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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.

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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.

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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

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Let’s first interpret the meaning and importance of the month-end close checklist.

Month-end closing is an accounting procedure that accountants usually undertake at the end of the month to close the accounting records for a particular month. So, a month-end closing checklist guides the entire month-end closing procedure.

It is crucial as it helps us remember things we might otherwise skip while finalizing the monthly books of accounts. Also, you can fix any discrepancies at the earliest, rather than it getting piled up at the year-end.

Month-end Close Checklist

Excel Download

A downloadable excel sheet has also been attached for your reference.

Month-end close checklist

Hope after reading this you might have got an insight into the checklist for month-end closing.

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Meaning of Core Business Operations

In layman’s language, the term “core business operations” refers to the organization’s main or essential area of activity for which it was founded or came into existence. It does not only focus on the mission and vision of the organization but also on building better business operations strategies by;

• Controlling market forces and supply chain management
• Improving the quality of technology
• Expanding the business marketplace and acquiring new businesses
• Increasing revenue generation
• Better customer base acquisition and customer relationship management
• Developing new areas of activities

It means that the success of an organization does not only depends upon the functioning and performance of various departments but also the company’s coordination in managing and performing various departmental activities for conducting the core business operations.

Examples of Core business operations/models

1. The core business model of Uber is to provide on-demand services to its users. It provides a virtual mobile platform that connects users with taxi or cab drivers. Although cab drivers use their cars while performing their services. Uber earns 20-30% of the total fare amount.

2. The core business model of Amazon is to provide an end to end virtual or e-commerce shopping experience to its customers. It connects customers (users) with the products listed by various trusted sellers. Amazon earns money through subscriptions for prime services, retail services and web services. Amazon charges 6%-25% professional fees on every product sold by the sellers on its platform.

3. The core business model of Walmart is to provide offline and online retail services such as health and fitness, grocery and general merchandise. Walmart charges only referral fees (based on the product category) and it does not impose any charges on maintaining seller accounts.

Core vs Non-core business operations

Example

1. Uber

• Core business operations– The core business operations of uber are mentioned above in example (1).
• Non-core business operations– Apart from the core business operations, uber performs a few non-core business operations such as Uber Eats which provides food delivery services to its users (customers)  is not the main/core business of Uber.

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Let me start with the term ledger balancing.

What is Ledger Balancing?

Balancing ledger accounts means totaling both the sides of the ledger account, finding the difference between the greater total & smaller total and then recording the difference on the smaller side.

If Debit side > Credit side, then we say that the ledger account has “Debit Balance”.
If Credit side > Debit side, then we say that the ledger account has “Credit Balance”.

Now, let’s move forward to discuss the question asked.

Why should a ledger be balanced?

Balancing a ledger account will help you with the following;

1. Necessary for preparation of trial balance

Trial Balance is a list of the debit and credit balances of all the ledger accounts prepared by the entity as on a specific date. Without balancing the ledger accounts, it is impossible to prepare the trial balance of an entity.

2. Necessary for the preparation of financial statements

Balancing of ledger accounts helps to prepare profit & loss account and balance sheet so as to ascertain the profit or loss and financial position of the business.

3. To determine the cash available

The amount of balance in Cash A/c gives an idea of the amount of cash available to the organization. The balance determined is compared with the actual cash available in the cash box. Discrepancies, if any are further investigated.

4. To determine the value of assets

Organizations need to know the book value of their tangible and intangible assets eg. plant & machinery, furniture, software, etc at the end of a period. So, the value of assets at a specific date can be determined only after balancing the asset ledger accounts. Assets accounts usually have a debit balance.

5. To ascertain the total expense and income

Ledger balancing of nominal accounts such as expenses eg. purchase, salary, professional fees, etc, and incomes eg. sales, interest earned, etc will indicate the number of expenses incurred and income earned during a specific period.

This will help in ascertaining the profit earned or loss incurred by the entity as the balances of nominal accounts get transferred to the statement of profit & loss. Also, the entity can make strategies to reduce the expenses if the current period expenses exceed the previous period expenses.

6. To ascertain the debt outstanding & the amount outstanding to creditors

Balancing ledger accounts pertaining to bank loans or other loans accepted will help you determine the principal amount outstanding at a given date.

Also, balancing the supplier’s accounts will help you ascertain whether the amount is payable to the supplier (credit balance) or whether you have already made advance payments but the corresponding goods or services are yet to be received (debit balance).

7. To determine the amount receivable from debtors

Balancing the debtor’s accounts will help you ascertain the amount due from your debtor (debit balance) at a particular date. In case, the debtors have already made advance payments but you haven’t rendered the corresponding goods or services, then the account will present a credit balance.

