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What is Profit and Loss Appropriation Account?

Ahuja Sahil
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Profit and Loss Appropriation Account

In case of a sole proprietorship, there is a single owner and any addition in the capital in form of net profit or reduction in form of drawings is directly done from the firm’s capital account. However, in case of a partnership, “Profit and Loss Appropriation Account” is created to demonstrate the change in each partner’s individual capital as a result of profit or loss incurred by the firm.

P&L Appropriation account helps to show a clear distinction between the capital contribution of each partner and the changes thereafter. Profit and Loss Appropriation Account is used for allocation of net profit among different partners. It is seen as an extension of the profit and loss account itself.

 

Template and Method of Preparation

It includes items such as interest on capital, interest on drawings, interest on partner’s loan, salaries to partners, commission, reserves, and profit share. (It doesn’t include drawings made by partners)

Credit

Net Profit (From the income statement) & Interest on drawings (charged to partners)

Debit

Interest on capital, salaries to partners, commission to partners, transfer to reserve, profit share, etc.

Profit and Loss Appropriation Account Format - 2

Note – Except rent if there are any funds payable to a partner for e.g. interest on capital, salaries, commission, etc. they should be treated as appropriation and are not supposed to be charged against profits.

 

Short Quiz for Self-Evaluation

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>Read Difference Between Profit and Loss & Profit and Loss Appropriation

 

What are Modern Rules of Accounting?

Ahuja Sahil
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American or Modern Rules of Accounting

There are a couple of ways to approach the art of accounting, traditional and modern. Classification of accounts under both traditional and modern rules of accounting is done very differently.

The UK or traditional style of accounting classifies all accounts of a business into 3 main types i.e. Real, Personal & Nominal. On the other hand, American or modern rules of accounting classify all accounts into 6 different types i.e. Asset, Liability, Capital, Revenue, Expense & Drawings.

Traditional or Golden rules of accounting are applied with real, personal, and nominal accounts, however, American or modern rules of accounting are applied with the modern classification of accounts.

 

Classification of Accounts and Modern Rules

The first step is to identify the type of account from either of the 6 categories shown in the below table. Once the account is determined correctly, apply modern rules of accounting to prepare a perfect journal entry.

Type of Accounts Debit Credit
Asset Increase Decrease
Liability Decrease Increase
Capital Decrease Increase
Revenue Decrease Increase
Expense Increase Decrease
Drawings Increase Decrease

 

Tip – Memorize the word (CRADLE) which means “small bed for a baby” in the English language.

C – Capital, R – Revenue, A – Assets, D – Drawings, L – Liability, E – Expense

Another way to look at modern rules of accounting is,

American or Modern Rules of Accounting

 

Example Journal Entries

  • Example I – Purchased furniture for 20,000 in cash, prepare the journal entry
Accounts Involved Amount Rule Applied
Furniture A/C 20,000 Asset – Dr. the increase
To Cash A/C 20,000 Asset – Cr. the decrease

 

  • Example II – Received 1,00,000 in the bank as a loan, prepare the journal entry
Accounts Involved Amount Rule Applied
Bank A/C 1,00,000 Asset – Dr. the increase
To Loan A/C 1,00,000 Liability – Cr. the increase

 

  • Example II – Received 5,00,000 via a cheque from Mr. Unreal as a trade receivable, prepare the journal entry
Accounts Involved Amount Rule Applied
Bank A/C 5,00,000 Asset – Dr. the increase
To Mr. Unreal A/C 5,00,000 Revenue – Cr. the increase

 

Short Quiz for Self-Evaluation

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>Read Step by Step Accounting Process

 

10 Tips to Follow for Freshers Before an Accounting Interview

Ahuja Sahil
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3
10 Tips to Follow for Freshers Before an Accounting Interview

Last updated on Jun 20th 2023

Tips to Follow for Freshers Before an Accounting Interview

Initial finance and accounting interviews can be hard-hitting and you don’t want to be caught off-guard. Here, we’ve compiled top 11 tips to follow for freshers before an accounting interview.

For obvious reasons we have not added the must-haves such as “hard work” & “dedication”. This list has been curated from real-life experiences and hopes to help you to achieve more out of your accounting interviews.

 

10. Revise your basics

Top grades in academics do not guarantee success in accounting and finance interviews. This is the main reason why we strongly suggest that you revise fundamentals of accounting and finance before your next encounter with an interviewer.

The idea is to avoid taking it for granted and never be complacent with yourself. You can subscribe and receive a free eBook with top 40 accounting interview questions asked by major companies around the world.

Revise Finance and Accounting Fundamentals

 

9. Know Your Job Profile – Don’t Be Trapped

This is one of the most important tips to follow for freshers before an accounting interview. A lot of freshers are prone to getting into the WRONG type of jobs because of not being able to handle the anxiety of starting a professional career.

A finance student getting into marketing, human resources, customer care, operations, and other unrelated work profiles is not the best way to kickstart a career.

It is highly advisable that you research your role & job profile. What are you expected to do 9 to 5? how are you going to spend a regular day at work? etc. Trust us, you don’t want to feel trapped and be sorry for your decision later on. It is also important because it allows you to anticipate questions and prepare precisely for the technical rounds.

 

8. Exhibit Stability

You may not have applied for the exact role you’ve always wanted, however, this isn’t something you need to convey to the interviewers. Talking about IJPs (Internal Job Postings), future plans, anything which shows that you’re not going to stay in this role for long is a strict NO!

Be careful about revealing your future plans, a lot of students get excited and start talking about fancy courses such as CPA, CA, CMA, ACCA, CFA, etc. that they are pursuing. Don’t get amazed to know that this is only a red flag in the eyes of the interviewer. There are however exceptions to this scenario where a specific course may be a plus for your role. Only reveal if you’re 100% sure about it.

 

7. Stay Motivated

You may have the best preparation and extraordinary educational background but on the day of the interview, you still need the unseen & intangible forces to work in your favour.

add motivation to the right attitude and the see the magic happen!

To reduce nervousness, stress, and anxiety related to an interview, we recommend that you try to watch motivational videos or do anything that makes you feel confident and positive.

 

6. MS-Excel

Most finance and accounting roles require you to work extensively with MS-Excel. Therefore, most of the accounting and finance interviews have at least one round related to Microsoft Excel.

