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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.

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 39 – Depreciation

>Read Difference between Depreciation, Depletion and Amortization

 

What is Interest Coverage Ratio?

Ahuja Sahil
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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.

 

Short Quiz for Self-Evaluation

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>Read What is Fixed Assets Ratio?

 

How to Show Trade Discount in Purchase Book?

Ahuja Sahil
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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?

Ahuja Sahil
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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.

 

Short Quiz for Self-Evaluation

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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?

Ahuja Sahil
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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)

Ahuja Sahil
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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?

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

 

Short Quiz for Self-Evaluation

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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?

Ahuja Sahil
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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?

Ahuja Sahil
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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?

Ahuja Sahil
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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.

 

Short Quiz for Self-Evaluation

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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?

Ahuja Sahil
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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.

 

Short Quiz for Self-Evaluation

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>Related Long Quiz for Practice Quiz 37 – Scrap Value

>Read How to Calculate Depreciation Rate For Fixed Assets?

 

What is the difference between Profit and Loss & Profit and Loss Appropriation Account?

Ahuja Sahil
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Profit and Loss Vs Profit and Loss Appropriation Account

Profit and loss appropriation account is an extension of the profit and loss account itself, however, there is a fundamental difference between profit and loss & profit and loss appropriation account.

By definition, a P&L account or Income statement is one of the three financial statements of an organization which summarizes revenues and expenses to ascertain net profit or a net loss of the organization for a specific time period.

By definition, a P&L appropriation account is used to demonstrate the division or allocation of profit/losses among the owners.

 

Basis Profit and Loss Account Profit and Loss Appropriation Account
Purpose P&L account is used to determine the Net Profit or Net Loss of an organization for a given accounting period. P&L appropriation account is used for the allocation and distribution of Net Profit among partners, reserves and dividends.
Made by P&L account is prepared by all types of businesses. P&L appropriation account is prepared mainly by partnership firms.
Balances Profit and loss account don’t have any opening or closing balance as it is prepared for a specific accounting period. The profit and loss appropriation account may have carried forward balance from the previous accounting period.
 Timing It is prepared after the trading account. It is made after the preparation of the profit and loss account.
 Nature Items debited are all expenses (charged against profit) Items debited are all appropriations of profit. (how profit is divided)
Partnership Preparation of P&L account is not based on a partnership agreement (exception – interest on a loan from partners) The preparation of P&L account is based on a partnership agreement.
Principle The matching principle is followed i.e. expenses for an accounting period are matched against related incomes. The matching principle is not followed while preparing a P&L appropriation account.

Related Topic- What are Balance Sheet Accounts?

 

Format of Both Accounts

Format of P&L account

Profit and Loss account format final accounts

 

Format of P&L Appropriation account (partnership)

Profit and Loss Appropriation Account Format

 

 

What is a Reclass Entry?

Ahuja Sahil
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Reclass Entry

Accounting for business also means being responsible for adjustments and corrections. One such adjustment entry is ‘reclass’ or reclassification journal entry. The process of transferring an amount from one ledger account to another is termed as reclass entry.

It is most often seen as a transfer journal entry & is a critical part of the final accounts of a business.

Uses of this entry

  • For correction of a mistake.
  • For reclassification of a long-term asset as a current asset.
  • For reclassification of a long-term liability as a current liability.
  • To change the type & purpose of an asset in the financial statements.

 

Example – Reclass Entry

Though there are quite a few reasons to perform a reclass entry however we will illustrate one of the most common scenarios i.e. correction of a mistake.

The finance department booked payment of Rent expenses for the current month using the below journal entry,

(Error journal entry)

rent debit by mistake

The above entry was posted to Rent A/C in error as the original payment related to Telephone expenses.

 

After finding the error a transfer entry was used to reclass the ledger amount of 5,000 in rent account to telephone expenses account.

(Correction reclass entry)

reclass entry in journal

Debit – Debited telephone expenses account to increase expenses by 5,000 in its ledger balance.

Credit – Credited rent account to decrease rent expenses by 5,000 in its ledger balance.

 

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>Read True-up Entry

 

What is a True-up Entry?

Ahuja Sahil
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True-up Entry Concept in Accounting

In its most generic form a true-up means to match, reconcile, tie-out two or more balances with the help of an adjustment. In accounting, this adjustment journal entry is called true-up entry.

