Accounting involves the creation, management, summation & communication of day-to-day transactions of a business ultimately leading to the preparation of financial statements.
On the other hand, finance has a wider scope and is mainly responsible to support in decision-making such as investment, divestment, cash management, Working capital management etc.
Difference between finance and accounting (table format)
Finance
Accounting
1. Finance is a branch of economics which deals with the efficient management of assets and liabilities.
1. Accounting is the occupation of summarizing financial transactions which were classified in the ledger account as a part of book-keeping.
2. It is a pre-mortem study of the organization’s funds or asset requirements.
2. It is a postmortem task of the recording of what has actually happened.
3. The aim of finance includes decision-making, strategy, managing & controlling.
3. The aim of accounting is to collect and present financial information for both internal and external purposes.
4. Determination of funds is based on a cash flow system, actual receipts and payments are recognized for revenue and payments.
4. Determination of funds is based on the accrual system, i.e. revenue is acknowledged at the point of sale and not when it is collected. Expenses are also recognized when they are incurred.
5. Few tools of finance include Ratio analysis, Risk management, Returns on investment, etc.
5. Few tools of accounting include Trading account, P&L account, Balance sheet, Cash flow statement, etc.
Finance and Accounting are both distinct, but complementary to each other.
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In the dual entry accounting system, a contra entry is an entry which is recorded to reverse or offset an entry on the other side of an account. If a debit entry is recorded in an account, it will be recorded on the credit side and vice-versa.
Debit and credit aspects of a single transaction are entered in the same account but in different columns. Each entry, in this case, is viewed as a contra entry of the other. Remember the word contra as “Against” or “Opposite”.
Examples of Contra Entry
1. Cash 50,000 withdrawn for an official purpose from the bank. Journal entry for this transaction will be
Cash A/C
50,000
To Bank A/C
50,000
In the above example, both entries, debit, and credit, are a contra entry of each other, they both offset each other. The narration is not required for such an entry and only a “C” is written in the left column which depicts that it is a contra entry.
2. Cash 10,000 received from a debtor is deposited into the bank
Bank A/C
10,000
To Cash A/C
10,000
The above amount is recorded in the bank column (debit) side of the double column cash book.
A contra entry is also used in the Intercompany netting to offset receivables and payables between 2 different legal entities/subsidiaries of a company so that one final (net) amount remains.
It will be easier to understand the meaning of deferred revenue expenditure if you know the word deferred, which means “Holding something back for a later time”, or “postpone”.
Deferred Revenue Expenditure is an expenditure that is revenue in nature and incurred during an accounting period, however, related benefits are to be derived in multiple future accounting periods.
These expenses are unusually large in amount and, essentially, the benefits are not consumed within the same accounting period.
Part of the amount which is charged to the profit and loss account in the current accounting period is reduced from total expenditure and the rest is shown in the balance sheet as an asset (fictitious asset, i.e. it is not really an asset).
Suppose that a company is introducing a new product to the market and decides to spend a large amount on its advertising in the current accounting period. This marketing spend is supposed to draw benefits beyond the current accounting period.
It is a better idea not to charge the entire amount in the current year’s P&L Account and amortize it over multiple periods.
The image shows a company spending 150K on advertising, which is unusually large as compared to the size of their business.
The company decides to divide the expense over 3 yearly payments of 50K each as the benefits from the spending are expected to be derived for 3 years.
50K will be shown in the current P&L and the remaining Amt. in BS
*Large losses originating from unforeseen circumstances, such as a natural disaster or fire, etc., may also be treated as deferred revenue expenditure.
Reasons
The benefits of such an expense are to be received in the future financial years. Therefore, it is logically incorrect to record 100% of such expenses as revenue expenditures and write them off in the current accounting period.
In most cases, these expenses are so large that they may consume all the profits of the company if written off in the current accounting year. As a result, the users of accounting information will get a false impression.
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The word contingent or contingency means “possible, but not certain to occur”. So, according to the definition, contingent liabilities are those liabilities that may or may not be incurred by a business depending on the outcome of a future event. The existence of this kind of liability is completely dependent on the occurrence of a probable event in future.
An example of such liability is a court case, only if the company loses the court case, contingent liability will actually be realized. In another example of contingent liabilities acting as a surety/guarantor on a loan and assuming the responsibility of paying it back in case of default may also be a case of contingent liability since if the principal debtor fails to pay you will be required to reimburse.
Unlike contingent assets, contingent liabilities are required to be disclosed as soon as they can be estimated, usually as a footnote to the balance sheet. If the possibility of the outflow of money or assets is remote then the disclosure may not be necessary.
There are two questions that need to be answered if a contingent liability is to be recorded with a journal entry:
Is the contingent liability probable?
Can the amount of obligation be estimated?
Example
Patent wars that usually happen between Top brands give a clear-cut explanation. Let’s suppose that Apple files a case of a patent violation on Samsung and Samsung not only realizes that it may have to pay for violations but also estimates how much in total. In this case, Samsung will record the estimated amount in their books of accounts as a Contingent Liability.
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Reserves and provisions are somewhat alike but are created for different reasons and under distinct circumstances. Both are important for a business and one can’t reduce the importance of the other. This article covers major points of difference between reserves and provisions.
Reserves are what a business would put away from its profits for future contingencies and strengthening of the business, whereas, provisions are aimed to satisfy an anticipated known expenditure.
Reserves
Provisions
1. Reserves are made to strengthen the financial position of a business and meet unknown liabilities & losses.
1. Provisions are made to meet specific liability or contingency, e.g. a provision for doubtful debts.
2. Reserves are only made when the business is profitable.
2. Provisions are made irrespective of profits earned or losses incurred by a business.
3. They can be used to distribute dividends to shareholders.
3. They cannot be used to distribute dividends as they are made for a specific liability.
4. They are made by debiting P&L Appropriation Account.
4. They are made by debiting the P&L Account.
5. It is not mandatory to create reserves for the business, it is mainly done for prudence.
5. It is mandatory to create provisions as per various laws.
6. Reserves are shown on the liability side of a balance sheet.
6. Provisions are either shown on the liability side of a balance sheet or as a deduction from the concerned asset.
7. It may be used for investment outside the business.
7. It can not be used for investment purposes.
Reserves
They are the portion of profits set aside to strengthen the financial position of a business. Generally, reserves are created to meet unknown future obligations which may arise due to miscellaneous business reasons.
For example – General reserve, reserve for expansion, dividend equalisation reserve, debenture redemption reserve, capital redemption reserve, increased replacement cost reserve, etc.
Specific reserves, as the name suggests are made for specific reasons and may only be used for that specific purpose. One major difference between reserves and provisions is that a provision is always specific, however, reserves may be generic.
They are shown in the balance sheet along with share capital.
Provisions
They are the portion of profits set aside to meet known losses/expenses in the future. The main purpose to create provisions is to meet recognized future obligations which may arise due to a specific business reason.