Few functions we recommend every fresher should be comfortable with are Sort, Filter, Concatenate, Vlookup, Hlookup, Pivot (basics), Conditional Formatting, Text to Column, Charts, Sumif, Countif, Left, Right, Mid, Trim, etc.

The above is not an exhaustive list but covers most of the major functions. Also, consider learning some basic excel shortcuts.

 

5. Journal Entries

For accounting students, this is your holy grail. There is almost no way that an accounting interview can exist without journal entries. Not only are you expected to be good with accounting fundamentals but you are also required to display superior journal entry skills.

We have a list of journal entries here that can help you prepare. Along with basic entries, the operations manager love to ask accrual related entries don’t forget to prepare them.

 

4. Don’t Overtalk & Embrace Smartwork

Overtalking rarely helps, more often than not we end up saying things that we didn’t want to or we reveal more than required. Please avoid this.

Staying Quiet at the right time is an uncommon tact

Nothing beats a combination of Smart Work and Hard Work. For example, if you are anticipating a group discussion in your interview make sure you’ve researched the best practices, to-dos, etc. related to a GD. Don’t be shy to Google and learn something new.

 

3. Communication Skills

More than 70% of rejections happen in the preliminary rounds where the people from the human resource department churn out the applicants. The biggest reason for rejection in Non-English speaking countries still remains “Poor Communication Skills”.

Few resources for improvement we recommend are; watching movies, reading, youtube channels, online courses on UDEMY, online certifications at COURSERA, etc. This is one area that requires persistence and constant practice.

 

2. Research About the Company

Don’t forget to research about the company, mainly, its main line of business, history & top management. The best way to do this is through Wikipedia or the company’s own website.

Be ready with a crisp and natural answer to this question “Why do you want to join our organization?”

 

1. Rejection isn’t the end of World

Last in our list of tricks and tips to follow for freshers before an accounting interview is related to handling rejection. There is always a chance that your entire interview experience may have been really awesome and all your answers were perfect, but, you will still be rejected.

Accept that you can’t control everything and sometimes the reason for failure isn’t you at all. There are numerous behind the scene management-related decisions that can impact your success in an accounting interview. A few of them are – reduction in no. of positions, the job is filled up by an IJP, budget constraints, hiring manager’s personal choice, etc.

Jack Ma, Alibaba Group’s founder was REJECTED! by KFC. 

~Goodluck~

 

>Read Accounting Interview Questions for Freshers

 

What is Debtor’s Turnover Ratio?

Ahuja Sahil
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0

Debtor’s Turnover Ratio or Receivables Turnover Ratio

Debtor’s turnover ratio is also known as Receivables Turnover Ratio, Debtor’s Velocity and Trade Receivables Ratio. It is an activity ratio that finds out the relationship between net credit sales and average trade receivables of a business.

It helps in cash budgeting as cash flow from customers can be computed on the basis of total sales generated by a business. It is to be noted that provision for doubtful debts is not subtracted from trade receivables.

 

Formula to Calculate Debtor’s Turnover Ratio

Formula for Debtor's Turnover Ratio

Net Credit Sales = Gross Credit Sales – Sales Return

Trade Receivables = Debtors + Bills Receivable

Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables)/2

 

Example – Receivables Turnover Ratio

Ques. Calculate debtor’s turnover ratio from the information provided below;

Total Sales – 5,00,000

Cash Sales – 2,00,000

Debtors (Beginning of period) – 50,000 & Debtors (End of period) – 1,00,000

Ans. 

Debtor’s turnover ratio or Accounts receivable turnover ratio = (Net Credit Sales/Average Trade Receivables)

Net Credit Sales = Total Sales – Cash Sales

= 5,00,000 – 2,00,000

Net Credit Sales = 3,00,000

Average Trade Receivables = (Opening Trade Receivables + Closing Trade Receivables)/2

= (50,000 + 1,00,000)/2

= 75,000

Ratio = (3,00,000/75,000) => 4/1 or 4:1

 

High and Low Debtor’s Turnover Ratio

A high ratio may indicate

• Low collection period allowed to customers.
• The company may operate majorly on the cash basis.
• Company’s collection of accounts receivable is efficient.
• A high proportion of quality customers pay off their debt quickly.
• The company is conservative with regard to the extension of credit.

A low ratio may indicate

• High collection period allowed to customers.
• Good credit period availed by the company from its suppliers.
• The company may have a high amount of cash receivables for collection.

 

Short Quiz for Self-Evaluation

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>Read Creditor’s Turnover Ratio

 

Accounting and Journal Entry for Bill of Exchange

Ahuja Sahil
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0

Journal Entry for Bill of Exchange

Bill of exchange is an instrument in writing signed by the maker which contains an order without any conditions. It directs another person to pay a specific sum of money to the bearer of the instrument (or) to a particular person (or) to the order of a particular person. Journal entry for bill of exchange is posted differently in the books of both drawee and the drawer.

A valid bill of exchange acts as a bill receivable for the drawer (Issuer) and a bill payable for the drawee (Acceptor).

 

Journal Entry in the Books of Drawer

Accounting in the books of drawer at different stages is shown as follows;

  • When the sale of goods on credit is recorded in books of the drawer.

When credit sales are recorded in the books of drawer

  • When a valid and accepted bill of exchange is received against the above credit sale.

Journal entry when bill is received from drawee

  • When payment is received, journal entry for bill of exchange is;

Journal entry when payment is received after maturity of a bill of exchange

 

Journal Entry in the Books of Drawee or Acceptor

Accounting in the books of drawee/acceptor at different stages is shown as follows;

  • When the purchase of goods on credit is recorded in the books of the drawee/acceptor.

Journal entry in books of drawee - purchase of goods on credit

  • When a valid and accepted bill of exchange is provided for the above credit purchase.

Journal entry in books of drawee - when bill is given to drawer

  • When payment is made, the journal entry for bill of exchange is;

Journal entry when payment is made at maturity of a bill of exchange

 

Short Quiz for Self-Evaluation

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>Read Bill of Exchange – with Template and Example

 

Accounting and Journal Entry For Provident Fund

Ahuja Sahil
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0

Journal Entry For Provident Fund (PF)

Provident fund or PF is a compulsory retirement savings plan managed by the government where employees contribute a fixed percentage of their monthly pay-out and the same amount is contributed by the employer. Accounting and Journal entry for provident fund is a 3 step process.