There are many reasons why a mismatch may exist between two balances;

  • Budgeting – Some recurring expenses are estimated at the beginning of the year and booked in each period accordingly. There is always a chance of going over or under the budget.
  • Timing Differences – If a bill or invoice is not received till the end of an accounting period the expense is accrued as per estimate after the actual bill/invoice is received it is then matched with the help of a true-up entry.
  • Errors & Omissions –  With manual intervention, there is always a chance of human errors and misses.
  • Quantification – Not every expense and situation can be quantified and anticipated in advance, for example, an increase in headcount resulting in an additional payment of insurance premium at the end of a year.

 

Example I – True-up Entry – Timing Difference

Unreal Corp. Pvt. Ltd. received their electricity bill for Q1’2017 in Q2’2017. The accountants pre-booked accrual for 10,000 as an anticipated expense in Q1’2017 however in Q2’2017 when the actual bill was received it was for 12,000 so a true-up entry was booked to raise the expenses by 2000.

Journal entry in Q1’2017 as per accrual of electricity expense to the amount of 10,000

As per the accrual-based accounting concept, it is required to anticipate and record all expenses even if the actual payment is not made in the same accounting period.

Journal entry in Q2 when the actual bill was received for 12,000 (bill for Q1)

Related Topic – What is a Contingent Liability?

 

Example II – True-up Entry – Budgeting Differences

Estimated Print & Stationery cost at the beginning of 2017 = 2000/Quarter

Actual Print & Stationery cost determined in Q4’2017 = 3000/quarter

Adjusted amount entered to true-up the balances in Q4’2017 = 3000 + (1000×3 for previous quarters)

Example 1 - journal entry and concept of true up in accounting

 

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>Read Reclass Entry

 

What are Intangible Assets?

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Meaning

Assets which don’t have a physical existence and can not be touched and felt are called intangible assets. Unlike tangible assets which can be touched & felt intangible assets are nonphysical, invisible, long-term and difficult to quantify.

This type of asset can either be definite i.e. it will expire after a certain time period or indefinite i.e. it will not expire and is not time-sensitive. For example, a patent is a definite intangible asset as it will expire after the time period for the patent is over (usually 20 years), however, a company’s brand name will remain throughout the company’s existence.

They are expected to last for more than 1 year and are usually held for production or supply of goods/services, rent to others, or for administrative purposes.

 

Examples of Intangible Assets

A list of examples of intangible assets are patents, licenses, brand names, logos, copyrights, trademarks, goodwill, other intellectual property etc.

They are not considered liquid assets and are challenging to sell in case of emergencies. Royalties, video games, mobile apps, music videos, YouTube/Instagram, etc. are some very common forms of such resources.

List of Intangible Assets

 

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>Related Long Quiz for Practice Quiz 26 – Intangible Assets

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What are Tangible Assets?

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Meaning of Tangible Assets

Assets that have a physical existence and can be touched and felt are called tangible assets. They consist of both fixed and current assets, they are always at risk of destruction from natural incidents, theft, accidents, etc. A business would usually insure them to safeguard themselves against unseen future events.

Such resources can be readily used as collateral against secured loans and may be sold to bring in cash in times of emergency. Unlike intangible assets, they can easily be stored and accumulated as well.

 

Examples of Tangible Assets

It’s easy to determine useful life for such physical assets. Examples of tangible assets are plant, machinery, building, stock, cash, furniture, etc.

Examples and List of Tangible Assets

 

Types of Tangible Assets

  • Current Assets – They are assets that are held for a short period mainly within a single accounting cycle of a business. Benefits of current assets are expected to flow for a period equal to or less than a year.

Examples – Cash, bank, stock, etc.

  • Fixed Assets – They are assets that are held for a long term and benefits of which are derived for multiple accounting periods. They can’t be converted to cash immediately.

Examples – Land, plant, machinery, vehicles, etc.

Fixed assets are charged with depreciation due to normal usage, wear and tear, new technology, or unfavourable market conditions.

 

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Top Accounting Interview Questions (With PDF)

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Finance and Accounting Interview Questions (FAQs)

We have a collection of top finance and accounting interview questions compiled with real-life experiences and research with working professionals. They are a must-read for all job seekers especially freshers and intermediate-level candidates with an experience range of 0-4 years.

