When a firm grants an extra amount of reward to its employees based on their performance, it is termed a bonus. An accrued bonus is contingent on performance. Bonus accruals are recorded in the books so that inaccuracies can be avoided in the financial statements. Such bonuses may be given as a singRead more
When a firm grants an extra amount of reward to its employees based on their performance, it is termed a bonus. An accrued bonus is contingent on performance. Bonus accruals are recorded in the books so that inaccuracies can be avoided in the financial statements.
Such bonuses may be given as a single flare amount or as a percentage of their salaries. These bonuses can be given quarterly or annually or in any manner in which the firm decides.
If the bonus is accrued to its employees at 5% of their salary of Rs 30,000, then the accrual bonus can be shown in the journal as follows:
The bonus expense account is debited because according to the modern rule of accounting “Increase in expense is debited”. Accrued bonus liability is credited because according to the rule of accounting, “Increase in liability is credited”.
When it is time to pay such bonus amounts to its employees, then they can be journalised as:
In this case, the accrued bonus liability is eliminated and hence debited because according to the rule of accounting, “ Decrease in liability is debited” whereas cash account is credited since “the decrease in the asset is credited.”:
Failing to accrue these bonuses will lead to an overstatement of revenues in the financial statements and hence result in inaccurate data. If employees do not meet the required performance targets, then a bonus will not be given and hence the entries will be reversed.
Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc. FORMULA Current Assets - Current Liabilities = Working Capital Zero workinRead more
Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc.
FORMULA
Current Assets – Current Liabilities = Working Capital
Zero working capital is when a company has the exact same amount of current assets and current liabilities. When both are equal, the difference becomes zero and hence the name, Zero working capital. Working Capital may be positive or negative. When current assets exceed current liabilities, it shows positive working capital and when current liabilities exceed current assets, it shows negative working capital.
Zero working capital can be operated by adopting demand-based production. In this method, the business only produces units as and when they are ordered by the customers. Through this method, all stocks of finished goods will be eliminated. Also, raw material is only ordered based on the amount of demand.
This reduces the investment in working capital and thus the investment in long term assets can increase. The company can also use the funds for other purposes like growth or new opportunities.
EXAMPLE
Suppose a company has Inventory worth Rs 3,000, Debtors worth Rs 4,000 and cash worth Rs 2,000. The creditors of the company are Rs 6,000 and short term borrowings are Rs 3,000.
Now, total assets = Rs 9,000 ( 3,000 + 4,000 + 2,000)
And total liabilities = Rs 9,000 ( 6,000 + 3,000)
Therefore, working capital = 9,000 – 9,000 = 0
The term set off in English means to offset something against something else. It thereby refers to reducing the value of an item. In accounting terms, when a debtor can reduce the amount owed to a creditor by cancelling the amount owed by the creditor to the debtor, it is termed as set off. It is coRead more
The term set off in English means to offset something against something else. It thereby refers to reducing the value of an item. In accounting terms, when a debtor can reduce the amount owed to a creditor by cancelling the amount owed by the creditor to the debtor, it is termed as set off.
It is commonly used by banks where they seize the amount in a customer’s account to set off the amount of loan unpaid by the customer.
Types
There are various types of set-offs as given below:
Transaction set-off – This is where a debtor can simply reduce the amount he is owed from the amount he owes to the creditor.
Contractual set-off – Sometimes, a debtor agrees to not set off any amount and hence he would have to pay the entire amount to the creditor even if the creditor owed some amount to the debtor.
Insolvency set-off – These rules are mandatory and have to be followed under the Insolvency rules 2016.
Bankers set-off – Here, the bank sets off the amount of a customer with another account of the customer.
Example
Let’s say Divya owes Rs 20,000 to Sherin for the purchase of goods. But, Sherin owed Rs 6,000 to Divya already for use of her Machinery. Therefore, the amount of 6,000 can be set off against the 20,000 owed to Sherin and hence Divya would effectively owe Sherin Rs 14,000.
