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  1. This answer was edited.

    Zero Working Capital Before diving into the concept of Zero Working Capital, let me help you understand the meaning of Working Capital. Working Capital is the term used to demonstrate whether the company possesses adequate current assets to discharge off its current liabilities. It is calculated asRead more

    Zero Working Capital

    Before diving into the concept of Zero Working Capital, let me help you understand the meaning of Working Capital.

    Working Capital is the term used to demonstrate whether the company possesses adequate current assets to discharge off its current liabilities. It is calculated as follows:

    Working Capital = Total Current Assets – Total Current Liabilities

    Now, taking this forward let us interpret the theory of Zero Working Capital.

    The Working Capital of a company can be positive or negative, ie. the total current assets may exceed the total current liabilities or vice-versa. However, there can be a situation when the total current assets are equivalent to the total current liabilities of the company. Such a situation is referred to as Zero Working Capital. Zero Working Capital is when,

    Total Current Assets = Total Current Liabilities, or

    Total Current Assets – Total Current Liabilities = Zero

    Example

    Zero Working Capital

    Using the data given in the balance sheet above, let us calculate the zero working capital.

    1. Total Current Assets = Cash in hand/bank + Sundry Debtors + Bills Receivable + Inventory
    = 15,000 + 1,80,000 + 1,00,000 + 55,000
    = 3,50,000

    2. Total Current Liabilities = Sundry Creditors + Bills Payable + Outstanding Expenses
    = 1,95,000 + 85,000 + 70,000
    = 3,50,000

    As there is no excess of Total Current Assets over the Total Current Liabilities, this situation is referred to as Zero Working Capital.

    Benefits and Approach of Zero Working Capital

    Zero Working Capital is one of the latest techniques in working capital management. Let us now understand the benefits and approach of zero working capital in real-life scenario.

    1. Reduction in the level of investments in working capital

    Zero Working Capital is a strategy to reduce the level of investment in the working capital and thereby increase the investments in the long term assets. Following this strategy, companies avoid excess investments in current assets and prefer paying off their current liabilities using the existing current assets only.

    2. Savings in Opportunity Cost of Funds

    Working Capital earns a very low rate of return as compared to long term investments. Also, maintaining zero working capital will help save the opportunity cost of funds as the company can now use the excess funds to exploit various other opportunities.  So, owing to its benefits, the management would certainly prefer zero working capital.

    3. Just-in-Time Methodology

    Zero Working Capital approach will be possible only if the Just-in-Time methodology is adopted by the company. Following the demand-based production and distribution system is advised. Very low or zero inventory is emphasized. Everything should be produced and supplied as and when the demand for the same arises.

    To keep in pace with the Just-in-Time practice, the receivable and payable terms should also be modified. Payable time granted by the supplier should be extended and the credit terms granted to the debtors should be cutback. This will ensure that you have the cash required to fund the supplier’s payment.

    Conclusion

    Zero Working Capital eventually helps in better management of the current assets and current liabilities but still considered to be a difficult scenario to be implemented in practical business life.

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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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  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/c Debit Increase in Asset
    To Sales a/c Credit Increase in Revenue

    And at the time of actual receipt of cash :

    Cash A/c Debit Increase in Asset
    To Accounts Receivable A/c Credit Decrease 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.

    Working capital = Current Assets - Current Liabilities I believe if you want to understand how the above formula works you will need to understand each part of this formula i.e you will first need to have a clear understanding about the concept of current assets and current liabilities. Current asseRead more

    Working capital = Current Assets – Current Liabilities

    I believe if you want to understand how the above formula works you will need to understand each part of this formula i.e you will first need to have a clear understanding about the concept of current assets and current liabilities.

    Current assets

    It refers to all the assets including cash and cash equivalents which are expected to be converted within a year or within the operating cycle of an entity if such entity has an operating cycle longer than a year.