Reserve means the amount set aside out of profits or other surpluses that are not meant to cover any liability, contingency, commitment, or legal requirement. Thus, the reserve covers the case of an amount that is neither a liability nor a provision. The following are the important types of reserves:
Capital Reserve- It is an accounting mechanism for conserving profits. It imparts an element of stability to the overall finances of a business enterprise. Capital reserve arises either as a gain on the sale of long-term assets or a settlement of liabilities. It does not include any free balance that might be used for the distribution of profits. Examples of the capital reserve are:
Profits emerging from the revaluation of fixed assets
Profits accruing on the sale of fixed assets
Profits from the re-issue of shares
Profits prior to incorporation of a company
Revenue Reserves – Revenue reserves are created out of revenue profit that is usually distributable profits. All distributable profits are not always available for paying dividends since a certain amount may be required to be kept aside either by law (minimum) or as a managerial decision (higher amount) for business needs. It is only after this that the profits will be available for distribution. A few examples are:
General Reserve
Dividend Equalization Reserve
Debenture Redemption Reserve
General Reserve – General reserve is a retention of a portion of revenue profits for the improvement of the overall financial status of an enterprise and to improve its health in general. It is a salient feature of corporate finance. The creation and maintenance of a general reserve helps in-
Conserving resources
Saving for unforeseen losses
Scope of business expansion
Specific Reserves – A business undertaking in contemporary times is involved in a range of business activities in pursuance of its goal of creating value in the organization. Some of the contingency situations can be looked after and financially managed by the creation of provisions for known events. Management may like to provide a second line of defence against some of these. A specific reserve is created for such a given purpose. A few examples are:
Contingency reserve
Capital Redemption reserve
Workmen Compensation reserve
Types of Provisions
The provision means an amount that is written off or retained, kept aside by way of providing for depreciation; or retained by way of providing for any unknown future liability of which the amount can not be ascertained with reasonable accuracy. Important types of Provision are-
Provision for Doubtful Debts – When it is certain that a debt will not be recovered, the amount is written off as bad debt. But, it is also likely that some of the remaining debts may not be recovered in full. This will be a loss to the business.
Hence, it is a common practice to make a suitable provision for doubtful debt at the time of ascertaining profit and loss. Such a provision is made by debiting the number of doubtful debts to the profit and loss account and crediting the account of provision for doubtful debts.
Provision for Discount on Debtors – In practice, business enterprises allow cash discounts to their customers. The tenure of that discount may spill over into the following accounting year for the sales made during the current year.
This requires a provision to be made on debtors and is treated as a loss for the current year. Provision for discount on debtors is created by debiting the profit and loss account and crediting the amount for provisions for a discount on debtors.
Provision for Taxation – A provision for taxation is created and maintained to meet the income tax payable which is a liability for the business, in the current year. Such provision is created by debiting the Income-tax amount of the profit and loss account for that year and crediting the amount for provision for taxation.
Provision for Depreciation – Provision for depreciation is the specific portion of depreciation for that accounting year. Depreciation is by principle charged at the end of the accounting year, and this leads to a lowering of the book value of the asset. However, this reduction isn’t accounted for by crediting the asset account in question, because the assets are going to be continued to be shown on the balance sheet at their original price.
Instead, these depreciation amounts are attributable to a specific account named ‘Accumulated Depreciation‘ which records the collective provisions for depreciation. Such provision is created by debiting the depreciation account and crediting the amount of provision for depreciation.
Reserves Vs Surplus
Following are the differentiating factors between Reserves and Surplus:
Meaning – Reserve is the amount set aside out of undivided profits and other surpluses in order to strengthen the financial position of the business, but not designed to meet any liability or contingency known to exist on the date of the Balance Sheet. The surplus is the credit balance of the profit and loss account after providing for dividends, bonuses, provision for taxation and general reserves, and all other external payments.
Creation – Reserves are an appropriation out of profits and are created only if profit has been earned. It is a matter of financial prudence. What remains after reserves have been created, of the profit earned in that year, is termed as surplus for that accounting period.
Purpose – General Reserves can be used by the company to meet any obligation unknown at that point in time. This includes issuing bonus shares, and dividend equalization, among others. The surplus is the “extra” funds available to the business and shows the operational stability of the company. It is usually transferred to the next year as retained earnings.
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An asset is a useful/valuable thing or person. Assets are divided in various ways depending on their physical existence, life expectancy, nature, etc. The difference between tangible assets and intangible assets is purely based on their physical existence in a business.
In simpler words, an asset is a piece ofproperty owned by an individual or organization which is recognized as having value and is available to meet obligations.
Tangible Assets
The best way to remember tangible assets is to remember the meaning of the word “Tangible” which means something that can be felt with the sense of touch.Assets which have a physical existence and can be touched and felt are called Tangible Assets. The main difference between tangible and intangible assets is where one can be touched and felt the other only exists on paper.
Tangible assets can include both fixed and current assets. A few examples of such assets include furniture, stock, computers, buildings, machines, etc.
Intangible Assets
The opposite of tangible assets, Intangible assets don’t have a physical existence and cannot be touched or felt.Intangible assets can either be definite or indefinite, depending on the kind of asset in question.
A few examples of such assets include goodwill, patent, copyright, trademark, company’s brand name, etc.
A patent is a definite intangible asset as it will expire after the patent is over, however, a company’s brand name will remain over the course of the company’s existence.
Difference between Tangible and Intangible Assets (table format)
Tangible Assets
Intangible Asset
1. They have a physical existence.
1. They don’t have a physical existence.
2. Tangible assets are depreciated
2. Intangible assets are amortized.
3. Are generally much easier to liquidate due to their physical presence.
3. Are not that easy to liquidate and sell in the market.
4. The cost can be easily determined or evaluated.
4. The cost is much harder to determine for Intangible assets.
5. They have a scrap value.
5. They do not have a scrap value.
6. May be accepted by financial institutions as collateral.
6. They are not accepted by financial institutions as collateral.
7. Such assets are held both on paper and by possession.
7. Such assets are held just on paper.
8. Examples: Vehicles, Plant & Machinery, etc.
8. Examples: Software, Logo, Patents, etc.
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Current assets are assets which are held by a business for a short period, mainly a year, or within an accounting cycle of a business. These are balance sheet accounts which can either be converted to cash or used to pay current liabilities within the same time frame.
These are typically seen as those assets which can easily be converted to cash to pay off current liabilities and outstanding debt payments.
Greater the number higher the liquidity of a company which leads to more working capital. It is important because it is used day in and day out to pay off a firm’s usual expenditure which is important for its operations. Such expenses include utility bills, short-term debts, overheads etc.
Examples of Current Assets
The list of current assets includes Cash, Bank, Debtors, Stock, Prepaid Expenses, etc. They are shown on the Assets side of the balance sheet.
Such short-term assets are also called circulating assets, circulating capital, or floating assets.
They are shown in the assets section of the balance sheet.
The current ratio which can be calculated as CA/CL also highlights the importance of having enough short-term assets vs. short-term liabilities.
It is used to determine the current assets turnover ratio for a company enabling evaluation of how well the company is using them to generate revenue. It can be calculated as (Total Net Sales/Average Current Assets).
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Depreciation is a reduction in the value of a tangible fixed asset due to normal usage, wear and tear, new technology, or unfavourable market conditions. Unlike amortization, which is applied to intangible assets, depreciation is applicable to tangible assets.
