All expenses whose benefits are received over the years or the expenses or losses that are to be written off over the years are classified as Deferred revenue expenses. It includes fictitious expenses like preliminary expenses, loss on issue of debentures, advertising expenses, loss due to unusual oRead more
All expenses whose benefits are received over the years or the expenses or losses that are to be written off over the years are classified as Deferred revenue expenses. It includes fictitious expenses like preliminary expenses, loss on issue of debentures, advertising expenses, loss due to unusual occurrences like loss due to fire, theft, and research and development expenses, etc.
DEFERRED REVENUE EXPENSES
There are certain expenses which are revenue in nature (i.e. expenses incurred to maintain the earning capacity of the firm and generate revenue) but whose benefits are received over a period of years generally between 3 to 7 years. It means its benefit is received not only in the current accounting period but over a few consecutive accounting periods.
CHARACTERISTICS
Revenue in nature
Benefits received for more than one accounting period.
Huge expenditure (large amount is involved)
Affects the profitability of the business (since a large amount is involved if charged in the same accounting period, then it will decrease the profitability for the year)
Written off over the years either partially or entirely.
Fictitious asset It doesn’t result in the creation of any asset but is shown as an asset (fictitious asset) on the Balance Sheet till fully written off.
EXAMPLES
ADVERTISING EXPENSES refers to the expenses incurred for promoting the goods or services of the firm through various channels like TV, Social media, Hoardings, etc.
As the benefit of advertising is not received not only in the period when such expenses were incurred but also in the coming few years, it is classified as Deferred revenue expense.
For example – Suppose the company incurred $10 lakh on advertising to introduce a new product in the market and estimated that its benefit will last for 4 years. In this case, $250,000 will be written off every year, for 4 consecutive years.
EXCEPTIONAL LOSSES are losses that are incurred because of some unusual event and don’t happen regularly like loss from fire, theft, earthquake, flood or any other natural disaster, confiscation of property, etc.
Since these losses can’t be written off in the year they occurred they are also treated as Deferred revenue expenditure and are written off over the years.
RESEARCH AND DEVELOPMENT EXPENSES are expenses incurred on researching and developing new products or improving the existing ones. Its benefits are received for many years and thus are classified as Deferred revenue expenses.
For example – Expenses incurred on the creation of intangible assets like patents, copyrights, etc.
PRELIMINARY EXPENSES are those expenses which are incurred before the incorporation and commencement of the business. It includes legal fees, registration fees, stamp duty, printing expenses, etc.
These expenses are fictitious assets and are written off over the years.
TREATMENT
It is debited to the P&L amount (amount written off that year) and the remaining amount on the Aeest side of the Balance Sheet.
In the above example of advertising expenses, in Year 1, $250,000 will be debited in the P&L A/c and the remaining amount of $750,000 is shown on the Asset side of the Balance Sheet.
In Year 2, $250,00 in P&L A/c and the remaining $500,000 in Balance Sheet.
In Year 3, $250,000 in P&L A/c and the remaining $250,000 in the Balance Sheet and in the last Year 4, only the remaining amount of $250,000 in P&L A/c and nothing in the Balance Sheet.
The Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities thatRead more
The Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities that are to be paid are recorded in the Realisation A/c.
DISSOLUTION OF PARTNERSHIP FIRM
It means the firm closes down its business and comes to an end. Simply, it means the firm will cease to exist in the future. As the firm is closing down, it will sell all its assets to realise all the value blocked in the assets, it is liable to pay off all of its liabilities whether due now or on some future date, and the remaining amount (if any) is distributed among the partners.
REALISATION ACCOUNT
This account is prepared only once, at the time of dissolution of the Partnership firm. It is opened to dispose of all the assets of the firm and make payments to all the external creditors of the firm.
It ascertains the profit earned or loss incurred on the realisation of assets and payment of liabilities.
The Realisation account is a NOMINAL ACCOUNT (Debit all expenses and losses, Credit all incomes and gains)
ITEMS RECORDED IN THE REALISATION ACCOUNT
DEBIT SIDE OF REALISATION ACCOUNT
1. TRANSFER OF ASSETS
Assets are any property or the possession of the business enterprise that allows it to get cash or any other benefit in the future.
Since all assets are sold at the time of the dissolution, all assets that can be converted into cash are transferred to the Debit side of the Realisation A/cat their book values.
Such as Plant & Machinery, Building, Debtors, etc.
EXCEPTIONS
Cash and Bank balances (as already in the most liquid form)
Fictitious assets ( Don’t have any realisable value)
NOTE – If there is any provision against any asset, such as ‘Provisions for Bad debts’ or ‘Provision for Depreciation, then such assets are transferred to the Debit side of the Realisation A/c at its gross value and the Provision is transferred to the Credit side of the Realisation A/c.
For example – Suppose there are Debtors of $50,000 and the Provision for Doubtful Debts is $2,000.
Then, Debtors will be recorded on the Debit side with a value of $50,000 and the Provision for Doubtful Debt on the Credit side with the amount of $2,000.
2. PAYMENT OF LIABILITIES
All liabilities are either paid in cash or the Partner agrees to pay for some liabilities. Since they are expenses, they are recorded on the debit side of the Realisation A/c as “Debit all expenses and Losses”
3. PROFIT ON REALISATION
There is profit when Cr. side > Dr. side, as it means incomes are more than the payments made. This profit is distributed among the partners.
CREDIT SIDE OF THE REALISATION ACCOUNT
1. TRANSFER OF LIABILITIES
Liabilities refer to the amount owed by the firm to outsiders. All liabilities must be paid off before accounts are closed. So, all external liabilities are transferred to the Credit side of the Realisation account, to make their payment.
Such as creditors, bills payable, loans, outstanding expenses, partner’s wife’s loan, etc.
EXCEPTION (not included)
Partner’s loan (internal liability and a separate account is created for it)
Undistributed Profits (like General reserve, Credit balance of P&L A/c, etc. because they belong to partners and are distributed among them. Also, they can’t be sold)
2. SALE OF ASSETS
Assets can be sold for cash or taken by the Partner. The amount received from the sale of assets is recorded on the credit side of the Realisation account as “Credit all incomes and gains”.
Also, if any asset is given to the creditors in part or full payment of his dues, then the agreed amount is deducted from the creditor’s claim and no other entry is passed.
3. LOSS ON REALISATION:
There is a loss, if the Dr. side> Cr. side, which means Expenses > Incomes. This loss is also distributed among the Partners.
A Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities to be pRead more
A Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities to be paid are transferred to the Realisation A/c.
So, Cash and Bank (already in liquid form), fictitious assets (doesn’t have any value to be realised), Partner’s Loan (internal liability) and Undistributed profits (not something that can be realised) are not included in the Realisation account.