Conclusion

A ledger must be balanced because of the following reasons:

• It is necessary for preparation of trial balance.
• It is necessary for the preparation of financial statements.
• Helps to determine the cash available.
• To determine the value of assets.
• To ascertain the total expense and income.
• To ascertain the debt outstanding & the amount outstanding to creditors.
• To determine the amount receivable from debtors.

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The bank reconciliation statement (BRS) is prepared by the accountant of the business. It is prepared periodically to match all the bank transactions in the cashbook with the bank statement and ensure the accuracy of the same.

The questions of who, why, and when usually go hand in hand, therefore, I would like to familiarize you with all the three, in brief, to make the concept simpler.

Why and when is a bank reconciliation statement prepared?

After a brief introduction, you might be wondering why and when is a bank reconciliation statement prepared by the accountant. As the closing balance of the cash book and that of the bank statement do not match in the books of accounts the accountants maintain a bank reconciliation statement. There are plenty of reasons why the balances do not match and some of them are as follows:

• The rate of interest or charges was not known at the time of recording transactions therefore no account is found.
• Cheques were issued by the company but not cleared by the bank.
• There is a mismatch in the date of entry and date of credit.

Due to some of the reasons as mentioned above, the closing balance in the books of accounts of the organization and that of the bank will not match, therefore, the accountants maintain a bank reconciliation statement depending on the value of the transactions.

In case the value of the transactions is high, the statement is reconciled on a daily or weekly basis whereas in the case of small transactions it is usually done monthly or as per the will of the organization.

Steps in preparation of a bank reconciliation statement

The following steps are usually followed by the accountants to prepare a BRS:

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What is Amortization?

Amortization can be referred to as the depreciation of intangible assets such as goodwill, patent, trademarks, copyrights, computer software, etc. It is the reduction in the value of intangible assets over a period of time.

Intangible assets having definite useful life lose their value over time due to technological changes, contract expirations, etc. So, finite-life intangible assets are amortized on a straight-line basis over the period of their estimated useful lives.

Journal Entry

The journal entry for charging amortization expenses in the books of accounts is as follows-

Rules as per the Modern Approach

Rules as per the Traditional  Approach

Treatment in the Financial Statements

Amortization expenses are shown in the Balance Sheet and the Profit and Loss account.

Let us also understand the same with the help of an example.

Example

Suppose Infosys Inc. acquired a new computer software for 1,000,000 in the month of January 20×1. The estimated useful life of the software is 5 years.

In this case, computer software worth 1,000,000 will be recorded as an intangible asset at the time of acquiring the software.

However, it will be amortized at the end of each year for 5 years on a straight-line basis ie. 200,000 will be recorded as an expense and will be written off from the amount of software each year for 5 consecutive years.

An extract of Profit & Loss A/c and Balance Sheet has been attached below for a better understanding of the presentation of amortization expenses.

The above profit & loss extract shows that 200,000 has been recorded as amortization expenses for the period Jan-Dec 20×1.

The above balance sheet extract shows 200,000 amortization expenses written-off from the amount of computer software for the period Jan-Dec 20×1. The balance of 800,000 will be proportionately written off in the next 4 years.

Conclusion

The above discussion may be summarised as follows:

• Amortization is the reduction in the value of intangible assets over a period of time.
• Intangible assets such as Goodwill, Patents, Trademarks, Copyrights, etc. are amortized.
• In the Profit and Loss Account, amortization is presented as “Depreciation and Amortization Expenses” under the head Expenses.
• In the Balance Sheet, it is reduced from the respective Intangible Assets under the head “Non-Current assets”

>Related Long Quiz for Practice Quiz 15 – Amortization

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An entity should not recognize a contingent asset in the financial statements. It can only be disclosed considering the probability of the inflow of economic benefits associated with the contingent asset.

A tabular representation of the question asked – When, Where & How to disclose Contingent Assets has been presented below.

When, Where & How to disclose Contingent Assets

Moving forward, let me also make you understand the disclosure with the help of an example.

Example of Disclosure of Contingent Assets

A fire broke out in the factory of ABC Jute Ltd destroying the entire jute worth 44,000,000. The jute destroyed was covered under an insurance policy. The policy prescribed acceptance of the amount of claim, amounting to 80% of the jute destroyed ie. 35,200,000 (80% * 44,000,000).

Before the end of the financial year, ABC Jute Ltd received informal information from the insurance company that their claim has been processed and the payment has been dispatched for the claim amount.

Suggest when, where & how to disclose this transaction in the financial statement.

Solution

There is a possible asset (claim amount) & the inflow of economic benefits is also probable ( > 50% – 95% probability). Therefore, ABC Jute Ltd can treat and disclose this as a Contingent Asset. Disclosure shall be made in the Notes to Accounts or Report of Board of Directors, considering the requirements of the accounting standards.

