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Working capital = Current Assets – Current Liabilities

I believe if you want to understand how the above formula works you will need to understand each part of this formula i.e you will first need to have a clear understanding of the concept of current assets and current liabilities.

Current assets

It refers to all the assets including cash and cash equivalents which are expected to be converted within a year or within the operating cycle of an entity if such entity has an operating cycle longer than a year.

Current liabilities

It refers to all the payables or debts which an entity expects to discharge within a year or the operating cycle of such entity provided such an entity has an operating cycle longer than a year.

I understand that even though you got a rough idea of this concept you may not be confident while applying this concept hence, to relate to this concept a numerical example would be of great help.

So, I believe once you have a look at the below-mentioned example you will be in a better position to comfortably apply this formula:

Here, Working Capital = Current Assets – Current Liabilities

= Cash in Hand + Cash at Bank + Trade Receivables + Prepaid Rent –Trade Payables  –                  Outstanding Salaries

= 5,000 + 56,000 + 64,000 + 3,000 – 20,000 – 20,000

= 128,000 – 40,000

= 88,000.

It will add more value to your understanding if you also interpret the concept of Gross Working Capital and Net Working Capital.

Gross Working Capital

Gross working capital is the sum total of current assets of an entity. It includes

• Cash and Cash Equivalents
• Trade Receivables
• Inventory
• Short term Investments
• Other Marketable Securities.

Net Working Capital

Now, the net working capital of an entity is nothing but the working capital of an entity. In simple terms, it is a difference between the current assets and current liabilities of an entity.

>Related Long Quiz for Practice Quiz 33 – Working Capital

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Meaning of Non-Current Liabilities

Non-current liabilities are obligations of an entity that becomes due at a future date and such future date falls beyond 12 months. Whereas current liabilities are those obligations wherein an entity is liable to honour such obligations within 12 months.

Meaning of Debt

Debt is any sum of money borrowed by an entity or a person from another entity or a person. Debt is borrowed generally when such an entity has a cash crunch or liquidity crunch or if it has an urgency of making a payment or any other purpose. It can be a long term or a short term debt.

The amount borrowed can be said to be a debt only if such a contract specifies the intention to repay at a future date the amount so borrowed. The borrower might have to pay interest if it’s agreed earlier in the agreement.

Is Non-Current Liability a Debt?

The answer to the above question is that it depends. When we take a bank loan it’s a debt but in case of a deferred tax liability or a long term provision even though it’s a part of non-current liability but it can not be called a debt.

I will give you an example of when it shall be called a debt

You have a business of manufacturing bottles and there been a huge demand for such bottles in the market recently so you decide to increase the production but your plant has a limited capacity hence you decide to purchase a new plant with higher capacity but your entity is facing a shortage of funds hence you apply to the bank for a loan of such amount.

The bank sanctions such loans and transfers the amount so required. Now, The agreement states that the amount borrowed is repayable by you after 5 years.

The loan mentioned in the above case qualifies to be a non-current liability since the obligation to repay arises after 5 years i.e > 12 months. And it’s also an amount borrowed by a person or an entity from another person or an entity. Hence, it’s a perfect example of debt.

You will be able to understand from the below balance sheet that even though deferred tax liability is included under the head of non-current liabilities it does not signify to be a debt. And a bank loan having obligation to pay after a year is covered under long term debt.

Conclusion

All the non-current liabilities are not long term debts but all the long term debts are non-current liabilities.

>Related Long Quiz for Practice Quiz 22 – Current Liabilities

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Importance of Financial Reporting

The importance of financial reporting cannot be exaggerated. It is considered a primary requirement of all the stakeholders for many reasons and purposes. Financial reporting discloses the position, liquidity and performance of the company. The following key points highlight why is financial reporting framework important,

Statutory – Financial Reporting is required by the law for performing statutory audits on the company’s financial statements and reports. These statements help the auditors to express their opinions on the fairness of the financial statements.

Internal Decisions – Financial Reporting is considered the best tool for formulating the internal decision of an organization by providing accurate and updated information on financial statements.

For example, Lenovo Inc’s profit and loss account registered a sharp decrease in net profit due to the use of obsolete technology and poor battery life. Hence the company management should focus on improving overall performance and formulating new strategies to regain customer trust and improve business performance.

External Users – Financial Reporting discloses financial statements that give an idea to the external users (say- creditors, third parties, banks and investors) on the financial creditworthiness, soundness, integrity and liquidity position of the company.