When salaries are paid to employees, the employer deducts the employee’s contribution from it and only the net amount is paid. Employer’s own contribution along with the employee’s share is later on deposited with the proper authority.

 

1. When salaries are paid, the below entry is posted.

Journal entry for provident fund when salary is paid

2. For employer’s own contribution to provident fund, the below entry is posted.

Journal entry for employer's own contribution to provident fund

3. When both the amounts are deposited, the below entry is posted.

Journal Entry when both PF amounts are deposited

If the amount has not been deposited within the accounting period, it is to be shown on the balance sheet as a current liability.

Related Topic  – Journal Entry for Income Tax Paid

 

Example of Accounting for Provident Fund

Show accounting and journal entry for provident fund deposits and deductions for the below information.

Total salaries – 1,00,000, PF deduction (employees) – 12,000, Employer share – 12,000

 

1. When salaries are paid (employee’s share is deducted)

Example - journal entry for PF when salary is paid

2. For employer’s own contribution to PF account (employer’s contribution journalized as salary)

Example - journal entry for employer's own contribution to PF

3. When both employee’s and self-contribution to PF account is deposited with the required authority.

Example - journal entry for PF when both the amounts are deposited

 

Short Quiz for Self-Evaluation

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>Read Accounting and Journal Entry for Credit Card Sales

 

What is a Bill of Exchange?

Ahuja Sahil
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Meaning

Bill of exchange is a financial instrument in writing containing an unconditional order signed by the maker, directing another person to pay a specific sum of money. The amount may be paid in any of the following ways;

  • to the bearer of the instrument, (or)
  • to the order of a particular person, (or)
  • to a particular person

 

Features of BOE

  • Bill of exchange is a written order.
  • Signed both by the drawer and the acceptor.
  • It is accepted by the drawee and doesn’t have any conditions attached.
  • Unlike a promissory note which is only a promise, a BOE is an order of payment on a specific date.
  • It is payable either on-demand or after a fixed period.

 

Parties Involved

Drawer – is the seller or the creditor who issues the instrument and is entitled to receive the money-back from the person to whom the credit is extended. Drawer signs the BOE.

Acceptor or Drawee – is the purchaser or the debtor who accepts the instrument and to whom credit has been extended. Drawee is required to pay the amount back to the seller. A bill of exchange is signed and accepted by the acceptor/drawee.

Payee – The person to whom the amount is supposed to be paid is called a payee. The drawer himself or a third party may be made a payee.

 

Template for Bill of Exchange

Sample Format - Bill of Exchange

 

Short Quiz for Self-Evaluation

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>Read Difference Between Ledger and Trial Balance

 

What is Stock Turnover Ratio?

Ahuja Sahil
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Stock Turnover Ratio

The inventory turnover ratio or stock turnover ratio indicates the relationship between “cost of goods sold” and “average inventory”. It indicates how efficiently the firm’s investment in inventories is converted to sales and thus depicts the inventory management skills of the organization.

It is both an activity and efficiency ratio. This ratio helps to determine stock-related issues such as overstocking and overvaluation. The stock turnover ratio is calculated as;

Stock Turnover Ratio Formula

In some cases, the numerator may be “Cost of Revenue from Operations” which is calculated as “Revenue from operations – Gross profit”.

COGS – It can be calculated with either one of these formulas;

  • Opening Stock + Purchases + Direct Expenses (*if provided) – Closing Stock
  • Net Sales – Gross Profit

Average Inventory – Average of stock levels maintained by a business in an accounting period, it can be calculated as;

  • (Opening Stock + Closing Stock)/2
  • Stock to include = Raw material + Work in Progress + Finished Goods

 

Example

Calculate the stock or inventory turnover ratio from the below information.

Cost of Goods Sold – 6,00,000

Stock at beginning of period – 2,00,000, Stock at end of period – 4,00,000

Average Inventory = (2,00,000 + 4,00,000)/2 = 3,00,000

Stock Turnover Ratio = (COGS/Average Inventory)

= (6,00,000/3,00,000)

=2/1 or 2:1

 

High Ratio – If the stock turnover ratio is high it shows more sales are being made with each unit of investment in inventories. Though high is favourable, a very high ratio may indicate a shortage of working capital and a lack of sufficient inventories.

Low Ratio – A low inventory turnover ratio may indicate unnecessary accumulation of stock, inefficient use of investment, over-investment in inventories, etc. This is a concern for the company as inventory could become obsolete and may result in future losses.

 

Short Quiz for Self-Evaluation

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>Read Proprietary Ratio

 

What is the Journal Entry for Interest on Drawings?

Ahuja Sahil
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Accounting and Journal Entry for Interest on Drawings

Cash or Goods withdrawn by a proprietor from the business for their personal use is labelled as drawings. Interest may be charged by the business at a fixed rate when a business owner draws funds or assets. Journal entry for interest on drawings includes two accounts; Drawings A/C & Interest on Drawings A/C.

Interest on drawings is an income for the business, hence, it is added to the interest account of the firm thereby increasing the total income of the business.

In common scenarios where interest on capital is charged by the owner, interest on drawings is also charged by the business.

Journal entry for interest on drawings is;

Drawings A/C Debit Debit the increase in drawings
 To Interest on Drawings A/C Credit Credit the increase in income

 

Example

Charge 10% interest on drawings at the end of the year to Maya, her total drawings from the business are valued at 1,00,000.

Maya’s Drawings A/C 10,000
To Interest on Drawings A/C 10,000

(Interest charged to Maya on drawings at 10% of 1,00,000 at the end of the year)

Maya’s withdrawals from the business at the end of the year are at 1,00,000 and she is charged interest on drawings at the rate of 10%, consequently, this increases the firm’s income by 10,000.

 

Short Quiz for Self-Evaluation

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Revision & Highlights Short Video

Highly Recommended!!

Do not miss our 1-minute revision video. This will help you quickly revise and memorize the topic forever. Try it :)

 

>Related Long Quiz for Practice Quiz 24 – Drawings

>Read Journal Entry for Interest on Capital

 

What is the Journal Entry for Interest on Capital?