In Simple Terms – Depreciation is when an asset loses value over time. This can be due to normal wear & tear, outdated technology, etc. Imagine you have a mobile phone that costs 5,000 & has a life of two years. It means 2,500 worth of value will disappear per year due to day-to-day usage (50%). This is the depreciation percentage & 2,500 is the depreciation amount.
Assets such as plant and machinery, furniture, building, vehicle, etc. which are expected to last more than one year, but not for infinity, are subject to such reduction. It is an allocation of the cost of a fixed asset in each accounting period during its expected time of use.
First, among types of depreciation methods is the straight-line method, also known as the Original cost method, Fixed instalment method, and Fixed percentage method.
The simplest & most used method of charging such a reduction is the straight-line method. An equal amount is allocated in each accounting period.
The rate of reduction is the reciprocal of the estimated useful life of an asset, so, for example, if the useful life of an asset is 5 years, the percentage charged will be 1/5 = 20%.
According to the Straight Line Method,
Depreciation Amt = (Cost of an asset − Salvage Value) / Useful life of the asset in years
Example – Straight Line Method
Asset cost = 1,000,000
Depreciation Rate = 20%
1st year = 20/100*1,000,000
=>2,00,000
2nd year = 20/100*1,00,000
=>2,00,000
Advantages of Straight Line Method are;
Simple and easy to understand.
The book value of an asset can be reduced to Zero.
A fair evaluation of an asset each year on the balance sheet.
Second, among the types of depreciation methods is the diminishing value method which is also known as the Written down value method, Reducing instalment method and Fixed percentage on diminishing balance.
According to the diminishing value method, it is charged on reducing balance & at a fixed rate. In this case, the written down value is spread between the useful life of the asset.
The percentage, at which the shrink happens, remains fixed, however, the amount of depreciation diminishing year after year.
According to the Diminishing Value Method,
R = Rate of Depreciation in %
n = Useful life of the asset in years
S = Residual/Scrap value of the asset
c = Cost of asset
Example – Diminishing Value Method
Asset cost = 1,000,000
Rate of reduction = 20% (DVM)
1st year = 20/100*1,000,000
=>2,00,000
2nd year = 20/100*(1,000,000-2,00,000)
=>1,60,000
Advantages of Diminishing Value Method are;
More practical and easy to apply.
The decreasing charge for depreciation cancels out increasing charges for repairs.
This method is applicable for income tax purposes.
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All expenses incurred before a company is formed i.e. cost incurred before the start of business operations is termed as preliminary expenses. They are a common example of fictitious assets and are written off every year from the profits earned by the business.
Examples of such expenses suffered before the incorporation of business are;
Legal cost (Govt. & Court related fees)
Professional fees (Lawyers, Chartered Accountants, etc.)
Stamp duty
Printing fees
Shown in Financial Statements
Also known as pre-operative expenses, preliminary expenses are shown on the asset side of a balance sheet.
The portion which is written off from the gross profit in the current year is shown on the income statement and the remaining balance is placed in the balance sheet. They are preferably written off within the same year (depending on amount & local accounting standards).
Accounting & Journal Entry for Preliminary Expenses
Stage – I – At the time of payment (Opening Entry)
Suppose company-A incurs a total of 100,000 as expenses before the start of business operations, the below entry will be used to show this.
Preliminary Expenses A/C
1,00,000
Debit the increase in expenses
To Bank
1,00,000
Credit the decrease in assets
(Paid via bank)
Stage – II – Preliminary Expenses Written Off (Indirect Expense)
Then company-A decides to write off the total amount of 100k in 5 years therefore only 1/5th (20,000) will be charged in this year’s income statement and remaining (80,000) will be shown in the balance sheet under the head Miscellaneous Expenditure.
Preliminary Exp. Written Off A/C
20,000
To Preliminary Expenses A/C
20,000
Stage III – Charging to Income Statement (Closing Entry)
Company-A then posts the related expense in the current period’s Profit and Loss Account.
The same entry is repeated for the next 4 years to fully amortize the charge in forthcoming accounting periods.
Profit and Loss A/C
20,000
To Preliminary Expenses A/C
20,000
They are not be confused with pre-commencement costs which are incurred immediately before the commencement of business, however, in this case, the business incorporation is already complete. Pre-commencement expenses are directly charged to the current period’s income statement. Example – Employee recruitment expenses, etc.
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Reduction in the value of an intangible asset by prorating its cost over a period of time (generally in multiple accounting periods) is called Amortization. Point worth remembering is that it can only be done for intangible assets such as copyrights, patents, trademarks, goodwill, etc. It is used for writing-off intangible assets whereas depreciation is used for tangible assets.
If related to obligations, it can also mean payment of any debt in regular instalments over a period of time. Home and other loans often talk about such amortization schedules.
If an intangible asset has an unlimited life then a yearly impairment test is done, which may result in a reduction of its book value.
Suppose a company Unreal Pvt Ltd. develops new software, gets copyright for 10,000, and it is expected to last for 5 years.
Now, if the company shows the entire 10,000 as an expense, it will not show the true and fair picture for that accounting period and the profits for that year will show deflated numbers. Hence, every year the company shall record 2,000 for 5 years to write off the copyright’s entire cost,2,000 X 5 Years
This will be seen as amortization of the copyright with the straight-line method. Writing off the entire copyright’s amount in 5 years over 5 equal instalments.
Accounting & Journal Entry for Amortization
Assuming that no contra account was prepared and the reduction was done directly from the intangible asset, the journal entry would be as follows;
Amortization Expense A/C
Debit
To Intangible Asset A/C
Credit
Only to the extent related to the current financial year, the remaining amount is shown in the balance sheet as an asset.
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The best way to understand this is to memorize the meaning of the word “fictitious” which means “not true” or “fake”. Fictitious assets are expenses or losses which are not written off completely during the accounting period of their occurrence.
They are not assets at all, however, they are shown as assets in the financial statements only for the time being.
A straightforward example is that of a significant promotional expense. Suppose a small company decides to spend a large sum of 10 Million on marketing a new product and the benefit of such an expense is to last for 5 years.
In year 1, (1/5th) of the total money spent i.e. 2 Million will be shown in the income statement whereas the remaining (4/5th) 8 Million will be shown in the balance sheet as a fictitious asset (under the head Miscellaneous Expenditure).
Important Points
They are written off against the firm’s earnings in more than one accounting period. Basically, they are amortized over a period of time.
They are recorded as assets in financial statements only to be written off in the future.
It is important to note that such assets do not exist physically or have any resale value.
The portion of the expense that is kept for the future is a fictitious asset, while that which is written off in the current period is not.
Reasons why some expenses are not expensed off entirely in the same year
Benefit in the future period – If a business determines that the benefit of an expense or loss will be derived in a future accounting period, then splitting the cost accordingly is both logical and advisable.
Incorrect financial numbers – A firm may not be able to justify its financial statements if they show the entire expense or loss in a single year. It may end up showing an unreasonably large net loss and this may affect the firm’s valuation of goodwill.
In Simple Terms – Fictitious assets are expenses/losses that are not completely written off during the accounting period in which they occur. There is no value in them, but they are still listed as assets in financial statements (temporarily). Why? – because the related benefits of these assets are expected to be received in the future; therefore, showing them as an expense today would do an injustice to the company’s financials.
