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Category: Category - Accounting Interviews

If the question is a frequently asked question in accounting and finance Interviews then please use this category on priority.

Discy Latest Questions

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  1. This answer was edited.

    No, Goodwill is not a fictitious asset. What is Good Will? Goodwill of an entity is an intangible asset. It can be said that it's the excess amount an entity is liable to pay when it purchases all the assets at a price higher than its fair market value of another entity. The purchasing entity is wilRead more

    No, Goodwill is not a fictitious asset.

    What is Good Will?

    Goodwill of an entity is an intangible asset. It can be said that it’s the excess amount an entity is liable to pay when it purchases all the assets at a price higher than its fair market value of another entity. The purchasing entity is willing to pay the higher amount reasons such as brand image, modernised technology, high-grade employee relationships etc.

    The goodwill is valued at the time of the merger of two or more entities or acquisition of one by another entity.

    It is generally noticed that better the organisation’s reputation higher is the value of goodwill.

    What is a Fictitious Asset?

    Fictitious means “Bogus” or “Untrue” and asset means anything beneficial for the organisation.
    Thus fictitious assets are not an asset but just the expenses or losses which can not be accounted for in the current reporting period rather are to be written off in the future reporting period.

    For Example,

    • Preliminary Expenses
    • Miscellaneous Expenses
    • Loss on Issue of Debentures
    • Discount on Share Issue.

     

    Why is goodwill not a fictitious asset?

    Goodwill is an intangible asset and not a fictitious asset. A fictitious asset does not have a realizable value as it is merely an expenditure incurred by the company. It does not have a tangible existence either. Whereas goodwill has a monetary value i.e it has a realizable value even though it has no tangible existence.  Hence, it’s an intangible asset.

    Goodwill is presented in a balance sheet as –

    Goodwill as an Intangible Asset


    Aastha.

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    First, let me help you interpret the difference between Receipts & Income along with the help of an example. Difference between Income & Receipts  Income Receipts Income refers to the amount received by an entity from its core business operations and day to day functioning. Any cash inflow rRead more

    First, let me help you interpret the difference between Receipts & Income along with the help of an example.

    Difference between Income & Receipts 

    IncomeReceipts
    Income refers to the amount received by an entity from its core business operations and day to day functioning.Any cash inflow received by an entity can be termed as receipts.
    All incomes affect the statement of profit & loss.But all receipts do not affect profit & loss statement.
    Income includes only revenue receipts.

     

    Receipts include both capital receipts & revenue receipts.
    It can be cash or non-cash in nature. For eg. non-cash items such as an unrealized gain from investments, profit on revaluation of fixed assets are also considered as income.It is only cash in nature.

    Examples of Receipts & Income

    For instance, XYZ Inc. receives the following amount in the month of January 20×1. Let us differentiate the following transactions as receipts or income.

    1. Borrowed 50,000 from a bank for establishing a new unit.
    2. Amount of 10,000 received from the disposal of an old machine.
    3. Amount of 600,000 received from the issue of new shares & debentures of XYZ Inc.
    4. 500,000 received as consideration for the sale of goods or services.
    5. Rent received 60,000 from the tenant.
    6. Interest & Dividend received 15,000 from investments in Amazon Inc.

    All the above examples can be termed as receipts but all of them cannot be termed as income. Only examples 4, 5, & 6 can be referred to as income for XYZ Inc.

    Eg. 1, 2, & 3 are capital receipts and will not affect the statement of profit & loss of XYZ Inc. Therefore they are termed only as receipts & not income.

    Whereas eg. 4, 5, & 6 are revenue receipts and will affect the profit & loss statement. Therefore, they can be referred to as income for XYZ Inc.

    Now moving forward, let me help you understand the difference between payments & expenditure, with the help of an example.

    Difference between Payments & Expenditure

    ExpenditurePayments
    Expenditure refers to the amount incurred by an entity for operating the business and for earning income.Any cash outflow incurred by an entity can be termed as payments.
    All expenses affect the statement of profit & loss.But all payments do not affect profit & loss statement.
    Expenditure includes only revenue expenditure.

     

    Payments include both capital expenditure & revenue expenditure.
    It can be cash or non-cash in nature. For eg. non-cash items such as depreciation, amortization, bad debts are also considered expenses.It is only cash in nature.

    Examples of Payments & Expenditure

    For instance, ABC Inc. incurs the following payments in the month of January 20×1. Let us differentiate these transactions as payments or expenditures.

    1. Paid 40,000 for the acquisition of new machinery.
    2. Paid 200,000 for the redemption of shares and debentures issued by ABC Inc.
    3. Repaid 45,000 amount of loan taken from the financial institution.
    4. Salary & Wages paid 100,000.
    5. Purchase of Raw materials 30,000.
    6. Professional fees paid 15,000.

