Similarly, someone asked Are loose tools current assets
Similarly, someone asked Are loose tools current assets
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Definition Prepaid expenses are those expenses whose payments are done in advance which can be for the goods or services whose benefit will accrue in the subsequent accounting period. A prepaid expense is a current asset. prepaid expenses are classified under the head current assets in the balance sRead more
Definition
Prepaid expenses are those expenses whose payments are done in advance which can be for the goods or services whose benefit will accrue in the subsequent accounting period.
A prepaid expense is a current asset. prepaid expenses are classified under the head current assets in the balance sheet.
This is because they provide future economic benefits to the company. As such, they are assets that can be used to generate revenue in the future.
For example prepaid rent, prepaid insurance, etc.
Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.
Or in other words, we can say that the expected realization period is less than the operating cycle period although it is more than the period of 12 months from the date of the balance sheet.
For example, goods are purchased with the purpose to resell and earn a profit, debtors exist to convert them into cash i.e., receive the amount from them, bills receivable exist again for receiving cash against it, etc.
Current liabilities are liabilities that are payable generally within 12 months from the end of the accounting period or in other words which fall due for payment in a relatively short period.
For example bills payable, short-term loans, etc.
Why current assets and not a current liability?
Now let me try to explain to you that prepaid expenses are classified as current assets and not as a current liability which is as follows :
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- we can say that the expected realization period is less than the operating cycle period although it is more than the period of 12 months from the date of the balance sheet.
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- expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.
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- In the business prepaid expense are treated as an asset which we can see on the asset side of the balance sheet.
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- Or in other words, we can say that it is initially recorded as a prepaid expense as an asset in the balance sheet and subsequently its value is expensed over time in the profit and loss account.
Example
Now let us take an example for explaining prepaid expenses which are mentioned below.
An insurance premium of Rs 50000 has been paid for one year beginning (previous year). The financial year ends on 31st march YYYY.
It means the premium for 6 months i.e., 1st April, YYYY(current year) to 30th September, YYYY(current year) amounting to Rs 25000 is paid in advance.
Thus, of premium paid in advance (Rs 25000) is a Prepaid Expense. It will be accounted as an expense in the financial year ending 31st march next year. In the balance sheet as of 31st march YYYY ( current year ) it will be shown as Current Asset.
Here is an extract of the profit /loss account and balance sheet of the above example:
Key points
There are a few things to keep in mind when dealing with prepaid expenses.
- First, is that the expenses are actually prepaid. This means that the expenses were paid for before they were used.
- Second, it is essential to track the number of prepaid expenses that have been used. That is to make sure that the prepaid expenses are not overstated on the company’s financial statements. This can happen if the company pays for more goods or services than it actually
- Last but not least it is important to keep in mind that changes in the value of prepaid expenses can impact the company’s net income. For example, if the company’s prepaid insurance increases in value, this will increase the company’s net income.
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Accruals are not the same as provisions both are totally different from each other. Accruals and provision both are vital parts of accounts but work differently Accrual Accrual expense means the transaction that takes place in a particular period must be accounted for in that period only irreRead more
Accruals are not the same as provisions both are totally different from each other. Accruals and provision both are vital parts of accounts but work differently
Accrual
Accrual expense means the transaction that takes place in a particular period must be accounted for in that period only irrespective of the fact when such an amount has been paid.
An accrual of the expenditure which is not paid will be listed in the books of accounts. These accruals can be further divided into two parts
Accrual Expense
Accrual Expense means any transaction that takes place in a particular period but the amount for it will be paid on a later period.
For example- 10,000 for the month of March was paid in April month then this rent will be accounted for in the books in March
These are the following accrued expense
- Accrual Rent– Accrual rent means the amount for using the land of the landlord is paid at a later period than the period when it is put into use.
- Insurance– Accrual insurance means the amount paid as a premium to the insurance company paid on a later period than the period when it is due
- Expense- Acrrual expense means the amount for any expense paid on a later period then the period when it pertains to be paid
- Wages- Accrual wages means the amount which is paid to employees on a later period than the period when the wages get due
Accrual Revenue
Accrual Revenue means any transaction that takes place in a particular period but the amount for it will be received on later period. For example- If interest of 10,000 on bonds for the period of March is received in April months then this amount will be accounted for in March. These are the following accrued revenue
- Accrual Rent– Accrual rent means the amount for using the land of an entity by another party is received on a later period than the period when it was put into use.
