for Accrued Income?

 

Journal Entry for Goods Distributed as Free Samples

When accounting for goods distributed as free samples purchases are credited and the advertisement account is debited.

Advertisement A/C Debit
 To Purchases A/C Credit

 

Example

A company Unreal Pvt Ltd. distributed goods as free samples, which cost 15,000 to the company. Journal entry for goods distributed as free samples will be posted as,

Advertisement A/C 15,000
 To Purchases A/C 15,000

 

Treatment of Free samples in Financial Statements

  • The amount is deducted from purchases in the trading account.
  • It is shown as an expense on the debit side of the profit and loss account.

 

Short Quiz for Self-Evaluation

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>Read Top Finance and Accounting Interview Questions

 

What are Direct and Indirect Expenses?

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What are Direct and Indirect Expenses?
  1. Direct Expenses (Meaning & Definition)
    1. Examples
    2. Direct Expenses List (with PDF)
    3. Are Direct Expenses Operating Expenses?
    4. Direct Expenses in Trading Account
    5. Direct Expenses in Service Industry
  2. Indirect Expenses (Meaning & Definition)
    1. Examples
    2. Indirect Expenses List (with PDF)
    3. Are Indirect Expenses and Overheads the same?
    4. Indirect Expenses in Final Accounts
    5. Is Salary a Direct or Indirect Expense?
  3. Direct Expenses Vs Indirect Expenses (Table Format)
  4. Quiz
  5. Conclusion

 

Expenses are amounts paid for goods or services purchased. They can either be directly or indirectly related to the core business operations. The type of expense and timing at which it is incurred by the business frames the key points of difference between direct and indirect expenses.

Meaning & Definition of Direct Expenses

“Direct”, as the word suggests, are those expenses directly related and assigned to the primary business operations of a business. In general, they relate to the purchase and production of goods and services.

They are expenses associated with purchasing goods and delivering them to a business location.

Such expenses are a part of the prime cost or the cost of goods/services sold by a company. They are also called direct costs and are directly related to the production of the main revenue-generating product or service.

They may differ for different types of companies, such as manufacturing companies, construction companies, technology companies, etc.

Direct Expenses

Real-life Examples

  • Imagine that you own a restaurant. The money spent on ingredients, rent of the restaurant, the chef’s salary, utility bills, etc., are all direct expenses.
  • Imagine that you are a retailer. The money spent on buying products wholesale, travelling expenses to the wholesaler, fuel and gas, etc., will be the direct costs.
  • Suppose you own a salon. In this case, no product is sold since it is a business in the service industry. Money spent on shampoos, combs, dyes, conditioners, etc., would be directly attributable to costs.

 

Examples of Direct Expenses

  • Wages
  • Factory rent
  • Cost of raw material
  • Premises renting
  • Carriage inwards
  • Fuel, etc.

Related Topic – Capex and Opex (Capital Expenditure & Operating Expenditure)

 

Direct Expenses List (with PDF)

The main logic to categorising any expense as direct is to ask yourself, “is the cost directly linked and attributable to the primary income-generating product of the company?”. If the answer is “Yes”, then it is most likely a direct expense.

Our team researched and compiled a list of the most commonly seen direct expenses.

General

  1. Wages
  2. Freight Inwards
  3. Manufacturing Expenses
  4. Factory Lighting
  5. Factory Rent
  6. Factory Insurance
  7. Gas, Water and Fuel
  8. Cargo Expenses
  9. Import Duty
  10. Shipping Expenses
  11. Dock Dues
  12. Octroi
  13. Motive Power
  14. Clearing Charges
  15. Custom Charges
  16. Coal, Oil, and Grease
  17. Overhaul of Machinery
  18. Repairs of Machinery
  19. Upkeep and Maintenance
  20. Loading and Unloading

 

Service Industry

In the service industry, some commonly seen direct expenses are:

  1. Salaries to professionals who provide the services.
  2. Amounts paid to other freelancers and part-timers.
  3. Other costs of rendering services, e.g. Fuel & Gas, etc.

 

Construction Industry

In the construction industry, some commonly seen direct expenses are:

  1. Construction Material costs
  2. Labour costs
  3. Equipment
  4. Subcontracting fees

PDF Download – List of Direct Expenses

Related Topic – Is Depreciation an Operating Expense?

