Prepaid expense means a service to be rendered in the future period for which the business has already paid the remuneration. Prepaid expenses are classified as assets. The benefits of this payment will accrue to the business at a later period. For example, insurance is often paid for annually on tRead more
Prepaid expense means a service to be rendered in the future period for which the business has already paid the remuneration. Prepaid expenses are classified as assets. The benefits of this payment will accrue to the business at a later period.
For example, insurance is often paid for annually on the basis of the calendar year. A business may pay insurance every year on 1st January for that entire year. While preparing the financial statements on 31st March, it will recognize the insurance premium for the period 1st April to 31st December of the next financial year as a prepaid insurance expense.
Why are prepaid expenses classified as assets?
First of all, let us understand what an asset is. An asset is anything over which the business has ownership rights and which it can sell for money. The benefits of this asset should accrue to the business.
In light of this definition, let us analyze prepaid expenses as an asset. As the business has already paid for these goods or services, it becomes a legal right of the business to receive the relevant goods or services at a later date. As the benefit of this expense would accrue to the business only at a later date, the prepaid expenses are classified as an asset.
Some examples of prepaid expenses are prepaid insurance, prepaid rent etc
Treatment of Prepaid Expenses
Prepaid expenses are recorded in the balance sheet under the heading “Current Assets” and sub-heading “Other Current Assets”
As per the Generally Accepted Accounting Principles or GAAP, expenses must be recognized in the accounting period to which they relate or in which the benefit due to them is likely to arise. Thus, we cannot recognize the prepaid expenses in the accounting period in which they are incurred.
Prepaid assets are classified as assets and carried forward in the balance sheet to be debited in the income statement of the accounting period to which they relate.
Adjusting Entries
Adjusting entries are those entries that are used to recognize prepaid expenses in the income statement of the period to which they relate. These entries are not used to record new transactions. They ensure compliance with GAAP by recognizing the expenses in the period to which they relate.
Conclusion
The GAAP and basic definition of an asset govern the treatment of prepaid expenses as an asset. The business incurs them in an accounting period different from the accounting period in which their benefit would accrue to the business. The business has a legal right to receive those goods or services.
The business carries them as a current asset on the balance sheet. In the relevant accounting period, they are recognized in the income statement.
Introduction Definition of prepaid expenses Definition of Current assets and Current Liabilities with examples Current Assets or Current Liabilities How to classify prepaid expenses for business owners and financial professionals. Answer the question "is it a CA or CL and don't forget to explain whyRead more
Introduction
Definition of prepaid expenses
Definition of Current assets and Current Liabilities with examples
Current Assets or Current Liabilities
How to classify prepaid expenses for business owners and financial professionals.
Answer the question “is it a CA or CL and don’t forget to explain why”.
Why are they CA and not why CL this question must be answered.
Accounting treatment of prepaid expenses
How prepaid expenses are recorded in financial statements
The impact of classifying prepaid expenses as current assets or current liabilities on a company’s financial statements
Conclusion
Recap of the main points discussed
Importance of proper classification of prepaid expenses for accurate financial reporting
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side. The profit is shown as the credit balance of profit and loss A/c. When the sum of itRead more
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side.
The profit is shown as the credit balance of profit and loss A/c. When the sum of items on the debit side of a profit and loss account is less than the sum of those on the credit side, it implies profit while when the sum of the items on the credit side is less than the sum of those on the debit side, it implies a loss for the entity.
The Reason for Credit
Profit is recorded as an increase in equity
To understand the reason why profit is recorded as a credit balance, we must first understand the basic principle of debit and credit.
The basic principle of debits and credits is that debits increase asset accounts and decrease liability and equity accounts while credits decrease asset accounts and increase liability and equity accounts.
The revenue that a company earns is credited to the income account and increases equity.
The expenses that a company incurs to earn that revenue are debited to the expense account and decrease equity.
The difference between revenue and expenses is the profit, which is recorded as an increase in equity.
