The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side. The profit is shown as the credit balance of profit and loss A/c. When the sum of itRead more
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side.
The profit is shown as the credit balance of profit and loss A/c. When the sum of items on the debit side of a profit and loss account is less than the sum of those on the credit side, it implies profit while when the sum of the items on the credit side is less than the sum of those on the debit side, it implies a loss for the entity.
The Reason for Credit
Profit is recorded as an increase in equity
To understand the reason why profit is recorded as a credit balance, we must first understand the basic principle of debit and credit.
The basic principle of debits and credits is that debits increase asset accounts and decrease liability and equity accounts while credits decrease asset accounts and increase liability and equity accounts.
The revenue that a company earns is credited to the income account and increases equity.
The expenses that a company incurs to earn that revenue are debited to the expense account and decrease equity.
The difference between revenue and expenses is the profit, which is recorded as an increase in equity.
Increase in equity due to revenue – decrease in equity due to expense = profit
Gross Profit Vs Net Profit
Revenue is the total income that a business or profession earns. Profit is the excess revenue that remains after reducing all expenses from it.
Gross profit is the profit that a company earns after reducing the cost of goods sold from sales revenue while net profit is the profit that a business earns after reducing the total of all its direct and indirect expenses from its direct as well as indirect allowable business income.
Conclusion
The basic principle of debit and credit governs the classification of profit as a debit or credit. Since profit increases our equity, it is a credit.
In the case of a company, it belongs to the shareholders. It is usually recorded in the retained earnings account. Profit can be reinvested in the business or can be distributed as a dividend. In the case of a sole proprietorship, the profit belongs to the owner and is recorded in the owner’s capital account.
The correct answer is option B. Wages and salaries are debited to the trading account. The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities. Let us discuss the above items and their treatments inRead more
The correct answer is option B. Wages and salaries are debited to the trading account.
The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities.
Let us discuss the above items and their treatments in the final accounts one at a time:
Wages Outstanding
Firstly, “wages outstanding” is not debited into the trading account. It is a liability that is shown in the balance sheet.
Outstanding wages imply remuneration due to be paid to the workers for the services they have already rendered to the business.
Since the company has already received the service, it becomes a legal obligation for it to pay the wages to the workers for those services. Hence, outstanding wages are a liability.
Wages and Salaries
Wages and Salaries are debited to the trading account.
Wages Vs Salaries
Let us understand the difference between wages and salaries. Wages are the regular payments that are made daily, weekly or fortnightly. Such payments are mostly made to factory workers.
Salaries, on the other hand, are assumed to imply the remuneration paid to office workers and sales staff.
Wages are debited to the trading account, while salaries are debited to the Profit and Loss account.
Director’s Remuneration
No, the director’s remuneration is not debited to the trading account. This is because director’s generation is a business expense. It is a kind of salary provided to the director for the services rendered by him to the company.
Directors’ remuneration refers to compensation the company gives to its directors for the services rendered. It is debited to the Profit and Loss Account.
Advance Payment of Wages
No, advance payment of wages is not debited to a trading account. It is shown by reducing it to wages. Advance payment of wages implying paying remuneration to the workers before the commencement of the period for which the wages relate to.
However, one must note that if both wages and prepaid wages appear within the trial balance, then only the figure written against wages would appear in the trading account. There would be no treatment for prepaid wages.
Let us consider a scenario where wages of amount 5,000 is appearing inside trial balance. Outside the trial balance, the following information is provided
Wages prepaid for the current financial year = 1,000
Wages prepaid for the next financial year = 2,000
In the above case, the total wages to be debited to the trading account would be 5,000 + 1,000 – 2,000 = 4,000
Significance of the Final Accounts
It helps in determining the net profit or loss of the entity for the current financial year.
It is a major source of guidance for investors. Shareholders decide whether or not to invest in a company on the basis of final accounts.
It allows banks and investors to see your business’s total income, debt load a,nd financial stability.