 

Are Direct Expenses Operating Expenses?

Direct expenses are not the same as operating expenses

Why?

Operating expenses are also known as operating costs, operating expenditures, etc. It is the cost that a business must incur on a day-to-day basis to function properly. Examples: Utility bills, marketing, office supplies, office rent, etc.

On the other hand, direct expenses are those that are incurred in order to manufacture or produce products/services that are then sold in the market to generate income. Examples: Factory rent, factory power, wages, etc.

Note the difference between the words “factory” and “office”.

  • In a factory, costs incurred are directly related to the production of the product or service (direct expense).
  • An office refers to a workplace that deals mainly with selling and administrative activities (operating expenses or indirect expenses)

Related Topic – Difference Between Loss and Expense

 

Direct Expenses in Trading Account

This heading will answer a frequently asked question related to the topic “where are direct expenses shown or entered?”

Direct expenses are shown on the debit side of a trading account because costs related to the production, procurement, buying and selling of goods/services should appear in this account.

Direct Expenses Shown in the Trading Account

This is where the initial gross profit or gross loss is determined.

Related Topic – What are Sundry Expenses?

 

Direct Expenses in the Service Industry

Intellectual skills, knowledge, expertise, and experience are among the few intangible items a business sells when running operating in the service industry. It does not involve a physical product. Examples: Accounting services, IT consulting, Hospitality, Payroll, Cleaning Business, etc.

Some service industry players need inventory, while others do not. Direct material costs consist of the parts and supplies you use, e.g. a cleaning company would use cleaning supplies, mops, brooms, etc. For such companies, these are direct expenses along with any other necessary costs associated with the action of providing services.

On the other hand, personal service companies such as an accounting firm (e.g. KPMG) may not require to spend anything as direct material costs. For such service,

  • A professional’s salary.
  • Money paid to freelancers & employees who work part-time.
  • Expenses directly associated with rendering services.

 

Cost of Services

Direct and Indirect costs can be declared on the income statement as expenditures since a personal service company does not hold inventory.

You can also use an independent “Cost of Sales A/c” to list the expenses on the profit and loss account. As an independent line item, each expense is reported separately.

Related Topic – Expense is Debit or Credit?

 

Meaning of Indirect Expenses

Unlike direct, indirect expenses are not directly related and assigned to the core business operations of a firm. They are also known as Opex or operating expenses.

Indirect expenses are necessary to keep the business up and running, but they can’t be directly related to the cost of the core revenue-generating products or services.

Just like direct expenses, indirect expenses can also be different for diverse organisations. These are usually shared costs among different departments/segments within the firm.

 

Examples of Indirect Expenses

  • Salaries
  • Telephone bills
  • Printing & Stationery
  • Legal & Accounting charges
  • Carriage outwards

Indirect Expenses

Related Topic – Profit and Loss Suspense Account

 

Indirect Expenses List (with PDF)

The main logic to categorising any expense as indirect is to ask yourself, “is the cost directly linked and attributable to the primary income-generating product of the company?”. If the answer is “No”, then it is most likely an indirect expense.

Our team researched and compiled a list of the most commonly seen indirect expenses.

  1. Office Rent, Rates & Taxes
  2. Salaries
  3. Legal Charges
  4. Audit Fees
  5. Advertisement Expenses
  6. Commission Paid
  7. Discount Allowed
  8. Depreciation
  9. Bank Charges
  10. Printing & Stationery
  11. Travelling Expenses
  12. Salesmen Salaries
  13. Warehouse Insurance
  14. Delivery Van Expenses
  15. Packing Charges
  16. Carriage Outwards
  17. Premises Rent (office-related)
  18. Brokerage Charges
  19. Postage & Cartage
  20. Selling Expenses
  21. Telephone Expenses
  22. Interest Payments
  23. Sundry Expenses
  24. Bad Debts
  25. Repairs & Renewals

PDF Download – List of Indirect Expenses

 

Are Indirect Expenses and Overheads the same?

As per Wikipedia, overhead or overhead expense “refers to an ongoing expense of operating a business. Overheads are the expenditure which cannot be conveniently traced to or identified with any particular revenue unit”.

Overhead expenses are crucial for business operations, but it is nearly impossible to directly associate them with products or services sold by the firm. They do not play a direct role in generating profits.