For Example, Apple Inc registers a sharp increase in profit every year and has a strong brand name, credibility and customer base across the world. Due to these reasons, the company has the capacity to procure funds from the banks and NBFCs. This helps the company to grow, prosper and generate huge loans.

Vital Information – Financial Reporting software provides vital information which can be used by the company for making quick and informed business decisions. Such as opening a new business branch across the country.

Planning and Analysis – Financial Reporting acts as a backbone to financial planning, decision and policymaking, financial analysis and is responsible for maintaining company standards.

Investment Decisions – Financial Reporting helps companies and organizations to raise share capital by attracting domestic and foreign investments through marketing, promotions and providing high returns on investments in the form of share dividends.

For Example- HSBC Bank pays off a higher percentage of dividends to its shareholder than compared to other banks. This helps to bank to attract new domestic and foreign investments thereby issuing shares to new shareholders. Financial reporting helps the bank in attracting shareholders by publishing financial statements in newspapers, magazines and prospectus.

Employees and Workers – Financial Reporting helps the employees and workers to understand and analyze the position and performance of the ownership as well as management of a company or an organization based on the audited financial statements.

For Example, Amazon has recorded a sharp spike in profits after deducting corporate taxes and other duties. The company management has decided to pay bonuses and incentives over and above its basic pay to all its prospective employees. This motivates the employees to work even harder and deliver better services to their clients

Financial Information – Financial Reporting furnishes financial information which helps the organization in bidding and negotiating a better business contract. It helps the government in framing suitable economic plans and policies by assessing financial statements and business performance.

Conclusion

We can conclude that financial reporting plays an important role in not only helping the organization to derive long-term profits but also creating an opportunity to expand and diversify the business by setting up long-term goals and better business strategies.

Difference between Assets and Inventory

>Related Long Quiz for Practice Quiz 21 – Inventory

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To begin with, financial reporting is mainly of two types: External and Internal. Reports are prepared for stakeholders (external) as well as the managers (internal) of the organization.
The different components of financial reporting are as follows:

1. The financial statements of a company- the income statement, balance sheet, cash flow statements, and the statement of shareholders equity.

2. The notes to financial statements

3. The quarterly and annual reports of a company

4. Prospectus

5. Management discussion & analysis

1. The financial statements

Income statement – The income statement of a company shows the revenues, expenses, net income, and earnings per share. It is the most important financial statement because it depicts the overall performance of a company.

Statement of financial position – It comprises a companies assets, liabilities, and equity.

Cash flow statement – A cash flow statement shows the monetary position of a company with the help of cash inflows and outflows during a particular financial period.

Statement of equity – This financial statement shows the changes in owners’ equity over a financial period.

2. Notes to financial statement

While recording and classifying the above mentioned financial statements in the books of accounts, the accountants have to maintain various notes to separately show the working. These notes comprise adjustments such as depreciation, interest, dividends, prepaid expenses, accrued income, etc.

3. The quarterly and annual reports of a company

These types of reports are usually prepared in the case of listed companies. These reports comprise the financial statements and their notes to accounts.

4. Prospectus

In terms of finance, a prospectus is a document that portrays the financial security of potential buyers. It is usually recorded in the financial reports of those companies that are going for IPOs.

5. Management discussion and analysis

The preparation of a financial report involves approval at all managerial levels and close analysis to avoid any kind of mistakes. However, this usually takes place in the case of public companies.

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Equity is the capital raised by a company for the purpose of purchase of assets or for making an investment in a specific project or for the smooth functioning of operations. It’s important as it represents the value of an investor’s stake in a company.

It can also be aid that its the sum of money that the company is required to pay at the time of its liquidation to its shareholders after realising all of its assets and paying off all of its debts. Equity is presented in the financial statement as a component of a Balance Sheet.

The formula for calculating the company’s equity

Shareholder’s Equity = Total Assets – Total Liabilities

Inclusive list of items under the head” Equity”

It is generally presented under two subheads – Equity and Other Equity.

The extract shown below indicates the position of Equity in a Balance Sheet;

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Depreciation as an Operating Expense

Yes, depreciation is an operating expense.

To understand this you might want to check the illustrative case given below;

You have an entity providing financial services to your clients. You had commenced it 4 years ago. At the time of the commencement of the operations you had 25 employees and laptops being the core assets of your business, were purchased by you for your team initially.