DISSOLUTION OF PARTNERSHIP FIRM
It means the firm closes down its business and comes to an end. Simply, it means the firm will cease to exist in the future. As the firm is closing down, its assets are sold, liabilities are paid off, and the remaining amount (if any) is distributed among the partners.
REALISATION ACCOUNT
This account is prepared only once, at the time of dissolution of the Partnership firm. It is opened to dispose of all the assets of the firm and make payments to all the external creditors of the firm.
It ascertains the profit earned or loss incurred on the realisation of assets and payment of liabilities.
Items not included in Realisation A/c
1. ASSETS
CASH AND BANK BALANCES are not included in the Realisation account as the purpose of the Realisation account is to sell assets to realise cash, but cash and bank are already in liquid form and thus, not included.
These are directly used for the payment of liabilities and if there is any remaining amount, then that amount is distributed among the partners.
FICTITIOUS ASSETS are huge expenses or losses that are written off over the years by writing off a portion of it every year for the next few years like accumulated losses, balance of Advertisement expenses, Preliminary expenses, Loss on the issue of Debentures, etc. They don’t have any physical existence or realisable value.
Since nothing can be realised from these assets they are not included in the Realisation account. These are transferred to the Partner’s Capital A/c.
2. LIABILITIES
PARTNER’S LOAN refers to the loan given to the firm by any partner of the firm.
Suppose, there are three Partners A, B and C. ‘C’ gave the firm a loan of $5,000. This $5,000 will be recorded as a Partner’s Loan and not just as a normal loan taken from an external party.
Since, Partner’s Loans are the internal obligation of the firm, they are not included in the realisation account instead a separate account is prepared to settle Partner’s Loan after all external liabilities are settled.
So, we can say in the Realisation account only external liabilities are included and paid.
UNDISTRIBUTED PROFITS are the Profits that are not distributed among the Partners like General Reserve, Reserve Fund, and Credit balance of P&L A/c.
They are not included in the realisation account as they can’t be sold as an asset neither they are any liabilities that should be paid. Undistributed profits belong to the Partners of the firm and thus, are transferred to Partner’s capital A/c.
Profit refers to the excess of total revenue over total expenses. According to the rule "Debit all expenses and losses, Credit all incomes and gains", expenses are recorded on the debit side while revenues are recorded on the credit side. There is profit when Total revenue > Total expenses, whichRead more
Profit refers to the excess of total revenue over total expenses. According to the rule “Debit all expenses and losses, Credit all incomes and gains”, expenses are recorded on the debit side while revenues are recorded on the credit side.
There is profit when Total revenue > Total expenses, which means the balance of the credit side > the balance of the debit side. Since, in accounting Dr. side is always equal to the credit side, a balancing figure (representing profit or loss) is shown on the shorter side, to make both sides equal.
When Credit side > Debit side, Profit(balancing figure) is shown on the Dr. side so that both sides are equal.
PROFIT
Profit refers to the excess of total revenue over the total expenses of the business for an accounting year. In simple words, it shows how much extra the firm earned after deducting all the expenses it incurred during the year.
Profit = Total Revenue – Total Expenses
Suppose, the firm earned a total revenue of $10,000 for the accounting year 2022-23. Also, it incurred total expenses of $6,000 during the year. So, Profit for the AY 2022-23 is $4,000.
ASCERTAINING PROFIT
To ascertain profit earned or loss incurred by the firm during an accounting year, it prepares two accounts.
Trading A/c
Profit and Loss A/c
Points to be noted:
Both accounts are Nominal Account which follows the rule “Debit all expenses and losses, Credit all incomes and gains”
The debit side records expenses while the Credit side records incomes.
Both are balanced accounts, which means its Dr. side is always equal to its Cr. side.
If they are not balanced, then a balancing figure is added to the shorter side which represents profit or the loss depending on which side is greater.
If Dr. side > Cr. side, it means expenses are more than the incomes and thus, there is a loss.
If Cr. side > Dr. side, it means there are more incomes than expenses and thus, there is Profit.
TRADING ACCOUNT
It is the first final account prepared for calculating gross profit or gross loss during the year because of the trading activities of the firm.
Trading activities are related to the buying and selling of goods. In between buying and selling a lot of activities are there like transportation, warehousing, loading, unloading, etc. All expenses that are directly related to buying and selling as well as manufacturing of goods are known as Direct expenses and are also recorded in the trading accounts.
Items included on the debit side:
Opening stock
Purchases
Direct expenses like wages, import duty, royalty, manufacturing expenses, etc.
Gross Profit
Items included on the credit side:
Sales
Closing stock
Gross loss
Gross Profit is when Cr. side (incomes) > Dr. side (expenses). It is recorded on the debit side as a balancing figure.
PROFIT AND LOSS ACCOUNT
A businessman incurs a lot of expenses during the year which may be directly related or indirectly related to the business.
As the Trading account only considers direct expenses, the businessman prepares the P&L A/c which considers all the expenses incurred during a year to ascertain net profit or loss.
Yes, Accounts Payable can have a Debit balance. Accounts payable is a liability and thus, has a credit balance but can have a debit balance in case the creditor is overpaid or when there is purchase return (for already-paid goods) ACCOUNTS PAYABLE Accounts payable refers to all short-term liaRead more
Yes, Accounts Payable can have a Debit balance. Accounts payable is a liability and thus, has a credit balance but can have a debit balance in case the creditor is overpaid or when there is purchase return (for already-paid goods)
ACCOUNTS PAYABLE
Accounts payable refers to all short-term liabilities of the business that are to be paid. These are usually paid within a duration of 90 days. It includes both Trade payable (goods and services purchased on credit) as well as expenses payable (used but payment not made yet) like rent payable, electricity bill, etc.
Businesses cannot make every payment on the spot. There can be cases when the business is facing a shortage of funds, can have funds but doesn’t have enough cash (or liquid funds) to make payment or simply doesn’t want to make payment on the spot to reduce its capital requirement.
So, like us businessmen also purchase goods on credit or use services for which payment is to be made soon. All these are liabilities for the business.
However, they must be related to the business to be considered as accounts payable.
DEBIT BALANCE OF ACCOUNTS PAYABLE
Debit balance of accounts payable means money owed by others. There is Debit balance when
OVERPAYMENT is made to the creditors or the supplier. It happens when the wrong amount is paid or payment is made twice for the same transaction.
Suppose you need to pay $10,000 as rent within 30 days. After 25 days you mistakenly made a payment of $12,000.