Yes, overheads and indirect expenses are mostly similar. However, some overhead costs (exceptions) can be directly related to a product, so a part of such costs may be direct.

For a deeper understanding of this topic, we recommend reading these two concepts on Wikipedia. Overhead Expense & Indirect Costs.

 

Indirect Expenses in Final Accounts

This heading will answer a frequently asked question related to the topic “where are indirect expenses shown or entered?”

Indirect expenses are shown on the debit side of an income statement this is because costs which are not directly related to the production, procurement, buying and selling of goods/services should appear in this account.

Indirect Expenses Shown in the Income Statement

It is here that the net profit and net loss are determined.

Related Topic – Paid Telephone Bill Journal Entry

 

Is Salary a Direct or Indirect Expense?

Employers pay salaries to their employees as compensation for the work they perform. If the salary expense can not be directly related to the production of products/services being offered by the company, then it is an indirect expense.

In most cases, salary is an indirect expense shown in the profit & loss account.

Another question asked often is, “Why are wages direct but salaries indirect expense?”

Wages, on the other hand, are payments made for a specific period of time. In the modern scenario, this can be related to freelancers and part-time workers.

Traditionally wages have always been categorized as direct expenses as it is assumed that they are related to the compensation made to the factory workers who help produce the primary selling item for the company.

In contrast, it is presumed that the money paid to other employees (not factory workers) is called salaries. This logic leads to wages becoming direct expenses, as opposed to salary expenses becoming indirect expenses.

Although the situation may be different in today’s world, direct and indirect expenses should be handled according to their respective rules regardless of the expense.

Related Topic – Journal Entry for Salary Due

 

Direct Vs Indirect Expenses in a Table Format

Direct Expenses Indirect Expenses
1. Expenses or direct costs incurred while manufacturing the main “product” or “service” of the company are termed direct expenses. 1. Expenses or indirect costs which are not directly related to the core “product” or “service” of the company are termed indirect expenses.
2. They become a part of the total cost of goods/services sold. 2. Indirect expenses are not included in the total cost of goods/services sold.
3. Shown on the debit side of a trading account. 3. Shown on the debit side of an income statement.
4. Direct expenses can be allocated to a specific product, department or segment. 4. Indirect expenses are usually shared among different products, departments and segments.
5. Examples – Direct labour (wages), cost of raw material, power, rent of factory, etc. 5. Examples – Printing cost, utility bills, legal & consultancy, postage, bad debts, etc.

Related Topic – Meaning of Write-off or Expense-off

 

Short Quiz for Self-Evaluation

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Conclusion

To understand and study direct expenses, it is important to study the company’s Trading Account. All the trading activities are recorded here. Therefore, it is the primary source for obtaining data related to the company’s essential buying and selling.

To understand and study indirect expenses, it is important to study the company’s Income Statement. All the operating activities of a company are recorded here. Therefore, it is the primary source of information for anything unrelated to the core revenue generation activities.

There is a clear difference between direct and indirect expenses. Other similar terms are:

  1. Fixed cost
  2. Variable cost
  3. Operating cost
  4. Non-operating costs
  5. COGS
  6. Extraordinary Expense
  7. Capital Expenditure, etc.

However, they may all be different when you deep-dive and understand them thoroughly.

 

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

>Read Receipt Vs Income Vs Payment Vs Expenditure

 

What is Accrued Income?

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Accrued Income

Also known as outstanding income, accrued income is the income which has been earned during a particular accounting period, however, the related funds have not been received until the end of that accounting period. So, it grows by addition and remains due to be received in the forthcoming accounting periods.

Examples include accrued interest on investment, accrued rent to be collected, commission earned but not received, etc. Accrued income is recorded in the books at the end of an accounting period to show the true numbers of a business.

Understand the word accrued as accumulation and addition of something.

Out of the three types of accounts in accounting, accrued income is a personal account and is shown on the asset side of a balance sheet.

Journal Entry for Accrued Income (or) Outstanding Income

Accrued Income A/C Debit
 To Income A/C Credit

 

Example

Let’s assume that in March there was an amount of 30,000 due to be received as interest on investment which isn’t received due to some reason. To record this in the financial statements for the period ending on March 31, the following journal entry is posted;

Accrued Interest A/C 30,000
 To Interest A/C 30,000

 

Revision and Highlights

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>Related Long Quiz for Practice Quiz 14 – Accrued Income

>Read Income Received in Advance

 

What are Outstanding Expenses?