    All the above examples can be referred to as payments by ABC Inc. but all of them cannot be termed as expenditures. Only examples 4, 5, & 6 can be referred to as expenditures for ABC Inc.

    Eg. 1, 2, & 3 are capital expenditures and will not affect the statement of profit & loss of ABC Inc. Therefore they are termed only as payments and not expenditures.

    Whereas eg. 4, 5, & 6 are revenue expenditures and will affect the profit & loss statement. Therefore, they can be referred to as expenditure for ABC Inc.

    Conclusion

    1. All cash incomes are receipts. But all cash receipts are not income.
    2. All cash expenditures are payments. But all cash payments are not expenditure.

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    In the business world, the terms "Debt" and "Liability" are used interchangeably and are understood to be the same. But in reality, they differ. Debt Debt is the money borrowed by a business entity which is to be repaid to the moneylenders at a future specified date. For Example, Term loans acceptedRead more

    In the business world, the terms “Debt” and “Liability” are used interchangeably and are understood to be the same. But in reality, they differ.

    Debt

    Debt is the money borrowed by a business entity which is to be repaid to the moneylenders at a future specified date.

    For Example,

    • Term loans accepted from a bank or financial institutions for business expansion
    • Car loan, Home loan, Education loan

    Liability

    Liability is an obligation to render goods or services or an economic obligation to be discharged off at a future date.

    For Example,

    • Outstanding payment to suppliers of raw materials
    • Outstanding Expenses – accrued rent, outstanding professional fees, outstanding electricity expenses, unpaid salary, etc
    • Income received in advance – rent received in advance, commission received in advance, etc
    • Bills payable
    • Debts accepted by an entity

    Key differences between Debt and Liability

    Now, let me help you understand the differences between the two terms discussed above, debt and liability.

    Particulars

    Debt

    Liability

    1. Narrow/Broad aspectDebt is an integral part of liability. It is a type of liability.Liability is a broader term and it includes debt and other payables.
    2. Repayment modeDebt can be repaid back only in cash.Liabilities other than debt can be settled by rendering goods or services or by paying cash.
    3. OccurrenceDebt does not arise on a daily basis. It results only when an entity borrows money from another party.Other liabilities arise during the course of the day to day operations of the business.
    4. Formal agreementDebt involves a formal agreement between the borrower and the lender.Liabilities apart from debt may not involve such a formal agreement between the parties.
    5. UtilizationDebt helps entities for business expansion and diversification.Liabilities help entities conduct their daily business functions and processes.
    6. Interest paymentThe repayment of debt involves payment of interest along with the principal amount.Discharge of other liabilities may not involve payment of interest along with the actual amount of liability.
    7. Option of installmentsDebt repayment usually provides an option of payment in installments.Liabilities settlement may not provide such an option to the borrower.

    Conclusion

    All debts are liabilities, but not all liabilities are debts.

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  1. Accumulated Depreciation Depreciation is a wear and tear of an asset due to efflux of time and various other factors. It's basically an allocation of the cost of a tangible asset over its useful life. Accumulated depreciation is the total depreciation charged on an asset until a specified date. ItsRead more

    Accumulated Depreciation

    Depreciation is a wear and tear of an asset due to efflux of time and various other factors. It’s basically an allocation of the cost of a tangible asset over its useful life.

    Accumulated depreciation is the total depreciation charged on an asset until a specified date. Its a contra asset account. And since its a contra asset account it reduces the balance of an asset i.e reduces debit balance and therefore has a credit balance.

    Accumulated Depreciation is an Asset or a Liability?

    Well if you ask me I would say that its neither an asset nor a liability.

    Reasons to justify the above statement:

    Why is it not an asset?

    Assets are the resources held by an entity so that it could provide some economic value for the entity. But, in the case of accumulated depreciation, it does not generate any economic benefit for an entity rather it indicated that a certain sum of economic benefit has already been availed.

    Why is it not a liability?

    A liability is an obligation of an entity for making payment at a specified future date to a third party. Here, accumulated depreciation does not represent an obligation of an entity rather it is maintained just for the purpose of record-keeping.

    Conclusion

    According to the reasons mentioned above it can neither be called as an asset nor a liability. This would be the correct answer to this question.

    But still, if you have to compulsorily classify the same as an asset or a liability I would definitely not classify as a liability as it would not ensure fair representation of the financial statements since then it would be considered an obligation made to a third party which is not the case here.

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  1. This answer was edited.

    In the Income Statement, Trading account represents the first part and Profit & Loss account represents the second part. Trading account gives the overall purview of all trading activities, such as purchase and sale of products. It is prepared to ascertain gross profit or gross loss. ProfitRead more

    In the Income Statement, Trading account represents the first part and Profit & Loss account represents the second part.