Increase in equity due to revenue – decrease in equity due to expense = profit
Gross Profit Vs Net Profit
Revenue is the total income that a business or profession earns. Profit is the excess revenue that remains after reducing all expenses from it.
Gross profit is the profit that a company earns after reducing the cost of goods sold from sales revenue while net profit is the profit that a business earns after reducing the total of all its direct and indirect expenses from its direct as well as indirect allowable business income.
Conclusion
The basic principle of debit and credit governs the classification of profit as a debit or credit. Since profit increases our equity, it is a credit.
In the case of a company, it belongs to the shareholders. It is usually recorded in the retained earnings account. Profit can be reinvested in the business or can be distributed as a dividend. In the case of a sole proprietorship, the profit belongs to the owner and is recorded in the owner’s capital account.
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and otherRead more
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs.when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and other such things.
Instructions – you can delete it after done with the answer. Points which can be covered, not necessary to cover all but you can take what you want leave out rest. Introduction: Definition of trial balance Importance of trial balance in accounting Purpose of trial balance: To verify the arithmeticalRead more
Instructions – you can delete it after done with the answer.
Points which can be covered, not necessary to cover all but you can take what you want leave out rest.
Introduction:
Definition of trial balance
Importance of trial balance in accounting
Purpose of trial balance:
To verify the arithmetical accuracy of the ledger
To ensure that all transactions are recorded
To identify any unbalanced entries in the ledger
How trial balance is prepared:
Step 1: Gather all ledger accounts and their balances
Step 2: Arrange the accounts in order of their nature (assets, liabilities, equity, income, and expenses)
Step 3: Total the debit balances and credit balances separately
Step 4: Compare the total debit balances with the total credit balances
Types of trial balance:
Unadjusted trial balance: prepared before adjusting entries are made
Adjusted trial balance: prepared after adjusting entries are made
Post-closing trial balance: prepared after closing entries are made
The correct answer is option B. Wages and salaries are debited to the trading account. The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities. Let us discuss the above items and their treatments inRead more
The correct answer is option B. Wages and salaries are debited to the trading account.
The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities.
Let us discuss the above items and their treatments in the final accounts one at a time:
Wages Outstanding
Firstly, “wages outstanding” is not debited into the trading account. It is a liability that is shown in the balance sheet.
Outstanding wages imply remuneration due to be paid to the workers for the services they have already rendered to the business.
Since the company has already received the service, it becomes a legal obligation for it to pay the wages to the workers for those services. Hence, outstanding wages are a liability.
Wages and Salaries
Wages and Salaries are debited to the trading account.
Wages Vs Salaries
Let us understand the difference between wages and salaries. Wages are the regular payments that are made daily, weekly or fortnightly. Such payments are mostly made to factory workers.
Salaries, on the other hand, are assumed to imply the remuneration paid to office workers and sales staff.
Wages are debited to the trading account, while salaries are debited to the Profit and Loss account.
Director’s Remuneration
No, the director’s remuneration is not debited to the trading account. This is because director’s generation is a business expense. It is a kind of salary provided to the director for the services rendered by him to the company.
Directors’ remuneration refers to compensation the company gives to its directors for the services rendered. It is debited to the Profit and Loss Account.
Advance Payment of Wages
No, advance payment of wages is not debited to a trading account. It is shown by reducing it to wages. Advance payment of wages implying paying remuneration to the workers before the commencement of the period for which the wages relate to.
However, one must note that if both wages and prepaid wages appear within the trial balance, then only the figure written against wages would appear in the trading account. There would be no treatment for prepaid wages.
Let us consider a scenario where wages of amount 5,000 is appearing inside trial balance. Outside the trial balance, the following information is provided
Wages prepaid for the current financial year = 1,000
Wages prepaid for the next financial year = 2,000
In the above case, the total wages to be debited to the trading account would be 5,000 + 1,000 – 2,000 = 4,000
Significance of the Final Accounts
It helps in determining the net profit or loss of the entity for the current financial year.