This helps in reducing the number of transactions and unnecessary flow of cash.
Depreciation is an accounting method that is used to write off the cost of an asset. The company must record depreciation in the profit and loss account. It is done so that the cost of an asset can be realised over the years rather than one single year. Furniture is an important asset for a businessRead more
Depreciation is an accounting method that is used to write off the cost of an asset. The company must record depreciation in the profit and loss account. It is done so that the cost of an asset can be realised over the years rather than one single year.
Furniture is an important asset for a business. As per the Income Tax Act, the rate of depreciation for furniture and fittings is 10%. However, for accounting purposes, the company is free to set its own rate.
JOURNAL ENTRY
Journal entry for depreciation of furniture is:
Here, depreciation is debited since it is an expense and as per the rules of accounting, “increase in expenses are debited”. Furniture is credited because a “ decrease in assets is credited”, and the value of furniture is reducing.
TYPES OF DEPRECIATION
Furniture can be depreciated in any of the following ways:
Straight-Line Method – It is calculated by finding the difference between the cost of the asset and its expected salvage value, and the result is divided by the number of years the asset is expected to be used.
Diminishing Value Method – It is calculated by charging a fixed percentage on the book value of the asset. Since the book value keeps on reducing, it is called the diminishing value method.
Units of Production
For accounting purposes, the two many methods used for depreciating furniture is the straight-line method and the diminishing value method. However, for tax purposes, they are combined into a block of furniture, where the purchase of new furniture is added and the sale of furniture is subtracted and the resulting amount is depreciated by 10% based on the written downvalue method.
EXAMPLE
If a company buys furniture worth Rs 30,000 and charges depreciation of 10%, then by straight-line method, Rs 3,000 would be depreciated every year for 10 years.
Now if the company decided to use the diminishing value method (or written down value method), then Rs 3,000 (30,000 x 10%) would be depreciated in the first year, and in the second year, the book value of the furniture would be Rs 27,000 (30,000-3,000). Hence depreciation for the second year would be Rs 2,700 (27,000 x 10%) and so on.
A balance sheet of a company is a financial statement that depicts the assets, liabilities and shareholders’ equity of the company at a point of time, usually at the end of the accounting year. A balance sheet of a company is reported in a vertical format which is different from that of a partnershiRead more
A balance sheet of a company is a financial statement that depicts the assets, liabilities and shareholders’ equity of the company at a point of time, usually at the end of the accounting year. A balance sheet of a company is reported in a vertical format which is different from that of a partnership where the horizontal format is used.
COMPONENTS OF A BALANCE SHEET
The three main components of a balance sheet are Assets, Liabilities and Shareholders’ equity.
Assets: They are divided into two main categories that are current assets and non-current assets. If an asset is expected to be realised within 12 months or is primarily held for being traded, or is cash or cash equivalent, then those assets are termed as current assets. All assets that are not current assets are grouped under non-current assets. They are normally realised after 12 months.
Liabilities: They are categorised as current liabilities and non-current liabilities. If the amount owed by the company to an outside party is due to be settled in 12 months, then it can be termed as a current liability. The rest of the liabilities are referred to as non-current liability.
Shareholders’ Equity: This is the money owed to the owners of the company, that is shareholders. It is also called net assets since it is equal to the difference between total assets and total liabilities. Their main categories are Shareholders’ Capital and Reserves and Surplus.
FORMAT OF BALANCE SHEET
As per the Companies Act 2013, the following format should be used for preparing a balance sheet.
From the above Balance sheet, we should get:
Assets = Liabilities + Shareholders’ Equity
Relevant notes for each component should also be prepared when necessary.
Under GST, Input Tax Credit (ITC) refers to the tax already paid by a person on input, which is available as a deduction from tax payable on output. This means that if you have paid tax on some purchases, then at the time of paying tax on the sale of goods, you can reduce it by the amount you alreadRead more
Under GST, Input Tax Credit (ITC) refers to the tax already paid by a person on input, which is available as a deduction from tax payable on output. This means that if you have paid tax on some purchases, then at the time of paying tax on the sale of goods, you can reduce it by the amount you already paid on purchase and pay only the balance amount.
