AccountingQA Latest Questions

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  2. Rahul_Jose Aspiring CA currently doing Bcom

    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

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Anushka Lalwani
Anushka Lalwani
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ReservesRevenue Reserve
  2. PriyanshiGupta Graduated, B.Com
    This answer was edited.

    Profits earned by a firm are not completely distributed to its owners, some of the profits are retained for various purposes. Reserves are profits that are apportioned or set aside to use in the future for a specific or general purpose. Reserves follow the Conservative Principle of accounting.  ReveRead more

    Profits earned by a firm are not completely distributed to its owners, some of the profits are retained for various purposes. Reserves are profits that are apportioned or set aside to use in the future for a specific or general purpose. Reserves follow the Conservative Principle of accounting. 

    Revenue reserve is created from the net profits of a company during a financial year. Revenue reserve is created from revenue profit that a company earns from the daily operations of the business.

    Various types of reserves are:

    • Capital Redemption Reserve: It is created to issue fully paid bonus shares or reduction of capital in accordance with Article 3 of the Companies Act, 2013.
    • General Reserve: It is a reserve created to provide for various requirements of the company from time to time.
    • Debenture Redemption Reserve: It is required by the Companies Act, 2013 to transfer the amount of debentures that are going to be redeemed in the following year to minimize the risk of default.
    • Securities Premium Reserve: When shares and debentures are issued at a price higher than the book value, then such higher amount is transferred to Securities Premium Reserve
    • Revaluation Reserve: It is created to revalue the assets and liabilities and provide for gain or loss.

    Different parts of profit are apportioned to create a different reserve and those reserves can only be used for purposes as defined.

    While accounting for Revenue Reserve, the profit decided to transfer to Revenue Reserve are first transferred to Profit and Loss Appropriation Account and then to Revenue Reserve Account. In the balance sheet, Revenue Account is shown under the Capital and Reserves head.

    Liabilities Amount Amount
    Share Capital
    Reserve and Surplus
    General Reserve
    Capital Redemption Reserve
    Securities Premium Account
    Profit and Loss Account

    Uses of Revenue Reserve:

    • Revenue Reserves are created to expand business or for meeting contingencies that may arise in the future.
    • It can also be used to distribute dividends or bonus shares to its shareholders.

    Example:

    Given that Revenue Reserve Account stands at Rs 1,00,000 and the company wants to distribute Rs. 40,000 as dividend to its shareholders. The treatment of this transaction in the financial statements will be-

    Particulars                                                                                                                           Amount (Rs.)

    Revenue Reserve Account                                                                                                    1,00,000

    (less) Dividend distributed                                                                                                    (40,000)

    The amount shown in Balance Sheet                                                                                    60,000

     

     

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A_Team
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  2. Bonnie Curious MBA (Finance)

    Yes, non-current assets are also known as fixed assets. These are long-term assets that are not intended for sale but are used by a company in its business operations. Examples of non-current assets include property, plant, and equipment, as well as intangible assets like patents and trademarks. TheRead more

    Yes, non-current assets are also known as fixed assets. These are long-term assets that are not intended for sale but are used by a company in its business operations.

    Examples of non-current assets include property, plant, and equipment, as well as intangible assets like patents and trademarks. These assets are recorded on a company’s balance sheet and are reported at their historical cost or at their fair market value, depending on the type of asset.

     

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Simerpreet
SimerpreetHelpful
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  2. Ayushi Curious Pursuing CA
    This answer was edited.

    Yes, sure! But lets us first understand what a revaluation account is. A revaluation account is prepared to recognise the change in the book value of assets and liabilities of an entity. These changes happen when assets and liabilities are revalued to present their fair value. It is a nominal accounRead more

    Yes, sure! But lets us first understand what a revaluation account is.

    A revaluation account is prepared to recognise the change in the book value of assets and liabilities of an entity. These changes happen when assets and liabilities are revalued to present their fair value.

    It is a nominal account because it represents gain or loss in value of assets and liabilities. However such gain or loss is unrealised because the assets and liabilities are not sold or discharged.

    After revaluation of assets and liabilities, the balance of the revaluation account can be debit or credit. The debit balance means ‘loss on revaluation’ and credit balance means ‘gain on revaluation’.

    The balance of revaluation is transferred to the capital account.