Examples
Promotional Expenses of a Business
The marketing expenditures of businesses are viewed as investments that are expected to produce long-term returns in future years. The value of these assets is periodically reduced through the process of amortization over a number of years.
Preliminary Expenses
The term “preliminary expenses” refers to all costs incurred before the formation of a business. Examples of such expenses incurred before the incorporation of a business are legal costs, professional fees, stamp duty, printing fees,
Discount Allowed on the Issue of Shares
An issue of shares at a discount occurs when a company issues its shares for a lower price than its face value. For example, if the face value of a share is 25 and the company issues it at 20, then 5 (25 – 20) is the discount provided by the company on the issue per share.
Now, if the company issues 90,000 such shares at a discount to different investors it would lead to a total loss of 90,000 x 5 = 450,000. Such a loss is treated as a miscellaneous expenditure (fictitious asset).
Loss Incurred on Issue of Debentures
The premium payable on redemption of debentures issued at par or at a discount is a capital loss. For example, if a debenture is issued at a par value of 20, however, the redemption is at a premium i.e. 22 then the loss incurred per debenture is 2 (22 – 20).
Now, if the company issues 80,000 such debenture the total loss incurred at the time of redemption shall be 80,000 x 2 = 160,000. This loss should be appropriately reduced over time.
Underwriting Commission
The underwriting commission is the compensation an underwriter receives from investors for placing a new issue. It is advisable to write off such a fee over time.
Net Loss Incurred by a Company
In some cases, the debit balance of a profit and loss account is also treated as a fictitious asset.
They are shown in the balance sheet on the asset side under the head “Miscellaneous Expenditure”. (To the extent not written off or adjusted)
The amount not written off in the current accounting period is shown on the balance sheet
The above example is provided to demonstrate an expense which may not be treated as an expenditure in the current accounting period, hence it will be recorded as a fictitious asset on the balance sheet.
Why are they shown on the balance sheet?
The organisation will receive returns from these expenses over time, much like it does from other assets. This is the concept behind treating such miscellaneous expenditures as assets.
Depreciation is not possible since they are not tangible, therefore they are amortized as time goes on.
Another way to ask this question is “Are intangible assets such as patents, copyrights, trademarks, etc. also fictitious assets?”.
In short, the answer is No, goodwill is not a fictitious asset and the same is true for other intangible assets.
Acquisitions involve two companies, one purchasing and one being acquired. Goodwill = Purchase price of the targeted/acquired company – (Fair market value of the total assets of the acquired company – Fair market value of the total liabilities of the acquired company)
Reason – An important characteristic of a fictitious asset is that it does not have a realizable value which means it can not be sold in the market to fetch money. However, it is not true for goodwill, patents, and copyrights, since they all have a monetary value and can be sold in the open market.
In addition to this, there is another frequently asked question: Are fictitious assets current assets?
The answer is that all intangible assets are not fictitious assets, however, all fictitious assets are definitely intangible in nature. In spite of this, it is important to note that they are not closely related.
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Fictitious Assets are to be Transferred to Which Account?
This is an accounting FAQ based on the concept of partnership accounting. They are to be transferred to the Partner’s Capital A/c.
As established in the article above that they are considered losses that are not transferred to the realisation account therefore they are transferred to Partner’s Capital account. This is because they are not real assets but are only shown in the financial statements for the time being.
Whenever possible, they are written off against the earnings of the firm. The transfer entry of fictitious assets, if any, is noted as follows:
Such treatment is based on the expectation that it will be beneficial to the business in the long run. This expectation may or may not go as planned and as time progresses, further modifications may be needed.
None of the accounting ratios is affected by these assets because of their false nature. They imitate assets except that they have no intrinsic value, they have no scrap value, and the ultimate goal is to write them off completely with the passing of time.
In accounting, assets such as Cash or Goods which are withdrawn from a business by the owner(s) for their personal use are termed as drawings. It is also called a withdrawal account. It reduces the total capital invested by the proprietor(s).
In the case of goods withdrawn by owners for personal use, purchases are reduced and ultimately the owner’s capital is adjusted. The adjustment is done at cost price.
For small firms withdrawals are ordinarily seen in the form of cash or business assets, however, if a business is incorporated they are often observed in the form of dividends or scrip dividends. It is a natural personal account out of the three types of personal accounts.
Journal Entry for Drawings of Goods or Cash
In case of cash withdrawn for personal use from in-hand-cash or the official bank account.
Drawings A/C
Debit
Debit the increase in drawings
To Cash (or) Bank A/C
Credit
Credit the decrease in assets
In case of goods withdrawn for personal use from the business.
Drawings A/C
Debit
Debit the increase in drawings
To Stock A/C
Credit
Credit the decrease in assets
*Purchases account can also be used instead of stock account as the firm’s stock/purchases are being reduced.
It is a temporary account which is cleared during the accounting process at the end of each accounting year & is not shown as a business expense.
A debit balance in drawing account is closed by transferring it to the capital account. It does not directly affect the profit and loss account in any way.
A leather manufacturer withdrew cash worth 5,000 from an official bank account for personal use. Post an appropriate journal entry for this scenario and also show journal entry for adjustment in the capital account.
Journal entry for cash withdrawn for personal use
Drawings A/C
5,000
To Bank A/C
5,000
(Bank balance reduced by 5,000)
Adjustment entry to show the decrease in capital
Capital A/C
5,000
To Drawings A/C
5,000
(Owner’s capital reduced by 5,000)
Type of Account and Where is it Shown in the Financial Statements
It is a Personal A/C and is adjusted from the capital. It is shown in the balance sheet on the liability side as a reduction in capital.
The accounting equation changes with every transaction that happens in a business. Similarly with withdrawals for personal use the accounting equation changes as follows;
Change in the Accounting Equation from Withdrawals for Personal Use
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Financial statements act as a report card for a business. The three major financial statements are prepared as a summary of figures and facts showing the financial condition of a business.
They are not only used to show how a business uses its funds committed by the shareholders and the lenders, but also to see where the business stands in terms of its financial position.
Profit & Loss Account or Income Statement
Balance Sheet or Statement of Financial Position
Cash Flow Statement or Statement Accounting for Variations in Cash
Profit & Loss Account or Income Statement
After the preparation of a trading account, a profit & loss account is prepared to determine the net profit earned or net loss incurred due to the operations of a business. It is an important final account of a business which shows the summarized view of revenues and expenses for a particular accounting period.
In the horizontal form of a P&L account, Gross profit or Gross loss, whatever is determined from the trading account, is transferred accordingly. The debit side will have all expenses and the credit side – all receipts, both arising out of day-to-day activities.
The difference between the two sides of this account is either net profit or net loss, which is then transferred to the capital account.
(Sample Format of a P&L Account)
Dr.
Cr.
Particulars
Amt
Particulars
Amt
To Trading A/C (Gross Loss)
By Trading A/C (Gross Profit)
To Rent
By Commission Earned
To Depreciation
By Bad Debts Recovered
To Bad Debts
By Interest Earned
To Printing & Stationery
By Dividends on Share
To Salaries
By Example Income 1^
To Legal Cost
To Example Expense 1^
By Capital A/C (Net Loss)*
To Capital A/C (Net Profit)*
*Either of the two will appear. ^Any head can be used instead of the example.