    Current liabilities

    It refers to all the payables or debts which an entity expects to discharge within a year or the operating cycle of such entity provided such an entity has an operating cycle longer than a year.

    I understand that even though you got a rough idea of this concept you may not be confident while applying this concept hence, to relate to this concept a numerical example would be of great help.

    So, I believe once you have a look at the below-mentioned example you will be in a better position to comfortably apply this formula:

    Working Capital Position in Balance sheet

    Here, Working Capital = Current Assets – Current Liabilities

    = Cash in Hand + Cash at Bank + Trade Receivables + Prepaid Rent –Trade Payables  –                  Outstanding Salaries

    = 5,000 + 56,000 + 64,000 + 3,000 – 20,000 – 20,000

    = 128,000 – 40,000

    = 88,000.

    It will add more value to your understanding if you also interpret the concept of Gross Working Capital and Net Working Capital.

    Gross Working Capital

    Gross working capital is a sum total of current assets of an entity. It includes

    • Cash and Cash Equivalents
    • Trade Receivables
    • Inventory
    • Short term Investments
    • Other Marketable Securities.

     

    Net Working Capital

    Now, the net working capital of an entity is nothing but the working capital of an entity. In simple terms, it is a difference between current assets and current liabilities of an entity.


    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.

    The simple meaning of capital, as known by many, is the sum of money invested in the business by the owner/shareholder/partners. It can be in the form of cash or assets. From the accounting perspective, capital is generally of three types, equity capital, debt capital, and working capital. Capital aRead more

    The simple meaning of capital, as known by many, is the sum of money invested in the business by the owner/shareholder/partners. It can be in the form of cash or assets. From the accounting perspective, capital is generally of three types, equity capital, debt capital, and working capital.

    Capital as a Liability

    A very common question that strikes us is that even though capital is invested by the owner in the form of cash or assets, why is it recorded on the liabilities side of the balance sheet? From the accounting perspective, Capital is a liability because the business is obliged to repay its owner.

    To make the point clear, I would like to introduce you to the two different accounting perspectives of the same.

    Internal Liability

    Firstly, in the case of equity capital, it refers to ownership and represents the owner’s fund. The company is obliged to repay the owners as it is an internal liability and interest on capital is also paid during the operations of a company. A company is considered as a separate legal entity from its owner. The proprietor/shareholder/partners have invested the amount with an aim and expectation of profits in return.

    However, the owners are repaid only if any amount is left after paying off all the obligations during the winding up of the company. It is not a mandatory liability like in the case of debt capital. It can also be represented as follows:

    Assets = Liabilities + Capital

    I have used the accounting equation to show the shareholder’s equity/capital as a difference and balancing figure between the company’s liabilities and assets. Since the capital invested is used to pay off all the debts, it has a credit balance and is recorded on the liabilities side of the balance sheet.

    External Liability

    Secondly, let us assume that company A has borrowed a certain sum of money from the company B, and holds onto the amount invested for realizing feasible profits in the future. The company is obliged to repay, irrespective of profits or loss.

    In simple words, I can conclude that capital is a liability.

    Capital as shown in the balance sheet

    Balance Sheet as at 31st March,yyyy

    Liabilities Amount  Assets Amount
    Capital 2,40,000 Cash in hand 70,000
    (+) Net Profit 70,000 Accounts receivables 50,000
    (-) Drawings (30,000) Patents 10,000
    (-)Interest on capital (20,000) Equipment 45,000
    Retained Earnings 10,000 Building 90,000
    Sundry Creditors 40,000 Prepaid Expense 35,000
    Outstanding Rent/Salary 5,000 Goodwill 20,000
    General Reserve 10,000 Investments 60,000
    Loan taken from Bank 55,000 Accrued Income 10,000
    3,80,000 3,80,000

    Hope this helps.

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  1. This answer was edited.