    Journal Entries related to Revaluation Account

     1. Increase in value of an asset upon revaluation:

    Asset A/c Dr. Amt
    To Revaluation A/c Cr. Amt
    (Being asset value increased upon revaluation)

    2. Decrease in value of an asset upon revaluation:

    Revaluation A/c Dr. Amt
    To Asset A/c Cr. Amt
    (Being asset value decreased upon revaluation)

    3. Increase in value of liabilities upon revaluation:

    Revaluation A/c Dr. Amt
    To Liabilities A/c Cr. Amt
    (Being liabilities value increased upon revaluation)

    4. Decrease in value of liabilities upon revaluation:

    Liabilities A/c Dr. Amt
    To Revaluation A/c Cr. Amt
    (Being liabilities value decreased upon revaluation)

    5. Transfer or distribution of the balance of revaluation account

    Revaluation A/c Dr. Amt
    To Capital/ Partners’ capital  A/c Cr. Amt
    (Being profit on revaluation transferred to capital account.

    or

    Capital/ Partners’ capital  A/c Dr. Amt
    To Revaluation A/c Cr. Amt
    (Being loss on revaluation transferred to capital account.

    Numerical example

    P, Q and R are partners of the firm ‘PQR Trading’. They share profits and losses in the ratio 3:2:1. On 1st May 20X1, they decided to admit S for 1/6th share in profits and losses of the firm. Upon the revaluation:

    • Plant and machinery increased from Rs 1,20,000 to Rs. 1,30,000
    • The stock decreased by Rs 5000
    • Debtors and creditors both decreased by Rs 4,000 and Rs 6,000 respectively.
    • Furniture decreased from Rs 25,000 to Rs 10,000
    • Land increased by Rs 40,000.

    Let’s prepare the revaluation account.

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Astha
AsthaLeader
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  2. Simerpreet Helpful CMA Inter qualified

    Outstanding Income is the income that is due and is being earned but not yet received. The person/ firm has the legal rights to receive that part of the income which it has earned. Outstanding Income is an Asset Account for the business/ the person. According to the modern approach, for Asset AccounRead more

    Outstanding Income is the income that is due and is being earned but not yet received. The person/ firm has the legal rights to receive that part of the income which it has earned.

    Outstanding Income is an Asset Account for the business/ the person.

    According to the modern approach, for Asset Account:

    • When there is an increase in the Asset, it is Debited.
    • When there is a decrease in Asset, it is Credited.

    So the journal entry  will be-

     

    For Example, Mr. Rashid works as a laborer in a factory and he earns wages @Rs 500/day.

    So by the end of the week, he receives a payment of Rs 3000 of Rs 3500 i.e. he receives payment of 6 days instead of 7 days. So here Rs 500 would be an outstanding income of Mr. Rashid as he has earned that income but has not received it yet.

    Journal Entry –

     

    Another example, Yes Bank gave a loan of Rs 10,00,000 to company Ford @ 10% as interest payable monthly. The interest for one month i.e. Rs 1,00,000 has not been received by Yes Bank which is being due. So it will be outstanding income for Yes Bank since it is due but not yet received.

    Journal entry-

     

    Accounting Treatment for Outstanding Income-

    • Treatment in Income Statement

    The Outstanding Income is shown on the credit side of the income statement as the income is earned for the current year but not yet received.

    • Treatment in Balance Sheet

    Outstanding Income is an Asset for the business and hence shown on the Assets side of the balance sheet.

     

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AbhishekBatabyal
AbhishekBatabyalHelpful
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  2. Ayushi Curious Pursuing CA

    Introduction Internal reconstruction refers to the process of restructuring a sick company’s balance sheet by certain methods to turn it financially healthy, thus saving it from potential liquidation. Explanation When a company has been making losses for many years, it has a huge amount of accumulatRead more

    Introduction

    Internal reconstruction refers to the process of restructuring a sick company’s balance sheet by certain methods to turn it financially healthy, thus saving it from potential liquidation.

    Explanation

    When a company has been making losses for many years, it has a huge amount of accumulated losses due to which the reserve and surplus appear at a very low or negative amount in the balance sheet.

    Also, such a company is said to be overcapitalised as it is not able to generate enough returns to its capital.

    As the company is overcapitalised, the assets are also overvalued. The balance sheet also contains many fictitious assets and unrepresented intangible assets.