    Trading account gives the overall purview of all trading activities, such as purchase and sale of products. It is prepared to ascertain gross profit or gross loss. Profit & Loss account gives the final working results of the business. It is prepared to ascertain net profit or net loss.

    Steps to prepare Income Statement from Trial Balance

    All the debit side items related to expenses and credit side items related to income listed in the trial balance shall be posted on the debit side and credit side of the income statement respectively.

    1. Post opening stock on the debit side of the income statement.

    2. Post purchases and sales on the debit and credit side respectively. Deduct purchase return from Purchases and sales return from Sales to arrive at the Net Purchases and Net Sales.

    3. Post all the direct expenses incurred for the purchase & production of goods eg. wages, factory rent, custom duty, carriage inward, manufacturing expenses, etc on the debit side.

    4. Post the amount of closing stock stated in the adjustments.

    5. Make all the necessary adjustments, if any, related to outstanding and prepaid expenses, goods withdrawn for personal use, goods destroyed, etc

    6. Now, find out the gross profit or gross loss.
    If total of credit side > total of debit side ie. credit balance, then the amount of difference is gross profit.
    If total of debit side > total of credit side ie. debit balance, then the amount of difference is gross loss.

    7. Carry forward the ascertained gross profit to the credit side or gross loss to the debit side of the second part of the income statement ie. profit & loss account.

    8. Post all the indirect expenses such as office or administrative expenses, financial expenses, selling or distribution expenses, etc on the debit side of the income statement.

    9. Post all the indirect incomes such as commission received, rent received, dividend received, etc on the credit side of the income statement.

    10. Consider all the necessary adjustments, if any, such as outstanding and prepaid expenses, outstanding and pre-received income, reserve for doubtful debts.

    11. Calculate depreciation and amortization on the assets and post the amount on the debit side.

    12. Now, find out the net profit or net loss.
    If total of credit side > total of debit side ie. credit balance, then the amount of difference is net profit.
    If total of debit side > total of credit side ie. debit balance, then the amount of difference is net loss.

    These steps complete the process of preparation of income statement from trial balance.

    Illustration

    A snippet of trial balance and income statement has been attached for better understanding.

    Trial Balance

    Prepare Income Statement from the above given Trial Balance.

    Income Statement

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  1. This answer was edited.

    Balance Sheet is a statement showing the financial position of a business entity on a particular day. It shows the liabilities and assets of the business. Steps to prepare Balance Sheet from Trial Balance All the debit side items related to assets listed in the trial balance shall be posted on the aRead more

    Balance Sheet is a statement showing the financial position of a business entity on a particular day. It shows the liabilities and assets of the business.

    Steps to prepare Balance Sheet from Trial Balance

    All the debit side items related to assets listed in the trial balance shall be posted on the assets side of the balance sheet. All the credit side items related to capital and liabilities listed in the trial balance shall be posted on the liabilities side of the balance sheet.

    1. Post the amount of capital on the liabilities side of the balance sheet under the head “capital & reserves”.

    2. Then, the net profit or net loss ascertained while preparing the income statement shall be added or reduced respectively from the amount of capital.

    3. Now, post all the “non-current liabilities” such as long-term bank loan, long-term debentures issued, etc on the liabilities side of the balance sheet.

    4. Then, post the “current liabilities” such as sundry creditors, bills payable, etc. Incorporate necessary adjustments related to outstanding expenses and pre-received income.

    5. Moving to the asset side, start with the head “non-current assets”.

    6. First, post the tangible assets under the head “non-current assets” such as plant & machinery, land & building, etc. Calculate depreciation/accumulated depreciation on the tangible assets and deduct the same to arrive at the net value.

    7. Second, post the intangible assets under the head “non-current assets” such as software, goodwill, etc. Calculate amortization/accumulated amortization on the intangible assets and deduct the same to arrive at the net value.

    8. Now, post all the long-term investments acquired such as bonds and debentures under the head “non-current assets”.

    9. After posting all the non-current assets, move forward to posting the “current assets” on the asset side of the balance sheet,

    10. Post “current assets” such as cash in hand, cash at bank, sundry debtors, bills receivable, etc. Incorporate necessary adjustments related to provision for doubtful debts, prepaid expenses, outstanding income,.

    11. Post the amount of closing stock given in the adjustments under the head “current assets”.

    12. The final step is totaling both the liability and asset side. Both sides of the balance sheet should be of equal amount.

    These steps complete the process of preparation of the balance sheet from the trial balance.

    Illustration

    A snippet of trial balance and balance sheet has been attached for better understanding.