Ahuja Sahil
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0

Accounting and Journal Entry for Interest on Capital

Owners may seek a return on investment in the form of a fixed rate of interest to the extent of the amount employed by them in the business. In order to ascertain a true picture of the business’s profitability, it is a common practice to provide interest on capital. Journal entry for interest on capital includes two accounts; Capital A/c & Interest on Capital A/c

Interest on capital is an expense for the business and is added to the capital of the proprietor thereby increasing his total capital in the business. It is not paid in cash or by the bank.

Journal entry for interest on capital is;

Interest on Capital A/c Debit Debit the increase in expense
 To Capital A/c Credit Credit the increase in capital

 

Example

Provide 10% interest on capital at the end of the year to Sam. His contribution to the business is 100,000.

Interest on Capital A/c 10,000
 To Sam’s Capital A/c 10,000

(Interest provided at 10% on 100,000 at the end of the year)

This shows that the company’s interest to be paid on capital has been increased by 10,000 consequently Sam’s capital has also been increased equally because of the interest earned by him on capital.

This will not be paid in cash or deposited in his bank account, although, it will increase his total capital investment in the business by 10%.

 

Short Quiz for Self-Evaluation

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Revision & Highlights Short Video

Highly Recommended!!

Do not miss our 1-minute revision video. This will help you quickly revise and memorize the topic forever. Try it :)

 

>Read Journal entry for Interest on Drawings

 

What are the Three Types of Personal Accounts?

Ahuja Sahil
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Three Types of Personal Accounts

Real, Personal and Nominal accounts are the traditional classification of account types in accounting, however, personal accounts are further distinguished under three categories such as Natural, Artificial, and Representative.

Golden rule of accounting for personal accounts is – Debit the Receiver & Credit the Giver

Three types of personal accounts by Accounting Capital

 

Natural Personal Accounts

These accounts are related to human beings i.e. natural persons who are created by God. They possess a physical existence.

Examples

Sam’s A/C, Maya’s A/C, Capital A/C, Drawings A/C, Debtor’s A/C, Creditor’s A/C, etc. come under the category of natural personal accounts.

Journal entry using natural personal account – 5,00,000 cash brought in as capital.

Journal Entry - Natural Personal Account

 

Artificial Personal Accounts

Second among three types of personal accounts is “Artificial” personal account. These accounts do not have a physical existence however, they are recognized as persons in business dealings. Most often they are legal entities created by human beings.

Examples

Any Public or Private company A/C, Bank A/C, Club A/C, Insurance company A/C, NGO A/C, Cooperative society A/C, etc. would fall under this category.

Journal entry using both natural and artificial personal accounts – 5,00,000 brought in as capital via bank cheque.

Journal Entry with Artificial Personal Account

 

Representative Personal Accounts

This account is different as compared to the other two types of personal accounts as it refers to accounts which represent a person or a group. (It is not directly their account but it represents & is linked to them)

Examples

Outstanding expense A/C, Prepaid expense A/C, Accrued Income A/C, Income received in advance A/C, Unearned commission A/C, etc.

Journal entry using representative personal account – 5,00,000 due to be paid for rent but not disbursed until the end of the period.

Journal Entry with Representative Personal Account

 

Short Quiz for Self-Evaluation

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>Read Trial Balance with Sample Format

 

Accounting and Journal Entry for Credit Card Sales

Ahuja Sahil
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Journal Entry for Credit Card Sales

Digitization and modernization have made credit cards a very common mode of payment. Credit cards allow customers to shop without cash and make swift hassle-free payments. Frequent credit card payments mean businesses have to deal with the aspect of accounting and posting journal entry for credit card sales.

There are majorly four credit card issuers in the world Visa, Master, Discover & American Express. For accounting and journal entry for credit card sales there are 2 scenarios;

Scenario 1 – When cash is received at a later date.

Scenario 2 – When cash is received immediately.

 

1. Accounting for Credit Card Sale when Money is Received at a Later Date

In case if the company’s bank account is not linked to the payer bank (issuer of swipe machine) then the business receives cash at a later date. The seller needs to submit all receipts of credit card sales as prescribed by the payer bank. Money is credited to the company’s account after deducting the commission on credit card sale.

  • Journal entry when the amount is due

When the amount is due it is shown as accounts receivable in the books of the business.

  • Journal entry when dues are settled at a later date

Following journal entry is posted in the ledger accounts when the amount is settled and the company’s bank account is credited with the net amount; i.e. after adjusting commission.

Journal entry for credit card sales when money is recevied at a later date - II

 

Example

Unreal Corp. has 5,00,000 as credit card sales on 10th of January which is due to be settled on the 30th of January. Commission rate charged by the issuer bank is 2% on total sales.

Journal entry on the date of transaction (10th January)

Example - Accounting for credit card sales - I

(Accounts Receivable account is used to show the amount due)

 

Journal entry on the date of settlement (30th January)

Example - Accounting for credit card sales - II

 

2. Accounting for Credit Card Sale when Money is Received Immediately

Nowadays payer banks issuing credit card machines (also known as Point of Sale terminals) automate the entire process. This means that the cash is credited automatically to the firm’s current account and no manual settlement is required. In this case, it is treated as an ordinary cash sale.

Journal entry for credit card sales when cash is recevied immediately

 

Example – When cash is received immediately

Unreal Corp. has a total of 5,00,000 as credit card sales on 10th January which is directly credited to the company’s account. Commission rate charged by the issuer bank is 2% on total sales.

Example when amount is settled immediately

(Sales account is credited as there is no requirement of accounts receivable account in this case)

 

Short Quiz for Self-Evaluation

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>Read Accounting and Journal Entry for Provident Fund

 

What are Revenue Receipts?

Ahuja Sahil
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Revenue Receipt

Revenue receipts are funds received by a business as a result of its core business activities. It leads to an overall increase in the total revenue of the company. These funds are generated from a firm’s operating activities hence they are shown inside trading and profit and loss account and not in a balance sheet.

They are recurring in nature which means that they can be seen quite often and can also be used for distribution of profits. Unlike capital receipts which can not be used to create reserves, revenue receipts are used to create reserve funds.

They have no effect on liabilities or assets of a company. Receipts of this kind affect the overall profit and loss of an organization & are booked on accrual basis which means as soon as the right of receipt is established.

 

Examples of Revenue Receipts

Few common examples are receipts from sale of good and services, discount received from creditors or suppliers, interests earned, dividends received, rent received, commission received, bad-debts recovered, income from other sources, etc.