    The balance sheet of such a ‘sick’ company looks like the following:

    Hence, to save the company from liquidation,

    • its assets and liabilities are revalued and reassessed,
    • its capital is reduced by paying off part of paid-up capital to shareholders or cancelling the paid-up capital.
    • the right of shareholders related to preference dividends is altered,
    • agreements are made with creditors to reduce their claims and
    • fictitious assets and accumulated losses are written off.

    In this way, its balance sheet gets rid of all undesirable elements and the company gets a new life without being liquidated.  This process is known as internal reconstruction.

    Legal compliance

    The internal reconstruction of a company is governed by the provisions of the Companies Act, 2013.

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Aadil
AadilCurious
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  2. Aditi
    This answer was edited.

    Deferred Tax Liability A deferred tax liability represents an obligation to pay taxes in the future. These taxes are owed by a company but are not due to be paid until a future date. Companies that incur such an obligation prepare and maintain two financial reports every year: a tax statement and anRead more

    Deferred Tax Liability

    A deferred tax liability represents an obligation to pay taxes in the future. These taxes are owed by a company but are not due to be paid until a future date.

    Companies that incur such an obligation prepare and maintain two financial reports every year: a tax statement and an income statement.

    This is because companies maintain their books as per book accounting rules (GAAP/IFRS), but they have to pay taxes according to tax accounting rules, and they each have to follow their own guidelines.

    For example, a tax statement follows the cash basis of accounting, and an income statement follows the accrual basis of accounting.

    Companies calculate their profit as per the accounting rules as well as tax laws known as accounting income and taxable income, respectively. Some differences arise due to the application of different provisions of law.

    These temporary differences are accounted for, recognized, and carried forward in the books of accounts and create deferred tax.

     

    Example

    Here is an example of deferred tax liability.

    In the given example, tax as per income statement is 70,000, whereas as per tax statement it is 56,000. This temporary difference is termed as deferred tax liability of 14,000.

    When accounting income is more than taxable income, it creates Deferred Tax Liability. It will be adjusted in the books of accounts during one or more subsequent year(s).

     

     

    How Does it Arise?

    There are several instances under which a company creates a deferred tax liability. Some other instances are:

    Depreciation Methods

    • One of the most common reasons for deferred tax liability is when a company uses different depreciation methods in the Income and Tax Statement.
    • Assets are depreciated by calculating the straight-line method in the Income Statement, while the written-down value method is used in the Tax Statement.
    • Since the straight-line value method produces lower depreciation when compared to the WDV method, accounting income is temporarily higher than taxable income.
    • The company recognises deferred tax liability as this difference between accounting income and taxable income.

    Treatment of Revenue & Expenses

    • Deferred tax liability can also arise when there is a difference in the way revenue and expenses are treated in books of accounts.
    • As mentioned earlier, accounting rules follow the accrual basis of accounting while tax laws follow the cash basis of accounting.
    • Meaning in the tax statement, income and expenses are recorded when they are received or paid, not when they are incurred or realised.
    • This difference in the treatment of revenue and expenses creates deferred tax liability.

     

     

    Impact on Financial Statements

    Recognising deferred tax liability and its subsequent effect on the company’s financial statement is important as it simplifies the process of auditing and analysing financial reports.

    Balance Sheet

    • Deferred tax liabilities are recorded on the liability side of the balance sheet under non-current liabilities.

    Cash Flow Statement

    • The deferred tax liability is added back to the net income in calculating cash flow from operating activities to show the actual cash flow.
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Anushka Lalwani
Anushka Lalwani
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ReservesRevenue Reserve
  2. Rahul_Jose Aspiring CA currently doing Bcom
    This answer was edited.

    A revenue reserve is a type of reserve where a portion of the net profit is set aside for future requirements. It serves as a great source of internal finance for the company to meet its short term requirements. The funds put into this reserve are earned from the daily operations of a company. RevenRead more

    A revenue reserve is a type of reserve where a portion of the net profit is set aside for future requirements. It serves as a great source of internal finance for the company to meet its short term requirements. The funds put into this reserve are earned from the daily operations of a company. Revenue reserves are shown on the liabilities side of a balance sheet under reserves and surplus. Some examples of revenue reserve are :

    • General Reserve: This reserve is used for no specific purpose, but the general financial growth of the company. It is a free reserve which means the company is not compelled to make one. It helps to curb future losses which may arise in the future.
    • Specific Reserve: These are those reserves that can only be used for specific purposes. This money cannot be used for any other requirement. It is not a free reserve. A reserve created to redeem debentures would be called a debenture redemption reserve.
    • Secret Reserve: This is a type of reserve whose existence is not disclosed in the balance sheet. This type of reserve cannot be created by joint-stock companies. However, banks and financial institutions are allowed to create such secret reserves.