In this case,
Firstly, you will record the transaction by crediting Accounts payable (as liability increased) by $10,000
When payment is made after 25 days, Accounts Payable is debited by $12,000 (as liability decreased)
So, there will be a debit balance of $2,000 (which means the creditor owes you) till the creditor returns the excess amount.
PURCHASE RETURN of already paid goods also result in debit balance of Accounts Payable.
Suppose you bought goods worth $50,000 from Mr A on credit and paid for the same. Later, you returned all the goods because they were defective. Now, there will be Debit balance of Accounts Payable till there is a full refund of $50,000 by Mr A.
How is Accounts Payable Treated Normally?
Accounts Payable are the current liabilities of the firm and are shown under the head Current Liabilities in the Balance Sheet. Its liability, thus has a credit balance which represents the amount owed by the firm to others. It is credited when increases and debited when decreases.
For example – Suppose you purchased goods worth $30,000 and agreed to pay after 30 days. So, Accounts payable will be credited by $30,000 and purchases will be debited by $30,000.
Purchases A/c – $30,000 (debit)
To Accounts Payable A/c – $30,000
After 30 days payment is made in cash, which means the liability decreased. So, Accounts Payable A/c will be debited.
Yes, Goodwill is a fixed asset because it adds to the value of the business over a long period. Goodwill can never be calculated for a short period. GOODWILL Basically, goodwill is a premium or you can say an additional price you are paying because of the reputation of a firm or a person. YouRead more
Yes, Goodwill is a fixed asset because it adds to the value of the business over a long period. Goodwill can never be calculated for a short period.
GOODWILL
Basically, goodwill is a premium or you can say an additional price you are paying because of the reputation of a firm or a person.
You may have seen some famous shop in your locality which usually charges a higher price as compared to the other local shops selling the same product.
You may have also noticed that bigger brands like Bata, Titan, Zara, etc. charge higher prices for their products as compared to the same products available in the local market and people are even willing to pay for them. Ever wondered why?
This is because of the goodwill created by them over the years by providing quality products and services, good employee relationships, a strong customer base, social service, a brand name and so on. Customers trust them and for this trust, they are even willing to pay higher prices.
Goodwill is the quantitative value (i.e. in monetary terms) of the reputation of the firm in the market.
FIXED ASSETS
An asset is any possession or property of the business that enables the firm to get cash or any benefit in the future.
Fixed Assets are assets which are purchased for long-term use. They are for continued use in the business for producing goods or services and are not meant for resale. For example- Plant, machinery, building, goodwill, patents etc.
Fixed assets can be tangible or intangible.
Tangible assets are those assets which can be seen and touched and have physical existence like Plant and machinery, building, stock, furniture etc.
Intangible assets are those assets which cannot be seen or touched i.e. they don’t have any physical existence like goodwill, patent, trademark, prepaid expenses etc. Even though they can’t be seen or touched by they have value and are not fictitious assets.
Goodwill as a Fixed Asset
Goodwill is an intangible asset as it cannot be seen or touched but has value and adds value to the business over a long period. Thus, goodwill is a fixed asset.
It is shown in the balance sheet as a Fixed asset under the head Intangible asset.
Goodwill can be
Self-generated (Non-Purchased goodwill)
Purchased goodwill
Self-generated goodwill is created over a period due to the good reputation of the business. It is the difference between the value of the firm and the fair value of the net tangible assets of the firm.
Goodwill = Value of the firm – Fair value of net tangible assets
Here, F.V of net tangible assets = Fair value of tangible assets- Fair value of tangible liabilities
Purchased goodwill arises when one business purchases another business. It is the difference between the price paid for the purchased firm and the sum of the fair market value of the assets received and liabilities to be paid by them on behalf of the purchased firm.
Goodwill = Purchase price – (F.V of assets received + F.V of liabilities to be paid)
Only purchased goodwill is recorded in the books of accounts because it is difficult to correctly calculate the value of self-generated goodwill as the future is uncertain, also its valuation depends on the judgement of the person calculating it, which defers from person to person. Since there is no fixed standard to calculate self-generated goodwill only purchased goodwill is recorded as the price paid for it at the time of acquiring another business.
Suppose Firm A acquired Firm B.
Purchase price= $100,000
Assets received=$60,000
Liabilities (to be paid by Firm A on behalf of Firm B) = $10,000
This, goodwill of $30,000 will be recorded under the head Fixed Asset, subhead Intangible Assets in the balance sheet of Firm A (that is in the balance sheet of the acquiring firm)
Trading A/c is a Nominal A/c which follows the rule “Debit the expenses and losses, Credit the incomes and gains” So, the Credit side of Trading A/c shows income from the sale of goods. It includes Sales, Closing stock (if adjustment for it has not been made yet) and Gross Loss (if any). TRADRead more
Trading A/c is a Nominal A/c which follows the rule “Debit the expenses and losses, Credit the incomes and gains”
So, the Credit side of Trading A/c shows income from the sale of goods. It includes Sales, Closing stock (if adjustment for it has not been made yet) and Gross Loss (if any).
TRADING ACCOUNT
Trading A/c is prepared for calculating the Gross Profit or Gross Loss arising from the trading activities of a business.
Trading activities are mostly related to buying and selling of goods. However, in between buying and selling, a lot of activities are involved like transportation, warehousing, etc. So, all the expenses that are directly related to manufacturing or purchase of goods are also recorded in the Trading A/c.
CREDIT SIDE OF TRADING ACCOUNT
It includes,
SALES – When goods are sold to earn a profit, it is called sales. It can be cash sales or credit sales.
Suppose you are in the business of manufacturing and trading shirts. You sold shirts worth $ 20,000 during the year. This $20,000 is your sales.
SALES RETURN – When the goods sold by you are returned by the customer, it is known as sales return. Sales return is deducted from the sales.
Continuing with the above example, the customers returned shirts of $1,000 because they didn’t like them. This return is known as sales return or return inward (as goods are coming back i.e. in)
CLOSING STOCK – Stock is nothing but goods that are either obtained for resale or manufactured for sale and are yet unsold on any particular date.
The value of stock at the beginning of an accounting year is called Opening stock while the value of the stock at the end of an accounting year is called Closing stock.
Closing stock is valued at cost price or market price whichever is less.
It includes,
Closing stock of raw materials
Closing stock of semi-finished goods
Closing stock of finished goods
For example – On 31st March 2023, there was unused raw material worth $1,000 and shirts worth $5,000 remained unsold.
So, we have Closing Stock of Raw material – $1,000
Closing Stock of Finished Goods – $5,000
Normally, the closing stock is given outside the Trial Balance because its valuation is made after accounts have been closed. It is incorporated in the books by transferring it to the Trading A/c. So, it is shown on the credit side of Trading A/c as well as on the assets side of the Balance sheet.
