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What is Provision for Doubtful Debts?

Ahuja Sahil
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Meaning and Example

Doubtful debts, as the name suggests, are those receivables which might become bad debts at some point in future. In other words, they are doubtful in recovery.

By analyzing the past trend, a business can ascertain the approximate percentage that becomes uncollectible every year out of the total credit allowed to buyers. This amount, thus estimated, is kept aside from the profits. This provision, made out of profits, is called Provision for Doubtful Debts.

 

Journal Entry to Create Provision for Doubtful Debts

Profit & Loss A/C Debit
To Provision for Doubtful Debts Credit

It is charged against the current year’s profits.

Provision for doubtful debts acts as a liability for the business and is shown on the liability side of a balance sheet. Every year the amount gets changed due to the provision made in the current year. Bad debts for the current year are to be set off, and an additional amount of provision is to be added.

When certain bad debts are to be written off and a provision for doubtful debts is to be made, the amount should be first debited against the existing balance of provision and the remaining balance in the account should be brought up to the required figure.

This can be easily understood as;

The calculation in the case where bad debts occurring in the following year have to be adjusted and an additional amount of provision is to be made, the calculation should be done in the following sequence:

=Bad debts (Add) New provision (Less) Old Provision

 

>Read Provision for Discount on Debtors

 

What is Income Received in Advance?

Ahuja Sahil
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Income Received in Advance

Sometimes earned revenue that belongs to a future accounting period is received in the current accounting period, such income is considered as income received in advance. It is also known as Unearned Revenue, Unearned Income, Income Received but not Earned because it is received before the related benefits are provided.

This revenue is not related to the current accounting period, for example, Rent received in advance, Commission received in advance, etc.

It is a personal account and is shown on the liability side of a balance sheet.

 

Journal Entry for Income Received in Advance

Income A/C Debit
 To Income Received in Advance A/C Credit

Example

In March 10,000 were received in advance for rent which belonged to the month of April. The journal entry to record this in the current accounting period (31st March) will be as follows:

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

 

Treatment in the Financial Statements

Following is how income received in advance is treated in the final accounts and how it is shown in both the Profit and Loss Account and the balance sheet.

  1. Reduction from the concerned income on the credit side of the income statement.
  2. Show as a liability in the balance sheet under the head “Current Liabilities“.

Treatment of income received in advance in the books

 

Revision and Highlights

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

>Read Accrued Income

 

What is a Profit Center?

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Profit Center

Profit Center is a section of a company that is treated as a separate sub-business within a company to which revenues can be traced. It directly adds to the profits of the company, hence it is responsible for its own costs and revenues.

Each profit centre or a few are managed by profit centre managers who are responsible for their own centers. This helps organizations to compare different profit centers and determine which ones need more attention and are earning fewer profits, etc.

Profit centers may be divisions, subsidiaries or departments. Results of profit centers are generally included in externally reported segment results.

 

Example

Asset management department (for an asset management company), Sales department, Advice & Wealth Management (for a wealth management company) etc.

Profit center example

Total of AWM will be total of all it sub profit centers

Profit Center and Cost Center

A profit center is that part of the activity of a business that is considered responsible for earning revenue and incurring expenses and also establishes the profit of a particular segment of activity. Profit centers are maintained to measure the performance of each individual to whom the responsibility was delegated.

A cost center is the smallest unit in an operational organization for which distinct cost collection and analysis is attempted. A cost center can be defined as an observable unit in a big organization, that is established for the convenience of cost detection.

 

Difference in Table Format

Difference between profit center and cost center table format

 

Why is the Profit Center important?

Managerial accounting mainly focuses on identifying the sources of profits in a business. This leads to accumulating the revenue generated and the expenses incurred in respect of these sources of profit.

  • Most organizations depend on the traditional income statement that shows the overall profit and cost for the whole business. The real problems and opportunities can be explored only with granular information.
  • Profit centers can help a business earn a superior return on its investments given the utilization of its limited resources in comparison with alternative opportunities available to it, with help of profit comparison.
  • Many businesses try to capture new markets by pricing their products and services too low. Price is very crucial in the absence of value. Charging prices below the required profit renders the business unsustainable. Hence, a grasp on expected profit levels is very much required.
  • Profit centers promote healthy competition among different units of the same business. The aim is to allow a microscopic view of the observable units of the business to establish how each of these units is performing financially, in terms of profitability.
  • Profit centers increase the profit consciousness of the business leading to overall enhanced profitability of the organization.