These accounting questions for interviews can also act as a great refresher for someone trying to brush up on their accounting fundamentals. Additionally, we recommend that you read our new blog post on “100 Accounting Terms You Must Know for Interviews“.

Bonus eBook in PDF at the end of this article!

Our research involved over 100 aspirants who went through a technical or written interview in companies such as EY, KPMG, Deloitte, PWC, Grant Thornton, Ameriprise Financial, American Express, FIS, Fluor Corporation, Genpact, Bechtel, Citigroup, Accenture, Agilent, UHG, UBS, Bank of America, HCL, Sapient, Blackstone, HSBC, FIS, WNS, AXA XL, BT, Boston Consulting Group, Royal Bank of Scotland, Whirlpool, GE, EXL, BlackRock, etc.

 

1. What are the three Golden Rules of Accounting?

three gold bricks used for golden rules of accountingFirst things first this is the most basic yet the easiest one to be taken for granted, know this well.

In bookkeeping, three golden rules of accounting are,

Personal Account – Debit the receiver, Credit the giver

Real Account – Debit what comes in, Credit what goes out

Nominal Account – Debit all expenses & losses, Credit all incomes & gains

Understand this with examples here Three Golden Rules of Accounting with examples

Related Topic – Accounts not Closed at the End of an Accounting Period?

 

2. What are the three main types of accounts?

They are Real, Personal and Nominal but wait… if don’t want to sound artificial and stand out from the crowd then make sure you are explaining your answer in brief (one line about each is ideal)

Real – All assets in business either tangible or intangible classify as real accounts.

Personal – Accounts related to a person, entity or any legal body, etc. are called personal accounts.

Nominal – All accounts related to expenses & losses or incomes & gains fall under this category.

Related Topic – List of Direct and Indirect Expenses

 

3. Why is Depreciation not Charged on Land?

Oh! this is a classic and one that fascinates the operations manager more than often. There is no scope for leaving this one out from any list of finance and accounting interview questions.

The reason why you will never see depreciation being charged on land is that land has an infinite useful life. Without knowing how many years a fixed asset will last depreciation cannot be charged.

The formula to calculate straight-line depreciation is (Cost of Fixed Asset – Scrap Value)/Useful life and you don’t have a number to fill the denominator here.

Related Topic – Quiz on Accounting Fundamentals for Beginners (#1)

 

4.  What is Amortization?

Accounting and Finance Interview Questions and Topics - Accounting CapitalAmortization is only done for Intangible assets, unlike depreciation which is for tangible assets. Reduction in value by prorating the cost of an intangible asset over multiple accounting periods is called amortization.

Example – A small-sized technology company Unreal Corp. spends 500,000 on R&D which is expected to sustain for 5 years so it may decide to amortize this & show 1,00,000 each year for 5 years in the financial statements.

If you may wish to deep dive into the topic here is our detailed article on Amortization with an example

Related Topic – How to show Amortization in Financial Statements?

 

5.  Why is Closing Stock not Shown in Trial Balance?

Not all goods purchased in beginning & during the accounting period are sold until the end of that period, this results in a remainder balance known as closing stock.

Closing stock is a part of purchases & trial balance already includes purchases, hence if the closing stock is shown as a separate item it will double count and result in an error.

Example – Purchases for a period = 60,000, Closing Stock (remainder out of purchases) = 10,000, if both of these items are separately shown inside the trial balance the effect will double up & trial balance will error-out.

This one also stands tall among top finance and accounting interview questions asked in technical rounds by hiring managers.

Related Topic – Return Inwards in Trial Balance

 

6.  What are the three main Financial Statements?

This is another very common question asked in finance and accounting interviews, especially with entry-level roles. Three main financial statements are the Income Statement, Balance Sheet, and Cash Flow Statement.

Again, follow the i.e. to add one brief statement to each one of them, but don’t over-talk it will only make you vulnerable to more questions.

Income Statement – It presents a summarized view of revenue, income, profit, and loss of a particular accounting period.

Balance Sheet – B/S would show them as on-date assets, liabilities & capital position of a business.

Cash Flow Statement – It shows the movement of cash and cash equivalents for a business during an accounting period.