However, if the closing stock is given inside the Trail Balance, it means that the closing stock must have already been deducted from the Purchases account. So, closing stock will only be shown on the assets side of the Balance sheet.
GROSS LOSS – If purchases and direct expenses exceed sales, then it is a Gross loss. In other words, when Debit side > credit side.
DEBIT SIDE OF TRADING ACCOUNT
It includes
OPENING STOCK – The value of the stock at the beginning of an accounting year is called Opening stock.
The closing stock of the last year becomes the opening stock of the current year.
PURCHASES – Goods that have been bought for resale or raw materials purchased for the manufacturing of the product are terms as Purchases. These goods must be related to the business you are doing. It includes cash as well as credit Purchases.
PURCHASES RETURN – When goods bought are returned to the suppliers due to any reason. This is known as Purchase return. Purchase return is deducted from the Purchases.
WAGES – Wages are paid to the workers who are directly engaged in the loading, unloading and production of goods.
CARRIAGE or CARRIAGE INWARDS or FREIGHT – It refers to the cost of transporting goods from the supplier.
MANUFACTURING EXPENSES – All expenses incurred in the manufacture of goods such as Coal, Gas, Fuel, Water, Power, Factory rent, Factory lighting etc.
DOCK CHARGES – These are charged by port authorities when unloading goods at a dock or wharf. Such charges paid in connection with goods purchased are considered direct expenses and are debited to Trading a/c.
IMPORT DUTY or CUSTOM DUTY – It is a tax collected on imports and specific exports by a country’s customs authorities.
If import duty is paid on the import of goods, then they are shown on the Dr. side of the Trading A/c.
ROYALTY – Royalty refers to the amount paid for the use of assets belonging to another person. It includes royalty for the use of intangible assets, such as copyrights, trademarks, or franchisee agreements. It is also paid for the use of natural resources, such as mining leases.
Royalty is charged to the Trading A/c as it increases the cost of production.
GROSS PROFIT – When sales exceed the amount of purchases and the expenses directly connected with such purchases i.e. when Credit side> Debit side.
Trading A/c is a nominal account which follows the rule "Debit all expenses and losses, Credit all incomes and gains". So, all expenses relating to the purchase or manufacturing of goods are shown on the debit side of the Trading A/c. It includes Opening Stock, Purchases, Wages, Carriage Inward, ManRead more
Trading A/c is a nominal account which follows the rule “Debit all expenses and losses, Credit all incomes and gains”.
So, all expenses relating to the purchase or manufacturing of goods are shown on the debit side of the Trading A/c. It includes Opening Stock, Purchases, Wages, Carriage Inward, Manufacturing Expenses, Dock charges, and other direct expenses that are directly related to the manufacturing or purchase.
TRADING ACCOUNT
Trading A/c is prepared for calculating the Gross Profit or Gross Lossarising from the trading activities of a business.
Trading activities are mostly related to buying and selling of goods. However, in between buying and selling, a lot of activities are involved like transportation, warehousing, etc. So, all the expenses that are directly related to manufacturing or purchase of goods are also recorded in the Trading A/c.
DEBIT SIDE OF TRADING A/C
The items shown on the Dr. side are,
OPENING STOCK – Stock is nothing but goods that are either obtained for resale or manufactured for sale and are yet unsold on any particular date.
The value of stock at the beginning of an accounting year is called Opening stock while the value of the stock at the end of an accounting year is called closing stock.
The closing stock of the last year becomes the opening stock of the current year.
Opening stock includes,
Opening Stock of Raw materials
Opening Stock of Semi-finished goods
Opening Stock of Finished goods
For example – Suppose you are in the business of manufacturing and trading shirts. On 31st March 2023, there was unused raw material worth $10,000 and shirts worth $50,000 remained unsold.
So, we have Closing Stock of Raw material – $10,000
Closing Stock of Finished Goods – $50,000
This closing stock of last year becomes your opening stock during the current year i.e. on 1st April 2023, we have
Opening Stock of raw material – $10,000
Opening Stock of Finished Goods – $50,000
PURCHASES – Goods that have been bought for resale or raw materials purchased for manufacturing the product are terms as Purchases. These goods must be related to the business you are doing.
It includes cash as well as credit Purchases.
Continuing with the above example, suppose you bought raw material worth $ 1,00,000 for manufacturing and shirts worth $50,000 for resale (and not for personal consumption) then both these will be termed as purchases for you. So, your purchases will be $1,50,000 ($1,00,000 + $50,000)
PURCHASES RETURN – When goods bought are returned to the suppliers due to any reason. This is known as Purchase return. Purchase return is deducted from the Purchases.
In the above example, you bought shirts worth $50,000 for resale. Out of which shirts worth $20,000 were defective. So, you returned them to the supplier. This return of $20,000 is your purchase return or return outwards (as goods are going out)
WAGES – Wages are paid to the workers who are directly engaged in the loading, unloading and production of goods.
For example – Paid $10,000 to workers for manufacturing shirts.
However, it would be included in Trading A/c only if the wages are paid for work which is directly relatedto the manufacturing or purchase of goods otherwise it will be shown in P&L A/c.
Suppose you hired a manager to take care of your business and paid him $20,000 as salary. This salary is indeed an expense for the business but is not directly related to the manufacturing of goods. Since it is an indirect expense, it can only be recorded in P&L A/c and not in the Trading A/c.
CARRIAGE or CARRIAGE INWARDS or FREIGHT – It refers to the cost of transporting goods from the supplier.
Suppose, you ordered raw material in bulk which was transported to you by a van and you paid its fare. This fare is nothing but your carriage inwards.
However, if carriage or freight is paid on bringing an asset, the amount should be added to the asset account and must not be debited to the trading account.
MANUFACTURING EXPENSES – All expenses incurred in the manufacture of goods such as Coal, Gas, Fuel, Water, Power, Factory rent, Factory lighting etc.
DOCK CHARGES – These are charged by port authorities when unloading goods at a dock or wharf. Such charges paid in connection with goods purchased are considered direct expenses and are debited to Trading a/c.
IMPORT DUTY or CUSTOM DUTY – It is a tax collected on imports and specific exports by a country’s customs authorities. If import duty is paid on the import of goods, then they are shown on the Dr. side of the Trading A/c.
For example – Paid $15,000 as import duty for importing shirts for resale.
ROYALTY – Royalty refers to the amount paid for the use of assets belonging to another person. It includes royalty for the use of intangible assets, such as copyrights, trademarks, or franchisee agreements. It is also paid for the use of natural resources, such as mining leases.
Royalty is charged to the Trading A/c as it increases the cost of production.
GROSS PROFIT – When sales exceed the amount of purchases and the expenses directly connected with such purchases i.e. when Credit side> Debit side.