- Accrued Interest– Accrued interest means the amount of interest received on a later period than the period when it pertains to receive
PROVISIONS
Provision refers to making a provision/allowance against any probable future expense that the company might incur in the near future. This amount is uncertain and difficult to predict its surety.
However, as per the prudence concept of accounting a company needs to anticipate the losses that will incur in the near future due to which provision is made.
For example- A company has debtors of 10,000 but as per the company’s previous records company anticipates that 1% of debtors will become bad debts. So in this case company will make a provision of 1% that is 100 on it.
There are various types of provisions which are-
- Provision on Depreciation– Provision for Depreciation means a provision for future depletion of assets has been already created
- Provision for Doubtful Debts– Provision for Doubtful Debts means a provision created against debtors that doesn’t seem to be recovered in the near future
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Return inwards in simple terms means sending back goods by the customer to the seller. Simply speaking when your customer purchases items from your business but is not satisfied with the items so received they return those items back to you. Some of the reasons for sending back the items are statedRead more
Return inwards in simple terms means sending back goods by the customer to the seller. Simply speaking when your customer purchases items from your business but is not satisfied with the items so received they return those items back to you. Some of the reasons for sending back the items are stated below:
- Incorrect items delivered by the seller
- The excess amount delivered to the buyer
- Return of expired/ spoiled good
In such a case, the return is initiated by the buyer and a credit note is issued to the buyer, and the same is recorded in the books of accounts. Also, this return inward is deducted from the total sales.
Example: M/s Pest ltd sold 4 units of fertilizers spraying tools of Rs 10,000 each to Mr. Zen. On inspection, he found 1 unit worth Rs 10,000 so received to be defective. Therefore the return of Rs 10,000 was initiated and goods were returned to the seller. A credit note of Rs 10,000 will be raised by the seller (M/s Pest ltd) to the buyer (Mr. Zen). The following adjustment will be shown in the trading account.
Return outwards means returning the goods by the buyer to the supplier. In layman language, when you purchase items for your business and you are not happy with the items then you may decide to return them.
In this case, a debit note is issued to the seller and is recorded in the books of accounts, and the same is reduced from the total purchases in the trading account so prepared.
Example: Suppose you are dealing in a business of clothing. You purchased 20 shirts for Rs.10,000 from a wholesale market. When you sold these shirts, you found 10 shirts worth Rs 5,000 to be defective which were returned by your customer. Therefore you will return these shirts to the wholesale market from where you purchased them. The following adjustment will be shown in the trading account.
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The term ‘bad debt’ and ‘write off’ are often used together in a sentence but they have different meanings. First, we will discuss them in brief to understand the differences between them. Bad debts We know, debtors for a business are their assets because the business has the right to receive moneyRead more
The term ‘bad debt’ and ‘write off’ are often used together in a sentence but they have different meanings. First, we will discuss them in brief to understand the differences between them.
Bad debts
We know, debtors for a business are their assets because the business has the right to receive money from the debtors due to the goods supplied to them.
But if due to circumstances, there appears no probability that the amount due to one or more debtors will be realised to the business, then such debts are categorised as bad debts.
In short, bad debts refer to the amount of money that will not be received from some debtors of the business due to some circumstances like insolvency of debtor etc.
Bad debt is deducted from debtors account by the following journal entry:
Bad debts A/c Dr. Amt To Debtors A/c Cr. Amt (Being bad debts written off from debtors) As bad debts are losses to a business, it is ultimately written off from the profit and loss account.
Profit and loss A/c Dr. Amt To Bad debts A/c Cr. Amt (Being bad debts written off to profit and loss account) Write off
In layman terms, write off means to deduct something out from something. In accounting, write off means to deduct or reduce value of assets by crediting it to a liability account which is usually a reserve account or the profit and loss account.
It also refers to the elimination of an item from the books of accounts particularly losses and expenses.
Generally, writing off is associated with the following:
- Bad debts.
- Damaged Inventories.
- Loss on issue or redemption of debentures.
- Preliminary expenses.