    Yes. Let's take a set of transactions and prepare all the requisite information asked. Following are the transactions for the period April 20x1 to March 20x2 in the books of Michael Traders 1-Apr Michael started business with cash 600,000, cash at Bank of America 700,000, furniture 200,000. 1-Apr PuRead more

    Yes.

    Let’s take a set of transactions and prepare all the requisite information asked.

    Following are the transactions for the period April 20×1 to March 20×2 in the books of Michael Traders

    1-Apr Michael started business with cash 600,000, cash at Bank of America 700,000, furniture 200,000.
    1-Apr Purchased Plant & Machinery worth 250,000 by cheque.
    25-Apr Purchased goods from ABC Ltd worth 800,000 @10% trade discount.
    5-May Cash Sales 1,000,000 @5% trade discount to XYZ Traders
    15-May Deposited cash with Bank of America 500,000.
    5-Jun Paid ABC Ltd 300,000 in cash.
    10-Jun Received commission 75,000 by cheque.
    25-Jun Cash Purchases 250,000.
    5-Jul Sold goods to XYZ Traders 475,000.
    15-Jul Received 275,000 by cheque from XYZ Traders.
    5-Aug Loan taken from Bank of America 200,000
    25-Aug Purchased goods from ABC Ltd 50,000.
    27-Aug Withdrew cash from bank 10,000.
    5-Sep Received commission 55,000 in cash.
    10-Sep Paid ABC Ltd 70,000 by cheque.
    20-Sep Received 90,000 in cash from XYZ Traders.
    1-Oct Bank loan repaid 50,000.
    25-Oct Cash Purchases 25,000.
    5-Nov Sold goods to XYZ Traders 47,000.
    15-Nov Withdrew cash from bank 15,000.
    5-Dec Received interest from bank 5,000.
    25-Dec Purchased goods from ABC Ltd 75,000.
    5-Jan Cash Sales 100,000.
    15-Jan Deposited cash with Bank of America 35,000.
    25-Feb Cash Purchases 450,000.
    28-Feb Office was taken on rent in the month of Feb. Office rent paid in cash 50,000.
    28-Feb Employees were hired in the month of Feb. Paid salary by cheque 30,000 & cash 30,000 for the month of Feb 20×2.
    5-Mar Sold goods to XYZ Traders 675,000.
    31-Mar Paid office rent by cheque 50,000.
    31-Mar Paid salary in cash 30,000 for the month of March 20×2.

    You are required to:
    (i) Journalize the above transactions and post them in Ledgers and prepare a Trial Balance.

    (ii) Prepare Trading A/c, Profit & Loss A/c and Balance Sheet taking into consideration:
    1. Closing Stock as on 31st March 20×2 is 200,000.
    2. Salary outstanding for the month of March 20×2 is 30,000.
    3. [email protected]% to be charged on Furniture & Fixtures and @15% on Plant & Machinery.

    1. Journal Entries

    April & May Journal

    June-Aug Journal

    Sep-Nov Journal

    Dec-Jan Journal

    Feb-March Journal

    2. Ledgers

    Ledger-Micheal Capital A/c

    Ledger-Purchases & Sales A/c

    Ledger-Furniture A/c & Plant & Machinery A/c

    Ledger-Creditor & Debtor A/c

    Ledger-Bank Loan A/c

    Ledger-Salary & Office Rent A/c

    Ledger-Interest & Commission received A/c

    Ledger-Cash A/c

    Ledger-Bank of America A/c

    3. Trial Balance

    Trial Balance

    4. Trading A/c & Profit and Loss A/c

    Trading A/c and Profit & Loss A/c

    5. Balance Sheet

    Balance Sheet

    An excel sheet of the entire transactions along with the requisite information asked has been attached for your reference.

    30-transactions-of-Journal-Ledger-Trial-Balance-Financial-Statements

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  1. This answer was edited.