Net credit sales can be defined as the total sales made by a business on credit over a given period of time less the sales returns and allowances and discounts such as trade discounts. Net Credit Sales = Gross Credit Sales – Returns – Discounts – Allowances. Credit sales can be calculated from the ARead more
Net credit sales can be defined as the total sales made by a business on credit over a given period of time less the sales returns and allowances and discounts such as trade discounts.
Credit sales can be calculated from the Accounts receivable/ Bills Receivable/ Debtors figure in the Balance Sheet. It will be normally shown under the Current Assets head in the Balance Sheet.
Alternatively, you may observe the bills receivable ledger account to locate the figure of credit sales.
Net Credit Sales and related terms
Before we try to understand the concept of net credit sales with an example, let us discuss the term sales return. Sales return means the goods returned by the customer to the seller. It may be due to defects or any other reasons.
Now let us take an example. John is a retail businessman. He sells smartphones. He buys 100 smartphones from Vivo on credit. The smartphones are worth ₹1.5 lahks. He then returns smartphones worth 20,000 rupees to Vivo. He also gets an allowance of rupees 5,000 from Vivo.
In the above example, the credit sales of Vivo are of rupees 1.5 lakh. The net credit sales is of
1.5 lakh – 20,000 – 5, 000 = 1.25 lakh rupees.
Importance of Net Credit Sales
Net Credit Sales figure together with the accounts receivable figure acts as an indicator of the credit policy of the company.
It offers insights into the ability of the company to meet short-term cash obligations.
The credit policy also affects the total current assets that the company has in the manifestation of Accounts Receivable
Advantages and Disadvantages of Credit Sales.
Advantages
Increased Sales – The credit Policy facilitates increased sales for the company. The company can attract more customers with a liberal credit policy. For example, Apple got more customers when it started to sell its products on an EMI basis.
Customer Loyalty / Retention- Regular customers can be retained and made to feel honored by offering them more liberal credit terms.
Disadvantages
Delay in Cash Collection – Credit Sales imply that the company would get cash on a delayed basis. This money could have otherwise been put to use for some other profitable venture or could have borne interest for the company
Collection Expenses– The company had to incur additional expenditures for collecting money from debtors.
Risk of Bad Debts – With credit sales, there is always the risk that the buyer may become bankrupt and may not be able to pay the money due to the seller.
Profit is debit or credit?
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side. The profit is shown as the credit balance of profit and loss A/c. When the sum of itRead more
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side.
The profit is shown as the credit balance of profit and loss A/c. When the sum of items on the debit side of a profit and loss account is less than the sum of those on the credit side, it implies profit while when the sum of the items on the credit side is less than the sum of those on the debit side, it implies a loss for the entity.
The Reason for Credit
Profit is recorded as an increase in equity
To understand the reason why profit is recorded as a credit balance, we must first understand the basic principle of debit and credit.
The basic principle of debits and credits is that debits increase asset accounts and decrease liability and equity accounts while credits decrease asset accounts and increase liability and equity accounts.
The revenue that a company earns is credited to the income account and increases equity.
The expenses that a company incurs to earn that revenue are debited to the expense account and decrease equity.
The difference between revenue and expenses is the profit, which is recorded as an increase in equity.
Increase in equity due to revenue – decrease in equity due to expense = profit
Gross Profit Vs Net Profit
Revenue is the total income that a business or profession earns. Profit is the excess revenue that remains after reducing all expenses from it.
Gross profit is the profit that a company earns after reducing the cost of goods sold from sales revenue while net profit is the profit that a business earns after reducing the total of all its direct and indirect expenses from its direct as well as indirect allowable business income.
Conclusion
The basic principle of debit and credit governs the classification of profit as a debit or credit. Since profit increases our equity, it is a credit.
In the case of a company, it belongs to the shareholders. It is usually recorded in the retained earnings account. Profit can be reinvested in the business or can be distributed as a dividend. In the case of a sole proprietorship, the profit belongs to the owner and is recorded in the owner’s capital account.
See lessWhich of the following is debited to trading account?