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What are Outstanding Expenses?
  1. Meaning and Overview
  2. Examples
  3. Outstanding Expenses Journal Entry
    1. Journal entry for outstanding rent
    2. Journal entry for outstanding salary
    3. Journal entry for outstanding wages
    4. Journal entry for outstanding commission
  4. Outstanding Expenses are Asset or Liability?
  5. Where do Outstanding Expenses Appear?
  6. Outstanding Expenses in Trial Balance?
  7. Outstanding Expense is Which Type of Account?
  8. Treatment in Final Accounts
  9. Revision Video
    1. Quiz
  10. Conclusion

 

Meaning and Overview

Outstanding expenses are those expenses which have been incurred during the current accounting period and are due to be paid, however, the payment is not made. Such an item is to be treated as payable by the business.

Examples – Outstanding salary, outstanding rent, outstanding subscription, outstanding wages, etc. Outstanding expenses are recorded in books of finance at the end of an accounting period to show the true numbers of a business. They are also casually known as expenses due but not paid, unpaid expenses, arrears, overdue expenses, etc.

Outstanding Expenses Summary

Expenses are the amounts paid for goods or services purchased. The accrual concept of accounting records transactions in the books of accounts when they occur regardless of when the money is received or paid.

It is not always possible to make and receive payments immediately, they may be late or in advance. Outstanding expenses, prepaid expenses, accrued income & income received in advance are all a result of held-up payments and receipts.

Related Topic – Expense is Debit or Credit?

 

Examples

Company-A has a rent obligation of 10,000/month that is due every 10th of the month. On Dec 10th, the company failed to make this payment.

The amount not paid by Company-A on 10th Dec is termed as “Outstanding Rent” in the current year (a classic example of an outstanding expense).

Summary of outstanding expense
Outstanding Expenses in a Nutshell

At the end of the period, this “expense due but not paid” impacts the financials of the business. As per accrual accounting, it is supposed to be journalized.

Related Topic – Is Depreciation an Operating Expense?

 

Outstanding Expenses Journal Entry

In the event that a business fails to make a payment when it is due it becomes an outstanding expense and is treated as a liability.

Journal Entry for Outstanding Expense

Expense A/c Debit Debit the increase in expense
 To Outstanding Expense A/c Credit Credit the increase in liability

(Being expense not paid on the due date)

Related Topic – What is Adjusted Trial Balance?

 

Journal Entry for Outstanding Rent

Rent is a periodic payment made to cover the cost of occupying and using a property (land, building, etc.). The payments are made to the owner of the property. It is often paid monthly, or yearly.

In the context of outstanding rent, it refers to rent due for a period that has already passed.

Outstanding rent journal entry should be recorded as follows:

At the time when rent is due and not paid.

Rent Expense A/c Debit Debit the increase in expense
 To Outstanding Rent A/c Credit Credit the increase in rent liability

(Being unpaid rent recorded)

 

Journal Entry for Outstanding Salary

Paying employees a salary is a way for employers to compensate them for their work. Most of the time, it is paid monthly and includes some benefits.

It is called an outstanding salary when a payment is due to be made to an employee but he or she has already worked for that period.

Outstanding salary journal entry should be recorded as follows:

At the time when salary is due but not paid.

Salaries A/c Debit Debit the increase in expense
 To Outstanding Salaries A/c Credit Credit the increase in salaries liability

(Being unpaid salaries recorded)

 

Journal Entry for Outstanding Wages

There is a slight difference between wages and salaries. It is common practice to refer to part-time jobs, jobs with variable hours, and jobs with repetitive duties as wages instead of salaries.

Usually, wages are paid weekly, bi-weekly, or monthly. The most common difference between salary and wages is that salaries are fixed amounts, but wages are determined by the number of hours an employee works.

Outstanding wages journal entry should be recorded as follows:

At the time when wages are due but not paid.

Wages A/c Debit Debit the increase in expense
 To Outstanding Wages A/c Credit Credit the increase in wages liability

(Being unpaid wages recorded)

 

Journal Entry for Outstanding Commission

Commissions are designed to provide incentives and rewards to salespeople for promoting certain products, sales behaviour, or for simply increasing the sold quantities.