- Bad loans and advances.
Write off can be done in one of the following methods:
- Direct write-off: The write off is directly done by crediting asset account or loss account and debiting the reserve or P/L account.
- Indirect write-off: Here, an intermediate account is involved between the asset account and liabilities account. A common example is writing off of bad debts where the bad debts account is the intermediate account.
Hence, the following differences can be observed between bad debts and write off or writing off:
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Brands can be considered as an Intangible asset as they are a long-term investment done by the company and it gives benefit to an entity in future periods. Like any other intangible asset, brands require long-term investment and will pay over time. Like any other asset, these brands can be bought anRead more
Brands can be considered as an Intangible asset as they are a long-term investment done by the company and it gives benefit to an entity in future periods.
Like any other intangible asset, brands require long-term investment and will pay over time. Like any other asset, these brands can be bought and sold. Brands are best used when they serve the vision and mission of the company.
So, we can definitely consider an organization brand as an intangible as it is expected to increase sales volume in the future period.
Further, we can understand both terms to get a deep understanding-
BRAND
Brand means a product, or service which has a unique identification and can be distinct from other products in the market. Branding is a process by which expenditure is incurred by an entity to create awareness towards the product in the customer’s eyes.
For example- Maggie, Coca-Cola, BMW
Brands can be created through these elements-
- Design
- Packaging
- Advertisement
INTANGIBLE ASSETS
Intangible asset are assets that can’t be seen or touched but the benefit of it occur in future periods for the entity. Even though intangible assets have no physical form but their benefits will accrue in future years. Businesses commonly hold intangible assets. Intangible assets can be further bifurcated in
Definite– Intangible assets that stay and give benefit for a limited or specific period of time covered under this
For example- An agreement is entered with an entity to patent a product for 5 years so this will stay for a definite period only
Indefinite– Intangible assets that stay and give benefit for an unlimited period of time covered under this
For example- A brand which is made by an entity will stay for an indefinite period
Intangible assets can be in various forms these are the following –
Trademark– A trademark is a sign, design, and expression that distinguish the company’s product or services from other company. Trademark is considered an Intellectual Property Right.
Goodwill– Goodwill refers to the value of the company that the company gets from its brand, customer base, and brand Reputation associated with its intellectual property.
Patents– A patent refers to a right reserved for a product exclusively by a person or entity. Under this the right of such making of the product gets reserved by the company and other person or entity can’t make this product.
Copyright– Copyright refers to an intellectual property right that protects the work of the original owner from being copied by some other person.
Brand– Brand means a product, or service that has a unique identification and can be distinct from other products in market
So, we can definitely consider that brand is a subpart of an intangible asset and can be considered as an intangible asset as it also can’t be touched or seen. Still, its benefit will accrue till future time. These both help an entity to grow its business till the future
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Capital Accounts record transactions of owners of a business and typically includes amount invested, retained, and withdrawn from the business. In the case of a partnership firm, there are multiple capital accounts as multiple people own the business. Capital Accounts in a partnership firm can be ofRead more
Capital Accounts record transactions of owners of a business and typically includes amount invested, retained, and withdrawn from the business. In the case of a partnership firm, there are multiple capital accounts as multiple people own the business.
Capital Accounts in a partnership firm can be of two types:
- Fixed Capital Account
- Fluctuating Capital Account
A fixed Capital Account is one where only non-recurring transactions related to capital accounts are recorded. For example:
- Capital introduced
- Capital withdrawn/ Drawings
For transactions that are recurring in nature like interest on capital, the interest of drawings a separate account called Partner’s Current Account is created.
Fluctuating Capital Accounts are the ones where there is a single account to record all types of transactions related to the partner’s capital account, whether recurring or nonrecurring.
Fixed Capital Accounts are usually created in cases where there are numerous recurring transactions and partners want to keep a record of the fixed amount invested in the business by all the partners at any point in time.
Fluctuating Capital Account is usually created in cases where the number of recurring transactions is not high or partners want to keep a record of the amount due to all the partners in business at any point in time.
However, the decision to choose what kind of capital account should be implemented in the firm is complete with the partners. They may choose whatever they think is a more suitable fit.