Learn more on Three Main Financial Statements, Details and their Format

Related Topic – How to show Suspense A/c in Financial Statements?

 

7.  What is Capital, type of account & where is it shown in the financial statements?

Also called net worth or owner’s equity, capital is the money brought in by the owner of the business as an investment to start the operations. Capital is a type of Personal Account which belongs to an individual or a firm (owner).

Capital is shown on the liability side of a balance sheet.

Here is our detailed article on Capital along with its Journal Entry here.

Related Topic – Is Capital an Asset or Liability?

 

8.  What are Fictitious Assets?

Keep in mind that fictitious assets are not assets; they are fake or deceptive. They are actually expenses and losses that could not be written off during the accounting period. They are written off in multiple future accounting periods.

Examples – Preliminary expenses, promotional expenses of a business, discount allowed on the issue of shares, the loss incurred on the issue of debentures, etc.

Fictitious assets are shown in the balance sheet on the asset side.

Related Topic – List of Fixed Assets & Current Assets 

 

9.  What is the Journal Entry for Goods Given in Charity?

When a business decides to give goods to charity it also needs to account for those goods in the appropriate financial statement(s), in this case, purchases are reduced with the exact cost of goods donated.

Journal entry

Journal entry for goods given in charity

Related Topic – Quiz on Journal Entries for Beginners (#4)

 

10.  What is the Journal Entry for Free Samples?

When a business wants to advertise a new product or a new line of products it may decide to distribute free samples to the customer. In this case, Purchase A/c is credited and Advertisement A/c is debited.

Journal entry

Journal entry for free samples

Related Topic – Salary Received Journal Entry

 

11.  What is Depreciation, different types of depreciation & its journal entry?

The reduction in the value of a tangible fixed asset due to normal usage, wear and tear, new technology or unfavourable market conditions is called Depreciation.

Journal entry

depreciation journal entry

Types of Depreciation

  • Straight Line Method
  • Diminishing Value Method
  • Annuity method
  • Machine hour rate method
  • Revaluation method
  • Sum-of-the-years’ digit method

Read more on Depreciation with examples along with types of depreciation

Related Topic – Provision for Depreciation Shown in Trial Balance

 

12.  What are Contingent Liabilities?

Contingent liabilities are those liabilities that may or may not be incurred by a business depending on the outcome of a future event. The existence of this kind of liability is completely dependent on the occurrence of a probable event in future.

Example – Let’s suppose that Apple files a case of a patent violation on Samsung and Samsung not only realizes that it may have to pay for violations but also estimates how much in total. In this case, Samsung will record the estimated amount in its books of accounts as a Contingent Liability.

Related Topic – How & Where to Shown Contingent Assets?

 

13.  What is the difference between Reserves and Provisions?

Difference between reserves and provisions

Related Topic – Why is Provision for Doubtful Debts Created?

 

14. What are Accruals?

Another very frequently discussed topic in the list of finance and accounting interview questions is accruals. They are expenses and revenues that have been incurred or earned but have not been recorded in the books of accounts. Adjustment entries are incorporated in the financial statements to report these at the end of an accounting period.

Accrued Expense is an expense that has been incurred, but has not been recorded in the books of accounts presently. It will require an adjustment entry in the books of accounts to reflect this in the financial statements.

Accrued Income is income that has been earned, but has not been recorded in the books of accounts presently. Similar to accrued expenses, an adjustment entry will be required in this case too.

There is some more explanation on Accruals along with a couple of examples here.

 

15. What is a Contra Account?

It is an account that is used to reduce or offset the value of an associated account. It holds the opposite sign for a particular type of account.

If an account has a debit balance (e.g for an Asset a/c), then there will be a credit balance in its contra account. The opposite is true for a liability account.

Example for contra accounts

contra account examples

Read more on Contra Account with more details and examples.

 

16. What are Drawings, what type of account is it & its journal entry?

When a proprietor withdraws cash or goods from their own business for personal use it is termed as drawings. It reduces capital invested and is a temporary account that is cleared at the end of each accounting period.

“Drawings” is a Personal Account & is shown on the liability side of a balance sheet.