    Trial Balance

    Prepare Balance Sheet from the above given trial balance. Net Profit for the year ended 31/03/yyyy is 610,000.

    Balance Sheet

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  1. This answer was edited.

    To begin with, let me familiarize you with the meaning of the term Ledger Balancing. What is Ledger Balancing? Balancing of Ledger accounts means totalling both the sides of ledger account, finding the difference between greater total & smaller total and then recording the difference on the smalRead more

    To begin with, let me familiarize you with the meaning of the term Ledger Balancing.

    What is Ledger Balancing?

    Balancing of Ledger accounts means totalling both the sides of ledger account, finding the difference between greater total & smaller total and then recording the difference on the smaller side.

    If Debit side > Credit side, then we say that the ledger account has “Debit Balance”.
    If Credit side > Debit side, then we say that the ledger account has “Credit Balance”.

    Now, let’s move forward to discuss the question asked.

    Why should a ledger be balanced?

    Balancing a ledger account will help you with the following-

    1. Necessary for preparation of trial balance

    Trial Balance is a list of the debit and credit balances of all the ledger accounts prepared by the entity as on a specific date. Without balancing the ledger accounts, it is impossible to prepare the trial balance of an entity.

    2. Necessary for preparation of financial statements

    Balancing of ledger accounts helps to prepare profit & loss account and balance sheet so as to ascertain the profit or loss and financial position of the business.

    3. To determine the cash available

    The amount of balance in Cash A/c gives an idea of the amount of cash available with the organization. The balance determined is compared with the actual cash available in the cash box. Discrepancies, if any are further investigated.

    4. To determine the value of assets

    Organizations need to know the book value of their tangible and intangible assets eg. plant & machinery, furniture, software etc at the end of a period. So, the value of assets as at a specific date can be determined only after balancing the asset ledger accounts. Assets account usually have a debit balance.

    5. To ascertain the total expense and income

    Ledger balancing of nominal accounts such as expenses  eg. purchase, salary, professional fees, etc and incomes eg. sales, interest earned, etc will indicate the amount of expenses incurred and income earned during a specific period.

    This will help in ascertaining the profit earned or loss incurred by the entity as the balances of nominal accounts get transferred to the statement of profit & loss. Also, the entity can make strategies on reducing the expenses if the current period expenses exceed the previous period expenses.

    6. To ascertain the debt outstanding & the amount outstanding to creditors

    Balancing ledger accounts pertaining to bank loans or other loans accepted will help you determine the principal amount outstanding at a given date.

    Also, balancing the supplier’s accounts will help you ascertain whether the amount is payable to the supplier (credit balance) or whether you have already made him advance payments but the corresponding goods or services are yet to be received (debit balance).

    7. To determine the amount receivable from debtors

    Balancing the debtor’s accounts will help you ascertain the amount due from your debtor (debit balance) as at a particular date. In case, the debtors have already made advance payments but you haven’t rendered the corresponding goods or services, then the account will present a credit balance.

    Hope the above given points give you an insight of the question asked – why should a ledger be balanced.

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  1. This answer was edited.

    Before answering the question you should first understand the meaning of debit and credit accounts. The images below might be of some help In the above equation, all the accounts covered on the left-hand side of the equation are classified as debit accounts and on the right-hand side are classifiedRead more

    Before answering the question you should first understand the meaning of debit and credit accounts.

    The images below might be of some helpUnderstanding of debit and credit account

    In the above equation, all the accounts covered on the left-hand side of the equation are classified as debit accounts and on the right-hand side are classified as credit accounts.

    Debit and Credit accounts

    Surplus, gains and revenue are credit accounts and expense, losses or deficits are credit accounts.

    Generally, All the debit accounts like plant and machinery, loan granted, sundry debtors, cash and the bank have a debit balance i.e they are most of the time positive.

    Similarly, all the credit accounts like the loan from a bank, sundry creditors, bills payable have a credit balance i.e they are most of the time negative as these accounts most of the time receive just credits.

    here we are simply analysing it based on numbers.

    Positive Debit Balance

    In simple terms, while balancing the ledger when the Debit side total > Credit side total the difference = Debit Balance. Most of the time, it maintains a “positive balance”.

    This is because when you add a debit to a debit it gives you a debit i.e when you add a positive number with another positive number you get a higher positive number and when you add a credit to debit it reduces the debit balance. But in most of the cases, it remains positive.

    We take up another example of a machinery account even though we credit the depreciation from that account the balance remains positive.

    Ledger Account

    Negative Credit Balance

    In simple terms, while balancing a ledger  Credit side total > Debit side total the difference = credit balance. All the credit accounts at most of the time maintain a credit balance i.e it has a “negative balance”. 