The correct answer is option B. Wages and salaries are debited to the trading account. The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities. Let us discuss the above items and their treatments inRead more
The correct answer is option B. Wages and salaries are debited to the trading account.
The trading account helps us to determine the Gross Profit Or Loss that a company earns or incurs by carrying on its core manufacturing or trading activities.
Let us discuss the above items and their treatments in the final accounts one at a time:
Wages Outstanding
Firstly, “wages outstanding” is not debited into the trading account. It is a liability that is shown in the balance sheet.
Outstanding wages imply remuneration due to be paid to the workers for the services they have already rendered to the business.
Since the company has already received the service, it becomes a legal obligation for it to pay the wages to the workers for those services. Hence, outstanding wages are a liability.
Wages and Salaries
Wages and Salaries are debited to the trading account.
Wages Vs Salaries
Let us understand the difference between wages and salaries. Wages are the regular payments that are made daily, weekly or fortnightly. Such payments are mostly made to factory workers.
Salaries, on the other hand, are assumed to imply the remuneration paid to office workers and sales staff.
Wages are debited to the trading account, while salaries are debited to the Profit and Loss account.
Director’s Remuneration
No, the director’s remuneration is not debited to the trading account. This is because director’s generation is a business expense. It is a kind of salary provided to the director for the services rendered by him to the company.
Directors’ remuneration refers to compensation the company gives to its directors for the services rendered. It is debited to the Profit and Loss Account.
Advance Payment of Wages
No, advance payment of wages is not debited to a trading account. It is shown by reducing it to wages. Advance payment of wages implying paying remuneration to the workers before the commencement of the period for which the wages relate to.
However, one must note that if both wages and prepaid wages appear within the trial balance, then only the figure written against wages would appear in the trading account. There would be no treatment for prepaid wages.
Let us consider a scenario where wages of amount 5,000 is appearing inside trial balance. Outside the trial balance, the following information is provided
In the above case, the total wages to be debited to the trading account would be 5,000 + 1,000 – 2,000 = 4,000
Significance of the Final Accounts
See lessHow to find net credit sales in the annual report?
Net credit sales can be defined as the total sales made by a business on credit over a given period of time less the sales returns and allowances and discounts such as trade discounts. Net Credit Sales = Gross Credit Sales – Returns – Discounts – Allowances. Credit sales can be calculated from the ARead more
Net credit sales can be defined as the total sales made by a business on credit over a given period of time less the sales returns and allowances and discounts such as trade discounts.
Net Credit Sales = Gross Credit Sales – Returns – Discounts – Allowances.
Credit sales can be calculated from the Accounts receivable/ Bills Receivable/ Debtors figure in the Balance Sheet. It will be normally shown under the Current Assets head in the Balance Sheet.
Credit sales = Closing debtors + Receipts – Opening debtors.
Alternatively, you may observe the bills receivable ledger account to locate the figure of credit sales.
Net Credit Sales and related terms
Before we try to understand the concept of net credit sales with an example, let us discuss the term sales return. Sales return means the goods returned by the customer to the seller. It may be due to defects or any other reasons.
Now let us take an example. John is a retail businessman. He sells smartphones. He buys 100 smartphones from Vivo on credit. The smartphones are worth ₹1.5 lahks. He then returns smartphones worth 20,000 rupees to Vivo. He also gets an allowance of rupees 5,000 from Vivo.
In the above example, the credit sales of Vivo are of rupees 1.5 lakh. The net credit sales is of
1.5 lakh – 20,000 – 5, 000 = 1.25 lakh rupees.
Importance of Net Credit Sales
Advantages and Disadvantages of Credit Sales.
Advantages
Disadvantages
- Delay in Cash Collection – Credit Sales imply that the company would get cash on a delayed basis. This money could have otherwise been put to use for some other profitable venture or could have borne interest for the company
- Collection Expenses– The company had to incur additional expenditures for collecting money from debtors.
- Risk of Bad Debts – With credit sales, there is always the risk that the buyer may become bankrupt and may not be able to pay the money due to the seller.
See less