Journal entry for cash withdrawn

Drawings Journal Entry for Cash Withdrawn

Journal entry for goods withdrawn

Drawings Journal Entry for goods Withdrawn

Related Topic – Balance and Type of Account of a Petty Cash Book

 

17. What is a Bank Reconciliation Statement & why is it prepared?

Almost all compilations of finance and accounting interview questions include at least one question on BRS, this topic is deemed important.

Bank Reconciliation Statement or BRS refers to a statement that is made to reconcile the bank balance shown on the bank statement or passbook with the bank balance shown in the cash book.

Both internal source(s) i.e. the cash book and external source(s) i.e. the bank statement/passbook are reconciled with each other, and then all the mismatches are identified and properly recorded.

Reasons for preparing a BRS

Reasons to Prepare Bank Reconciliation Statement

More on Bank Reconciliation Statement and reasons to prepare a BRS

 

18. What is Deferred Revenue Expenditure?

Another one among the list of commonly asked finance and accounting interview questions is Deferred Revenue Expenditure. It is an expenditure that is revenue in nature and incurred during an accounting period, but its benefits are to be derived from a number of following accounting periods.

The part of the amount which is charged to the profit and loss account in the current accounting period is reduced from the total expenditure and the rest is shown on the balance sheet as an asset.

Example – A small business spends 1,50,000 on advertising which is unusually large for them. The benefits from it are expected to be derived over 3 years so the company decides to divide the expense over 3 yearly payments of 50K. This type of expense is amortized.

Example Deferred Revenue Expenditure

Related Topic – Is Deferred Revenue a Liability?

 

19. What is the difference between Trade Discount & Cash Discount?

Difference between trade discount and cash discount

Related Topic – How to Calculate Provision for Discount on Debtors?

 

20. What is a Credit Note and Debit Note?

Be ready for this question in accounting interviews for roles related to Accounts Payable and Accounts Receivable.

Debit Note – When a buyer returns goods to the seller, he sends a debit note as an intimation to the seller of the amount and quantity being returned and requesting the return of money.

Credit Note – When a seller receives goods (returned) from the buyer, he prepares and sends a credit note as an intimation to the buyer showing that the money for the related goods is being returned in the form of a credit note.

Related Topic – Debit Note Vs Credit Note

 

21. Additional 20 Finance and Accounting Interview Questions in our eBook

Golden Book of Accounting Interviews eBook Amazon Ratings

Golden Book of Accounting and Finance Interviews Part I - 3D

Get Full Version of eBook with 40 Question & Answers

The first of our two-book series “Golden Book of Accounting and Finance Interviews – Part I” contains 20 additional finance and accounting interview questions including the ones in the above article. Our eBook is a great resource for every job seeker.

*2022-23. As this eBook requires an update every year, it is no longer a free download but comes at a very nominal price of just 99 INR. This is our researched list of accounting interview questions and answers.

>Read 11 Tips to Follow for Freshers Before an Accounting Interview

>Read Compilation Journal Entries

 

What is Revenue Expenditure?

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Revenue Expenditure

During the normal course of business, any expenditure incurred of which benefit is received during the same accounting period is called revenue expenditure. These expenses help a business sustain its operations and may not result in an increase in revenue.

Examples of such expenses are wages, rent, power, bad debts, depreciation, telephone, printing, cost of goods (to be sold), freight, maintenance of fixed assets, etc.

Unlike capital expenditure, these expenses are relatively small & recurring in nature. Sometimes referred to as revex these are used for meeting daily requirements of a business, therefore, they are short-term i.e. the benefit received is consumed by the business within the same accounting year.

Related Topic – What is a Control Account?

 

Revenue Expenditure in Financial Statements

It is shown on the debit side of the trading account & Income statement, the accounting treatment for both revex and capex is done differently. 

All expenses are shown on the debit side of the below Trading and Profit & Loss account are revenue in nature.

revenue expenditure in financial statements

The amount transferred to trading and P&L account should only be to an extent to which goods or services have been consumed. For example, cost of goods (to be sold) is a revenue expenditure, however, only the cost of goods actually sold in the current accounting period should be transferred to the trading account.

 

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>Read Difference Between Capital Receipts and Revenue Receipts

 

What are Different Types of Purchase Orders?