 

Problems with Profit Centers

There are reasons for a business to establish profit centers but, the process may lead to some difficulties also:

  • Profit Centers can lead to decentralization. But, decentralized decision making may force the top management to rely further upon the mid-management reports. This leads to a loss of control.
  • Divisionalization can lead to additional costs because of the additional required management controls, staff, and record-keeping resources.
  • An excess of Profit consciousness may result in overemphasis on short-run profitability at the expense of long-run sustainable growth.
  • There is no completely functional system in place yet, to ensure that divisional profit will contribute to the overall organizational growth or not.
  • There has to be a check on the level and nature of competition budding among different profit centers of the same business.

 

 

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> ReadCost Centerand Service Center

 

What is Cost Center?

Ahuja Sahil
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Definition of Cost Center

A function or department in the organization that does not directly add to the profit, but costs the organization money to operate is known as a cost center. The cost center indirectly adds to the profitability of the business.

The cost center operates on a budget decided by the organization. By showcasing operational excellence, the cost centers manage to keep a check on the costs incurred by them and stick to the budgetary restrictions.

The cost centers do not involve themselves in the investment or revenue decisions of an organization. Their main function is to track expenses. This allows for more accurate budgets and forecasts. The data that they provide is basically for internal reporting. The management can use the data provided by cost centers to improve operational efficiency and maximize profits.

Some cost centers observed in organizations are:

  • Accounting Department
  • IT Department
  • HR Department
  • Quality Control Department (in case of manufacturing units)
  • Maintenance Staff

 

Example

Human Resources department, Finance department, etc.

Example showing cost center
The total of HR will be the total of all its sub cost centers.

Similarly, for the Research & Development department, it incurs lots of costs in its endeavor to come up with new products for the company, though it is difficult to say how much profit it generates for the company. The sum of Research, Planning, and Implementation of new plans will be the total for this department.

Uses

  • A cost center is used to track expenditure for a specific function.  Without creating such a cost center, it would take immense effort to measure the cost of supplying this service exactly. It would require breaking up of all expenditures of the business department wise, which is a very tedious task.
  • It is also used to allocate resources to the most profitable activities as this requires to track costs for all activities undertaken.

 

Cost Unit and Cost Center

Cost Unit

It is a representing unit of product, service, or time (can be a combination of these) in respect to which costs may be ascertained, collected, or expressed. For instance, a business may like to determine the cost per tonne of steel, per tonne-kilometre of a transport service, or cost per machine hour.

  • A single contract/project can also be a cost unit
  • A batch/group of identical items that maintains its identity through one or more stages of production can also be a cost unit
  • Cost units are usually units of physical measurement such as area, volume, weight, value, number, or time

 

Example

A brick-making company ascertains its cost per 1,000 bricks.

An electricity production company measures its cost per kilowatt-hour(kwh).

A hospitality business determines its cost of maintenance per room.

A transport business ascertains its cost incurred per passenger kilometre.

These are the cost units for the above-mentioned businesses and include parameters of physical measurement.

 

Differences

Sometimes, cost center and cost unit act as one, but they have clear distinguishable characteristics:

difference between cost center and cost unit in table format

 

Types of Cost Centers

Following is the broad classification of cost centers, observed in an organization:

  • Personal CC

A personal cost center refers to a person or a group of people. For example, a sales manager, a workforce manager, etc.

  • Impersonal CC

The impersonal cost center refers to a location, equipment, a group of these, or both. For example, the London branch, boiling house, cooling tower, the generator set, etc.

  • Production CC

A production cost center is associated with a product or manufacturing work. It is a cost center where the raw material is handled for conversion into finished products. Here both direct and indirect expenses are incurred. For example, machine shops, welding shops, and assembly shops, etc.

  • Service CC

A service cost center involves providing services to the production department. It serves as an ancillary unit to a production cost center. For example, payroll processing department, powerhouse, service centers, plant maintenance centers, etc.

 

Short Quiz for Self-Evaluation

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> Read Service Center and Profit Center

 

What is the Difference Between Net Profit and Operating Profit?

Ahuja Sahil
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Net Profit VS Operating Profit

The term “profit” is divided into different types according to the source of benefit and the stage at which it is calculated during the life cycle of a business. This article illustrates the difference between net profit and operating profit.

Some of the most common forms of profit that can be found in financial statements are gross profit, net profit, operating profit, etc. All of them are calculated for different reasons, and each plays a diverse role in their journey through the accounting cycle.