EXAMPLE
Suppose Ashok purchased goods worth Rs 100 while paying tax at 10%, that is Rs 10. He now sold the goods for Rs 200, with a tax payable of Rs 20. Now, Ashok can avail input tax credit of Rs 10 that he already paid for the purchase and hence the net tax payable is Rs 10 (20-10).
METHOD OF UTILISATION OF ITC
The central government collects CGST, SGST, UTGST or IGST based on whether the transactions are done intrastate or interstate.
The amount of input tax credit on IGST is first used for paying IGST and then utilised for the payment of CGST and SGST or UTGST. Similarly, the amount of ITC relating to CGST is first utilised for payment of CGST and then for the payment of IGST. It is not used for the payment of SGST or UTGST. Meanwhile, the amount of ITC relating to SGST is utilised for payment of SGST or UTGST and then for the payment of IGST. Such amounts are not used for payment of CGST.
We can see how Input Tax Credit is used from the below example and table:
When a business deposits its money into a bank account, it receives a percentage of the amount deposited as bank interest. The journal entry for interest received from a bank is as follows: Since the Bank account is a current asset, it gets debited. This is in accordance with the modern rules of accRead more
When a business deposits its money into a bank account, it receives a percentage of the amount deposited as bank interest. The journal entry for interest received from a bank is as follows:
Since the Bank account is a current asset, it gets debited. This is in accordance with the modern rules of accounting where an increase in assets is debited while a decrease in assets is credited. According to the traditional rules (golden rules) of accounting, a bank account is classified under Personal account with the rule of “debit the receiver” and “credit the giver”. In the given journal entry bank account is receiving money and is hence debited.
Meanwhile, Bank interest is the income received by the business and according to the modern rule of accounting, an increase in incomes is credited and a decrease in incomes is debited. Whereas, considering the traditional rules (golden rules), bank interest comes under Nominal account where “all incomes are credited” and “all expenses are debited”. Therefore, considering these rules, bank interest is credited.
EXAMPLE
If Gregor Ltd has a bank account with HSBC, having an opening balance of Rs 10,000 earning an interest of 5% per annum, then the journal entry for interest received from the bank is recorded as
The interest amount is taken on the amount deposited in the bank (10,000 * 5%).
Capital Work in Progress refers to the total cost incurred on a fixed asset that is still undergoing construction as on the balance sheet date. These costs are not allowed to be used as an operating asset until the asset is ready to use. Until the construction of the asset is completed, the costs arRead more
Capital Work in Progress refers to the total cost incurred on a fixed asset that is still undergoing construction as on the balance sheet date. These costs are not allowed to be used as an operating asset until the asset is ready to use. Until the construction of the asset is completed, the costs are recorded as capital work in progress.
Depreciation is the systematic allocation of the cost of an asset over its useful life. Depreciation is charged on an asset from the date it is ready to use. Since Capital Work in Progress is not yet ready to use, depreciation cannot be charged on it.
Example
If a company owns a Machinery worth Rs. 45,000 out of which Rs. 15,000 is part of capital work in progress, then depreciation on such machinery would be calculated only on the part of machinery that is ready to use that is Rs. 30,000 (45,000-15,000).
When an asset is undergoing construction, the journal entry for each expense would be recorded as
Further, when all construction of the above asset is completed, it is transferred to fixed asset account. This would be recorded as
After transfer to Fixed Asset account, depreciation can be calculated and shown as below
If the construction of an asset is complete but has not been put to use till now, depreciation is still calculated as it is ready for use. It can be done through various methods like straight-line method, written down value method etc.