Balance Sheet or a Statement of Financial Position
After the preparation of trading and P&L account, a balance sheet is to be prepared. 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.
It is not only required to be prepared according to the companies act but also needed to ascertain the financial position of a business.
The liabilities and capital are shown on the left-hand side, whereas the assets are shown on the right-hand side. According to the accounting equation Assets = Capital + Liabilities, the total of the Left-hand side should always be equal to the right-hand side in a balance sheet.
(Sample Format of a Balance Sheet)
Liabilities
Amt
Assets
Amt
Capital
Land & Building
Reserves & Surplus
Plant & Machinery
Outstanding Expenses
Furniture
Loans
Stock
Trade Creditors
Sundry Debtors
Bills Payable
B/R
Misc. Investments
Cash
Total
Total
Cash Flow Statement or Statement Accounting for Variations in Cash
A Cash Flow Statement is a financial statement which is mandatory to be prepared according to the law along with the other two financial statements.
Cash flow statement shows the movement of cash and cash equivalents, it is an in-depth inflow and outflow for a given period of time. The statement shows the net cash flow from operating, investment and financing activities.
A cash flow statement depicts the sources and uses of a company’s cash and equivalents, which is very important information for stakeholders.
(Sample Format of a Cash Flow Statement)
Cash Flow Statement Indirect Method
Amt
Cash flows from operating activities
Net profit before taxation
Adjustments for,
Depreciation
Investment income
Interest expense
Foreign Exchange Loss
Operating profit before working capital changes
Working capital changes:
Add Decrease/Less Increase in Sundry Debtors
Add Decrease/Less Increase in Inventories
Less Decrease/Add Increase in Sundry Creditors
Cash flow from operations
Interest paid
Income taxes paid
Cash flow from extraordinary items
1. Net cash from operating activities
Cash flows from investing activities
Purchase of fixed asset
Proceeds from sale of equipment
Investment income
Dividends Received
2. Net cash spent in investing activities
Cash flows from financing activities
Proceeds from issue of share capital
Proceeds from long-term borrowings
Payment of long-term borrowings
Interest & dividends paid
3. Net cash used in financing activities
Net increase in cash and cash equivalents 1+2+3
Add Cash and cash equivalents at beginning of the period
Cash and cash equivalents at end of the period
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Also known as working assets, it is part of the total capital which is currently employed in a company’s day-to-day operations. Cash or liquid assets vital to run a company’s daily operations are collectively known as Working Capital. It is computed as the difference between current assets and current liabilities.
Evaluation is done to find out if a business has enough current assets to cover all its short-term liabilities. Monitoring helps with efficient management of a company’s operations and maintenance of its short-term financial health.
The volume and composition of working capital vary among different sectors, size, and types of organizations. For example – a manufacturing unit typically sells on credit basis and hence generates plentiful short-term receivables.
On the other hand, a business which runs solely on cash (example – jewellery) may have very few receivables. Another example may be that of a business which only accepts custom orders (example – made to order clothing) may not have a lot of inventory pile-up.
In the case of inadequacy of working assets, current assets are less than current liabilities, which means the company has to pay more money than it will receive in short-term.
Current Assets < Current Liabilities
A poor working capital condition is the first indication of financial problems for a business and shows that it is struggling to keep up with its daily operations.
Excess Working Capital
In cases where current assets are considerably higher as compared to current liabilities, it is said to be an excess of WC.
Current Assets > Current Liabilities
Surplus WC may indicate inefficiency in the way the business operations as it symbolises that current assets are sitting idle and need to be put to better use.
Example
Calculate working assets for the business, with the help of the below extract from a balance sheet.
Liabilities
Amt
Assets
Amt
..
Current Liabilities
Current Assets
Sundry creditors
75,000
Bank
1,00,000
Bills payable
25,000
Cash
50,000
Bank overdraft
75,000
Debtors
1,50,000
..
Current Assets = 1,00,000 + 50,000 + 1,50,000
Current Liabilities = 75,000 + 25,000 + 75,000
Applying the formula = Current Assets – Current Liabilities
= 3,00,000 – 1,75,000
= 1,25,000
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A suspense account is an account temporarily used in general ledger to carry doubtful amounts which can either be a payment or a receipt. Despite considerable efforts, if the reason(s) causing these questionable amounts are not found, the difference in the trial balance is temporarily transferred to a suspense account till it is properly analyzed and classified.
The difference amount is temporarily recorded in a suspense a/c and should be cleared at some point as it possesses a control risk. It is used to mitigate risk which is addressed and when the errors are rectified.
It is used only because a proper account for a particular transaction couldn’t be determined at the time when the transaction was recorded. When the right account is determined, the amount shall be moved from the suspense account to its proper account.
Cash received from Unreal Pvt Ltd. for 5,000 is wrongly posted to Unreal Pvt Ltd’s. account as 50,000, It is however correctly recorded in the cash account.
Cash A/C
50,000
To Unreal Pvt Ltd A/C
50,000
Faulty Journal Entry
Considering the fact that the proper account couldn’t be determined at the time of correction, the journal entry for rectification will be
Unreal Pvt Ltd A/C
45,000
To Suspense A/C
45,000
Rectification entry
What happens in case a suspense account is not closed?
In case a suspense a/c is not closed at the end of an accounting period, the balance in suspense account is shown on the asset side of a balance sheet if it is a “Debit balance”. In case of a “Credit balance”, it is shown on the liability side of a balance sheet.
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Compound means a thing that is composed of two or more separate components. Similarly, when used in accounting, a compound journal entry means a journal entry which includes multiple accounts that are either debited or credited, unlike a simple journal entry which only includes 1 debit and 1 credit.
In other words, an entry which has more than one account in debit, credit, or both is termed as a compound journal entry.
Explanation with Example
On January 7, YYYY, 9,500 received in cash from Unreal Pvt Ltd. as the full and final settlement of their account worth 10,000. (Allowed a discount of 500)
Date
Particulars
LF.
Debit
Credit
Type of Account*
Rule Applied*
7 Jan YYYY
Cash A/C
9500
Real A/C
Dr. What comes in
Discount Allowed
500
Nominal A/C
Dr. All losses
To Unreal Pvt Ltd.
10,000
Personal A/C
Cr. The giver
*Used for the explanation purposes.
In the above example of a compound journal entry, there are 2 accounts being debited and 1 account being credited. There are other examples of such entry where you will find more debits than credits or multiple accounts being credited and debited at the same time and so on. It all depends on the complexity of a transaction.
As per the accounting cycle, preparing a trial balance is the next step after posting and balancing ledger accounts. It is a statement of debit and credit balances that are extracted on a specific date.
It is made as an attempt to prove that the total of ledger accounts with a debit balance is equal to the total of ledger accounts with a credit balance. As the name suggests, it is an actual “trial” of the debit and credit balances, they should be equal.
A journal and a ledger are maintained according to the double-entry concept of accounting. In a trial balance, the sum of debits and credits must match.