CREDIT SIDE OF TRADING A/C
SALES – When goods are sold to earn a profit, it is called sales. It can be cash sales or credit sales.
SALES RETURN – When the goods sold are returned by the customer, it is known as a sales return. Sales return is deducted from the sales.
CLOSING STOCK – The goods remaining unsold at the end of the year are termed as closing stock. It is valued at cost price or market price whichever is less.
GROSS LOSS – If purchases and direct expenses exceed sales, then it is a Gross loss. In other words, when Debit side > Credit side.
What are some examples of deferred revenue expenses?
All expenses whose benefits are received over the years or the expenses or losses that are to be written off over the years are classified as Deferred revenue expenses. It includes fictitious expenses like preliminary expenses, loss on issue of debentures, advertising expenses, loss due to unusual oRead more
All expenses whose benefits are received over the years or the expenses or losses that are to be written off over the years are classified as Deferred revenue expenses. It includes fictitious expenses like preliminary expenses, loss on issue of debentures, advertising expenses, loss due to unusual occurrences like loss due to fire, theft, and research and development expenses, etc.
DEFERRED REVENUE EXPENSES
There are certain expenses which are revenue in nature (i.e. expenses incurred to maintain the earning capacity of the firm and generate revenue) but whose benefits are received over a period of years generally between 3 to 7 years. It means its benefit is received not only in the current accounting period but over a few consecutive accounting periods.
CHARACTERISTICS
EXAMPLES
ADVERTISING EXPENSES refers to the expenses incurred for promoting the goods or services of the firm through various channels like TV, Social media, Hoardings, etc.
As the benefit of advertising is not received not only in the period when such expenses were incurred but also in the coming few years, it is classified as Deferred revenue expense.
For example – Suppose the company incurred $10 lakh on advertising to introduce a new product in the market and estimated that its benefit will last for 4 years. In this case, $250,000 will be written off every year, for 4 consecutive years.
EXCEPTIONAL LOSSES are losses that are incurred because of some unusual event and don’t happen regularly like loss from fire, theft, earthquake, flood or any other natural disaster, confiscation of property, etc.
Since these losses can’t be written off in the year they occurred they are also treated as Deferred revenue expenditure and are written off over the years.
RESEARCH AND DEVELOPMENT EXPENSES are expenses incurred on researching and developing new products or improving the existing ones. Its benefits are received for many years and thus are classified as Deferred revenue expenses.
For example – Expenses incurred on the creation of intangible assets like patents, copyrights, etc.
PRELIMINARY EXPENSES are those expenses which are incurred before the incorporation and commencement of the business. It includes legal fees, registration fees, stamp duty, printing expenses, etc.
These expenses are fictitious assets and are written off over the years.
TREATMENT
It is debited to the P&L amount (amount written off that year) and the remaining amount on the Aeest side of the Balance Sheet.
In the above example of advertising expenses, in Year 1, $250,000 will be debited in the P&L A/c and the remaining amount of $750,000 is shown on the Asset side of the Balance Sheet.
In Year 2, $250,00 in P&L A/c and the remaining $500,000 in Balance Sheet.
In Year 3, $250,000 in P&L A/c and the remaining $250,000 in the Balance Sheet and in the last Year 4, only the remaining amount of $250,000 in P&L A/c and nothing in the Balance Sheet.
See lessWhat is recorded in the Realisation account?
The Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities thatRead more
The Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities that are to be paid are recorded in the Realisation A/c.
DISSOLUTION OF PARTNERSHIP FIRM
It means the firm closes down its business and comes to an end. Simply, it means the firm will cease to exist in the future. As the firm is closing down, it will sell all its assets to realise all the value blocked in the assets, it is liable to pay off all of its liabilities whether due now or on some future date, and the remaining amount (if any) is distributed among the partners.
REALISATION ACCOUNT
This account is prepared only once, at the time of dissolution of the Partnership firm. It is opened to dispose of all the assets of the firm and make payments to all the external creditors of the firm.
It ascertains the profit earned or loss incurred on the realisation of assets and payment of liabilities.
The Realisation account is a NOMINAL ACCOUNT (Debit all expenses and losses, Credit all incomes and gains)
ITEMS RECORDED IN THE REALISATION ACCOUNT
DEBIT SIDE OF REALISATION ACCOUNT
1. TRANSFER OF ASSETS
Assets are any property or the possession of the business enterprise that allows it to get cash or any other benefit in the future.
Since all assets are sold at the time of the dissolution, all assets that can be converted into cash are transferred to the Debit side of the Realisation A/c at their book values.
Such as Plant & Machinery, Building, Debtors, etc.
EXCEPTIONS
NOTE – If there is any provision against any asset, such as ‘Provisions for Bad debts’ or ‘Provision for Depreciation, then such assets are transferred to the Debit side of the Realisation A/c at its gross value and the Provision is transferred to the Credit side of the Realisation A/c.
For example – Suppose there are Debtors of $50,000 and the Provision for Doubtful Debts is $2,000.
Then, Debtors will be recorded on the Debit side with a value of $50,000 and the Provision for Doubtful Debt on the Credit side with the amount of $2,000.
2. PAYMENT OF LIABILITIES
All liabilities are either paid in cash or the Partner agrees to pay for some liabilities. Since they are expenses, they are recorded on the debit side of the Realisation A/c as “Debit all expenses and Losses”
3. PROFIT ON REALISATION
There is profit when Cr. side > Dr. side, as it means incomes are more than the payments made. This profit is distributed among the partners.
CREDIT SIDE OF THE REALISATION ACCOUNT
1. TRANSFER OF LIABILITIES
Liabilities refer to the amount owed by the firm to outsiders. All liabilities must be paid off before accounts are closed. So, all external liabilities are transferred to the Credit side of the Realisation account, to make their payment.
Such as creditors, bills payable, loans, outstanding expenses, partner’s wife’s loan, etc.
EXCEPTION (not included)
2. SALE OF ASSETS
Assets can be sold for cash or taken by the Partner. The amount received from the sale of assets is recorded on the credit side of the Realisation account as “Credit all incomes and gains”.
Also, if any asset is given to the creditors in part or full payment of his dues, then the agreed amount is deducted from the creditor’s claim and no other entry is passed.
3. LOSS ON REALISATION:
There is a loss, if the Dr. side> Cr. side, which means Expenses > Incomes. This loss is also distributed among the Partners.
See lessWhat is not included in Realisation account?
A Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities to be pRead more
A Realisation account is prepared at the time of dissolution of the Partnership firm to ascertain profit or loss from the sale of assets and payment of liabilities of the firm. All assets that can be converted into cash (i.e. from which any value can be realised) and all external liabilities to be paid are transferred to the Realisation A/c.