An elaborated example of revenue receipts is interest earned – money received via earned interest is classified as revenue receipts as it is generated from regular business activities, doesn’t reduce assets or increase liabilities and & is a result of recurring business activity.

Sample view in a company

Examples of revenue receipts

 

Short Quiz for Self-Evaluation

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>Read Capital Receipts

 

What are Capital Receipts?

Ahuja Sahil
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Capital Receipts

Capital receipts are funds received by a business which are not revenue in nature & lead to an overall increase in the total capital of a company. These are funds generated from non-operating activities of a business hence are not shown inside the income statement instead they are shown inside a balance sheet.

They are non-recurring in nature which means that they don’t occur regularly and can’t be used for distribution of profits. Unlike revenue receipts which can be used to create reserves, capital receipts are not used to create reserve funds.

They end up increasing liabilities or reducing assets in a company. Receipts of this kind do not affect the overall profit or loss of an organization & are booked on accrual basis which means as soon as the right of receipt is established.

 

Examples of Capital Receipts

Few common examples are funds received from issue of shares or debentures, cash from sale of fixed assets, borrowings such as loans, insurance claims, disinvestments, additional capital introduced by the proprietor(s), etc.

An elaborated example of capital receipts is sale of equipment – money received via sale of equipment is classified as capital receipts as it reduces the asset of the company, is an occasional & non-routine activity.

Another example explained is insurance claim received for loss of machinery – this is also a relevant illustration as sum of money received is due to reduction of an asset of the firm.

Sample view in a company

Example of capital receipts

 

Short Quiz for Self-Evaluation

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>Read Revenue Receipts

 

What is the Difference Between Depreciation and Amortization?

Ahuja Sahil
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Depreciation Vs Amortization

One of the main principles of accrual accounting is that an asset’s cost is proportionally expensed based on the period over which it is used. Both depreciation and amortization (as well as depletion and obsolescence) are methods that are used to reduce the cost of a specific type of asset over its useful life. This article describes the main difference between depreciation and amortization.

Depreciation is for tangible fixed assets whereas amortization is for intangible assets, however, in a way they are similar yet different at the same time. We have compared depreciation and amortization in 5 distinct points below;

 

Depreciation

1. Reduction in the value of a tangible asset due to normal usage, wear and tear, new technology, or unfavourable market conditions is called depreciation. Assets such as plant and machinery, buildings, vehicles, etc. which are expected to last more than one year, but not for an infinite number of years are subject to depreciation.

2. It only applies to fixed tangible assets.

3. Straight line, Diminishing value, etc. are a few of the various methods to charge depreciation.

4. Journal entry for depreciation

Depreciation Journal Entry*without using accumulated depreciation account

 

5. Example of Depreciation

Machinery cost  = 10,000, Depreciation Rate = 20%

= 20/100*10,000

Depreciation charge (1st year) = 2,000

 

Amortization

1. The process of spreading the cost of an intangible asset such as patent, copyright, trademark, etc. over a specific period i.e. equal to the course of its useful life is called Amortization.

2. It only applies to intangible assets.

3. Only the Straight-line method is used for the amortization of intangible assets.

4. Journal entry for amortization

Amortization Journal Entry*without using an accumulated amortization account

 

5. Example of Amortization

Patent cost = 10,000, Useful life of patent = 10 years

Amortization rate/year = 10%

1st year = 10/100*10,000

Amortization expense (1st year) = 1,000

Demonstrated above are the major points of difference between depreciation and amortization along with their respective examples.

Related Topic – Asset Disposal Account

 

Difference Between Depreciation & Amortization (Table Format)

Depreciation vs Amortization

 

Related Topic – Difference between Tangible and Intangible Assets

 

Types of Depreciation and Amortization

Types of Depreciation

These types of depreciation are mandated by law and enforced by professional accounting practices all over the world.

  • Straight-line method: Under this method, depreciation is calculated on the original cost of the asset after deducting the scrap value. Depreciation is charged every year and at the end of the life of the asset, the value of the asset becomes zero. The amount of depreciation is the same every year.
  • Written down value method: The rate of depreciation is fixed in this method, but depreciation at this rate is calculated on the balance of the asset standing in the books on the first day of each accounting year. It is suitable for assets with high repair charges. It is also known as
  • Annuity method: Under this method, the amount of depreciation includes some portion of the expected amount of interest also. This interest is the forgone expected interest that the purchaser would have earned had he invested the cost of the asset somewhere else.
  • Depreciation Fund Method: Under this method, an amount equal to the annual depreciation is charged against the profits every year and accumulated in the form of a sinking fund. This amount is invested to earn interest and used to replace the asset after the end of its useful life.
  • Group Depreciation: Under this method, the value of homogeneous assets is totalled up and from this total, the residual value of all the assets is deducted and the balance is found. This balance is divided by the average of the estimated lives of all these assets and the result is the depreciation for one year.

 

Types of Amortization

Types of amortization usually refer to the various methods of amortization of a loan schedule. This finds more use in finance management than general accounting.

  • Straight-line amortization: A constant amortization method where the principal remains constant, but the interest changes with the outstanding obligation. The instalment amount keeps changing.
  • Mortgage style amortization: Also known as a constant payment method. The instalment amount does not change, but the principal and the interest keep changing.
  • Interest-only amortization: A different kind of setup where the principal is paid in a lump sum after the amortization schedule expires.
  • Line of credit amortization: It works like a revolving letter of credit. The amount is withdrawn in the draw period and repaid in the repayment period.

Related Topic – Adjustments in Final Accounts

 

Is goodwill depreciated or amortized?

Goodwill is an intangible fixed asset. It is created through a process that carries a certain value but can not be seen or touched. It is an attractive force that results in additional profits and/or value creation. Its value depends on factors like popularity, image, prestige, honesty, fairness, etc.

Nonetheless, it is an asset and hence its cost has to match up with the revenue it generated in a particular accounting year. Since goodwill is an intangible asset, its value has to be amortized. But, in a disruptive decision of 2001, the Financial Accounting Standards Board (FASB) disallowed the amortization of goodwill as an intangible asset.

The reason was that most companies use the purchase method to evaluate and record the amount of goodwill in their books since goodwill comes into the picture when a new business is purchased, or a new asset is purchased. This happens when a company pays more than the fair value of an asset.