A commission payable in the current year that remains unpaid till the end of the year is an outstanding commission.

Outstanding commission payable journal entry should be recorded as follows:

At the time when a commission is owed but not paid.

Commission A/c Debit Debit the increase in expense
 To Outstanding Commission A/c Credit Credit the increase in liability

(Being unpaid commission recorded)

Related Topic – Journal Entry for Commission Received

 

Outstanding Expenses are Assets or Liability?

The term “liabilities” refers to money owed by companies or individuals. Money, goods, or services may be used in exchange to pay off liabilities over time. An expense that is unpaid after it is due is considered outstanding and it is treated as a liability (current) for the business.

Reason – The logic of why payment due for an expense is treated as a liability by the business is because the benefit in exchange for the payment is already received. It stays a liability till the time the actual expense owed is paid. It is the obligation and responsibility of the business to pay them off.

Such an expense has an expired value which means the benefit in exchange for the payment is expired.

 

Why is it considered a current liability?

Liabilities that are generally expected to be settled within the current accounting year (usually 12 months) are called current liabilities.

The expectation around an outstanding expense is to convert it from being a liability to realising it as an expense within a year.

It is typical for current liabilities to be settled with current assets such as cash. In this way, they contribute to the calculation of the current ratio and cash ratio.

Related Topic – Why is Income Received in Advance Treated as Current Liability?

 

Where do Outstanding Expenses Appear?

Outstanding expenses in balance sheet are viewed as a liability and shown on the balance sheet under the head “Current Liabilities”. Such entries help provide accurate accounting information to both internal and external users of accounting information as well as compliance with accounting laws.

It is shown as a current liability until it is fully paid, after which it is removed from the balance sheet and no longer shown.

Outstanding expenses appear in the balance sheet

  • Expense not paid is an obligation for the business that shows up on the balance sheet to ensure liabilities are not understated.
  • It is shown as a current liability because the assumption is that the delayed payment will be settled within one accounting year.

 

Outstanding Expenses in Trial Balance

If outstanding expenses appear inside the trial balance

In such a scenario it implies that the adjusting entry has already been posted. In this case, it is only shown in the balance sheet as a “current liability” and no adjustment is required in the income statement.

For example, if outstanding wages are shown in the trial balance, they will be recorded on the liabilities section of the Balance Sheet (only). Accounts that appear in the trial balance are only shown in one place in the final accounts/financial statements.

Outstanding expense shown in trial balance

 

If outstanding expenses appear outside the trial balance

In case it appears outside the trial balance then it is considered an adjustment in the final accounts and adjusted both in the income statement and the balance sheet. (two adjustments)

Trading & Income Statement – Show as an addition to respective indirect expense

Balance Sheet – Show under “Current Liabilities” on the balance sheet

Related Topic – List of Debit and Credit Items in Trial Balance

 

Outstanding Expenses is Which Type of Account?

The outstanding expense is a personal account and is treated as a liability for the business. It is also shown on the liability side of a balance sheet.

Due to its indirect link to a person or group, it makes sense to call it a representative personal account. As per the rules of debit and credit, it follows the rule of Dr. the receiver and Cr. the giver.

However, as per modern accounting rules, it is a liability and follows the rule of Cr. the increase and Dr. the decrease.

 

Treatment in Final Accounts

Treatment of Outstanding Expenses in Financial Statements/Final Accounts

  • Trading & Profit and Loss A/c  Show on the Dr. side (add to respective direct or indirect expense)
  • Balance Sheet: Show on the “Liabilities” side (under the head “Current Liabilities”)

 

Example

In the year, a company paid Rs 10,000 in salaries and estimated the outstanding salaries to be Rs 2,000. Adjust outstanding expenses in final accounts at the end of the period.

Adjustment of Outstanding Expense in Final Accounts

 

Revision and Highlights

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Conclusion

A similar concept is accrued expense, which can be used interchangeably but it differs slightly from outstanding expense. Both of them differ in the following ways:

Business expenses that have been incurred but are not due to be paid yet are known as accrued expenses. No matter when the payment is made, this type of expense is recorded in the books of accounts when it is incurred.

However, the term outstanding expense refers to an expense that has been incurred and is already past due.

It is uncommon to see frequent overdue payments as it impacts a buyer’s ability to purchase raw materials on credit and any delayed payment is seen as a doubtful debt which is different from bad debts.