    This is because when you add a credit to another credit you get a higher balance of credit similarly when you debit the credit account it reduces the credit balance. But most of the time it still gives a credit balance i.e remains negative. But you do not put a negative sign while you account for it.

    The below-given ledger might be of some help to understand this better –

    Ledger having credit balance

    I hope you got your answer.


    Aastha Mehta.

     

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  1. This answer was edited.

    The different types of financial statements are as follows: Statement of financial position A statement of financial position is also known as a balance sheet. It comprises of a companies assets, liabilities, and equity. With the help of a balance sheet, the financial position of a company is displaRead more

    The different types of financial statements are as follows:

    • Statement of financial position

    A statement of financial position is also known as a balance sheet. It comprises of a companies assets, liabilities, and equity. With the help of a balance sheet, the financial position of a company is displayed ‘as at’ a particular date which is usually at the end of a fiscal period.

      Presentation of a balance sheet
      Balance sheet as at 31st March, yyyy

    balance sheet

    • Income statement

    Unlike a balance sheet, the income statement of a company shows the revenues, expenses, net income, and earnings per share. It is also referred to as the profit and loss a/c. It is the most important financial statement because it depicts the overall performance of a company. The sales of a company are put forward followed by the deduction of all expenses to ascertain the net profit or loss. In case the public companies issue the financial statements the earnings per share figure might also be added.

    Presentation of an Income statement

    income statement

    • Cash flow statement

    As the name suggests, a cash flow statement shows the monetary position of a company with the help of cash inflows and outflows during a particular financial period. It is broadly divided into three categories, operating activities, investing activities, and financing activities. It measures how a company pays off its liabilities, funds its expenses and investments.

    Presentation of a cash statement

    cash flow

    • Statement of changes in equity

    This financial statement shows the changes in owners’ equity over a financial period. The changes are observed through the net profit or loss in the income statement, the issuance or repayment of the share capital, payment of dividends, the gains or losses recognized in equity, etc. It Is also referred to as the statement of retained earnings.

    Hope this helps.

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  1. This answer was edited.

    No, Prepaid Expense is Not a Fictitious Asset. Meaning of Prepaid Expense A prepaid expense is an expense incurred by an entity in advance before receiving such goods or services. The payment made pertains to future reporting period and so it is recorded as an asset. The payment so made earlier shalRead more

    No, Prepaid Expense is Not a Fictitious Asset.

    Meaning of Prepaid Expense

    A prepaid expense is an expense incurred by an entity in advance before receiving such goods or services. The payment made pertains to future reporting period and so it is recorded as an asset. The payment so made earlier shall be treated as an expense in the year of receipt of goods or services. The asset recorded earlier shall be written off proportionately to the expense so accrued.

    Meaning of Fictitious Asset

    Fictitious means “Fake” or “Untrue” and Asset means anything that gets the economic benefit or adds value to the organization. Fictitious asset is not the actual asset as it does not have a monetary value. In other words, it cannot be realised.

    Fictitious Assets can be said to be a Deferred Revenue Expense.

    Now even though you have received the answer that these are not fictitious assets but the question that still arises is  – why are the prepaid expenses not treated as fictitious assets?

    When you read the below para you will no longer have this doubt.

    Why are the Prepaid Expenses Not Fictitious Assets?

    Prepaid expenses and fictitious assets are both of revenue nature. Prepaid expenses are expenses incurred in advance. Since the expense has not yet become due it is recorded as an asset. If such expense becomes due in the next reporting period it shall be treated as a current asset otherwise a non-current asset.

    For Example,

    You have taken a showroom on rental basis and you are supposed to pay an amount of 10,000 every month as a rental expense. You have a surplus fund and hence, you have paid 2 months advance rent concerning the next reporting period.

    The amount of 20,000 paid shall be treated as a prepaid expense in the current reporting period and presented as a current asset in the balance sheet and the next reporting period at the end of each month, it shall be written off and treated as an expense in the income statement.

    Fictitious assets are deferred revenue assets and thus are unusually heavy expenses. These are spread over for more than one reporting period and hence are recorded as a non-current asset but these are not actually an asset and so they are treated as fictitious assets. They may or may not provide any future benefit.

    For Example,

    Preliminary expenses are fictitious assets since these are already incurred but are spread over more than one reporting period and they do not provide any future benefit.

    The Accounting Treatment of Prepaid expense:

    At the time of incurring the expense

    Pre Paid Expense A/cDebitDebit the increase in an asset.
    To Cash A/cCreditCredit the decrease in an asset.

    The balance sheet given below shall be of some help to understand this:

    Prepaid expenses in Balance Sheet

    At the time such expense becomes due –

     Expense A/cDebitDebit the increase in an expense.
    To Pre Paid Expense A/cCreditCredit the decrease in an asset.