After 4 years do you still believe that if you dispose of these laptops or you decide to replace them you will get the same amount you had spent initially for purchasing them or could they have the same features and technology that a newly launched laptop currently has or uses?

The answer to this is Obviously Not. The new laptop available in the market will have better features and might be faster. Also, these used laptops shall not possess the same value at the time of their replacement.

I will have a quick run over the concept of “What is Depreciation?”

Depreciation is nothing but a diminution in the value of an asset, due to natural wear and tear, exhaustion of subject matter, effluxion of time accident, obsolescence or similar causes.

Assuming you have received an answer but you still don’t get the logic for treating it as an operating expense the below-given para may be of some help.

An operating expense is an expense that a business incurs for carrying on its normal operations. Hence, since depreciation is charged on an asset that’s used for day-to-day business operations it is covered under operating expense even though it’s a non-cash expense.

Based on the above para you would agree that all the operating expenses are presented on the debit side of profit and loss or an income statement. And since depreciation is related to an asset used for manufacturing or providing service or aiding business for that matter it is an operating expense and so it shall also be presented on the debit side of an income statement.

You can check the profit and loss statement added below for a better understanding of the treatment of depreciation in the income statement.

The depreciation can be treated as a non-operating expense only in specific circumstances where the assets are not used for the main operations of the business. When such an asset is used for an incidental operation then we treat depreciation as a non-operating expense.

>Related Long Quiz for Practice Quiz 28 – Operating Expense

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Meaning of Days Payable Outstanding

Days Payable Outstanding (DPO) refers to the average number of days taken by an organization (or) company to pay to its outstanding suppliers/vendors. It is calculated on the credit purchases made by an organization. It is computed on a monthly, quarterly (or) annual basis. This portraits how well can a company manage its cash outflows.

If the company takes less time to make payment to its outstanding suppliers then it states that an organization has a strong financial position. but if the company takes a more (or) longer time to pay its outstanding supplier then it could either be an action plan or else the company’s financial position is weak.

Formula

The following formula is used for calculating the Days Payable Outstanding (DPO) of an organization.

Where Cost of Goods Sold (COGS) = Opening Inventory + Purchases – Closing Inventory.

Example

ABC Ltd has furnished you with the following information. Compute Days Payable Outstanding.

Calculation

Days Payable Outstanding = Average Accounts Payable * No. of days/Cost of Goods Sold

= 45,000 * 30/2,25,000

= 6 Days

In my perspective, 6 days is a low average period for an organization for making the payments to all the outstanding suppliers. Therefore it represents a fairly good DPO. Although it depends on the organization about their understandability of high or low DPO.

What is a Purchase Requisition?

In the case of larger organisations, it may so happen that the procurement department places an order of purchase only once such requirement is approved by another department.

When the procurement department intends to procure goods it will have to issue a purchase requisition to its financial wing. Thus the document sent to such another department for approval is called a purchase requisition.

I am inserting the specimen of a purchase requisition you can have a glance;

For Example

ABC Ltd is engaged in manufacturing packed food products, It procures raw materials from various vendors and the company has a policy that before placing any order the department needs to seek the approval of the company’s finance wing. Hence, the procurement department for seeking such approval shall issue a Purchase requisition document.

It includes the following:

• Vendor Information
• Quantity or Units
• Description of Goods
• Location of the Purchaser
• Amount or Price

What is a Purchase Order?

After receipt of the Purchase Requisition from the procurement department, the financial department of an organization shall issue a purchase order to the Vendor.

Continuing the purchase requisition example-

When the finance department of ABC Ltd receives the purchase requisition from the Procurement department for the purchase of raw materials the finance department will analyse the document and once satisfied with the content shall issue a purchase order in favour of the external vendor. And thus the order is said to be placed successfully.

I am inserting the specimen of purchase order you can have a glance;

It includes the following:

• Purchase Order Number
• Purchaser and Vendor Information
• Quantity or Units of Goods
• Price or  Amount
• Invoice Number and Invoice Related Information
• Description of goods
• Payment Terms

Difference between Purchase Requisition and Purchase Order

Purchase Requisition is used to simply seek permission from another department within the entity whereas other department uses a purchase order to actually place an order i.e make a purchase of specific goods required.

Where Purchase requisition is a document generally used internally within an organisation whereas the purchase order is generally issued to the external vendor. The purchase order is issued after purchase requisition.

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“Accumulated Depreciation” is the contra account used to record depreciation.