It is a major source of guidance for investors. Shareholders decide whether or not to invest in a company on the basis of final accounts.
It allows banks and investors to see your business’s total income, debt load a,nd financial stability.
What is net credit sales? Net credit sales are those revenues by a business entity, less all sales returns and allowances. Immediate payment in cash is not included in net credit sales. Formula The formula for net credit sales is as follows: Net credit sales = Sales on credit - Sales returns - SalRead more
What is net credit sales?
Net credit sales are those revenues by a business entity, less all sales returns and allowances. Immediate payment in cash is not included in net credit sales.
Formula
The formula for net credit sales is as follows:
Net credit sales = Sales on credit – Sales returns – Sales allowances
In the balance sheet, you can find credit sales in the “short-term assets “section. It can be calculated from account receivables, bills receivables, and debtors of the balance sheet.
Sales return: A sales return is when a customer or client returns or sends a product back to the seller. And this can happen due to various reasons, including:
Excess quantity ordered
Not upto Customer expectations
Shipping delays ( product arrived late )
Accidentally ordered an item and there can be more such reasons.
Sales allowance: A sales allowance is a discount that a seller offers a buyer as an alternative to the buyer for returning the product.
Because of a problem or issue with the buyer’s order or we can say that he is not satisfied with the product.
Cash sales: Cash sales are sales in which the payment is done at once or I can say that buyer has obligation to make payment to the seller.
Cash sales are considered to include bills, checks, credit cards, and money orders as forms of payment.
Example
Now after understanding the terms used in the formula let me explain to you with an example which is as follows:-
First, we will calculate the Total Sales for the Period:- In the month of May, Flipkart company had cash sales of Rs 80,000. The total amount in Accounts Receivables is Rs 150,000, with Rs 30,000 as the carryover from April’s receivables.
Since you only want to know about credit sales in the current period (September), you subtract Rs 30,000 from the total. This means that for the month of September, Flipcart Company had sales totaling Rs 200,000 (80,000 + 120,000).
Second, we will subtract the Sales Returns:- During the month of September, Flipcart Company issued Rs 20,000 in refunds, because several items were damaged during shipment, so the customer could not use them.
This amount would reduce the total number of cash sales if the accounts receivable balance was from a credit customer. This reduces the total sales to Rs 180,000 (Rs 200,000 in total sales – Rs 20,000 in returns).
Thirdly we will subtract the Sales Allowances:- Sales allowances are discounts offered to customers for not asking for full refunds.
For example, an item that had been shipped to a customer was the wrong size, but the customer told that he will agree to keep the item if the price could be adjusted. Flipcart Company issued Rs 10,000 in allowances in May.
After this deduction, the total sales for May are Rs 170,000 (Rs 180,000 – Rs 10,000).
Then at last there are any cash sales then subtract:- After figuring out the total number of sales for September and then subtracting the sales returns and allowances, the cash sales are deducted since you are focusing on net credit sales for the period.
After deducting the Rs 60,000 in cash sales, Flipcart Company has Rs 110,000 as net credit sales.
Why do we need net credit sales?
Net Credit sales help to calculate the accounts receivable turnover ratio.
Net credit sales also indicate the amount of credit you offer to your customer.
Net credit sale is also used to calculate other financial analysis items like days sales outstanding.
Are prepaid expenses an asset?
Prepaid expense means a service to be rendered in the future period for which the business has already paid the remuneration. Prepaid expenses are classified as assets. The benefits of this payment will accrue to the business at a later period. For example, insurance is often paid for annually on tRead more
Prepaid expense means a service to be rendered in the future period for which the business has already paid the remuneration. Prepaid expenses are classified as assets. The benefits of this payment will accrue to the business at a later period.