So, Cash and Bank (already in liquid form), fictitious assets (doesn’t have any value to be realised), Partner’s Loan (internal liability) and Undistributed profits (not something that can be realised) are not included in the Realisation account.
DISSOLUTION OF PARTNERSHIP FIRM
It means the firm closes down its business and comes to an end. Simply, it means the firm will cease to exist in the future. As the firm is closing down, its assets are sold, liabilities are paid off, and the remaining amount (if any) is distributed among the partners.
REALISATION ACCOUNT
This account is prepared only once, at the time of dissolution of the Partnership firm. It is opened to dispose of all the assets of the firm and make payments to all the external creditors of the firm.
It ascertains the profit earned or loss incurred on the realisation of assets and payment of liabilities.
Items not included in Realisation A/c
1. ASSETS
CASH AND BANK BALANCES are not included in the Realisation account as the purpose of the Realisation account is to sell assets to realise cash, but cash and bank are already in liquid form and thus, not included.
These are directly used for the payment of liabilities and if there is any remaining amount, then that amount is distributed among the partners.
FICTITIOUS ASSETS are huge expenses or losses that are written off over the years by writing off a portion of it every year for the next few years like accumulated losses, balance of Advertisement expenses, Preliminary expenses, Loss on the issue of Debentures, etc. They don’t have any physical existence or realisable value.
Since nothing can be realised from these assets they are not included in the Realisation account. These are transferred to the Partner’s Capital A/c.
2. LIABILITIES
PARTNER’S LOAN refers to the loan given to the firm by any partner of the firm.
Suppose, there are three Partners A, B and C. ‘C’ gave the firm a loan of $5,000. This $5,000 will be recorded as a Partner’s Loan and not just as a normal loan taken from an external party.
Since, Partner’s Loans are the internal obligation of the firm, they are not included in the realisation account instead a separate account is prepared to settle Partner’s Loan after all external liabilities are settled.
So, we can say in the Realisation account only external liabilities are included and paid.
UNDISTRIBUTED PROFITS are the Profits that are not distributed among the Partners like General Reserve, Reserve Fund, and Credit balance of P&L A/c.
They are not included in the realisation account as they can’t be sold as an asset neither they are any liabilities that should be paid. Undistributed profits belong to the Partners of the firm and thus, are transferred to Partner’s capital A/c.
See lessWhy is profit on debit side?
Profit refers to the excess of total revenue over total expenses. According to the rule "Debit all expenses and losses, Credit all incomes and gains", expenses are recorded on the debit side while revenues are recorded on the credit side. There is profit when Total revenue > Total expenses, whichRead more
Profit refers to the excess of total revenue over total expenses. According to the rule “Debit all expenses and losses, Credit all incomes and gains”, expenses are recorded on the debit side while revenues are recorded on the credit side.
There is profit when Total revenue > Total expenses, which means the balance of the credit side > the balance of the debit side. Since, in accounting Dr. side is always equal to the credit side, a balancing figure (representing profit or loss) is shown on the shorter side, to make both sides equal.
When Credit side > Debit side, Profit(balancing figure) is shown on the Dr. side so that both sides are equal.
PROFIT
Profit refers to the excess of total revenue over the total expenses of the business for an accounting year. In simple words, it shows how much extra the firm earned after deducting all the expenses it incurred during the year.
Profit = Total Revenue – Total Expenses
Suppose, the firm earned a total revenue of $10,000 for the accounting year 2022-23. Also, it incurred total expenses of $6,000 during the year. So, Profit for the AY 2022-23 is $4,000.
ASCERTAINING PROFIT
To ascertain profit earned or loss incurred by the firm during an accounting year, it prepares two accounts.
Points to be noted:
TRADING ACCOUNT
It is the first final account prepared for calculating gross profit or gross loss during the year because of the trading activities of the firm.
Trading activities are related to the buying and selling of goods. In between buying and selling a lot of activities are there like transportation, warehousing, loading, unloading, etc. All expenses that are directly related to buying and selling as well as manufacturing of goods are known as Direct expenses and are also recorded in the trading accounts.
Items included on the debit side:
Items included on the credit side:
Gross Profit is when Cr. side (incomes) > Dr. side (expenses). It is recorded on the debit side as a balancing figure.
PROFIT AND LOSS ACCOUNT
A businessman incurs a lot of expenses during the year which may be directly related or indirectly related to the business.
As the Trading account only considers direct expenses, the businessman prepares the P&L A/c which considers all the expenses incurred during a year to ascertain net profit or loss.
Items written on the Debit side
Items written on the Credit side
Net Profit is when the Cr. side (incomes)> Dr. side(expenses). It is recorded on the Debit side as a balancing figure.
See lessCan accounts payable have a debit balance?
Yes, Accounts Payable can have a Debit balance. Accounts payable is a liability and thus, has a credit balance but can have a debit balance in case the creditor is overpaid or when there is purchase return (for already-paid goods) ACCOUNTS PAYABLE Accounts payable refers to all short-term liaRead more
Yes, Accounts Payable can have a Debit balance. Accounts payable is a liability and thus, has a credit balance but can have a debit balance in case the creditor is overpaid or when there is purchase return (for already-paid goods)
ACCOUNTS PAYABLE
Accounts payable refers to all short-term liabilities of the business that are to be paid. These are usually paid within a duration of 90 days. It includes both Trade payable (goods and services purchased on credit) as well as expenses payable (used but payment not made yet) like rent payable, electricity bill, etc.
Businesses cannot make every payment on the spot. There can be cases when the business is facing a shortage of funds, can have funds but doesn’t have enough cash (or liquid funds) to make payment or simply doesn’t want to make payment on the spot to reduce its capital requirement.
So, like us businessmen also purchase goods on credit or use services for which payment is to be made soon. All these are liabilities for the business.
However, they must be related to the business to be considered as accounts payable.
DEBIT BALANCE OF ACCOUNTS PAYABLE
Debit balance of accounts payable means money owed by others. There is Debit balance when
OVERPAYMENT is made to the creditors or the supplier. It happens when the wrong amount is paid or payment is made twice for the same transaction.
Suppose you need to pay $10,000 as rent within 30 days. After 25 days you mistakenly made a payment of $12,000.
In this case,
PURCHASE RETURN of already paid goods also result in debit balance of Accounts Payable.
Suppose you bought goods worth $50,000 from Mr A on credit and paid for the same. Later, you returned all the goods because they were defective. Now, there will be Debit balance of Accounts Payable till there is a full refund of $50,000 by Mr A.
How is Accounts Payable Treated Normally?