Let me help you understand the meaning of accumulated depreciation.

Meaning of Accumulated Depreciation

Accumulated Depreciation is the total cumulative depreciation of tangible fixed assets up to a particular date. It is associated with assets such as plant & machinery, furniture & fixtures, equipment, building, vehicles, etc. It is the total depreciation already charged as an expense over the estimated useful life of the assets. It is a contra asset account & has a credit balance.

Accumulated depreciation is presented in the balance sheet and reduced from the gross amount of fixed tangible assets to derive the net value of the asset.

Example of Accumulated Depreciation

Suppose Chocolate Ltd bought a chocolate manufacturing machine worth 500,000 in the month of January 20×1. The estimated useful life of the machine is 5 years with no scrap value.

Following the straight-line method of depreciation, the machine will be depreciated with an amount of 100,000 at the end of every year for 5 consecutive years.

Journal Entry at the end of each year for 5 consecutive years will be;

The depreciation charged every year will be added to the balance of accumulated depreciation. Then, the entire amount of accumulated depreciation is reduced from the gross amount (cost) of the machine in the balance sheet to arrive at the net value.

Journal Entry at the end of 5th year ie. on 31/12/20×5 to remove the machine and accumulated depreciation from the entity’s accounting records will be;

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In simple words, a petty cash book which is usually prepared by the ordinary or imprest system is a book of accounting prepared for the purpose of recording expenses of small value. For example stamps, wages, postage, carriage, stationery, etc.

The two types of petty cashbook are:

1. Simple petty cashbook – In this type of book, receipt of any amount is recorded on the debit side cash column and the payments on the credit side cash column. It is similar to a cashbook.
2. Analytical petty cashbook – In this type of book, a separate column is maintained for each commonly occurring expense. For miscellaneous payments, a column of sundries is added.

The pdf containing a format for both types of petty cashbooks is attached as follows.

petty cashbook formats

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Types of Financial Statements

• Statement of financial position

A statement of financial position is also known as a balance sheet. It comprises a company’s assets, liabilities, and equity. With the help of a balance sheet, the financial position of a company is displayed on a particular date which is usually at the end of a fiscal period.

Presentation of a balance sheet.

Balance sheet as of 31st March, YYYY

• Income statement

Unlike a balance sheet, the income statement of a company shows the revenues, expenses, net income, and earnings per share. It is also referred to as the profit and loss a/c. It is the most important financial statement because it depicts the overall performance of a company.

The sales of a company are put forward followed by the deduction of all expenses to ascertain the net profit or loss. In case the public companies issue the financial statements the earnings per share figure might also be added.

Presentation of an Income statement

• Cash flow statement

As the name suggests, a cash flow statement shows the monetary position of a company with the help of cash inflows and outflows during a particular financial period.

It is broadly divided into three categories, operating activities, investing activities, and financing activities. It measures how a company pays off its liabilities, and funds its expenses and investments.

Presentation of a cash statement

• Statement of changes in equity

This financial statement shows the changes in owners’ equity over a financial period. The changes are observed through the net profit or loss in the income statement, the issuance or repayment of the share capital, payment of dividends, the gains or losses recognized in equity, etc. It Is also referred to as the statement of retained earnings.

>Read Where is Amortization Shown in Financial Statements?

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No, an invoice is not a receipt.  To make the concept easy and understandable I would like to first explain the meaning of Invoice and Receipt followed by an example of each and Key differences between them. I would like to conclude my answer with a snippet of the Invoice and Receipt.

Meaning of Invoice

Invoice refers to a legal document issued by the person who is selling the goods and services to the person who is purchasing/buying these goods and services. An Invoice is issued to make payment. The person who sells goods and services is called a seller (or) vendor and the person who buys goods and services is called a customer (or) buyer.

Example- When we purchase any product from the online store (or) perform online shopping, then the seller of the goods (or) service provides an invoice to the customer thereby allowing the customer to make payment after the delivery of the goods.

Meaning of Receipt

Receipt refers to the acknowledgement of payment which states that seller (or) vendor of goods and services has received payment from the customer (or) buyer of goods and services. It is conclusive proof that payment has been made by the customer. In the case of transmission of goods, it acts as proof of ownership. It is also a legal document similar to an invoice.

Example- When you go to a grocery store (or) supermarket for purchasing various products, after making the payment the staff member gives you an acknowledgement. Thus this acknowledgement is known as a receipt.