The following disclosure shall be made by ABC Jute Ltd as of the end of the reporting period:

Notes to Accounts(Financial Statements)/Report of Board of Directors

Contingent Asset

ABC Jute Ltd has filed for the receipt of the insurance claim amount of 35,200,000 (44,000,000* 80%) to the insurance company, in respect of the jute destroyed.
The inflow of economic benefits has been considered as probable because it has received informal information from the insurance company that their claim has been processed and the payment has been dispatched.

Hope you got an insight into the disclosure requirements of Contingent Assets.

>Related Long Quiz for Practice Quiz 18 – Contingent Assets

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Accumulated Depreciation

Depreciation is a wear and tear of an asset due to the efflux of time and various other factors. It’s basically an allocation of the cost of a tangible asset over its useful life.

Accumulated depreciation is the total depreciation charged on an asset until a specified date. It’s a contra asset account. And since it’s a contra asset account it reduces the balance of an asset i.e reduces debit balance and therefore has a credit balance.

Accumulated Depreciation is an Asset or a Liability?

Well if you ask me I would say that it’s neither an asset nor a liability.

Reasons to justify the above statement:

Why is it not an asset?

Assets are the resources held by an entity so that they could provide some economic value for the entity. But, in the case of accumulated depreciation, it does not generate any economic benefit for an entity rather it indicated that a certain sum of economic benefit has already been availed.

Why is it not a liability?

A liability is an obligation of an entity for making payment at a specified future date to a third party. Here, accumulated depreciation does not represent an obligation of an entity rather it is maintained just for the purpose of record-keeping.

Conclusion

According to the reasons mentioned above, it can neither be called an asset nor a liability. This would be the correct answer to this question.

But still, if you have to compulsorily classify the same as an asset or a liability I would definitely not classify it as a liability as it would not ensure fair representation of the financial statements since then it would be considered an obligation made to a third party which is not the case here.

>Related Long Quiz for Practice Quiz 39 – Depreciation

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A question often asked is, “Is bad debt an asset or liability?”. Let us try to understand this concept in detail.

What are Bad Debts?

In layman’s language, a Bad Debt is a non-cash expense incurred by a business when the debtor does not repay the amount owed by him in due course of time for reasons such as fraud, insolvency of the debtor, etc.

We can also refer to them as Uncollectible Accounts Expenses and Irrecoverable Debt.

What is a Liability?

Liabilities refer to the financial obligations of a business. In simple words, it is a sum of money owed by a debtor to a creditor under an agreement and is repayable on a specified period. For example, Bank Loans, Accounts Payable, Bank Overdrafts, etc.

Are Bad Debts an Expense or a Liability?

Bad Debts are an expense to the business and not a liability as the amount that was expected to be received from the debtor is irrecoverable and has a negative effect on the books of accounts by way of reduction from the accounts receivable.

It is recorded on the asset side of the balance sheet. However, it is entered in the balance sheet as a contra asset account, i.e. as a reduction from the accounts receivable. It is also recorded under operating expenses in the Income Statement as well as in the profit and loss a/c on the debit side.

Therefore, we can easily conclude now that bad debts are an expense and not a liability.

This concept is further explained with an example stated below.

Example

XYZ Ltd sells machinery to ABC Ltd. for 5,000 at 60 days credit. However, ABC Ltd has been declared bankrupt and can no longer pay the specified amount. This amount of 5,000 is a non-cash expense for XYZ Ltd and leads to a fall in the accounts receivables. Hence, it is a bad debt. It is not a liability for the company but an expense.

Bad Debts Shown in the Income Statement

An extract of an Income Statement showing Bad debts is given below:

What is Provision for Bad Debts?

When a business anticipates that a debtor may not repay the money owed by him, it prepares a Provision for Bad debts. This helps the business in preparing for any loss that may occur in the future.

Conclusion

The key takeaways from the above discussion are as follows:

• A Bad Debt is a debtor who fails to repay the amount he owes to the business.
• Liabilities refer to the financial obligations of a business.
• Bad Debts are an expense to the business and not a liability.
• It is entered in the balance sheet as a contra asset account, i.e. as a reduction from the accounts receivable.

>Read

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The term negative working capital is derived from the concept of working capital. To begin with, I would like to briefly explain the meaning of working capital.

In simple terms, Working Capital refers to the total amount of current assets excluding the total amount of current liabilities in a business. It can have a positive or a negative value, wherein the two are an indicator of the well-being of a business. The formula to calculate working capital is as follows:

Negative Working Capital

In simple words, Negative working capital refers to the excess of net current liabilities over the net current assets. As the word itself suggests, a ‘negative’ working portrays a downfall in the financial position of a business and its inefficient functioning.

A company is said to be facing financial difficulty and is not in a position to pay off its debts when the value of working capital is negative.

Example

Calculate the working capital of XYZ Ltd.

(Extract of Balance Sheet)

Note: As we can see the total current liabilities of XYZ Ltd. are exceeding the total current assets therefore, the working capital is negative.