It acts as a base to create the final accounts of a business such as an Income statement, a Trading A/C, and a Balance Sheet.
To prepare a trial balance it is important to ensure the arithmetic conceptual accuracy. Due to the dual aspect of accounting, the sum of total credits should be equal to the sum of total debits.
Due to its accuracy, tallied Trial Balances offer significant peace of mind regarding the accuracy of ledger balances.
It acts as a summarized form of all ledger balances, in case the debit and credit balances do not match then it is concluded that there is some error and the difference is temporarily transferred to a “Suspense A/C” and corrected afterwards.
Auditors may decide to use it and transfer the account balances onto their auditing software. They can then perform various different kinds of inspections.
Debit and Credit Accounts
In order to provide a summary statement view of the balances of various accounts, the trial balance is prepared. This also indicates the correct nature of the balances of different accounts. A general rule to follow here is;
Assets & Expenses shall have a Debit Balance.
Liabilities & Incomes shall have a Credit Balance.
The reason or logic behind the above rule is to keep the accounting equation in balance and this is the convention commonly followed. The accounting equation is A = L + E, or assets equal liabilities plus equity. The concept is based on the understanding that all assets of a business are either the financial right of the creditors (liabilities) or the owner (equity) in different proportions.
To balance the equation, a double-entry system with debits and credits is used. A debit increases the asset balance while a credit increases the liability or equity. This is required because they are on different sides of the accounting equation. This results in the majority of asset accounts having debit balances, and the majority of liability and equity accounts having credit balances.
Also, expenses cause the owner’s equity to decrease. Since the owner’s equity’s normal balance is a credit balance, an expense must be recorded as a debit. Similarly, incomes cause the owner’s equity to increase, and hence an income is recorded as a credit.
The following are a few examples of different accounts and their natural balance. Items that appear on the debit side of the trial balance:
Land and Buildings
Plant and Machinery
Furniture and Fixtures
Office Tools and Equipment
Cash at Bank
Cash in Hand
Motor Van
Loss from the sale of fixed assets
Travelling charges
Printing and postage expenses
Items that appear on the credit side of the trial balance:
Capital Account
Sundry Creditors
Bank Overdraft/Loan
Bills Payables
Sales (Revenue)
Purchase Returns
Common stock
Un-earned revenues
Retained earnings
Interest Received
Trial Balance and Balance Sheet
A Trial balance is a summary of balances of all accounts recorded in the ledger. It is prepared at the end of a particular period to indicate the correct nature of the balances of various accounts. A balanced trial balance ascertains the arithmetical accuracy of financial records.
A balance sheet is a statement that represents the financial position of a business on a particular date. All assets and liabilities are presented in the balance sheet in a classified form. Thus, it is a summary of the complete accountancy record. A balance sheet helps the user quickly get a handle on the financial strength and capabilities of the business along with its weaknesses.
Both the trial balance and the balance sheet are very crucial to the financial statements as a whole as they serve different purposes. A Trial balance is used-
To check the arithmetical accuracy of the ledger accounts
To locate errors in recording
To provide a basis for preparing the financial statements
A Balance sheet is used-
To know the actual financial standing of a business on a given day
To ascertain and identify the trends in a business
To project and make provisions for future probable setbacks
A trial balance and a balance sheet may seem similar as they both are the description of accounts and not the accounts themselves. Both are statements and are prepared at a particular point in time. But, they are actually very different as explained in the following table:
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When a business is small there is only one general ledger that is maintained. As the size of the business increases, the number of accounts also grow along with that. New subledgers are created under the general ledger accounts, these subsets of the general ledger are called subledger.
Similar types of accounts are grouped together and their representative account is shown in the general ledger. Few examples include accounts receivable,accounts payable, property, etc.
Example
Let’s take an example of the general ledger control account “Accounts Receivable”, which is made up of the following individual debtors of the business:
(AR1) + (AR2) = Accounts Receivable A/C (To be shown in GL)
So, one can imagine a big multinational corporation where hundreds and thousands of debtors, creditors, etc. are not uncommon. It becomes almost impossible to maintain one single ledger.
Hence, creating such subsets is the best possible option to not only maintain the data efficiently but also for calculations and quick access to information on an individual level.
It is also known as the principal book of accounts as well as the book of final entry. It is a book in which all ledger accounts and related monetary transactions are maintained in a summarized and classified form. All accounts combined together make a ledger and form a permanent record of all transactions.
It is the most important book of accounting as it helps in the creation of trial balance which then acts as a base for the preparation of financial statements.
Example:An account can be either an Asset, Liability, Capital, Revenue or an Expense account. Few examples of each are Furniture, Cash, Creditors, Bank Loan, Capital, Drawings, Sales, Rent, etc.
It is shown in “T” format and divided into 2 columns: the left-hand side represents the debit side and the right-hand side represents the credit side.
The process of transferring a transaction from a journal to a ledger account is called Posting. It is an essential task as it summarizes all transactions related to that account at one place.
Posting is made to accounts from journal entries and various subsidiary books.
Account Types and their Balances
Type of Account
Normal Balance
Assets
Debit
Liabilities
Credit
Capital
Credit
Revenue
Credit
Expenses
Debit
Drawings
Debit
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Liabilities are obligations a business owes to external or internal parties. As per the accounting equation liabilities are equal to the difference between assets and capital. For example, if Business A sells goods to Business B on credit, the amount owed by B to A is treated as a liability.
Internal Liability – All obligations which a business has to pay back to internal parties such as promoters (owners), employees etc. are termed as internal liabilities. Examples – Capital, Salaries, Accumulated profits, etc.
External Liability – All obligations which a business has to pay back to external parties i.e. lenders, vendors, etc. are termed as external liabilities. Example – Borrowings, Creditors, Taxes, Overdrafts, etc.
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Journal is the primary book of accounting where daily records of business transactions are first recorded in chronological order, i.e. in the increasing order of dates.
In case of a large business where the number of transactions is substantially more, it is divided into various subsidiary books; such as cashbook, sales book, purchase book, B/R book, B/P book, etc.
It is also called the book of original or first entry. It is a preliminary record where business transactions are first entered into the accounting system. This stage is also known as the original record stage & marks the beginning of a double-entry accounting system.
Sample Format & Template
Recording a transaction in a journal using an accounting entry is called Journalizing. It records both the debit and credit side of a business transaction.
The entry of a business transaction recorded in the journal is called a Journal Entry. It shows details of a transaction in a summarized form.
The act of transferring an accounting entry from a journal or a subsidiary book into a ledger account is called Posting.
Nowadays, for businesses and big corporations the entries carry over several pages, hence the totals are mentioned at the end of each page in front of the debit and credit columns.
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Both bookkeeping and accounting are used interchangeably in the financial world, however, there is a notable difference between bookkeeping and accounting. Bookkeeping is a part of accounting whereas accounting itself is a wider concept.
Definition of Bookkeeping – Literally, it means the activity of keeping (or maintaining) financial books, i.e. recording financial transactions & events. The books referred to, in this context, are the books of accounts. This involves extensive data input. Few activities under book-keeping are;
The input of invoice and voucher details into ERP systems.
Receiving and recording payments by customers.
Making and recording payments to vendors.