When a loan is taken from a person by a business, there is an asset and liability being created. Cash is being brought into the business which increases the asset whereas the financial obligation of the company rises when a loan is taken and hence a liability increases. For example, Mark Ltd. has taRead more
When a loan is taken from a person by a business, there is an asset and liability being created. Cash is being brought into the business which increases the asset whereas the financial obligation of the company rises when a loan is taken and hence a liability increases.
For example, Mark Ltd. has taken a loan from John for $5,000. Therefore the journal entry can be shown as:
According to the modern rules of accounting, increase in assets is Debit and increase in liability is credit. The company may have taken the loan to finance its business or for some emergency. When it is time for the business to pay off the loan, they can either pay it off completely or in instalments. They must pay off the principal amount along with interest.
Now for our above example, if Mark Ltd paid off the entire loan after one year at 10% interest, then the journal entry would be:
Here, the interest on loan account is debited since an increase in expense is debited. Loan account will be debited because the obligation is now reduced and hence liability decreases. Finally, we credit cash since cash is leaving the business which implies a decrease in assets.
If the entire loan is not paid off in that year, then the balance of the loan amount will be shown in the balance sheet under the head liabilities.
Preliminary expenses are those expenses that are incurred before the company’s business commences. These expenses are written off annually which does not involve any flow of cash. Therefore, in the cash flow statement, preliminary expenses are added back to net profit before tax and extraordinary itRead more
Preliminary expenses are those expenses that are incurred before the company’s business commences. These expenses are written off annually which does not involve any flow of cash. Therefore, in the cash flow statement, preliminary expenses are added back to net profit before tax and extraordinary items under the head operating activities (indirect method).
A cash flow statement is a financial statement that summarises the cash and cash equivalents entering and leaving the company. They can be classified into operating activities, investing activities and financing activities.
Reason for Treatment
Operating activities refer to those sources or usage of cash that relates to business activities.
As per the indirect method, the cash flow statement for operating activities begins with net profit before tax and extraordinary items. Since the company records non-cash expenditures also, they should add these back to net profit to find out the true cash flows. This is why preliminary expenses are added to net profit in the indirect method.
As per the direct method, all cash receipts are added and all cash expenses are subtracted to get cash flow from operating activities. Since preliminary expenses are a non-cash activity, they do not require any treatment in the direct method.
Preliminary expenses do not fall under the head investing activities as investing activities involve the acquisition or disposal of long term assets or investments. They do not fit in financing activities either as financing activities relate to change in capital or borrowings of the company.
Example
If the balance in preliminary expenses for the year 2019 was Rs.5,000 and its balance in 2020 reduced to 3,000, then its treatment in the cash flow statement would be:
How to do bonus accrual accounting entries?
When a firm grants an extra amount of reward to its employees based on their performance, it is termed a bonus. An accrued bonus is contingent on performance. Bonus accruals are recorded in the books so that inaccuracies can be avoided in the financial statements. Such bonuses may be given as a singRead more
When a firm grants an extra amount of reward to its employees based on their performance, it is termed a bonus. An accrued bonus is contingent on performance. Bonus accruals are recorded in the books so that inaccuracies can be avoided in the financial statements.
Such bonuses may be given as a single flare amount or as a percentage of their salaries. These bonuses can be given quarterly or annually or in any manner in which the firm decides.
If the bonus is accrued to its employees at 5% of their salary of Rs 30,000, then the accrual bonus can be shown in the journal as follows:
When it is time to pay such bonus amounts to its employees, then they can be journalised as:
In this case, the accrued bonus liability is eliminated and hence debited because according to the rule of accounting, “ Decrease in liability is debited” whereas cash account is credited since “the decrease in the asset is credited.”:
Failing to accrue these bonuses will lead to an overstatement of revenues in the financial statements and hence result in inaccurate data. If employees do not meet the required performance targets, then a bonus will not be given and hence the entries will be reversed.
See lessWhat is zero working capital?
Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc. FORMULA Current Assets - Current Liabilities = Working Capital Zero workinRead more
Working capital is defined as the difference between current assets and current liabilities of a business. Current assets include cash, debtors and stock whereas current liabilities include creditors and short term loans etc.