To summarise the difference between the two following table can be used:
Fixed Capital Account Fluctuating Capital Account Non-recurring transactions are recorded. Recurring transactions are recorded. Created where the number of recurring transactions is high to maintain a separate record. Created where the number of recurring transactions is low. Examples: · Capital introduced
· Capital withdrawn
Examples: · Interest on capital
· Interest in drawings
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Expenses are of two types, are Direct Expenses Indirect Expenses Direct Expenses Direct expenses are those expenses are which are directly related to the manufacturing or production of the final goods. These expenses are also known as Manufacturing expenses. Manufacturing or production of gooRead more
Expenses are of two types, are
- Direct Expenses
- Indirect Expenses
Direct Expenses
Direct expenses are those expenses are which are directly related to the manufacturing or production of the final goods. These expenses are also known as Manufacturing expenses.
Manufacturing or production of goods indicates the conversion of Raw material into finished goods. the expenses incurred in the stage of conversion are treated as Direct expenses or Manufacturing expenses.
Direct expenses are shown on the Debit side of the Trading Account.
Indirect Expenses
Indirect expenses are those expenses that are incurred to run a business day-to-day and maintenance of the company. In other words, they are not directly related to making a product or service or buying a wholesale product to resell.
Indirect expenses are classified into three types, which are
- Factory Expenses
- Administrative Expenses
- Selling & Distribution Expenses
Indirect Expenses are shown on the Debit side of the Profit and Loss Account.
Presentation of Direct Expenses in Trading Account
Examples of Direct Expenses
- Gas, water, and Fuel: Gas, water, and fuel are the essentials to run a factory and are used in machinery to manufacture its final goods.
- Wages: Wages are the daily payments to the workers or Labours working in the factory premises on a daily or weekly payment basis.
- Freight and Carriage: Freight and Carriage are the expenses related to the importing of raw materials from the godown or from the outsiders to the Factory.
- Factory Rent: Rent paid for the factory area or any payment related to the place of the factory is known as factory rent.
- Factory Lighting: The expenses related to the uniform distribution of light over the working plane are obtained in the factory premises.
- Factory Insurance: The payment of insurance related to the factory will come under direct expenses.
- Manufacturing Expenses: Any other expenses related to the manufacturing process of finished goods are manufacturing expenses.
- Cargo Expenses: These are the expenses related to goods or freight being shipped or carried by the ocean, air, or land from one place to another.
- Upkeep and Maintenance: These are the expenses related to the maintenance of the factory for smooth running.
- Repairs on Machinery: The expenses related to any repair on machinery which is used in the production.
- Coal, Oil, and Grease: Coal, oil, and grease are the essentials to run machinery which results in the conversion of raw material to finished goods.
- Custom Charges: The expenses related to the payment of any Customs duty for the material imported.
- Clearing Charges: A clearing charge is a charge assessed on securities transactions by a clearing house for completing transactions using its own facilities.
- Depreciation on Machinery: Generally it is a nonmonetary expense but recorded in the trading account as a direct expense as per the accrual accounting.
- Import duty: any payment related to the importing of any machinery or any material from other countries is known as import duty.
- Octroi: this is the tax levied by a local political unit, normally the commune or municipal authority, on certain categories of goods as they enter the area.
- Shipping expenses: any expense related to the shipment charges of the raw material is known as shipping expenses.
- Motive power: Motive Power basically means any power, such as electricity or steam energy, etc, used to impart motion to any source of mechanical energy.
- Dock dues: a payment that a shipping company must pay for the use of a port.
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Effective Capital is an amount calculated for purpose of arriving at the maximum limit of managerial remuneration as per the Companies Act, 2013 where profit is inadequate or no profit. Other than that it has no use. Computation of effective capital is given in Explanation I to Schedule II of the CoRead more
Effective Capital is an amount calculated for purpose of arriving at the maximum limit of managerial remuneration as per the Companies Act, 2013 where profit is inadequate or no profit. Other than that it has no use.
Computation of effective capital is given in Explanation I to Schedule II of the Companies Act. Schedule II deals with remuneration payable to managers in case of no profit or inadequate profit in the following manner:
Computation of effective capital is done in the following manner:
Numerical example:
ABC Ltd reports its balance sheet as given below:
We will compute its effective capital for both an investment company and a non-investment company.
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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.
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