 

Net Profit

The word Net means “after all deductions”. Accordingly, the profit earned after all deductions is called Net Profit. It is also called Net Income or 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 and other miscellaneous expenses.

Net Profit = Total Revenue – Total Cost

Net Profit = Gross Profit – (Total expenses from operations, interests and taxes)

Net profit can be found on a company’s income statement & it is further transferred to the organization’s balance sheet. (Add to capital)

Net profit shown in the financial statements
Net Profit Shown on the Income Statement

Related Topic – Difference Between Revenue and Profit

 

Operating Profit

Profit earned from a firm’s core business operations is called Operating Profit. So a shoe company’s operating profit will be the profit earned only from selling shoes. Operating profit doesn’t include any profits earned from investments and interests. It is also known as Operating Income, PBIT and EBIT (Earnings before Interest and Taxes).

It is the excess of Gross Profit over Operating Expenses.

Operating Profit = Gross Profit – Operating Expenses

Operating Profit = Net Profit – Non-Operating Expenses – Non-Operating Income

 

Example of Net Profit vs Operating Profit

Calculate both operating and net profit from the below information.

ParticularsAmtParticularsAmt
Gross Profit2,00,000Interest on Loans35,000
Carriage Outwards15,000Interest on Investments10,000
Advertising17,000Printing and Stationery3,000
Salaries40,000Loss on Sale of Furniture9,000
Rent37,000General Expenses10,000
Lighting11,000Donation4,000

Solution:

Add Gross Profit 2,00,000
Operating Profit = Gross Profit – Operating Expenses­
Less Carriage Outwards (15,000)
Less Advertising (17,000)
Less Salaries (40,000)
Less Rent (37,000)
Less Lighting (11,000)
Less Printing and Stationery (3,000)
Less General Expenses (10,000)
Operating Expenses (1,33,000)
2,00,000 – 1,33,000
Operating Profit 67,000

Related Topic – Journal Entry for Profit on Sale of Fixed Assets

 

Total Revenue (Operating + Non-Operating Income)
Add Gross Profit 2,00,000
Add Interest on Investments 10,000
Total Revenue 2,10,000
Net Profit = Total Revenue – Total Cost
Total Cost (Operating + Non-Operating Expenses)
Less Operating Expenses  (1,33,000)
Less Non-Operating Expenses
Interest on Loans (35,000)
Loss on Sale of Furniture (9,000)
Donation (4,000)
Total Cost (1,81,000)
2,10,000 – 1,81,000
Net Profit 29,000

One of the main points of difference between net profit and operating profit is that net profit takes into account earnings from all sources & all sorts of deductions. In contrast, operating profit only considers profits earned from operations.

 

The difference in Table Format

Difference between operating profit and net profit table format

A few more differences are;

  • Net profit is often used by investors and analysts to evaluate a company’s overall financial performance.
  • Operating profit is often used by managers to identify areas for improvement in a company’s operations.
  • Net profit is affected by a company’s financial decisions, such as borrowing money or paying dividends.
  • Operating profit is not affected by these financial decisions.

 

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What is the Difference between Gross Profit and Operating Profit?

Ahuja Sahil
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Gross Profit Vs Operating Profit

Gross Profit

The word Gross means “before any deductions”. This implies that profit before any deductions is called Gross profit. It is also called “Sales Profit”. Difference between gross profit and operating profit can be understood from their point of origin, deductions (if any), etc.

It is the difference between total revenue earned from selling products/services and total cost of goods/services sold.

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

 

Operating Profit

The profit earned from a firm’s core business operations is called Operating profit. So, a shoe company’s operating profit will be the profit earned from only selling shoes. 

The Operating profit doesn’t include any profits earned from investments and interests. It is also known as “Operating Income”, “PBIT” (Profit before Interest and Taxes) and “EBIT” (Earnings before Interest and Taxes).

It is the excess of Gross Profit over Operating Expenses.

Operating Profit = Gross Profit – Operating Expenses

Operating Profit = Net Profit – Non-Operating Expenses – Non-Operating Income

 

Example

Gross profit from operations of a shoe company = 20,00,000

Profit from investment = 1,00,000

Operating Expenses for Selling Shoes = 10,00,000

Operating Profit = 20,00,000 – 10,00,000 = 10,00,000.

*Any other profit earned from different sources, except operations of the business, will not be included to calculate the operating profit. 

One of the main points of difference between gross profit and operating profit is that gross profit takes into account earnings from all sources whereas operating profit only considers profits earned from operations.