FASB allowed the evaluation for impairment, annually for goodwill. Impairment evaluation is a complex and costly process, so the FASB reallowed the amortization of goodwill as an intangible asset over 10 years in 2014, only for private companies.

Goodwill can be amortized in the following way:

ABC Ltd is purchasing a smaller company X that has a net worth of 450 million. But, X enjoys a reputation in the niche local market so the purchase consideration was fixed at 500 million. After doing a thorough revaluation, the accountants found the fair value of X assets to be 470 million.

ABC Ltd records goodwill as (purchase consideration – net worth) = 50 million

The amortization amount is (book value of assets – fair value of assets) = 30 million

Now, goodwill in the books of ABC Ltd will be recorded at (50 million – 30 million) = 20 million

While the amortized goodwill of 30 million will be spread over 10 years at 3 million per year. This amount will be charged to the profit & loss account for 10 years.

 

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>Related Long Quiz for Practice Quiz 39 – Depreciation

>Read Difference between Depreciation, Depletion and Amortization

 

What is Interest Coverage Ratio?

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Interest Coverage Ratio

Interest Coverage ratio is a type of solvency ratio (long-term solvency) which is derived by dividing “Earnings before Interest and Taxes” of a company with its “Interest on Long-Term Debt“. Ideal number for this ratio is 1.5 or above, anything less than that shows the company doesn’t earn enough w.r.t its interest payments.

The ratio helps lenders and debenture holders to measure the capacity of a company to pay the interest liability on its long-term borrowings; higher the ratio greater the ability of the company to service its interest and hence lesser the risk of a financial default.

Interest Coverage ratio is also known as Times-Interest-Earned ratio.

 

Formula to Calculate Interest Coverage Ratio

Interest Coverage Ratio

EBIT: Earnings before Interest and Taxes

Interest on Long-Term Debt:  Total interest obligation of the company on its long-term borrowings

 

Explanation with an Example

From the below information of Unreal Corp. calculate its interest coverage ratio

Long Term-Loans = 1,00,000

Total Interest on Loans = 5,000

EBIT = 1,00,000

Interest Coverage Ratio = EBIT/Interest Expenses

= 1,00,000/5,000

= 20 (In this case the company’s earnings before interest and taxes are 20 times that of their interest expenses in an accounting period)

 

High Ratio – High coverage ratio depicts good financial condition & shows that the company earns enough profit before taxes and interest payments to pay off its interest expenses. The ability to pay interest obligations is critical for a company to stay in business as per going concern concept.

Low Ratio – Low coverage ratio shows the company is burdened by debt expenses and doesn’t earn enough EBIT relatively to its interest expenses. Banks and NBFCs would hesitate extending credit to such an organization.

 

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>Read What is Fixed Assets Ratio?

 

How to Show Trade Discount in Purchase Book?

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Trade Discount in Purchase Book or Purchase Journal

A discount granted by a seller of goods or services on the retail price is called a trade discount. It is provided as a business consideration such as trade practices, large quantity orders, etc. Trade discount in the purchase book is shown in a separate row as a reduction and thus arriving at a final net amount to be recorded.

Trade discount is not shown in a ledger account, the net amount thus calculated after deducting trade discount from the cost of goods purchased is posted to the debit side of the purchase account in the ledger.

Cost of Goods Purchased – Trade Discount = Net Amount to Record

 

Example Showing Trade Discount in Purchase Book

Prepare the purchase book of Unreal Pvt Ltd. from the following details.

Jan 7 – Purchased 10 Keyboards from ABC Co. for 300 each (for resale, invoice # 60)

Less: Trade discount @ 10%

 

Purchase Journal for Unreal Pvt Ltd.

Trade discount in purchase book

 

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What is Fixed Assets Ratio?

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Fixed Assets Ratio

The fixed Assets ratio is a type of solvency ratio (long-term solvency) which is found by dividing the total fixed assets (net) of a company by its long-term funds. It shows the amount of fixed assets being financed by each unit of long-term funds.

It helps to determine the capacity of a company to discharge its obligations towards long-term lenders indicating its financial strength and ensuring its long-term survival.

 

Formula to Calculate Fixed Assets Ratio

Fixed Assets Ratio Formula

 

Net fixed assets: (Total of fixed assets – Total depreciation till date) + Trade Investments including shares in subsidiaries.

Long-term funds: Share capital + Reserves + Long-term loans.

 

Explanation with an Example

From the balance sheet of Unreal corporation calculate its fixed assets ratio;

 Liabilities  Amt  Assets  Amt
 Share Capital  2,00,000  Plant & Machinery  1,90,000
 Reserves & Surplus  40,000  Furniture  10,000
 Short-Term Loans  25,000  Inventories  60,000
 Trade Payable  25,000  Trade Receivable  30,000
 Expense Payable    10,000  Short-Term Investment  10,000
 Total  3,00,000  Total  3,00,000

 

From the above balance sheet (considering nil depreciation)

Net Fixed Assets = Plant & Machinery + Furniture

= 1,90,000 + 10,000

= 2,00,000

Long-Term funds = Share Capital + Reserves + Long-Term Loans

= 2,00,000 + 40,000

= 2,40,000

Fixed Assets Ratio = 2,00,000/2,40,000

= 0.83

This shows that for 1 currency unit of the long-term fund, the company has 0.83 corresponding units of fixed assets; furthermore, the ideal ratio is said to be around 0.67.

 

High and Low Fixed Assets Ratio

Ideally, fixed assets should be sourced from long-term funds & current assets should be from short-term funds/current liabilities.

High – A ratio of more than 1 indicates net fixed assets of the company are more than its long-term funds which demonstrate that the company has bought some of its fixed assets with the help of short-term funds. This depicts operational inefficiency.

Low – A ratio of less than 1 indicates long-term funds of the company are more than its net fixed assets It is desirable to some extent as it means that a company has sufficient long-term funds to cover its fixed assets.

 

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>Related Long Quiz for Practice Quiz 35 – Fixed Assets

>Read What is Interest Coverage Ratio?

 

What is the Difference Between Capital Receipts and Revenue Receipts?