Accounts Payable are the current liabilities of the firm and are shown under the head Current Liabilities in the Balance Sheet. Its liability, thus has a credit balance which represents the amount owed by the firm to others. It is credited when increases and debited when decreases.
For example – Suppose you purchased goods worth $30,000 and agreed to pay after 30 days. So, Accounts payable will be credited by $30,000 and purchases will be debited by $30,000.
Purchases A/c – $30,000 (debit)
To Accounts Payable A/c – $30,000
After 30 days payment is made in cash, which means the liability decreased. So, Accounts Payable A/c will be debited.
Accounts Payable A/c – $30,00
To Cash – $30,000
See lessIs goodwill a fixed asset?
Yes, Goodwill is a fixed asset because it adds to the value of the business over a long period. Goodwill can never be calculated for a short period. GOODWILL Basically, goodwill is a premium or you can say an additional price you are paying because of the reputation of a firm or a person. YouRead more
Yes, Goodwill is a fixed asset because it adds to the value of the business over a long period. Goodwill can never be calculated for a short period.
GOODWILL
Basically, goodwill is a premium or you can say an additional price you are paying because of the reputation of a firm or a person.
You may have seen some famous shop in your locality which usually charges a higher price as compared to the other local shops selling the same product.
You may have also noticed that bigger brands like Bata, Titan, Zara, etc. charge higher prices for their products as compared to the same products available in the local market and people are even willing to pay for them. Ever wondered why?
This is because of the goodwill created by them over the years by providing quality products and services, good employee relationships, a strong customer base, social service, a brand name and so on. Customers trust them and for this trust, they are even willing to pay higher prices.
Goodwill is the quantitative value (i.e. in monetary terms) of the reputation of the firm in the market.
FIXED ASSETS
An asset is any possession or property of the business that enables the firm to get cash or any benefit in the future.
Fixed Assets are assets which are purchased for long-term use. They are for continued use in the business for producing goods or services and are not meant for resale. For example- Plant, machinery, building, goodwill, patents etc.
Fixed assets can be tangible or intangible.
Tangible assets are those assets which can be seen and touched and have physical existence like Plant and machinery, building, stock, furniture etc.
Intangible assets are those assets which cannot be seen or touched i.e. they don’t have any physical existence like goodwill, patent, trademark, prepaid expenses etc. Even though they can’t be seen or touched by they have value and are not fictitious assets.
Goodwill as a Fixed Asset
Goodwill is an intangible asset as it cannot be seen or touched but has value and adds value to the business over a long period. Thus, goodwill is a fixed asset.
It is shown in the balance sheet as a Fixed asset under the head Intangible asset.
Goodwill can be
Self-generated goodwill is created over a period due to the good reputation of the business. It is the difference between the value of the firm and the fair value of the net tangible assets of the firm.
Goodwill = Value of the firm – Fair value of net tangible assets
Here, F.V of net tangible assets = Fair value of tangible assets- Fair value of tangible liabilities
Purchased goodwill arises when one business purchases another business. It is the difference between the price paid for the purchased firm and the sum of the fair market value of the assets received and liabilities to be paid by them on behalf of the purchased firm.
Goodwill = Purchase price – (F.V of assets received + F.V of liabilities to be paid)
Only purchased goodwill is recorded in the books of accounts because it is difficult to correctly calculate the value of self-generated goodwill as the future is uncertain, also its valuation depends on the judgement of the person calculating it, which defers from person to person. Since there is no fixed standard to calculate self-generated goodwill only purchased goodwill is recorded as the price paid for it at the time of acquiring another business.
Suppose Firm A acquired Firm B.
Purchase price= $100,000
Assets received=$60,000
Liabilities (to be paid by Firm A on behalf of Firm B) = $10,000
Goodwill = $100,000 – ($60,000 + $10,000) = $30,000
This, goodwill of $30,000 will be recorded under the head Fixed Asset, subhead Intangible Assets in the balance sheet of Firm A (that is in the balance sheet of the acquiring firm)
See lessWhat is credit side of trading account?
Trading A/c is a Nominal A/c which follows the rule “Debit the expenses and losses, Credit the incomes and gains” So, the Credit side of Trading A/c shows income from the sale of goods. It includes Sales, Closing stock (if adjustment for it has not been made yet) and Gross Loss (if any). TRADRead more
Trading A/c is a Nominal A/c which follows the rule “Debit the expenses and losses, Credit the incomes and gains”
So, the Credit side of Trading A/c shows income from the sale of goods. It includes Sales, Closing stock (if adjustment for it has not been made yet) and Gross Loss (if any).
TRADING ACCOUNT
Trading A/c is prepared for calculating the Gross Profit or Gross Loss arising from the trading activities of a business.
Trading activities are mostly related to buying and selling of goods. However, in between buying and selling, a lot of activities are involved like transportation, warehousing, etc. So, all the expenses that are directly related to manufacturing or purchase of goods are also recorded in the Trading A/c.
CREDIT SIDE OF TRADING ACCOUNT
It includes,
SALES – When goods are sold to earn a profit, it is called sales. It can be cash sales or credit sales.
Suppose you are in the business of manufacturing and trading shirts. You sold shirts worth $ 20,000 during the year. This $20,000 is your sales.
SALES RETURN – When the goods sold by you are returned by the customer, it is known as sales return. Sales return is deducted from the sales.
Continuing with the above example, the customers returned shirts of $1,000 because they didn’t like them. This return is known as sales return or return inward (as goods are coming back i.e. in)
CLOSING STOCK – Stock is nothing but goods that are either obtained for resale or manufactured for sale and are yet unsold on any particular date.
The value of stock at the beginning of an accounting year is called Opening stock while the value of the stock at the end of an accounting year is called Closing stock.
Closing stock is valued at cost price or market price whichever is less.
It includes,
For example – On 31st March 2023, there was unused raw material worth $1,000 and shirts worth $5,000 remained unsold.
So, we have Closing Stock of Raw material – $1,000
Closing Stock of Finished Goods – $5,000
Normally, the closing stock is given outside the Trial Balance because its valuation is made after accounts have been closed. It is incorporated in the books by transferring it to the Trading A/c. So, it is shown on the credit side of Trading A/c as well as on the assets side of the Balance sheet.
However, if the closing stock is given inside the Trail Balance, it means that the closing stock must have already been deducted from the Purchases account. So, closing stock will only be shown on the assets side of the Balance sheet.
GROSS LOSS – If purchases and direct expenses exceed sales, then it is a Gross loss. In other words, when Debit side > credit side.
DEBIT SIDE OF TRADING ACCOUNT
It includes
OPENING STOCK – The value of the stock at the beginning of an accounting year is called Opening stock.
The closing stock of the last year becomes the opening stock of the current year.