 

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>Read Difference between Revenue and Profit

 

What is the Difference Between Cost and Management Accounting?

Ahuja Sahil
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Cost Accounting Vs Management Accounting

The difference between cost and management accounting is very important to understand as both of them serve different purposes and different audiences.

A person from the cost accounting team may not find a piece of information relevant, but a management accountant may not be able to work without it. A cost accountant and a manager would need different sets of information from the accounting records of a business.

 

Cost Accounting

It is the branch of accounting which is mainly concerned with “Cost aspect of accounting”. Cost accounting intends to capture and competently manage a company’s costs of production by examining and evaluating various alternative courses of action.

  • The main goal of cost accounting is to find out the cost of production or services rendered and use this information to evaluate the profitability and efficiency of business operations. The most appropriate course of action is sought based on ability and cost-efficiency.
  • It considers both past and present numbers in the process of evaluation.
  • Example: Let’s assume that an FMCG company has decided to introduce a new product in their range, they will need cost accounting information, such as the cost of production per unit, to price the product correctly in the market.

 

Management Accounting

  • It helps in effective performance management, control, planning, decision-making, etc. It generally includes budgeting decisions as well. Since management accounting is not a legal requirement, it is not based on Generally Accepted Accounting Principles and accounting standards.
  • It is the branch of accounting, which is mainly concerned with “Internal users of information”, commonly –  the managers. Management accounting provides a basis to the internal users to make a logical and informed decision.
  • It focuses mainly on the future and concerned with future projections.
  • Example: Let’s assume that a Sr. Manager wants to make an internal decision on an investment made in a particular business segment. It will need internal management accounting data such as the return on investment, etc.

 

The above mentioned are a few key points of difference between the cost accounting and the management accounting.

 

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

 

What is the Difference Between Financial Accounting and Cost Accounting?

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Financial Accounting VS Cost Accounting

The difference between financial accounting and cost accounting is very important to understand as both of them serve different purpose and audience.

A person from the management may not find certain information relevant, and at the same time, a cost accountant can’t work without this information. A creditor and a cost accountant would need different sets of information from the accounting records of a business.

 

Financial Accounting

  • It is a branch of accounting, which deals with classifying, measuring and recording a business transaction. Financial accounting is concerned with the preparation of financial statements for the purpose of demonstrating the performance and position of a business. The end products are P&L Account for the period end and Balance Sheet as on the last day of the accounting period.
  • It is mainly concerned with the “External users of information” such as Shareholders, Government, Lenders, Public and other users of accounting information.
  • It focuses on the history and historical records.
  • Example: Suppose a Bank wants to decide whether to extend credit to a firm. It will need to look into the business’ financial accounting data such as financial statements.

Related Topic – Difference Between Financial and Management Accounting

 

Cost Accounting

  • It is the branch of accounting, which is mainly concerned with “Cost aspect of accounting”. Cost accounting intends to capture and competently manage a company’s cost of production by examining and evaluating various alternative courses of action.
  • The main goal of cost accounting is to find out the cost of products or services rendered and use this information to evaluate the profitability and efficiency of business operations. The most appropriate course of action is developed based on ability and cost-efficiency.
  • It considers both past and present numbers during the evaluation process.
  • Example: Let’s say that an FMCG company has decided to introduce a new product in their range; they will need cost accounting information such as the cost of production per unit, etc. to price the product correctly in the market.

 

The above information presents a few key points of difference between financial accounting and cost accounting.

 

Short Quiz for Sef-Evaluation

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>Read Bookkeeping Vs Accounting

 

What is a Credit Note?

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Credit Note

When a customer returns goods purchased on credit he/she also expects some form of confirmation from the seller along with the cancellation of related dues. A credit note is a document sent by a seller to the buyer as a notification to acknowledge that the goods have been registered as “returned” (return inwards) and a credit has been provided to them for the eligible amount.

In other words, it is a commercial document issued by a seller to the buyer. It acts as evidence of sales returns and a reduction of the amount owed by the buyer for an invoice raised earlier. A credit note is also called a “credit memo”.

It reduces the amount due to be paid by the customer, if the amount due is nil then it allows further purchases in lieu of the credit note itself.

A credit note is issued for the value of goods returned by the customer, it may be less than or equal to the total amount of the order.

Example of Credit Note

Company B purchases goods worth 1,00,000 from Amazon in a (business to business) transaction, however, 10,000 worth of goods were found damaged due to some reason & this was notified to Amazon at the time of actual delivery.