Efficiently processing payroll information, etc.
Definition of Accounting – Accounting, on the other hand, is the process that includes recording, classifying, summarizing, and interpreting the financial information of an economic unit. The economic unit is considered as a separate legal entity. Accounting information is widely used by various types of parties for several different reasons. Few activities under accounting are;
Preparation of a trial balance, ledger accounts, etc.
Difference between Bookkeeping and Accounting (Table)
Bookkeeping
Accounting
Definition
1. Bookkeeping is mainly related to the process of identifying, measuring, recording, and classifying financial transactions.
1. Accounting is the process of summarizing, interpreting, and communicating financial transactions that were classified in the ledger account as a part of bookkeeping
Stage
2. It is the beginning stage and acts as a base for accounting
2. Accounting begins where bookkeeping ends.
Management Decisions
3. Management can not make decisions based on bookkeeping.
3. Management can make decisions based on accounting.
Objective
4. The objective of bookkeeping is to keep proper and systematic records of financial transactions.
4. The objective of accounting is to ascertain the financial position and further communicate the information to the relevant parties.
Financial Statements
5. Financial statements are not prepared during bookkeeping.
5. Financial statements are prepared on the basis of records obtained through bookkeeping.
Skill Level
6. Bookkeeping doesn’t require any special skills as it is mechanical in nature.
6. Accounting, on the other side, requires special skills due to its analytical and somewhat complex nature.
Duties of a Bookkeeper & Accountant
In light of the above discussion, it can be established that there is a usual overlapping between the roles of a bookkeeper and an accountant. It can be hard at times to clearly distinguish the two but the generally accepted convention is that the bookkeeper contributes to the early stages of the common accounting cycle, while an accountant contributes to the latter stages.
Duties of a Bookkeeper
To look out for financial data and identify economic transactions for a business.
To distinguish between material economic activities and immaterial economic activities.
To record events measured in monetary terms, in an orderly manner in a journal or other subsidiary books.
To properly maintain the required books of original entry.
To produce required bills and invoices with reference to transactions.
To post all debits and credits in the general ledger.
To classify all transactions in a systematic manner.
To balance and reconcile all the accounts in the books of accounts.
To summarize the balances in an accurate trial balance.
To prepare the bank reconciliation statement.
To follow and report on budgetary compliance.
To follow due diligence in following the generally accepted conventions of recording and maintaining books of accounts.
Duties of an Accountant
To examine the recorded transactions in order to check the efficiency of the records.
To suggest adjustment entries if any error is present in the bookkeeping process.
To analyze the trial balance in order to prepare the financial statements.
To prepare the Trading as well as Profit and Loss account to capture the profitability of the business.
To prepare the Balance Sheet to reflect the financial position of the business.
To estimate the cost of operations and revenue generated for the business.
To gauge the income tax and other compliance-related requirements of the company.
To interpret the financial statements in a way that can be useful for business decision making by the owners and other stakeholders.
To communicate necessary accounting information to the internal as well as the external users.
To provide consultation and insights to the owners to help them make an informed decision.
The most accepted definition of an audit is given as an evaluation of a personal organization, process, system, or business. The term is most ordinarily used with respect to audits in accounting, and sometimes in project management, legal departments, and financial management also. In other words, an audit is a necessarily unbiased analysis or examination of an organization’s statements. The audit can be both internal as well as external.
Auditing vs Bookkeeping
Auditing starts after the accounting cycle is completed. It is not a part of traditional bookkeeping and/or accountancy. Bookkeeping and auditing are similar in the way that both of them deal with the financial records of the business involved. Also, the utmost care and due diligence is the way to go for both a bookkeeper as well as an auditor. The Bookkeeper works for the organization, while an auditor can be external or internal.
Despite all this, auditing is a completely different process when compared to bookkeeping. The basic difference between the two lies in the tasks involved and the objective of performing the two activities.
Bookkeeping is the process of maintaining the records of the business and making sure that all requirements are fulfilled. On the other hand, auditing involves doing analytical and backtesting on the records to establish authenticity.
Bookkeeping is done with the simple purpose of recording all material economic activities of a firm in a uniform manner so that it can form the base for decision making. On the other hand, auditing is performed with the objective of evaluating the truthfulness and fairness of the records.
Accountancy vs Accounting vs Auditing
Accountancy and accounting are used interchangeably. In-depth analysis shows that while accounting refers to the steps in the accounting process like recording, classifying, summarizing, etc, accountancy is used to denote the overall duties or functions performed by an accountant.
Accountancy and auditing are also related in the same fashion. Accountancy starts where bookkeeping ends while auditing is performed after accountancy is complete. Both of them are similar in a way that they both have to rely on the records as maintained by the bookkeeping. Both accountancy and auditing are analytical in nature and are performed to make the most of the financial records. The techniques and tools are different in both cases, however.
Accountancy involves summarizing and interpreting financial data to facilitate informed decision making. Auditing is the process of checking and ensuring that financial records are reliable.
Accountancy is very detailed and generally tries to not miss any detail. If a detailed audit is not being performed, an auditor will usually rely on random samples of financial information.
Accountancy is governed by accounting standards while auditing is governed by legal acts that are not very flexible in their approach.
An accountant is generally appointed by the management and will be paid a salary. An auditor on the other hand may be appointed by some external authority also and will be paid a specific fee.
Difference Between Bookkeeping and Accounting (PDF)
Download PDF to see the comparison between bookkeeping and accounting.
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Petty Cash Book is an accounting book used for recording cash expenses which are small and of little value, for example, stamps, postage and handling, stationery, carriage, daily wages, etc.
These are expenses which are incurred day after day; usually, petty expenses are large in quantity but insignificant in value. To record such expenses, a different book known as a petty cash book is maintained. It may be maintained by ordinary or by the imprest system.
Ordinary system
As part of the normal process of petty cash management, the petty cashier receives an appropriate amount of money.
When the petty cashier spends the amount, he or she submits the account to the head cashier for approval.
Imprest system
The word “imprest” means – A fund that a business uses for small expenditures and usually restores to a fixed amount after a period of time. Imprest system refers to paying an advance at the start and reimbursing the amount spent from time to time.
An Imprest system is where an estimate is made of the amount required to cover small expenses for a given period (for example, a month, quarter, etc.) and the same amount is advanced to the petty cashier as the opening balance.
It is then used by him/her to manage all petty expenses and make the required payments. At the beginning of a new period, the money is replenished when it has been spent. This amount is called imprest money.
Advantages of the Imprest System
Better Accuracy: At regular intervals, the cashier checks the petty cash book to ensure that any mistakes are quickly corrected.
Expense Management: Because petty cash cannot be spent beyond the available petty cash, petty expenses are kept within the limits of imprest.
Fraud Management: As the petty cashier is prohibited from drawing cash as and when we desire, misuse of cash can be minimized.
Type 1 – Simple Petty Cash Book
This type of book is maintained just like a cash book. Any cash, which the petty cashier receives, will be recorded on the debit side (left) cash column of the book and any cash which he pays out will be recorded on the credit side (right) cash column of the book.
Considered the most beneficial method of recording petty cash payments. In the analytical version, a separate column is used for each commonly occurring item of expenditure such as stamps, postage & handling, stationery, wages etc.