FORMULA
Current Assets – Current Liabilities = Working Capital
Zero working capital is when a company has the exact same amount of current assets and current liabilities. When both are equal, the difference becomes zero and hence the name, Zero working capital. Working Capital may be positive or negative. When current assets exceed current liabilities, it shows positive working capital and when current liabilities exceed current assets, it shows negative working capital.
Zero working capital can be operated by adopting demand-based production. In this method, the business only produces units as and when they are ordered by the customers. Through this method, all stocks of finished goods will be eliminated. Also, raw material is only ordered based on the amount of demand.
This reduces the investment in working capital and thus the investment in long term assets can increase. The company can also use the funds for other purposes like growth or new opportunities.
EXAMPLE
Suppose a company has Inventory worth Rs 3,000, Debtors worth Rs 4,000 and cash worth Rs 2,000. The creditors of the company are Rs 6,000 and short term borrowings are Rs 3,000.
Now, total assets = Rs 9,000 ( 3,000 + 4,000 + 2,000)
And total liabilities = Rs 9,000 ( 6,000 + 3,000)
Therefore, working capital = 9,000 – 9,000 = 0
See lessWhat is the meaning of “set off” in accounting?
The term set off in English means to offset something against something else. It thereby refers to reducing the value of an item. In accounting terms, when a debtor can reduce the amount owed to a creditor by cancelling the amount owed by the creditor to the debtor, it is termed as set off. It is coRead more
The term set off in English means to offset something against something else. It thereby refers to reducing the value of an item. In accounting terms, when a debtor can reduce the amount owed to a creditor by cancelling the amount owed by the creditor to the debtor, it is termed as set off.
It is commonly used by banks where they seize the amount in a customer’s account to set off the amount of loan unpaid by the customer.
Types
There are various types of set-offs as given below:
Example
Let’s say Divya owes Rs 20,000 to Sherin for the purchase of goods. But, Sherin owed Rs 6,000 to Divya already for use of her Machinery. Therefore, the amount of 6,000 can be set off against the 20,000 owed to Sherin and hence Divya would effectively owe Sherin Rs 14,000.
This helps in reducing the number of transactions and unnecessary flow of cash.
See lessWhat is furniture depreciation rate?
Depreciation is an accounting method that is used to write off the cost of an asset. The company must record depreciation in the profit and loss account. It is done so that the cost of an asset can be realised over the years rather than one single year. Furniture is an important asset for a businessRead more
Depreciation is an accounting method that is used to write off the cost of an asset. The company must record depreciation in the profit and loss account. It is done so that the cost of an asset can be realised over the years rather than one single year.
Furniture is an important asset for a business. As per the Income Tax Act, the rate of depreciation for furniture and fittings is 10%. However, for accounting purposes, the company is free to set its own rate.
JOURNAL ENTRY
Journal entry for depreciation of furniture is:
Here, depreciation is debited since it is an expense and as per the rules of accounting, “increase in expenses are debited”. Furniture is credited because a “ decrease in assets is credited”, and the value of furniture is reducing.
TYPES OF DEPRECIATION
Furniture can be depreciated in any of the following ways:
For accounting purposes, the two many methods used for depreciating furniture is the straight-line method and the diminishing value method. However, for tax purposes, they are combined into a block of furniture, where the purchase of new furniture is added and the sale of furniture is subtracted and the resulting amount is depreciated by 10% based on the written downvalue method.
EXAMPLE
If a company buys furniture worth Rs 30,000 and charges depreciation of 10%, then by straight-line method, Rs 3,000 would be depreciated every year for 10 years.
Now if the company decided to use the diminishing value method (or written down value method), then Rs 3,000 (30,000 x 10%) would be depreciated in the first year, and in the second year, the book value of the furniture would be Rs 27,000 (30,000-3,000). Hence depreciation for the second year would be Rs 2,700 (27,000 x 10%) and so on.
See lessHow to show format of balance sheet as per companies act 2013?