For example, insurance is often paid for annually on the basis of the calendar year. A business may pay insurance every year on 1st January for that entire year. While preparing the financial statements on 31st March, it will recognize the insurance premium for the period 1st April to 31st December of the next financial year as a prepaid insurance expense.
Why are prepaid expenses classified as assets?
First of all, let us understand what an asset is. An asset is anything over which the business has ownership rights and which it can sell for money. The benefits of this asset should accrue to the business.
In light of this definition, let us analyze prepaid expenses as an asset. As the business has already paid for these goods or services, it becomes a legal right of the business to receive the relevant goods or services at a later date. As the benefit of this expense would accrue to the business only at a later date, the prepaid expenses are classified as an asset.
Some examples of prepaid expenses are prepaid insurance, prepaid rent etc
Treatment of Prepaid Expenses
Prepaid expenses are recorded in the balance sheet under the heading “Current Assets” and sub-heading “Other Current Assets”
As per the Generally Accepted Accounting Principles or GAAP, expenses must be recognized in the accounting period to which they relate or in which the benefit due to them is likely to arise. Thus, we cannot recognize the prepaid expenses in the accounting period in which they are incurred.
Prepaid assets are classified as assets and carried forward in the balance sheet to be debited in the income statement of the accounting period to which they relate.
Adjusting Entries
Adjusting entries are those entries that are used to recognize prepaid expenses in the income statement of the period to which they relate. These entries are not used to record new transactions. They ensure compliance with GAAP by recognizing the expenses in the period to which they relate.
Conclusion
The GAAP and basic definition of an asset govern the treatment of prepaid expenses as an asset. The business incurs them in an accounting period different from the accounting period in which their benefit would accrue to the business. The business has a legal right to receive those goods or services.
The business carries them as a current asset on the balance sheet. In the relevant accounting period, they are recognized in the income statement.
See lessPrepaid expenses is current assets or current liabilities?
Introduction Definition of prepaid expenses Definition of Current assets and Current Liabilities with examples Current Assets or Current Liabilities How to classify prepaid expenses for business owners and financial professionals. Answer the question "is it a CA or CL and don't forget to explain whyRead more
Introduction
Current Assets or Current Liabilities
Accounting treatment of prepaid expenses
Conclusion
See lessProfit is debit or credit?
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side. The profit is shown as the credit balance of profit and loss A/c. When the sum of itRead more
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side.
The profit is shown as the credit balance of profit and loss A/c. When the sum of items on the debit side of a profit and loss account is less than the sum of those on the credit side, it implies profit while when the sum of the items on the credit side is less than the sum of those on the debit side, it implies a loss for the entity.
The Reason for Credit
Profit is recorded as an increase in equity
To understand the reason why profit is recorded as a credit balance, we must first understand the basic principle of debit and credit.
The basic principle of debits and credits is that debits increase asset accounts and decrease liability and equity accounts while credits decrease asset accounts and increase liability and equity accounts.
The revenue that a company earns is credited to the income account and increases equity.
The expenses that a company incurs to earn that revenue are debited to the expense account and decrease equity.
The difference between revenue and expenses is the profit, which is recorded as an increase in equity.
Increase in equity due to revenue – decrease in equity due to expense = profit
Gross Profit Vs Net Profit
Revenue is the total income that a business or profession earns. Profit is the excess revenue that remains after reducing all expenses from it.
Gross profit is the profit that a company earns after reducing the cost of goods sold from sales revenue while net profit is the profit that a business earns after reducing the total of all its direct and indirect expenses from its direct as well as indirect allowable business income.
Conclusion
The basic principle of debit and credit governs the classification of profit as a debit or credit. Since profit increases our equity, it is a credit.
In the case of a company, it belongs to the shareholders. It is usually recorded in the retained earnings account. Profit can be reinvested in the business or can be distributed as a dividend. In the case of a sole proprietorship, the profit belongs to the owner and is recorded in the owner’s capital account.
See lessWhat is the meaning of accrual in accounting with example?
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and otherRead more
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and other such things.