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Different Types of Purchase Orders

A purchase order (PO) is an official document generated by a buyer of goods/services as an offer for the seller. It becomes a “legal document of contract” once the seller accepts the purchase order. There are mainly 4 different types of purchase orders;

  1. Standard PO
  2. Contract PO
  3. Blanket PO
  4. Planned PO

 

Standard Purchase Order

It is the most basic and widely used among different types of purchase orders, it is created when a buyer is sure about the order details such as the item, price, delivery schedule, payment terms etc.

Example – Unreal corp. decides to buy 50,000 x 9W led bulbs from GE for a unit price of 10 each to be delivered within 60 days of the order date. In such case, Unreal corp. will raise a standard PO and send it to GE for acceptance.  

 

Contract Purchase Order

It is created for a set period of time (often for a year) the item, pricing, quantity etc. can’t be anticipated precisely. In this case, a contract purchase order can be raised by the buyer, which upon acceptance becomes a legal contract.

During the contract period, the buyer can raise a standard PO with specifications of requirements and request for goods.

Example – Unreal Corp. analyzes and concludes that it often requires led bulbs of different wattage around different times of the year, however, the requirement is irregular and can’t be anticipated. In this case Unreal corp. can raise a contract purchase order.

 

Blanket Purchase Order

It is used in cases where the item is known, but the quantity and required delivery schedules are unknown. There can be numerous delivery dates against a blanket PO, they are often used in case of large quantities with exceptional discounts.

Example – Unreal corp. decides to buy 5,00,000 x 9W led bulbs each year but they are not sure about the delivery schedule & quantity of each release. In such a situation Unreal corp. will raise a blanket purchase order.

 

Planned Purchase Order

It is used for a planned purchase anticipated for long-term where the delivery schedule is not known in advance. The dates of delivery can only be anticipated therefore only tentative dates are provided to the seller. Item, pricing and quantity are however known in advance.

Example – Unreal Corp. has evaluated that it will have a long-term need for the next 5 years to buy 25,000 x 11W led bulbs each year. Instead of raising a standard PO each time Unreal Corp. can create a planned purchase order.

The reference table is shown below with different types of purchase orders and their respective scenarios

Types or purchase orders or POs

 

Short Quiz for Self-Evaluation

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What is Three-Way Matching?

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Three-Way Matching

Three-way matching is a procedure used in accounts payable to authenticate and verify the disbursal of payment to a creditor. This type of match involves matching Purchase Order (PO), Goods Receipt Note (GRN) & Invoice. Various departments work together to check things like price billed, quantity billed, quality & quantity of goods received etc.

Three-way matching is an important & common technique for firms since it mitigates credit risk by avoiding fraud invoices, underpaying, overpaying etc.

Three-Way Matching Accounting

Purchase Order (PO) – After a supplier has been finalized an official document is issued by a company to a supplier to buy specific goods or services. It usually contains the date, quantity, pricing, shipping terms, T&C etc.

Goods Receipt Note (GRN) – It is a document which is usually signed by the buyer at the time of delivery thus acting as evidence that the quantity delivered is exactly as desired by the buyer in its purchase order.

Invoice – Also known as a bill, it is a statement of all items purchased by a buyer in an order with price & quantity along with the total sum due on a particular date.

To avoid payment delays for a minor difference buyers would usually have a small currency amount set as a tolerance limit so any mismatch within the prescribed threshold is ignored and the invoice is paid after successful three-way matching.

 

Short Quiz for Self-Evaluation

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Read> Days Payable Outstanding (DPO)

 

What are Final Accounts?

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Final Accounts

As the name suggests they are the final accounts which are prepared at the last stage of an accounting cycle. Final accounts show both the financial position of a business along with the profitability, they are used by external and internal parties for various purposes.

Trading account, Profit and Loss account and Balance Sheet together are called final accounts.

 

Trading Account

This account is the first account prepared as a final account, it is prepared to ascertain gross profit or gross loss incurred during an accounting period. On the debit side i.e. the LHS of the trading account items such as opening stock, purchases, and all direct expenses are shown.

Gross Profit – If the total of credit side is greater than debit side i.e. RHS > LHS the excess is called Gross Profit. It is transferred to the credit side of Profit and Loss account.

Gross Loss – If the total of the debit side is greater than the credit side i.e. LHS > RHS the excess is called Gross Loss. It is transferred to the debit side of Profit and Loss account.