    The income statement given below shall be of some help to understand this:

    Prepaid expense in income statement  Treatment of Prepaid Expense in the income statement


    Aastha.

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  1. Yes, it is possible for a company to show positive cash flows but still be in grave trouble. To begin with, let me explain to you the meaning of positive cash flows. Meaning of Positive Cash flows Positive Cash flow is an indication that the cash balance of an entity has increased from its previousRead more

    Yes, it is possible for a company to show positive cash flows but still be in grave trouble.

    To begin with, let me explain to you the meaning of positive cash flows.

    Meaning of Positive Cash flows

    Positive Cash flow is an indication that the cash balance of an entity has increased from its previous year. It also represents that the cash inflow is greater than the cash outflow during the period.

    Positive Cash flow =
    Closing Cash & Cash Equivalents > Opening Cash & Cash Equivalents; OR
    Cash Inflow > Cash Outflow

    Reasons why a company has positive cash flows but is still facing grave trouble

    There might arise situations where you witness positive cash flows in the statement of cash flow but still, the company is facing hardships, owing to various reasons.

    1. Increase in bad debts

    Bad debts being a non-cash expense will never be reflected in the cash flow statement. However, a company may face great deal of hardships, if its bad debts increase over time, instead of reporting positive cash flows.

    2. Increase in borrowings accepted

    Positive cash flows can also arise because of the increase in the loans accepted by entities. Increase in borrowings will result in higher interest payments which could be troublesome. Also, repayment of the loan accepted could be challenging for an entity.

    3. Delay in payments

    In order to report positive cash flows during an accounting period, the company might delay the payment of the amount due to the creditors, moneylenders, etc.

    However, this could prove to be adverse for the entity as it will have to anyway discharge all these amounts due in the future period. Also, it could be possible that the entity will have to settle these amounts due along with interest or penalties.

    4. Sale of inventory at lower cost

    Positive cash flows can even occur as a result of the entity selling its inventory at a price lower than its purchase price. This is done by companies to generate immediate cash to pay bills due, to avoid bankruptcy, and for its day to day operations.

    So, despite having positive cash flow, the company might run into losses by selling its inventory at a loss.

    5. Revenues earned not introduced back into the business

    Earning revenue increases positive cash flow. But, it is utmost important for a company to bring back the revenue earned and utilize it for the growth prospects, increase the production and sales of the business, and for further expansion. Positive cash flow arising from earning revenues but not directing it back for business purposes is worthless.

    6. Disposing of long-term assets

    Positive cash flow could also be a result of the cash inflow arising from the sale of long-term assets. Companies in need of cash might dispose off their assets primarily held for long-term purposes. This could land them in big trouble in the future as there would be lack of assets generating future economic value to the entity.

    I hope after reading this answer, you might have got an insight of the various reasons for companies facing trouble despite reporting positive cash flows.

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  1. This answer was edited.

    As we can see, the term ‘Bad Debt’ comprises of the word ‘bad’, which gives us a fair idea that it is something about the debtors who are not good for the business. So basically, Bad Debt is the amount owed by the customer to the business which is now irrecoverable. It is an expense for the businessRead more

    As we can see, the term ‘Bad Debt’ comprises of the word ‘bad’, which gives us a fair idea that it is something about the debtors who are not good for the business.
    So basically, Bad Debt is the amount owed by the customer to the business which is now irrecoverable. It is an expense for the business and it may arise due to reasons such as fraud, insolvency of the debtor, etc. We can also refer to it as Uncollectible Accounts Expense and Irrecoverable Debts.

    Yes, bad debts are recorded in the Income statement.  The Income statement shows the aggregate financial position of a business during a specified period by displaying the amount of revenue generated and expenses incurred by a business. Bad debts being an expense are recorded under operating expenses in the Income Statement or on the debit side in the Profit & Loss a/c.

    Example

    ABC Ltd. sells goods to a retailer for 40,000 at 50 days credit. However, after 50 days, the company realizes that the retailer has been declared insolvent and the amount is no longer recoverable. This amount of 40,000 is an expense for ABC Ltd and leads to a fall in the accounts receivable.
    The journal entries to be recorded in the books of ABC Ltd are as follows:

    Bad debts a/cDebit40,000Debit the increase in expense
    To Retailer’s a/cCredit40,000Credit the decrease in asset

    (being amounts written off as bad debts transferred to bad debts account)

    Profit and loss a/cDebit40,000
    To Bad debts a/cCredit40,000

    (being bad debts transferred to profit and loss a/c)

    Bad debts as shown in the Income statement

    (Extract of Income Statement)

    PARTICULARSAMOUNTAMOUNT
    Revenue8,00,000
    Expenses:
    COGS50,000
    Insurance expense60,000
    Depreciation expense20,000
    Bad debts expense40,000
    Total Expense1,70,000

    Hope this helps.