    Retained Earnings is that part of the net profit which is left after the distribution of dividends to shareholders. This amount can be invested in the company to gain profits. It is not technically a reserve as it is held after distribution of dividends but it can still be used as one.

    On the other hand, a capital reserve is not a part of the revenue reserve. It is created from capital profits to finance long term projects of a company. It is used for specific purposes only.

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A_Team
A_Team
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  2. SidharthBadlani CA Inter Student
    This answer was edited.

    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.

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Simerpreet
SimerpreetHelpful
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Working Capital
  2. Astha Leader Pursuing CA, BCom (Hons.)
    This answer was edited.

    Let us first understand what working capital is. Working capital means the funds available for the day-to-day operations of an enterprise. It is a measure of a company’s liquidity and short term financial health. They are cash or mere cash resources of a business concern. It also represents the exceRead more

    Let us first understand what working capital is.

    Working capital means the funds available for the day-to-day operations of an enterprise. It is a measure of a company’s liquidity and short term financial health. They are cash or mere cash resources of a business concern.

    It also represents the excess of current assets, such as cash, accounts receivable and inventories, over current liabilities, such as accounts payable and bank overdraft.

    working capital formula

    Sources of Working Capital

    Any transaction that increases the amount of working capital for a company is a source of working capital.

    Suppose, Amazon sells its goods for $1,000 when the cost is only $700. Then, the difference of $300 is the source of working capital as the increase in cash is greater than the decrease in inventory.

    Sources of working capital can be classified as follows:

    short term and long term sources of working capital

    Short Term Sources

    • Trade credit: Credit given by one business firm to the other arising from credit sales. It is a spontaneous source of finance representing credit extended by the supplier of goods and services.
    • Bills/Note payable: The purchaser gives a written promise to pay the amount of bill or invoice either on-demand or at a fixed future date to the seller or the bearer of the note.
    • Accrued expenses: It refers to the services availed by the firm, but the payment for which is yet to be done. It represents an interest-free source of finance.
    • Tax/Dividend provisions: It is a provision made out of current profits to meet the tax/dividend obligation. The time gap between provision made and payment of actual payment serves as a source of short-term finance during the intermediate period.
    • Cash Credit/Overdraft: Under this arrangement, the bank specifies a pre-determined limit for borrowings. The borrower can withdraw as required up to the specified limits.
    • Public deposit: These are unsecured deposits invited by the company from the public for a period of six months to 3 years.
    • Bills discounting: It refers to an activity wherein a discounted amount is released by the bank to the seller on purchase of the bill drawn by the borrower on their customers.
    • Short term loans: These loans are granted for a period of less than a year to fulfil a short term liquidity crunch.
    • Inter-corporate loans/deposits: Organizations having surplus funds invest with other organizations for up to six months at rates higher than that of banks.
    • Commercial paper: These are short term unsecured promissory notes sold at discount and redeemed at face value. These are issued for periods ranging from 7 to 360 days.
    • Debt factoring: It is an arrangement between the firm (the client) and a financial institution (the factor) whereby the factor collects dues of his client for a certain fee. In other words, the factor purchases its client’s trade debts at a discount.

    Long Term Sources

    • Retained profits: These are profits earned by a business in a financial year and set aside for further usage and investments.
    • Share Capital: It is the money invested by the shareholders in the company via purchase of shares floated by the company in the market.
    • Long term loans: These loans are disbursed for a period greater than 1 year to the borrower in his account in cash. Interest is charged on the full amount irrespective of the amount in use. These shareholders receive annual dividends against the money invested.
    • Debentures: These are issued by companies to obtain funds from the public in form of debt. They are not backed by any collateral but carry a fixed rate of interest to be paid by the company to the debenture holders.

    Another point I would like to add is that, although depreciation is recorded in expense and fixed assets accounts and does not affect working capital, it still needs to be accounted for when calculating working capital.

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