See lessWhy is trial balance prepared?
Instructions – you can delete it after done with the answer. Points which can be covered, not necessary to cover all but you can take what you want leave out rest. Introduction: Definition of trial balance Importance of trial balance in accounting Purpose of trial balance: To verify the arithmeticalRead more
Instructions – you can delete it after done with the answer.
Points which can be covered, not necessary to cover all but you can take what you want leave out rest.
Which of the following is debited to trading account?
The correct answer is option B. Wages and salaries are debited to the trading account. The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities. Let us discuss the above items and their treatments inRead more
The correct answer is option B. Wages and salaries are debited to the trading account.
The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities.
Let us discuss the above items and their treatments in the final accounts one at a time:
Wages Outstanding
Firstly, “wages outstanding” is not debited into the trading account. It is a liability that is shown in the balance sheet.
Outstanding wages imply remuneration due to be paid to the workers for the services they have already rendered to the business.
Since the company has already received the service, it becomes a legal obligation for it to pay the wages to the workers for those services. Hence, outstanding wages are a liability.
Wages and Salaries
Wages and Salaries are debited to the trading account.
Wages Vs Salaries
Let us understand the difference between wages and salaries. Wages are the regular payments that are made daily, weekly or fortnightly. Such payments are mostly made to factory workers.
Salaries, on the other hand, are assumed to imply the remuneration paid to office workers and sales staff.
Wages are debited to the trading account, while salaries are debited to the Profit and Loss account.
Director’s Remuneration
No, the director’s remuneration is not debited to the trading account. This is because director’s generation is a business expense. It is a kind of salary provided to the director for the services rendered by him to the company.
Directors’ remuneration refers to compensation the company gives to its directors for the services rendered. It is debited to the Profit and Loss Account.
Advance Payment of Wages
No, advance payment of wages is not debited to a trading account. It is shown by reducing it to wages. Advance payment of wages implying paying remuneration to the workers before the commencement of the period for which the wages relate to.
However, one must note that if both wages and prepaid wages appear within the trial balance, then only the figure written against wages would appear in the trading account. There would be no treatment for prepaid wages.
Let us consider a scenario where wages of amount 5,000 is appearing inside trial balance. Outside the trial balance, the following information is provided
In the above case, the total wages to be debited to the trading account would be 5,000 + 1,000 – 2,000 = 4,000
Significance of the Final Accounts
See lessHow to find net credit sales from balance sheet?
What is net credit sales? Net credit sales are those revenues by a business entity, less all sales returns and allowances. Immediate payment in cash is not included in net credit sales. Formula The formula for net credit sales is as follows: Net credit sales = Sales on credit - Sales returns - SalRead more
What is net credit sales?
Net credit sales are those revenues by a business entity, less all sales returns and allowances. Immediate payment in cash is not included in net credit sales.
Formula
The formula for net credit sales is as follows:
Net credit sales = Sales on credit – Sales returns – Sales allowances
In the balance sheet, you can find credit sales in the “short-term assets “section. It can be calculated from account receivables, bills receivables, and debtors of the balance sheet.
Credit sales = closing debtors + receipts – opening debtors
Steps to calculate net credit sales
Terms relevant to understand before calculation
Sales return: A sales return is when a customer or client returns or sends a product back to the seller. And this can happen due to various reasons, including:
Sales allowance: A sales allowance is a discount that a seller offers a buyer as an alternative to the buyer for returning the product.
Because of a problem or issue with the buyer’s order or we can say that he is not satisfied with the product.
Cash sales: Cash sales are sales in which the payment is done at once or I can say that buyer has obligation to make payment to the seller.
Cash sales are considered to include bills, checks, credit cards, and money orders as forms of payment.
Example
Now after understanding the terms used in the formula let me explain to you with an example which is as follows:-
Why do we need net credit sales?
- Net credit sale is also used to calculate other financial analysis items like days sales outstanding.
See less