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  1. This answer was edited.

    Accounts receivable as an asset I think before getting onto this question you should have a clear idea about what does an account receivable mean. An account receivable refers to an amount due to be received by the company for the sale of goods or services rendered. It's the value of goods that theRead more

    Accounts receivable as an asset

    I think before getting onto this question you should have a clear idea about what does an account receivable mean.

    An account receivable refers to an amount due to be received by the company for the sale of goods or services rendered. It’s the value of goods that the customer has not yet paid even though he has received the title of goods or enjoyed services.

    In simple words, any sum of money owed by a person for purchase made on a credit basis refers to an account receivable.

    For Example,

    Uber Inc. purchases 2000 units of smartphones from Apple Inc. for gifting them to its employees it purchases it on a 45 days credit and the amount remains due on a reporting date hence such an amount due becomes an account receivable for Apple Inc.

    Moving ahead, the answer to your question is that ” account receivable is an asset”.

    Why is it an asset?

    As explained earlier accounts receivable is the money owed by the client to the company. Hence, it can be said that the company has a right to receive the money since it has already delivered a product or rendered service. Because of this, the customer must pay to the company within a specific time frame.

    And so it’s an Asset since it ensures the future economic benefit for the company.

    The accounting treatment of such a transaction at the time of making a credit sale:

    Accounts Receivable a/cDebitIncrease in Asset
    To Sales a/cCreditIncrease in Revenue

    And at the time of actual receipt of cash :

    Cash A/cDebitIncrease in Asset
    To Accounts Receivable A/cCreditDecrease in Asset

    It shall be presented in the balance sheet under the head of the current asset if the amount is receivable within a year and beyond that, it’s recorded under the head of non-current assets
    In case you are unable to understand the position of such item in a balance sheet the below example would be of great help

    Presentation of Account receivable in an extract of balancesheet

    Why is it not a revenue?

    Revenue is the income generated by an entity. A major part of such revenue comes from sales or if an entity renders services from such services. It covers only that part of it pertaining to the current reporting period.

    Whereas the balance in the accounts receivable includes the unpaid dues from the customers for the current reporting period and earlier reporting period.

    Thus it can be said that the accounts receivable balance > amount reported in an income statement.

    Because of the reasons stated above, it can safely be concluded that accounts receivable is an asset.

    If the bad debts exist the company will have to reduce such balance from the total of accounts receivable and will have to debit it in its profit and loss statement.

    I have tried to answer it as simply as I can and I hope it helps.


    Aastha Mehta

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  1. This answer was edited.

    Trial Balance Are you facing difficulty in understanding the crux of the trial balance? I would like to help you by providing the meaning followed by items to be included on either side of the trial balance. Meaning The term trial balance refers to as the total of all the general ledger balances. ItRead more

    Trial Balance

    Are you facing difficulty in understanding the crux of the trial balance? I would like to help you by providing the meaning followed by items to be included on either side of the trial balance.

    Meaning

    The term trial balance refers to as the total of all the general ledger balances. It is a statement prepared at a certain period to check the arithmetic accuracy of the accounts (i.e., whether they are mathematically correct and balanced). It contains a list of all the general ledger accounts.

    Trading account, Profit and Loss account and Balance Sheet are prepared according to the ledger balances as posted in the trial balance.

    Now its time to learn about the various items which are placed on either side of the trial balance.

    Items that appear on the debit side of trial balance

    Generally, assets and expenses have a positive balance so they are placed on the debit side of trial balance. An asset and expense increases when it is debited and visa versa

    Exclusive List of Items

    1. Land and Buildings
    2. Plant and Machinery
    3. Furniture and Fixtures
    4. Office Tools and Equipment
    5. Cash at Bank
    6. Cash in Hand
    7. Motor Van
    8. Loss from the sale of fixed assets
    9. Travelling charges
    10. Printing and postage expenses
    11. Legal expenses
    12. Selling and distribution expenses
    13. Sundry debtors
    14. Bills receivables
    15. Commission paid
    16. Rent paid
    17. Interest paid
    18. Discount allowed
    19. Opening stock
    20. Purchases
    21. Prepaid expenses
    22. Advertisement expenses
    23. Bad Debts
    24. Wages and salaries
    25. Bank charges

    Items that appear on the credit side of trial balance

    Generally capital, revenue and liabilities have credit balance so they are placed on the credit side of trial balance. The capital, revenue and liability increases when it is credited and visa versa.