Key Differences between Invoice and Receipt

The following are the major key difference between receipt and invoice

I would like to add a snippet of the invoice and receipt for a clear and better understanding

 Invoice

Receipt

Cash receipt of ABC Ltd is shown below

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No, Goodwill is not a fictitious asset.

What is Goodwill?

The goodwill of an entity is an intangible asset. It can be said that it’s the excess amount an entity is liable to pay when it purchases all the assets at a price higher than the fair market value of another entity. The purchasing entity is willing to pay the higher amount reasons such as brand image, modernised technology, high-grade employee relationships etc.

The goodwill is valued at the time of the merger of two or more entities or the acquisition of one by another entity.

It is generally noticed that better the organisation’s reputation higher is the value of goodwill.

What is a Fictitious Asset?

Fictitious means “Bogus” or “Untrue” and asset means anything beneficial for the organisation.
Thus fictitious assets are not an asset but just the expenses or losses which can not be accounted for in the current reporting period rather are to be written off in the future reporting period.

For Example,

• Preliminary Expenses
• Miscellaneous Expenses
• Loss on Issue of Debentures
• Discount on Share Issue.

Why is goodwill not a fictitious asset?

Goodwill is an intangible asset and not a fictitious asset. A fictitious asset does not have a realizable value as it is merely an expenditure incurred by the company. It does not have a tangible existence either. Whereas goodwill has a monetary value i.e it has a realizable value even though it has no tangible existence.  Hence, it’s an intangible asset.

Goodwill is presented in a balance sheet as;

>Related Long Quiz for Practice Quiz 30 – Fictitious Assets

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When a sum of money is received by the company before providing the goods or services, it is known as an advance received from the customer.

It could be due to many reasons such as demand for security deposit by the landlord, payment security for purchasing goods in bulk, confirmation of the order, etc. It can also be referred to as Unearned Income or Deferred Revenue. 

No, advance received from a customer is not treated as revenue. It is treated as a current liability, according to the accrual basis of accounting, because the amount is not yet earned. It is recorded on the liabilities side of the balance sheet until an invoice is sent to the customer.

After the customer is billed or invoiced, the advance received shown on the liabilities side of the balance sheet is removed and recorded as revenue. Once the revenue is earned, there will be a decrease in liability by that amount and an increase in the revenue.

Example

Mr K ordered cellphones in bulk from XYZ Ltd. and made an advance payment of 40,000 on the 5th of May. When the order was ready an invoice was sent to Mr K on the 5th of June of the same financial year. The journal entries in the books of XYZ Ltd. are as follows;

(being advance received from the customer)

(being customer invoiced)

(being Mr K’s advance account cleared)

Placement in the Income Statement

(Extract of Income Statement)

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A ledger account consists of the financial transactions of a business. It is generally used by accountants to record summarized monetary transactions. It is also known as the principal book of accounts and books of final entry.

As per my understanding, the ‘Debit and Credit format’ refers to a ‘Ledger account format’.

Note

• The ledger account consists of two sides namely, debit and credit. The left-hand side represents the debit balance and the right-hand side represents the credit balance.
• The posting into a ledger account is done from the journal entries of the company or the various subsidiary books.
• Each Journal entry is moved into a separate ledger account.

Example

Considering the journal entries of ABC Ltd., post the same into ledger accounts.

Cash A/C

(The cash a/c has a debit balance as it is an asset.)

Machinery A/C

(The machinery a/c has a debit balance as it is an asset.)

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Negative Goodwill

Yes, I believe goodwill can have a negative balance. We call this negative goodwill “Bargain Purchase“.

It’s a difference between the purchase price paid for an asset and its actual fair market value. Although you should know that it’s an extremely rare case scenario.

Negative Goodwill v/s Goodwill

I think if you get an idea of the difference between the two you will be in a better position to understand why it arises and what exactly does it mean.

• Negative goodwill is exactly opposite to goodwill as while goodwill is favourable for the seller the bargain purchase is not favourable for his company
• Negative goodwill arises when the purchase price of an asset is lower than its market value.
• Whereas in the case of goodwill the purchase price is higher than its market value. To simply state it goodwill is a premium paid by the buyer for the assets of such another company.
• While negative goodwill is favourable to the buyer the positive goodwill is favourable to the seller.