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Capital Receipts vs Revenue Receipts

There are two types of amounts received by a firm during its regular course of business, Capital Receipts and Revenue Receipts. Difference between capital receipts and revenue receipts can be compiled as follows;

 

Capital Receipts

1. Capital receipts refer to amounts received by a business which lead to an increase in the total capital. They increase liabilities or reduce assets. These are funds generated from non-operating activities of a business hence are not shown inside the income statement.

2. They are shown inside a balance sheet.

3. They are non-recurring in nature which means that they don’t occur regularly.

4. They are not available for distribution of profits.

5. Capital receipts are not obtained by the normal course of business operations.

6. Examples – Issue of shares or debentures, Sale of fixed assets, Loans received, Additional capital introduced by the proprietor(s), etc.

7. Sample view of capital receipts in a company

Examples of capital receipts

 

Revenue Receipts

1. Revenue receipts are amounts received by a business as a result of its core activities. These are funds generated from a firm’s operating activities hence are not shown inside the balance sheet.

2. They are shown on the credit side of Trading and Profit & Loss Account.

3. They are recurring in nature and can be seen quite often.

4. They are available for the distribution of profits.

5. Revenue receipts are obtained by the normal course of business operations.

6. Examples – Sales (inventory), Sales (services rendered), Discount received from creditors or suppliers, Sale of scrap, Interest earned, Dividends received, Rent received, etc.

7. Sample view of revenue receipts in a company

Examples of revenue receipts

The points mentioned above end up covering almost all major areas of difference between capital receipts and revenue receipts.

 

> Read Capex and Opex

 

How to Prepare a Journal Entry? (Steps)

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Steps to Prepare a Journal Entry

Journalizing is the process of recording a business transaction in the accounting records (Journal Book). The process to prepare a journal entry or in other words make a journal entry from scratch is divided into 4 different steps.

Steps to prepare a Journal Entry

 

Example and Explanation – Steps by Step

Example – Unreal Corp. is a local business that decides to buy furniture for 5,000 in cash. Prepare a journal entry to be noted in the journal book.

Journal Entry for Furniture Purchased in Cash

 

  • Step I – Identify the accounts involved in the transaction – there will be a minimum of two such accounts. Going back to the above example the accounts identified in this case are “Furniture A/C” & “Cash A/C”.

Simple journal entry – There will be NO more than 2 accounts involved, one for debit and the other for credit.

Compound journal entry – There will be more than 2 accounts involved all of which are required to be identified.

 

  • Step II – Determine the type of accounts involved – The approach to determining the type of an account may either be traditional or modern.

Traditional Classification of Accounts – Real, Personal & Nominal. In the above example “Furniture A/C is Real” & “Cash A/C is Real”.

Modern Classification of Accounts – Asset, Liability, Capital, Revenue, Expense & Drawings. In the above example “Furniture A/C is Asset” & “Cash A/C is Asset”.

Once the type of account is identified the next step is to apply the proper rule(s) of accounting.

 

  • Step III – After identifying the accounts & correctly determining their types the next step is to apply appropriate rules of accounting to either debit or credit the respective accounts with the currency value.

Three Golden Rules of Accounting  – In the aforementioned example the applied rule is for Real accounts i.e. “Debit” what comes in and “Credit” what goes out.

Modern Rules of Accounting  – In the very same example the modern rule applied will be for Asset accounts i.e. “Debit” the increase in assets and “Credit” the decrease in assets.

 

  • Step IV – Inside the journal book, record the transaction along with narration or a short description which depicts the purpose of the transaction.

Example on how to prepare a journal entry

 

> Read List of Top Journal Entries used in Accounting

 

What is the Difference between Current Assets and Current Liabilities?

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Current Assets Vs Current Liabilities

Assets and liabilities are classified in many ways such as fixed, current, tangible, intangible, long-term, short-term etc. While analyzing the balance sheet of a company it is important to know the difference between current assets and current liabilities. Here the distinction is related to the age of assets and liabilities.

 

Current Assets

  • Current assets are short-term assets either in the form of cash or a cash equivalent which can be liquidated within 12 months or within an accounting period.
  • They are short-term resources of a business and are also known as circulating or floating assets.
  • Current assets are realized in cash or consumed during the accounting period.
  • A major difference between current assets and current liabilities is that more current assets mean high working capital which in turn means high liquidity for the business.
  • Examples of Current Assets – Cash, Debtors, Bills receivable, Short-term investments, etc.
  • They are placed on the assets side of a balance sheet in the order of their liquidity.

Examples of Current Assets

 

Current Assets in Balance Sheet

Related Topic – Difference between Tangible and Intangible Assets

 

Current Liabilities

  • Current Liabilities are short-term liabilities of a business which are expected to be settled within 12 months or within an accounting period.
  • They are short-term obligations of a business and are also known as short-term liabilities.
  • Current liabilities are paid in cash/bank (settled by current assets) or by the introduction of new current liabilities.
  • One important difference between current assets and current liabilities related to the liquidity of a business is that more current liabilities mean low working capital which means low liquidity for the business.
  • Examples of Current Liabilities – Bank overdraft, Creditors, Bills payable, etc.
  • They are placed on the liabilities side of a balance sheet, usually, the principal portion of notes payable is shown first, accounts payable next and remaining current liabilities in the end.

Examples of Current Liabilities

 

Current Liabilities in Balance Sheet

 

Revision & Highlights Short Video

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>Related Long Quiz for Practice Quiz 20 – Current Assets

>Related Long Quiz for Practice Quiz 22 – Current Liabilities

> Read Difference between Current Assets and Fixed Assets

 

What is Balance B/D and Balance C/D?

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Balance B/D and Balance C/D

In bookkeeping, Balance B/D and Balance C/D are terms used for balancing and closing of ledger accounts from the current period to the following period.

Balance B/D – is the balance brought down as opening balance of a ledger pulled from the previous accounting period.

Balance C/D – is the balance carried down as the closing balance of a ledger pushed to the next accounting period.

If Debit side > Credit side it is called Debit Balance

If Credit side > Debit side it is called Credit Balance

 

Example – To Balance C/D and By Balance B/D

To Balance c/d – In a ledger account when Credit side > Debit side the difference in balance is inserted on the debit side to balance the account, the differential amount is denoted as “To Balance c/d”.

By Balance b/d – In the following accounting period closing credit balance of previous period (To Balance c/d) is brought down to the credit side of ledger account, this amount is the opening balance of next period and is denoted as “By Balance b/d”.