    Exclusive List of Items

    1. Sundry Creditors
    2. Bank Overdraft/Loan
    3. Bills Payables
    4. Sales (Revenue)
    5. Purchase Returns
    6. Common stock
    7. Un-earned revenues
    8. Retained earnings
    9. Rent Received
    10. Interest Received
    11. Discount from Creditors
    12. Discount on Purchases
    13. Dividend Received
    14. Interest on Drawings
    15. Bad Debts recovered
    16. Provision on Bad Debts (Cr.)
    17. Apprentice premium
    18. Miscellaneous/Sundry income
    19. Commission received
    20. Bank interest received
    21. Compensation received
    22. Outstanding income
    23. Income from investments
    24. Bonds payable
    25. Other incomes

     

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  1. This answer was edited.

    Purchase Order Introduction Purchase Order is a commercial document issued by a buyer to the seller specifying the quantity, price, description, quality of goods required, and the payment terms, etc. It is the first step and a very integral part of an organization’s procurement process. Purchase OrdRead more

    Purchase Order

    Introduction

    Purchase Order is a commercial document issued by a buyer to the seller specifying the quantity, price, description, quality of goods required, and the payment terms, etc. It is the first step and a very integral part of an organization’s procurement process. Purchase Order precedes the Purchase Invoice.

    Now, the question arises whether a purchase order is legally binding, and once issued can it be cancelled by any of the parties to a transaction.

    So, let me help you address the first question-Whether a purchase order is legally binding or not?

    Purchase Order – Legally binding or not?

    The issue of a purchase order by the buyer does not itself result in a legally binding contract. A legally binding contract gets executed between the parties to a transaction only on the acceptance of the purchase order by the seller. It provides legal protection to the buyer and seller both.

    1. From the buyer’s perspective-

    So, let me help you understand how does a purchase order legally protects the buyer.

    On the acceptance of the purchase order, the vendor or supplier is obligated to deliver the requested goods as stated in the order. He is also compelled to consider the other conditions in the order specifying the description, type, and quality of goods.

    Example-
    Let’s say you order 10 computers for your company from a well-known vendor, paid for the same, but on the delivery date you end up receiving only 8 computers.

    In this case, if you have an acknowledged purchase order with you, you will certainly be able to prove that you received less quantity than what you paid for. The purchase order will serve as an on-record legal document for your purchase.

    Had you not possessed an acknowledged purchase order, you would have certainly landed up in big trouble.

    2. From the seller’s perspective-

    Purchase Order can be used as a legal document in the court of law by a seller to sue the buyer in case he refuses to pay the agreed amount for the goods supplied. This is possible only because of the legally binding contract status of the purchase order.

    3. Trade Finance-

    Banks and financial institutions facilitate domestic and international trade transactions and provide financial assistance based on purchase orders issued.

    Example-
    To produce the goods as requested by the buyer, the supplier can approach a bank for funds based on the acknowledged purchase order.

    In case the supplier does not provide credit terms for payment to the buyer and the buyer does not possess the requisite funds for payment. Then in such a situation, banks or financial institutions accept the purchase order as a legal document for providing financial assistance to the buyer.

    Now, let me help you understand the next question asked-Can Purchase Order be cancelled?

    Cancellation of a Purchase Order

    To help you understand, whether the cancellation of a purchase order is possible or not, we must consider various situations related to the acceptance and cancellation of the purchase order-

    • Situation 1-


    Can a purchase order be cancelled before its acceptance?

    –The question to this scenario is yes. As the purchase order has not been accepted by the seller, it can be easily cancelled by the buyer, because it has not yet attained a legally binding status.

    • Situation 2-


    Can the buyer cancel a purchase order after the goods have been delivered to him by the supplier?

    –In this scenario, goods have been dispatched and delivered ie. the purchase order has already been acknowledged by the vendor. In such a case, the vendor might not accept a cancellation request as desired by the buyer. Or the vendor may accept your request but may charge some fees for the same.

    • Situation 3-


    Can the purchase order be cancelled by the supplier or the buyer after it is acknowledged as a legal binding contract?

    –The purchase order gets a legal binding status only after its acknowledgement by the seller. So, in this case, we will have to consider the terms and conditions laid out in the order.

    If purchase order allows cancellation without fulfillment of any additional terms and conditions, and both the parties mutually decide to terminate the order. Then in such a case, no party shall be liable to sue or be sued in the court of law.

    But, if the purchase order does not allow cancellation after its acceptance, it becomes legally binding on the parties to fulfill the requirements stated in the order. If one party does not obey the terms detailed in the order, the other party certainly has the right to sue. The order will be considered to be an on-record legal document if such a situation arises.

    Conclusion-

    As discussed with examples, it is evident that-

    1. A purchase order is legally binding.
    2. It can be cancelled considering the terms and conditions listed in the order.
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