PURCHASES – Goods that have been bought for resale or raw materials purchased for the manufacturing of the product are terms as Purchases. These goods must be related to the business you are doing. It includes cash as well as credit Purchases.
PURCHASES RETURN – When goods bought are returned to the suppliers due to any reason. This is known as Purchase return. Purchase return is deducted from the Purchases.
WAGES – Wages are paid to the workers who are directly engaged in the loading, unloading and production of goods.
CARRIAGE or CARRIAGE INWARDS or FREIGHT – It refers to the cost of transporting goods from the supplier.
MANUFACTURING EXPENSES – All expenses incurred in the manufacture of goods such as Coal, Gas, Fuel, Water, Power, Factory rent, Factory lighting etc.
DOCK CHARGES – These are charged by port authorities when unloading goods at a dock or wharf. Such charges paid in connection with goods purchased are considered direct expenses and are debited to Trading a/c.
IMPORT DUTY or CUSTOM DUTY – It is a tax collected on imports and specific exports by a country’s customs authorities.
If import duty is paid on the import of goods, then they are shown on the Dr. side of the Trading A/c.
ROYALTY – Royalty refers to the amount paid for the use of assets belonging to another person. It includes royalty for the use of intangible assets, such as copyrights, trademarks, or franchisee agreements. It is also paid for the use of natural resources, such as mining leases.
Royalty is charged to the Trading A/c as it increases the cost of production.
GROSS PROFIT – When sales exceed the amount of purchases and the expenses directly connected with such purchases i.e. when Credit side> Debit side.
See lessWhat is debit side of trading account?
Trading A/c is a nominal account which follows the rule "Debit all expenses and losses, Credit all incomes and gains". So, all expenses relating to the purchase or manufacturing of goods are shown on the debit side of the Trading A/c. It includes Opening Stock, Purchases, Wages, Carriage Inward, ManRead more
Trading A/c is a nominal account which follows the rule “Debit all expenses and losses, Credit all incomes and gains”.
So, all expenses relating to the purchase or manufacturing of goods are shown on the debit side of the Trading A/c. It includes Opening Stock, Purchases, Wages, Carriage Inward, Manufacturing Expenses, Dock charges, and other direct expenses that are directly related to the manufacturing or purchase.
TRADING ACCOUNT
Trading A/c is prepared for calculating the Gross Profit or Gross Loss arising from the trading activities of a business.
Trading activities are mostly related to buying and selling of goods. However, in between buying and selling, a lot of activities are involved like transportation, warehousing, etc. So, all the expenses that are directly related to manufacturing or purchase of goods are also recorded in the Trading A/c.
DEBIT SIDE OF TRADING A/C
The items shown on the Dr. side are,
OPENING STOCK – Stock is nothing but goods that are either obtained for resale or manufactured for sale and are yet unsold on any particular date.
The value of stock at the beginning of an accounting year is called Opening stock while the value of the stock at the end of an accounting year is called closing stock.
The closing stock of the last year becomes the opening stock of the current year.
Opening stock includes,
For example – Suppose you are in the business of manufacturing and trading shirts. On 31st March 2023, there was unused raw material worth $10,000 and shirts worth $50,000 remained unsold.
So, we have Closing Stock of Raw material – $10,000
Closing Stock of Finished Goods – $50,000
This closing stock of last year becomes your opening stock during the current year i.e. on 1st April 2023, we have
Opening Stock of raw material – $10,000
Opening Stock of Finished Goods – $50,000
PURCHASES – Goods that have been bought for resale or raw materials purchased for manufacturing the product are terms as Purchases. These goods must be related to the business you are doing.
It includes cash as well as credit Purchases.
Continuing with the above example, suppose you bought raw material worth $ 1,00,000 for manufacturing and shirts worth $50,000 for resale (and not for personal consumption) then both these will be termed as purchases for you. So, your purchases will be $1,50,000 ($1,00,000 + $50,000)
PURCHASES RETURN – When goods bought are returned to the suppliers due to any reason. This is known as Purchase return. Purchase return is deducted from the Purchases.
In the above example, you bought shirts worth $50,000 for resale. Out of which shirts worth $20,000 were defective. So, you returned them to the supplier. This return of $20,000 is your purchase return or return outwards (as goods are going out)
WAGES – Wages are paid to the workers who are directly engaged in the loading, unloading and production of goods.
For example – Paid $10,000 to workers for manufacturing shirts.
However, it would be included in Trading A/c only if the wages are paid for work which is directly related to the manufacturing or purchase of goods otherwise it will be shown in P&L A/c.
Suppose you hired a manager to take care of your business and paid him $20,000 as salary. This salary is indeed an expense for the business but is not directly related to the manufacturing of goods. Since it is an indirect expense, it can only be recorded in P&L A/c and not in the Trading A/c.
CARRIAGE or CARRIAGE INWARDS or FREIGHT – It refers to the cost of transporting goods from the supplier.
Suppose, you ordered raw material in bulk which was transported to you by a van and you paid its fare. This fare is nothing but your carriage inwards.
However, if carriage or freight is paid on bringing an asset, the amount should be added to the asset account and must not be debited to the trading account.
MANUFACTURING EXPENSES – All expenses incurred in the manufacture of goods such as Coal, Gas, Fuel, Water, Power, Factory rent, Factory lighting etc.
DOCK CHARGES – These are charged by port authorities when unloading goods at a dock or wharf. Such charges paid in connection with goods purchased are considered direct expenses and are debited to Trading a/c.
IMPORT DUTY or CUSTOM DUTY – It is a tax collected on imports and specific exports by a country’s customs authorities. If import duty is paid on the import of goods, then they are shown on the Dr. side of the Trading A/c.
For example – Paid $15,000 as import duty for importing shirts for resale.
ROYALTY – Royalty refers to the amount paid for the use of assets belonging to another person. It includes royalty for the use of intangible assets, such as copyrights, trademarks, or franchisee agreements. It is also paid for the use of natural resources, such as mining leases.
Royalty is charged to the Trading A/c as it increases the cost of production.
GROSS PROFIT – When sales exceed the amount of purchases and the expenses directly connected with such purchases i.e. when Credit side> Debit side.
CREDIT SIDE OF TRADING A/C
SALES – When goods are sold to earn a profit, it is called sales. It can be cash sales or credit sales.
SALES RETURN – When the goods sold are returned by the customer, it is known as a sales return. Sales return is deducted from the sales.
CLOSING STOCK – The goods remaining unsold at the end of the year are termed as closing stock. It is valued at cost price or market price whichever is less.
GROSS LOSS – If purchases and direct expenses exceed sales, then it is a Gross loss. In other words, when Debit side > Credit side.
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