Amazon (seller) issues a credit note for 10,000 in the name of Company-B (buyer). This reduces the accounts receivable for Amazon by 10,000 and the buyer is only required to pay 90,000.

Who issues a credit note

 

Important Characteristics

1. It is sent to inform about the credit made in the account of the buyer along with the reasons.

2. The sales return book is updated on its basis. (In case of return of goods)

3. Usual reasons range from goods found incomplete, damaged, inaccurate goods sent, etc.

4. It shows a negative amount.

Related Topic  – What is the difference between credit and debit note?

Journal Entry for Credit Note

In the books of the buyer

Goods returned are purchase returns for the buyer, this action leads to the following;

  1. A decrease in liability to pay the respective creditor.
  2. A decrease in expense previously incurred to purchase goods.
Creditor’s A/C Debit
 To Purchase Return A/C  Credit

 

Logic - Journal Entry for Credit Note in the books of buyer

 

In the books of seller

Goods received as returned are sales return for the seller, this action leads to the following;

  1. A decrease in revenue previously booked as sales.
  2. A decrease in assets as money will not be received from the debtor anymore.
Sales Return A/C Debit
 To Debtor’s A/C Credit

 

Logic - Journal Entry for Credit Note in the books of Seller

 

Sample Credit Note Template

Template for Credit Note

 

Revision and Highlights

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

 

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>Related Long Quiz for Practice Quiz 19 – Credit Note

>Read Debit Note

 

What is Days Payable Outstanding (DPO)?

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Days Payable Outstanding (DPO)

Days payable outstanding or DPO is the average number of days that a company takes to pay its outstanding suppliers after a credit purchase has been recorded.

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

Days payable outstanding or DPO 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 for preserving working capital, however, while preserving the working capital a company also needs to ensure that all payments to its suppliers are done within the due date. Monitoring the DPO enables the management to ensure that cash is utilized optimally and the payment terms with creditors are maintained.

 

Formula to Calculate Days Payable Outstanding (DPO)

Formula for Days Payable Outstanding DPO
DPO can be expressed in either way

LOW DPO – The company is taking less number of days to pay back to its suppliers. This is usually a sign of good financial health.

HIGH DPO – The company is taking more number of days to pay back to its suppliers. This may be done temporarily as a strategic decision or it may be a result of week liquidity of the company.

Related Topic – What is Purchase Book (with Template)?

Example

Below are the details of a trading business.

Average AP for April 25,000
Cost of Goods Sold in April 2,50,000
No. of days in the month 30
DPO (25,000/2,50,000)*30

Days Payable Outstanding = 3 Days

It means the average number of days that the company takes to pay its invoices is 3 days.

 

Short Quiz for Self-Evaluation

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>Read Days Sales Outstanding

 

What is Capital?

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Capital

In its simplest form, capital means the funds brought in to start a business by the owner(s) of a company. It is an investment by the proprietor(s) or partner(s) in the business. Bringing equity into a business can mean money or assets as well. It is business’ liability towards the owner(s) also referred to as one of the internal liabilities of the business. It is also called Net Worth or Owner’s Equity.

Examples include vehicles, patents, buildings, etc.

  • It can increase with fresh investments or profits earned by the business.
  • It can decrease with drawings made by the owner(s) or losses incurred by the business.

 

What Type of an Account is Capital and Where is it Shown in Financial Statements?

It is a liability for the business and, according to the traditional classification of accounts, it is a Personal A/C. Capital is shown on the “Liability” (left hand) side of a balance sheet.

 

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>Read Accounting Acronyms

 

What is a Service Center?

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Service Center

A service center is an organizational unit which provides services to other departments within an organization. Its main task is to serve other departments within the organization, such as other service centers, cost centers and profit centers. A service center can be further divided into sub service centers.

 

Example

Technology department, Real Estate department, etc.

Example showing service center
Total of Technology will be total of all its sub service centers

>Read Cost Center and Profit Center

 

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

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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?

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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

 

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What is the Journal Entry for Income Received in Advance?

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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

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What is the Journal Entry for Accrued Income?

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

 

What is the Journal Entry for Prepaid Expenses?

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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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What is the Journal Entry for Outstanding Expenses?

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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?

 

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What is the Difference Between Debit Note and Credit Note?

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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?

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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.

 

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What is the Difference Between Fixed Assets and Current Assets?

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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.

 

Short Quiz for Self-Evaluation

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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.

 

Short Quiz for Self-Evaluation

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>Read Final Accounts

 

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?

Ahuja Sahil
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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

 

 

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