In case of a bargain purchase, the Purchase Price of an Asset < its Fair Market Value

the above statement could be interpreted with the help of a below-mentioned example

The company ABC faced financial distress for a few years and hence the board of directors had only 2 alternatives left i.e either to sell the company or file for liquidation. The company was hence sold for an amount lower than its fair market value

It is reflected from below mentioned illustration

You would doubt that even though the goodwill can have a negative balance how shall it be presented in the Financial Statements.

Negative Goodwill in an income statement

It should be recognized as a “gain on acquisition “ in the income statement of an acquirer.
The below image would be of some help-

Negative Goodwill in a Balance Sheet

It can be shown as a part of liability or as a negative balance in the books of Seller Company since it is unfavourable for such company whereas goodwill is shown as an intangible asset. Alternatively, such a negative balance can also be shown as a negative balance under the intangible asset.

I generally follow the alternative approach to present negative goodwill under the head of intangible assets but you can follow any method you are comfortable with since both are acceptable in the industry.

If you are still confused about how to present negative goodwill in a balance sheet perhaps the below-stated example may be of some help

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Branches of accounting

The types or branches of accounting are as follows:

• Financial accounting – Strict compliance with the generally accepted principles of accounting (GAAP) is observed while recording and classifying the business transactions and preparing the financial statements of a company. It primarily processes historical data in chronological order for external users.

• Managerial accounting – This branch of accounting focuses on preparing data related to the operations of a company which shall be beneficial for the managers in making key decisions. It does not strictly abide by GAAP and is for the internal users.

•  Cost accounting – It is similar to managerial accounting and is usually used in the manufacturing industries as they have lots of costs and resources to manage. As the name suggests, it focuses on classifying and recording the production costs (fixed as well as variable costs).

• Auditing – This branch of accounting is of two types, internal and external auditing. Internal auditing comprises how a company functions and distributes the accounting tasks among its employees, on the other hand, external auditing involves an independent third party that analyses a company’s financial statements and ensures that it abides by GAAP.

• Tax accounting – This focuses on the preparation of tax returns and planning. It enables a business in determining the income and other types of taxes, and how to legally minimize the amount of tax owed.

• Accounting Informations System – AIS, includes the management of accounting software, employees, and bookkeeping. It focuses on the monitoring, implementation, application, and observation of accounting systems.

• Forensic accounting – It is a trending branch of accounting. Forensic accounting focuses on the legal affairs of a business such as fraud, disputes, legal charges, claim settlements, etc.

• Fiduciary accounting – It refers to the management of property for a third party or business. The accountants manage the administration of a property. For example, trust accounting, estate accounting, etc.

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Accounts receivable as an asset

I think before getting onto this question you should have a clear idea about what does an account receivable means.

An account receivable refers to an amount due to be received by the company for the sale of goods or services rendered. It’s the value of goods that the customer has not yet paid even though he has received the title of goods or enjoyed services.

In simple words, any sum of money owed by a person for purchase made on a credit basis refers to an account receivable.

For Example,

Uber Inc. purchases 2000 units of smartphones from Apple Inc. for gifting them to its employees it purchases it on a 45 days credit and the amount remains due on a reporting date hence such an amount due becomes an account receivable for Apple Inc.

Moving ahead, the answer to your question is that ” account receivable is an asset”.

Why is it an asset?

As explained earlier accounts receivable is the money owed by the client to the company. Hence, it can be said that the company has a right to receive the money since it has already delivered a product or rendered service. Because of this, the customer must pay the company within a specific time frame.

And so it’s an Asset since it ensures the future economic benefit for the company.

The accounting treatment of such a transaction at the time of making a credit sale;

And at the time of actual receipt of cash;

It shall be presented in the balance sheet under the head of the current asset if the amount is receivable within a year and beyond that, it’s recorded under the head of non-current assets
In case you are unable to understand the position of such an item in a balance sheet the below example would be of great help

Why is it not revenue?

Revenue is the income generated by an entity. A major part of such revenue comes from sales or if an entity renders services from such services. It covers only that part of it pertaining to the current reporting period.

Whereas the balance in the accounts receivable includes the unpaid dues from the customers for the current reporting period and earlier reporting period.

Thus it can be said that the accounts receivable balance > amount reported in an income statement.

Because of the reasons stated above, it can safely be concluded that accounts receivable is an asset.

If the bad debts exist the company will have to reduce such balance from the total of accounts receivable and will have to debit it in its profit and loss statement.

I have tried to answer it as simply as I can and I hope it helps.