Working capital = Total current assets – Total current liabilities

= 1,13,000 – 1,26,000

= (13,000)

>Related Long Quiz for Practice Quiz 33 – Working Capital

Overview of Purchase Return

When the buyer of goods returns the goods purchased back to the seller, the transaction is referred to as purchases return. The buyer may return the goods to the seller (the creditor) due to excessive purchases, defective goods, or any such reason. For recording this transaction, adjustments can be made to the Purchase A/c or a separate Purchase Return A/c can be created in the books of the buyer.

The purchase return account is credited for recording the transaction and the respective accounts payable are debited.

When the goods purchased by the business on credit are returned to the seller, it reduces the Accounts Payable and is a ‘gain’ or ‘income‘ for the organization, hence purchase return is a nominal account.

As per Modern Rules

Purchase Return (Income) is Credited (Cr.) when increased & Debited (Dr.) when decreased.

Why is it like this?

This is a rule of accounting that is not to be broken under any circumstances.

How is it done?

For instance, you own a trading business and you purchased goods on credit from the supplier. Upon receiving the stock, you find a few defective items which you return to the supplier. In the financial books, the Purchase return account will be credited since it is an increase in income for the organization.

Given below is the timeline of how it would be recorded in the financial books.

Step 1 – The following journal entry is recorded in the books of accounts when the defective items are returned. (Rule Applied – Cr. the increase in income or revenue)

(Goods sent back to suppliers)

Step 2 – To transfer the income to “Trading A/c”.

(Goods returned are transferred to the trading account)

As per the Golden Rules of Accounting

Purchase Return (Income) is Credited (Cr.)

As per the golden rules of accounting for (nominal accounts) incomes and gains are to be credited.

The account of expenses, losses, incomes, and gains are called Nominal accounts. The balance of these accounts is always zero at the beginning of the financial year. Since the purchase return is an income for the business, it is to be credited.

Example

For instance, you manufacture bottles but a part of the raw material you purchased from the supplier is not of the required quality so you return the material to the supplier. In the financial books, the Purchase return account will be credited because it is an income for the organization since the amount payable to the supplier decreases.

Below is the timeline of how it would be recorded in the financial books.

Step 1 – For the above example, the journal entry for the raw material returned, “Purchase Returns A/c” is credited. ( Rule Applied – Cr. all incomes and gains)

(Raw material sent back to suppliers)

Step 2 – To transfer the income to the “Trading Account”

(Materials returned are transferred to the trading account)

Purchase Return Inside Trial Balance

Purchase returns show a credit balance in the trial balance. A trial balance example showing a credit balance for purchase returns is provided below.

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Sales Return and Allowances

When the goods or commodities are sold by the dealer or a manufacturer to the customer and the customer returns these goods or part thereof then such return made by the customer is called a sales return for the seller or the dealer.

It’s a contra revenue account. It is reduced from the total sales amount. Generally, it is recorded in the “Sales Return and Allowance Account”.

Accounting Treatment of Sales Return in Books of Accounts;

When initially the goods are sold on credit and later on a part of them are returned the journal entry shall be,

When goods are sold initially for cash and later on a part of them are returned;

Example

You have a stationery store and a customer placed an order to buy 4 packs of blue gel pens but mistakenly you delivered 3 packs of blue and 1 pack of black pens. Each pack is sold for an amount of 100.

Initially, you must have recorded sales in your book as;

Now, the customer placed an order for 4 packs of blue gel pens and you sent 3 packs of blue gel and 1 pack of black gel pens hence, the customer returns a pack of black gel pens.

Now, you will record this return in your books as;

Sales Allowance

When the goods are sold by the seller or the dealer and a few of them are defective or damaged or not as per the specification for that matter then to maintain the relationship with the customer the seller sometimes grants allowances.

Such allowances granted are called sales allowances. It is a contra revenue account. And hence, it’s reduced from the total sales.

Accounting Treatment

When initially the goods are sold on credit and later on it was discovered that a part of them are defective the seller extends some allowance. The journal entry for this transaction shall be;

When initially the goods are sold on a cash basis and later on it was discovered that a part of them are defective the seller extends some allowance. The journal entry for this transaction shall be;

For Example,

Mr Alex has a business dealing in shirts. He sold 10 shirts to Mr Allen. The price of each shirt was 100 and so Mr Allen immediately paid 1000 cash.

At the time of initial recognition of sales, Mr Alex recorded it in his books as;

Later on, Mr Allen found that one of the shirts was defective and hence, he gave an intimation of the same to Mr Alex. Mr Alex agreed to give him an allowance and thus gave him a 50% discount on that shirt. The journal entry for the same shall be –

The sales are recorded as a net of all the returns and allowances made by the seller during the accounting period.

The following image illustrates the formula for net credit sales;