A balance sheet of a company is a financial statement that depicts the assets, liabilities and shareholders’ equity of the company at a point of time, usually at the end of the accounting year. A balance sheet of a company is reported in a vertical format which is different from that of a partnershiRead more
A balance sheet of a company is a financial statement that depicts the assets, liabilities and shareholders’ equity of the company at a point of time, usually at the end of the accounting year. A balance sheet of a company is reported in a vertical format which is different from that of a partnership where the horizontal format is used.
COMPONENTS OF A BALANCE SHEET
The three main components of a balance sheet are Assets, Liabilities and Shareholders’ equity.
FORMAT OF BALANCE SHEET
As per the Companies Act 2013, the following format should be used for preparing a balance sheet.
From the above Balance sheet, we should get:
Assets = Liabilities + Shareholders’ Equity
Relevant notes for each component should also be prepared when necessary.
See lessWhat is input tax credit example?
Under GST, Input Tax Credit (ITC) refers to the tax already paid by a person on input, which is available as a deduction from tax payable on output. This means that if you have paid tax on some purchases, then at the time of paying tax on the sale of goods, you can reduce it by the amount you alreadRead more
Under GST, Input Tax Credit (ITC) refers to the tax already paid by a person on input, which is available as a deduction from tax payable on output. This means that if you have paid tax on some purchases, then at the time of paying tax on the sale of goods, you can reduce it by the amount you already paid on purchase and pay only the balance amount.
EXAMPLE
Suppose Ashok purchased goods worth Rs 100 while paying tax at 10%, that is Rs 10. He now sold the goods for Rs 200, with a tax payable of Rs 20. Now, Ashok can avail input tax credit of Rs 10 that he already paid for the purchase and hence the net tax payable is Rs 10 (20-10).
METHOD OF UTILISATION OF ITC
The central government collects CGST, SGST, UTGST or IGST based on whether the transactions are done intrastate or interstate.
The amount of input tax credit on IGST is first used for paying IGST and then utilised for the payment of CGST and SGST or UTGST. Similarly, the amount of ITC relating to CGST is first utilised for payment of CGST and then for the payment of IGST. It is not used for the payment of SGST or UTGST. Meanwhile, the amount of ITC relating to SGST is utilised for payment of SGST or UTGST and then for the payment of IGST. Such amounts are not used for payment of CGST.
We can see how Input Tax Credit is used from the below example and table:
See lessWhat is the journal entry for interest received from bank?
When a business deposits its money into a bank account, it receives a percentage of the amount deposited as bank interest. The journal entry for interest received from a bank is as follows: Since the Bank account is a current asset, it gets debited. This is in accordance with the modern rules of accRead more
When a business deposits its money into a bank account, it receives a percentage of the amount deposited as bank interest. The journal entry for interest received from a bank is as follows:
Since the Bank account is a current asset, it gets debited. This is in accordance with the modern rules of accounting where an increase in assets is debited while a decrease in assets is credited. According to the traditional rules (golden rules) of accounting, a bank account is classified under Personal account with the rule of “debit the receiver” and “credit the giver”. In the given journal entry bank account is receiving money and is hence debited.
Meanwhile, Bank interest is the income received by the business and according to the modern rule of accounting, an increase in incomes is credited and a decrease in incomes is debited. Whereas, considering the traditional rules (golden rules), bank interest comes under Nominal account where “all incomes are credited” and “all expenses are debited”. Therefore, considering these rules, bank interest is credited.
EXAMPLE
If Gregor Ltd has a bank account with HSBC, having an opening balance of Rs 10,000 earning an interest of 5% per annum, then the journal entry for interest received from the bank is recorded as
The interest amount is taken on the amount deposited in the bank (10,000 * 5%).
See lessCan capital work in progress be depreciated?