What may happen if outstanding expenses are not recorded?

  • There will be an understatement of liabilities.
  • There will be an overstatement of profits.
  • As a result, there is a risk that the financial statements will be incorrect.
  • The company may have to face legal issues as a consequence of this.

 

>Related Long Quiz for Practice Quiz 34 – Outstanding Expenses

>Read Bad Debts

 

What is the Difference Between Gross Profit and Net Profit?

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Gross Profit Vs Net Profit

Profit is the friendliest term to the owner(s) of a business, however, during the life-cycle of a business, the term “profit” is divided into different sections in order to find out the exact sources where the benefit is derived from.

Gross Profit

The word Gross means “before any deductions”. This implies that the profit before any deductions is called the Gross profit. It is also called “Sales Profit“.

It is the difference between total revenue earned from selling products/services and the total cost of goods/services sold. (Depending on if the company is selling goods or services)

Gross Profit = Net Sales – Cost Of Goods Sold

GP = Net Sales – COGS

Gross Profit can be found on a company’s trading account.

 

Example

Net Sales = 1,50,000

Opening Stock = 10,000, Purchases = 1,00,000, Closing Stock = 20,000

GP = Net Sales – COGS (OS +P – CS)

GP =  1,50,0000 – (10,000 + 1,00,000 – 20,000) = 60,000

Related Topic – Difference Between Net Profit and Operating Profit

 

Net Profit

The word Net means “after all deductions”. This implies that profit after all deductions is called Net Profit. It is also called “Net Income” & “Net Earnings”. It is the difference between ‘total revenue earned’ and ‘total cost incurred’.

Deductions include adjustments related to the cost of doing business such as taxes, depreciation or other miscellaneous expenses.

Net Profit = Total Revenue – Total Cost

Net Profit = Gross Profit – (Total Expenses for Operations, Interests & Taxes)

Net profit can be found on a company’s income statement.

 

Example

Let’s assume that

Total Operating + Non-Operating Revenues & Gains  = 60,000

Total Operating + Non-Operating Expenses & Losses = 40,000

Net Profit = Total Revenues – Total Costs

NP = 60,000 – 40,000 = 20,000

 

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>Read Difference Between Current Assets and Liquid Assets

 

What is SOX?

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SOX or Sarbanes Oxley Act

The SOX act refers to a United States federal law that came into existence in 2002. It has set standards which are expected to be followed in corporate governance, financial reporting and auditing for all publicly listed companies under the SEC (Securities and Exchange Commission). The law was passed as a reaction to corporate governance failures and high-profile scandals. The SOX helps protect and safeguard the investors. The U.S. Securities and Exchange Commission is required to enforce the rulings on the listed companies.

Few infamous scandals which lead to forced government intervention included companies like Enron, WorldCom, Adelphia, etc.

 

The SOX is also called “Public Company Accounting Reform and Investor Protection Act” and “Corporate and Auditing Accountability and Responsibility Act”. The act has 11 sections which include guidelines from having independent auditors to the accountability of individuals in case of a corporate fraud.

 

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>Read Control Accounts

 

What is Control Account?

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Control Account

An account which has a balance equal to the total of its underlying subsidiary ledger accounts is called a Control Account. These are accounts shown in the general ledger and they serve the purpose of checking if the total in the general ledger is equal to the total of its associated subledgers.

It is a summarized form of all related subledger accounts.

 

Example

Subledger 1 + Subledger 2 + Subledger 3 + …  = Control A/C

In below image, rectangle shows General Ledger, the two big circles are control accounts and the smaller circles depict its respective subledgers, the aggregate of all subledgers is equal to the net amount of its respective control account.

Assuming balances, S1 = 2,00,000, S2 = 3,00,000, S3 = 5,00,000

S1 + S2 + S3 = 10,00,000 (To be shown in GL)

 

Control Account example

 

What is the Use of a Control Account?

  • It helps to check accuracy between the total of all subledger accounts and its related account in General Ledger.
  • It helps to keep the General Ledger free from all redundant information required to prepare financial statements of a business. For example, if we talk about a sales ledger control account, a company can have hundreds and thousands of debtors, hence it will not be practical to have all of them listed in GL.

 

>Read Types of Ledger Accounts

 

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