A column for “sundries” is usually added for miscellaneous payments. When a petty expense is recorded on the right-hand side of the book, the same amount is also recorded in the proper expense column.
Simple Petty Cash Book Vs Analytical Petty Cash Book
Simple Petty Cash Book
Analytical Petty Cash Book
There is no separate record for each type of petty expense.
In the analysis column, each item of expense that occurs frequently is listed.
It is difficult to determine the total expenses under different headings at the end of the period.
It is easy to determine expenses under different headings at the end of the period.
In a similar way to a cash book, each page is divided down the middle.
A large portion of the page is provided for expenses, with separate columns for expenses incurred on a regular basis.
Advantages of the Petty Cash Book
Efficiency: This book helps to save the time of the chief cashier.
Control: Managing small payments is easier with the help of this book.
Reduces Effort: As these entries are not recorded in the cash book and posted into the ledger, redundant and extra work is saved.
Ledger Accounts Prepared Easily: Only the totals are taken and posted in the ledger. Information that is unnecessary & trivial is omitted which helps in direct posting to the ledger.
Balancing of a petty cash book is done at the end of an accounting period. The columns for “payments” and “expenses” are totalled and it equals the total in the “Total Payment” column.
In the analytical type petty cash book, the closing balance (balance c/d) then becomes the opening balance (balance b/d) of the next period.
Petty Cash Journal Entry
(Entry 1) – When the amount is advanced to the petty cashier
Petty Cash A/c
Debit
Debit the increase in asset
To Cash A/c
Credit
Credit the decrease in asset
(Entry 2) – When petty cashier submits expense accounts
Expense 1 A/c
Debit
Debit the increase in expense
Expense 2 A/c
Debit
Debit the increase in expense
Expense 3 A/c
Debit
Debit the increase in expense
To Petty Cash A/c
Credit
Credit the decrease in asset
(Each expense is debited with its respective amount)
Posting
Each item in the book of petty expenses is posted in the ledger accounts at the end of a specific period which is pre-decided (usually – weekly, bi-weekly, monthly, or quarterly)
Ledger entry for each expense is not directly posted instead a petty cash account is maintained in the firm’s ledger.
In the ledger book, each petty expense account is kept separately.
Example to Show Ledger Posting
The petty cashier submitted the below expenses with their respective amounts for the current period amounting to 900. The cashier was advanced 1,000 as petty cash for the period. Post appropriate entries into individual ledger accounts.
Jan 3 – Entry at the start of the period when cash is handed over to the petty cashier,
Petty Cash A/c
1,000
To Cash A/c
1,000
The chief cashier records petty cash advances to the petty cashier on the credit side of the cash book as “By Petty Cash A/c”. In this case, the entry would for 1,000.
Jan 9 – Entry for each expense at the time of submission of accounts by the petty cashier,
Stationery A/c
500
Cartage A/c
300
Postage A/c
100
To Petty Cash A/c
900
To pass the journal entry for total expenses paid, individual petty expenses are debited and credited to Petty Cash Account. A separate account is maintained for each petty expense.
(Solution)
Stationery A/c
Date
Particulars
Amount
Date
Particulars
Amount
Jan 9
To Petty Cash A/c
500
Journal entry posted in the Stationery account on the debit side by writing “To Petty Cash A/c”.
Cartage A/c
Date
Particulars
Amount
Date
Particulars
Amount
Jan 9
To Petty Cash A/c
300
Journal entry posted in the Cartage account on the debit side by writing “To Petty Cash A/c”.
Postage A/c
Date
Particulars
Amount
Date
Particulars
Amount
Jan 9
To Petty Cash A/c
100
Journal entry posted in the Postage account on the debit side by writing “To Petty Cash A/c”.
Petty Cash A/c
Date
Particulars
Amount
Date
Particulars
Amount
Jan 3
To Cash A/c
1,000
Jan 9
By Stationery A/c
500
Jan 9
By Cartage A/c
300
Jan 9
By Postage A/c
100
Jan 9
By Balance c/d
100
1,000
1,000
Jan 10
To Balance b/d
100
Jan 10
To Cash A/c
900
Journal entries for each receipt and payment are posted in the Petty Cash Account on the debit & credit sides.
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A Cash Book is a type of subsidiary book where cash (or) bank receipts and cash (or) bank payments made during a period are recorded in a chronological order. Receipts are recorded on the debit – the left hand side, and payments are recorded on the credit – right hand side.
Entries are recorded just like a ledger account with the help of “To” and “By“. The number of cash transactions in a business is generally large, hence it is convenient to have a separate cash book to record such transactions.
In case a transaction affects both the cash and the bank account, a contra entry is recorded. There are 3 types of a cash book.
Single Column Cash Book
Also known as a simple cash book or a one column cash book, a single column cash book has one relevant column on each side which shows the simple “receipts” and “payments” of cash. Receipts are shown on the left side and the right side is for payments.
Sample Format of One Column Cash Book
Date
Particulars
LF.
Cash
Date
Particulars
LF.
Cash
Receipt Side
Receipt Side
Receipt Side
Receipt Side
Payment Side
Payment Side
Payment Side
Payment Side
Receipt Side
Receipt Side
Receipt Side
Receipt Side
Payment Side
Payment Side
Payment Side
Payment Side
Balancing
Just like any other account, it is balanced at the end of a period. The total of receipts should always be greater than the payments. The difference is mentioned on the credit side as “Balance c/d”. The balance on the debit side is then written with “To Balance b/d”, this is the beginning cash balance of a business for the next period.
Double Column Cash Book
Also known as a two column cash book, a double column cash book is the one which has a “Bank” column in addition to the regular “Cash” column. Just like the other type of books, it records receipts from cash and bank on the left side and payments – on the right side.
Sample Format of Two Column Cash Book
Date
Particulars
Cash
Bank
Date
Particulars
Cash
Bank
Triple Column Cash Book
Also called a three column cash book, a triple column cash book has “Cash”, “Bank” and “Discount Allowed” on the receipt on the left side and “Cash”, “Bank”and“Discount Received” on the payments are on the right side of the cash book. Cash discount is recorded, when payments are made in cash or by check.
Sample Format of Three Column Cash Book
Date
Particulars
Discount
Cash
Bank
Date
Particulars
Discount
Cash
Bank
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Also known as a B/P book, bills payable book is a subsidiary or secondary book of accounting where all bills of exchange, which are payable by the business, are recorded. The total value of all the bills payable for an accounting period is transferred to the books of accounts.
In a mid to large sized business where the number of bills exchanging hands is large in number, it is tough to journalize all bills drawn. All such bills are entered in an accounting ERP or a register depending on the business, furthermore, all these entries are transferred to the respective ledger accounts at a regular interval, often monthly.
A bill receivable for a “drawer” is a bill payable for a “drawee”. Bills payable account will usually have a credit balance, as it is supposed to be paid at maturity, it acts as a liability for the business. Generally, every bill has a 3-day grace period.
Sample Format of a B/P Book
The person, who draws the bill of exchange, is called a “drawer” and the customer, on whom it is drawn, is called a “drawee” or an “acceptor”.
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