>Related Long Quiz for Practice Quiz 10 – Accounts Receivable – Intermediate

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I think firstly you should have a glance over the concept of cost centre and then try and apply the concept while interpreting below given example.

Meaning of a Cost Centre

It’s a smaller part of a larger organization wherein the manager of such a unit is responsible to keep costs in line or within the budget. Unlike profit centres, the managers of the cost centre do not have any direct responsibility for the profits of the organization.

Few Examples of Cost Centre

In the case of Walmart, its corporate office will have an accounting department, marketing department, information technology department. These departments do not generate any revenue.

Take up the Accounting department- one can not argue that the accounting dept. is responsible for generating revenue. It will have only one responsibility to incur costs within the specified budget.

In the case of XYZ Ltd., the marketing dept, finance dept and production dept are the primary cost centres but the sales executives Mr A, B and C are also considered as cost centres. This will help the organization track its performance.

In the case of ABC university the reading hall, computer lab and careers i.e its HR dept. are the cost centres as these departments only incur the cost and help in providing better educational services but the manager or an in charge of these departments are not engaged directly with generating revenue.

Here in the case of Uber Inc. the human resources department, project managers and customer service department are cost centres as these do not generate revenue directly.

We will analyse the HR department-It does not generate revenue as it’s the administrative department but it’s an essential part of an organisation. It helps in storing data of the employees, manages their complaints, hiring, promoting and terminating employees of the organisation.

The project managers are responsible to plan a project they are also responsible to prepare its budget and tracking its progress. They as such do not add up to the profit but are important to complete the project.

process-of-preparing-income-statement-from-trial-balance

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In the Income Statement, the Trading account represents the first part and the Profit & Loss account represents the second part.

The trading account gives the overall purview of all trading activities, such as the purchase and sale of products. It is prepared to ascertain gross profit or gross loss. The profit & Loss account gives the final working results of the business. It is prepared to ascertain net profit or a net loss.

Steps to prepare Income Statement from Trial Balance

All the debit side items related to expenses and credit side items related to income listed in the trial balance shall be posted on the debit side and credit side of the income statement respectively.

1. Post opening stock on the debit side of the income statement.

2. Post purchases and sales on the debit and credit side respectively. Deduct purchase return from Purchases and sales return from Sales to arrive at the Net Purchases and Net Sales.

3. Post all the direct expenses incurred for the purchase & production of goods eg. wages, factory rent, custom duty, carriage inward, manufacturing expenses, etc on the debit side.

4. Post the amount of closing stock stated in the adjustments.

5. Make all the necessary adjustments, if any, related to outstanding and prepaid expenses, goods withdrawn for personal use, goods destroyed, etc

6. Now, find out the gross profit or gross loss.
If the total of credit side > total of debit side ie. credit balance, then the amount of difference is gross profit.
If the total of debit side > total of credit side ie. debit balance, then the amount of difference is gross loss.

7. Carry forward the ascertained gross profit to the credit side or gross loss to the debit side of the second part of the income statement ie. profit & loss account.

8. Post all the indirect expenses such as office or administrative expenses, financial expenses, selling or distribution expenses, etc on the debit side of the income statement.

9. Post all the indirect incomes such as commission received, rent received, dividend received, etc on the credit side of the income statement.

10. Consider all the necessary adjustments, if any, such as outstanding and prepaid expenses, outstanding and pre-received income, reserve for doubtful debts.

11. Calculate depreciation and amortization on the assets and post the amount on the debit side.

12. Now, find out the net profit or net loss.
If the total of credit side > total of debit side ie. credit balance, then the amount of difference is net profit.
If the total of debit side > total of credit side ie. debit balance, then the amount of difference is a net loss.

These steps complete the process of preparation of income statement from trial balance.

Illustration

A snippet of the trial balance and income statement has been attached for better understanding.

Prepare Income Statement from the above-given Trial Balance.

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

Yes, investments are assets.

First, let me familiarize you with the meaning of the term investments in order to understand its nature.

Meaning of Investments

Investments are assets or resources owned and controlled by entities. They provide future economic value to entities. They are held with an intention to generate additional income or to benefit from the appreciation in value over time. 

Examples of investments
1. Investment in Mutual funds
2. Investment in Government securities
3. Investment in Debentures & Bonds
4. Acquiring Shares of companies
5. Acquisition of Land & Building to earn rentals or for capital appreciation
6. Investment in Subsidiaries, Associates, and Joint Venture

Analyzing the meaning of investments themselves, we can conclude that investments are assets for entities acquiring them.