Capital Work in Progress refers to the total cost incurred on a fixed asset that is still undergoing construction as on the balance sheet date. These costs are not allowed to be used as an operating asset until the asset is ready to use. Until the construction of the asset is completed, the costs arRead more
Capital Work in Progress refers to the total cost incurred on a fixed asset that is still undergoing construction as on the balance sheet date. These costs are not allowed to be used as an operating asset until the asset is ready to use. Until the construction of the asset is completed, the costs are recorded as capital work in progress.
Depreciation is the systematic allocation of the cost of an asset over its useful life. Depreciation is charged on an asset from the date it is ready to use. Since Capital Work in Progress is not yet ready to use, depreciation cannot be charged on it.
Example
If a company owns a Machinery worth Rs. 45,000 out of which Rs. 15,000 is part of capital work in progress, then depreciation on such machinery would be calculated only on the part of machinery that is ready to use that is Rs. 30,000 (45,000-15,000).
When an asset is undergoing construction, the journal entry for each expense would be recorded as
Further, when all construction of the above asset is completed, it is transferred to fixed asset account. This would be recorded as
After transfer to Fixed Asset account, depreciation can be calculated and shown as below
If the construction of an asset is complete but has not been put to use till now, depreciation is still calculated as it is ready for use. It can be done through various methods like straight-line method, written down value method etc.
See lessWhat is the journal entry for loan taken from a person?
When a loan is taken from a person by a business, there is an asset and liability being created. Cash is being brought into the business which increases the asset whereas the financial obligation of the company rises when a loan is taken and hence a liability increases. For example, Mark Ltd. has taRead more
When a loan is taken from a person by a business, there is an asset and liability being created. Cash is being brought into the business which increases the asset whereas the financial obligation of the company rises when a loan is taken and hence a liability increases.
For example, Mark Ltd. has taken a loan from John for $5,000. Therefore the journal entry can be shown as:
According to the modern rules of accounting, increase in assets is Debit and increase in liability is credit. The company may have taken the loan to finance its business or for some emergency. When it is time for the business to pay off the loan, they can either pay it off completely or in instalments. They must pay off the principal amount along with interest.
Now for our above example, if Mark Ltd paid off the entire loan after one year at 10% interest, then the journal entry would be:
Here, the interest on loan account is debited since an increase in expense is debited. Loan account will be debited because the obligation is now reduced and hence liability decreases. Finally, we credit cash since cash is leaving the business which implies a decrease in assets.
If the entire loan is not paid off in that year, then the balance of the loan amount will be shown in the balance sheet under the head liabilities.
See lessWhat is the treatment of preliminary expenses in cash flow statement?
Preliminary expenses are those expenses that are incurred before the company’s business commences. These expenses are written off annually which does not involve any flow of cash. Therefore, in the cash flow statement, preliminary expenses are added back to net profit before tax and extraordinary itRead more
Preliminary expenses are those expenses that are incurred before the company’s business commences. These expenses are written off annually which does not involve any flow of cash. Therefore, in the cash flow statement, preliminary expenses are added back to net profit before tax and extraordinary items under the head operating activities (indirect method).
A cash flow statement is a financial statement that summarises the cash and cash equivalents entering and leaving the company. They can be classified into operating activities, investing activities and financing activities.
Reason for Treatment
Operating activities refer to those sources or usage of cash that relates to business activities.
As per the indirect method, the cash flow statement for operating activities begins with net profit before tax and extraordinary items. Since the company records non-cash expenditures also, they should add these back to net profit to find out the true cash flows. This is why preliminary expenses are added to net profit in the indirect method.
As per the direct method, all cash receipts are added and all cash expenses are subtracted to get cash flow from operating activities. Since preliminary expenses are a non-cash activity, they do not require any treatment in the direct method.
Preliminary expenses do not fall under the head investing activities as investing activities involve the acquisition or disposal of long term assets or investments. They do not fit in financing activities either as financing activities relate to change in capital or borrowings of the company.
Example
If the balance in preliminary expenses for the year 2019 was Rs.5,000 and its balance in 2020 reduced to 3,000, then its treatment in the cash flow statement would be:
See less