Balance B/D and Balance C/D

Related Topic – What are Closing Entries?

 

Example – By Balance C/D and To Balance B/D

By Balance c/d – In a ledger account when Debit side > Credit side the difference in balance is inserted on the credit side to balance the account, the differential amount is denoted as “By Balance c/d”.

To Balance b/d – In the next accounting period closing debit balance of previous period (By Balance c/d) is brought down to the debit side of ledger account, this amount is the opening balance of next period and is denoted as “To Balance b/d”.

Balance B/D and Balance C/D -2

Asset, Liability & Capital accounts are balanced whereas Revenue and Expense accounts are not balanced.

 

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> Read Balance B/F and Balance C/F

 

What is Balance B/F and Balance C/F?

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Balance B/F and Balance C/F

In bookkeeping, Balance B/F and Balance C/F are a couple of accounting jargon used while journalizing. They play a role in totalling and carrying forward balances from one page of the journal book to the next one.

Balance B/F – Balance Brought Forward | Balance C/F – Balance Carried Forward

To understand balance b/f and balance c/f begin with understanding carried forward first and brought forward next.

 

Example – Balance C/F

The journal book maintained by a business includes many journal entries, due to a large number of entries multiple pages of the journal book are used.

At the end of a journal page, debit and credit balances are totalled and carried forward to the next page, this balance pushed forward from the current page to the next page is termed as “Balance C/F” or “Total C/F” (Carried Forward).

Below is a sample journal book for Unreal Corp.

Balance C/F Example

Highlighted in yellow is the total of both debit and credit sides on this page of the journal book, this balance will be carried forward to the next page & should be treated as the opening balance of the next page.

Related Topic – What is Bookkeeping?

 

Example – Balance B\F

At the beginning of a new journal page, the opening balance is quoted from the previous page, this balance pulled forward from the previous page to the current page is termed as “Balance B/F” or “Total B/F” (Brought Forward).

Consequently from the above example when Unreal Corp. moves to the next page of its journal book it will bring both the closing debit and credit balance from the previous page.

Below is a sample of the journal book for Unreal Corp. (Next Page)

Balance B/F Example

Balance B/F & Balance C/F are used in journal books whereas Balance B/D & Balance C/D are used with ledger accounts.

 

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>Read Balance B/D and Balance C/D

 

How To Calculate Scrap Value of an Asset?

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Calculate Scrap Value of an Asset -SLM/WDV

The scrap value of an asset may be defined as the maximum value that can be fetched by salvaging or selling it after its useful life. It is also known as salvage value, residual value or break-up value.

To know how to calculate the scrap value of an asset it is important to remember the below formula

Formula of how to calculate scrap value of an asset

 

How to Calculate Scrap Value of an Asset with SLM Depreciation

Straight Line Method Formula = (Cost of Asset – Scrap Value)/Useful Life in Years

Unreal Corp. Pvt Ltd. purchases machinery worth 1,00,000

Cost of machine = 1,00,000 | Estimated life of the asset = 9 years | Depreciation (Straight Line Method) = 10% p.a

Depreciation year 1 = 10/100 * 1,00,000 = 10,000

Cost of asset after Year 1 = 1,00,000 – 10,000 = 90,000

Similarly total depreciation for 9 years = 10,000*9 = 90,000

To Calculate Scrap Value of an Asset = Cost of Asset –  Total Depreciation

After 9 years scrap value  = 1,00,000 – 90,000 = 10,000

Related Topic – More Assets Related Questions and Answers

 

How to Calculate Scrap Value of an Asset with WDV Depreciation

Written Down or Diminishing Balance Method

Written Down Value Method Formula =

diminishing value method of depreciation formula

 

Using the same example as above, Unreal Corp. Pvt Ltd. purchases machinery worth 1,00,000

Cost of machine = 1,00,000 | Estimated life of the asset = 9 years | Depreciation (Written Down Value) = 10% p.a

The same formula is used to calculate the scrap value of an asset whichever method of depreciation is used (SLM/WDV)

Calculating Scrap value of asset with Diminishing Balance Method depreciation

Scrap Value= 100000 – 61257.95 = 38742.05

The above examples should make it easy for anyone aspiring to learn how to calculate the scrap value of an asset, especially with the help of some examples.

 

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>Related Long Quiz for Practice Quiz 37 – Scrap Value

>Read What is Scrap Value of an Asset with Examples

 

What is Scrap Value of an Asset?

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Scrap Value of an Asset – Meaning

Scrap value of an asset may be defined as the estimated price that can be collected by salvaging or selling the asset after its useful life. In other words, it is the approximated value at which an asset can be sold in the open market after the expiration of its service life. 

The residual value of an asset is often insignificant or zero. It is also known as salvage value, residual value or break-up value. Asset disposal account may be created at the time of sale.

Formula to calculate the residual value of an asset is;

Scrap Value  = (Cost of Asset – Total Depreciation) 

Cost of Asset = Purchase Price + Freight + Installation

Scrap value of an asset differs based on the method of depreciation followed by the business .i.e. straight-line method (or) Reducing balance method of depreciation. In the case of fixed assets vs current assets, only the former has “scrap value”.

 

Example 1 – Residual Value with the Straight Line Method

Unreal Corp. Ltd purchases machinery worth 50,000 and estimates that its useful life will be 9 years and rate of depreciation (SLM) 10% p.a. So, the given details & calculation is as follows:

Cost of Fixed Asset – 50,000

Estimated life of the asset – 9 years

Depreciation Rate – 10% p.a. i.e. Amt 5,000 p.a. (Total Depreciation = 5,000 x 9)

Salvage value = (50,000 – 45,000) = 5,000

Related Topic – What are NPAs (Non-Performing Assets)?

Example 2 – Scrap Value with Written Down Value Method

Scenario 2: Assume that the same company in Example 1 follows reducing balance method of depreciation, there will be a variation in the amount of depreciation and scrap value of an asset.

The calculation is as follows:

Scrap value of an asset example - WDV Method

So, the Scrap value = (50,000 – 30,629) = 19,371

If the residual or salvage value of an asset past its useful life is not insignificant it may keep on existing on the company’s balance (asset side) until the time it’s disposed of.

 

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>Related Long Quiz for Practice Quiz 37 – Scrap Value

>Read How to Calculate Depreciation Rate For Fixed Assets?

 

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