Presentation of Investments in Financial Statements

1. Long-term Investments

Investments that are held for more than a period of 1 year are termed as Long-term Investments.

Examples

a. Investment in Real Estate to earn rentals or for capital appreciation
b. Purchase of Debentures or Corporate/Government Bonds having a maturity period of more than a year
c. Investment in Subsidiaries, Associates or Joint Venture

Treatment in Financial Statements

2. Short-term Investments

Investments that are held with an intention to dispose off within a period of 1 year are referred to as Short-term Investments. They are held primarily for the purpose of trading. They are also known as Marketable Securities.

Examples

a. Investment in Mutual Funds
b. Acquisition of Shares of companies

Treatment in Financial Statements

An extract of the balance sheet has been attached for a better understanding of the presentation of investment.

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

Yes. But first, let me familiarize you with the meaning of Chart of Accounts.

Meaning of Chart of Accounts

Chart of Accounts is a numbered listing (account codes) of the various accounts that form part of the accounting records of an entity. The codes used help to group similar accounts together. For e.g., if you want to see only the operating expenses incurred.

In this case, you need to enter only the range code assigned to operating expenses & you will get all the operating expenses transactions together in one place.

Chart of Accounts varies from one entity to another depending on the size of the entity.

Example of Chart of Accounts

In the example given below, 1st digit of the numeric codes signifies different account types. “1” represents assets, “2” represents liabilities, “3” represents equity, “4” represents revenues, & “5” represents expenses.

A downloadable excel sheet has been attached for your reference.

Example of Chart of Accounts

Meaning

Tangible assets are those assets that can be measured, touched, and felt. These are long-term assets. These assets are used to help produce goods and services.

These assets can be used as collateral when loans need to be borrowed. These assets are used for the long term and are very efficient for operational use. These assets need maintenance and repair.

Intangible assets are those assets that cannot be touched or felt but still hold value in the company.

These assets help as an advantage when there are competitors as it helps in brand recognition and reputation. This will lead to an increase in revenue due to the reputation. It also adds value to the financial reports.

List of Tangible and Intangible Assets

Notes

Intangible assets: (invisible)

1. Legal fees – It is an intangible asset as it refers to the fees incurred in the registration of trademarks and patents.
2. Patents – A patent is an exclusive right that is granted to an inventor by law which permits them to exclude anyone from producing, using, or selling their invention for a given period.
3. Licenses – It refers to a right that is purchased to operate a business.
4. Trademark – It is a legal right that protects the distinct identity of a company. It can comprise a name, logo, slogan, or anything that depicts a company’s unique identity.
5. Franchises – Franchises is a license/permission granted by the owner, under certain conditions, to produce or sell a product or service.
6. Goodwill – It refers to the reputation of a company which is determined by its profits and losses.
7. Copyrights – It is an intellectual property right obtained by a creator usually in the fields of art, music, literature, etc, which restricts a person from publishing the content without the consent of the owner.
8. Brand equity – Brand equity is the value of the unique identity of a business. It can be positive or negative.
9. Broadcast rights –  Broadcast rights refer to the rights obtained under a licensing agreement for broadcasting a program.
10. Research & Development –  Research and development includes the development of software and technological innovations for a company.

Tangible assets: (visible)

1. Plant & Machinery – Plant and machinery are used to convert raw materials into finished goods. They are recorded in the books of accounts at a depreciated value.
2. Cash and Cash equivalents – It refers to the cash in hand and cash at the bank. The cash equivalents are usually stated at the value they are convertible into cash.
3. Land & Building – It represents the ownership of a physical property of the business.
4. Equipment –  Equipment used in the production activities of a business.
5. Furniture & Fixtures – Furniture and fixtures are movable equipment that is a part of the office layout.
6. Inventory – Inventory is valuable items that are usually stored in a warehouse with a plan of being sold or utilized in the process of production.
7. Marketable securities – Marketable securities refer to the stocks, bonds, and shares that can be easily converted into cash.
8. Investments – Investments refer to a liquid asset that is purchased with the expectation of being sold in the future.
9. Raw materials – Raw materials are tangible materials used for manufacturing goods.
10. Vehicles – The vehicles used by the proprietor such as cars, trucks, or tractors used for the operating activities of a business.

>Related Long Quiz for Practice Quiz 26 – Intangible Assets

>Related Long Quiz for Practice Quiz 32 – Tangible Assets