    Accounts that do not get closed at the year-end Traditional Perspective- According to traditional accounting perspective, personal (say- creditors, debtors, capital etc) and real accounts (say- land, machinery, patents etc) are not closed and their balances are carried forward for the next accountinRead more

    Accounts that do not get closed at the year-end

    • Traditional Perspective– According to traditional accounting perspective, personal (say- creditors, debtors, capital etc) and real accounts (say- land, machinery, patents etc) are not closed and their balances are carried forward for the next accounting period.

     

    • Modern Approach– According to modern accounting perspective, permanent account are not closed and their balances are brought forward to the next accounting year.

     

    Permanent Accounts-

    Permanent accounts are those accounts that appear at the time of preparation of Balance Sheet. These accounts are measured cumulatively and their balances never get closed until the organization is legally wound up. These accounts include asset account, capital account and liabilities account.

    Example- As on 31st March, yyyy if the ABC and Co. had Cash at Bank amounting to 2,50,000, then that amount will be carried forward (c/f) as opening bank balance in next accounting year. If the bank balance increased by 2,00,000, then at the end of the accounting year Cash at Bank would become 4,50,000. This amount will be again c/f onto the next accounting period and the cycle keeps going.

    A snippet of the cash account will help to develop an understanding of all personal and real accounts whose balances are carried forward to the next accounting period.

    Cash Account

     

    I have also explained the accounts that get closed at the year-end for your better understanding.

    Accounts that get closed at the year-end

    • Traditional Perspective- According to traditional accounting perspective, Nominal accounts (say- factory expenses, salary & wages, depreciation, discount received, interest received etc.,) get closed at the end of the accounting year.

     

    • Modern Perspective- According to modern accounting perspective, the temporary account gets closed at the end of the accounting period. They are closed so that the previous year’s income and expenses do not get mixed with the current year’s income and expenses. This would help the users of financial statements to know the true net profit.

     

    Temporary Accounts-

    Temporary accounts are those accounts which appear at the time of preparation of Income Statement (i.e., trading and profit & loss account). These accounts get settled by either debiting or crediting them yielding Gross profit and Net profit. The temporary account includes expenses account, income account and withdrawals.

    Example- Salary paid 2,00,000 to the employees for the previous year gets closed in the previous accounting period itself and their balances are not carried forward in the next accounting year.

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  1. This answer was edited.

    Before directly diving into the question asked-Is income received in advance a liability or an asset? I will make you equipped with the meaning of the word “Income received in advance”. Meaning of "Income received in advance" Income received in advance refers to an income that has been received by tRead more

    Before directly diving into the question asked-Is income received in advance a liability or an asset? I will make you equipped with the meaning of the word “Income received in advance”.

    Meaning of “Income received in advance”

    Income received in advance refers to an income that has been received by the entity in the current accounting period but it actually relates to the future accounting period. The entity has just received the income but has not earned it yet. It is also known as Unearned Income.

    The entity receiving the income in advance still has an obligation to render the goods or services in the next accounting period, corresponding to the income received. Only after the entity renders the goods or service, the transaction will be considered as complete. So, because of this reason, income received in advance is certainly considered to be a liability.

    As per the accrual system of accounting and to present the true and fair financial position of the entity, income received is to be recorded in the books of accounts, irrespective of when the actual goods or services are provided. So, income received in advance is recorded as a liability in the current accounting period.

    Income received in advance includes

    • Rent received in advance
    • Commission received in advance
    • Professional fees received in advance
    • Premium received in advance, etc.


    From the meaning of the word “Income received in advance” itself, we can conclude that it is a liability and not an asset.

    Treatment in Financial Statements

    Income received in advance is shown in both the Balance Sheet and Profit and Loss account.

    Financial Statement Treatment
    Profit and Loss account Reduced from the respective income on the credit side of profit and loss account
    Balance Sheet Presented as a liability in the balance sheet under the head “Current Liabilities”

    A snippet of the balance sheet has been attached to show the presentation of Income received in advance.

    Income received in advance presented in balance sheet

    Conclusion

    Income received in advance is a liability and not an asset.

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