Below is a sample format of trading account

Trading account format final accounts

Related Topic – Difference between Gross Profit and Net Profit

 

Profit and Loss Account

After preparation of trading account a profit and loss account also known as an income statement is prepared to ascertain the Net Profit or Net Loss incurred by a business. It begins with Gross Profit or Gross Loss being transferred from the trading account.

On the debit side of a Profit and Loss account, all indirect expenses such as salary, rent, office and admin, marketing, stationery etc. and loss incurred by the sale of assets or fire/theft etc. are mentioned.

On the credit side of a Profit and Loss account, all indirect incomes such as interest earned, dividends received on shares, bad debts recovered, profit on the sale of assets etc. are mentioned.

Below is a sample format of profit and loss account or income statement

Profit and Loss account format final accounts

Related Topic – Difference between Trial Balance and Balance Sheet

 

Balance Sheet

Both trading account and income statement help to determine the profitability of a business whereas a balance sheet is constructed to find out the financial position of the business as on a particular date. The balance sheet consists of capital, assets, and liabilities of a business.

It is a statement and not an account, it has no debit or credit side there “To” & “By” are not used inside a balance sheet. On the LHS of a balance sheet are all liabilities including capital and RHS will be all assets, for a balance sheet liabilities will always be equal to assets.

Below is a sample format of profit and loss account or income statement

Balance sheet format final accounts

 

Short Quiz for Self-Evaluation

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>Read What is Posting?

 

What are Trade Receivables and Trade Payables?

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Trade Receivables

It is the total amount receivable to a business for sale of goods or services provided as a part of their business operations. Trade receivables consist of Debtors and Bills Receivables. Trade receivables arise due to credit sales.

They are treated as an asset to the company and can be found on the balance sheet.

Trade Receivables = Debtors + Bills Receivables

 

Example – Trade Receivables

Calculate trade receivables from the below balance sheet

Calculate trade receivable numerical

Trade Receivables = 6000 (sundry debtors) + 9000 (bills receivable)

= 15,000

Debtors are people or entities to whom goods have been sold or services have been provided on credit and payment is yet to be received for that. In addition, debtors are treated as current assets in a business.

Bills Receivable (B/R) is a bill of exchange accepted by a debtor or is received in way of an endorsement from them. The amount which is due to be received on a specific date is mentioned in the bill.

Related Topic – What is Provision for Doubtful Debts?

 

Trade Payables

It is the total amount payable by a business for goods purchased or services availed as a part of their business operations. Trade payables comprise of Creditors and Bills Payables. Trade payables arise due to credit purchases.

They are treated as a liability for the company and can be found on the balance sheet.

Trade Payables = Creditors + Bills Payables

 

Example – Trade Payables

Calculate trade payables from the below balance sheet

Calculate trade payable numerical

Trade Payables = 10,000 (sundry creditors) + 10,000 (bills payable)

= 20,000

Creditors are people or entities from whom goods have been purchased or services have been availed on credit and payment is yet to be made against that. In addition, creditors are treated as current liabilities in a business.

Bills Payable (B/P) is a bill of exchange accepted by a business the amount for which will be payable on the specific date mentioned in the bill.

 

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What is the Journal Entry for Recovery of Bad Debts?

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Journal Entry for Recovery of Bad Debts

At times a debtor whose account had earlier been written off by a creditor as a bad debt may decide to make a payment. This is called “recovery of bad debts”. While posting the journal entry for bad debts recovered it is important to note that it is treated as a gain for the business & that the debtor should not be credited as in the case of sales.

While journalizing for bad debts debtor’s personal account is credited and the bad debts account is debited because bad debts written off are treated as a loss to the business and now when they are recovered it is seen as a fresh gain.

Journal entry for recovery of bad debts is as follows;

Cash A/c Debit Real A/C Dr. What comes in
 To Bad Debts Recovered A/C Credit Nominal A/C Cr. income & gains

Debit (Cash A/c) assuming the recovery was done in cash

 

Rules applied as per modern or US style of accounting 

Cash or Bank A/C Debit the increase in assets
Bad Debts Recovered A/C Credit the increase in income

 

The closing journal entry for bad debts recovered would be as follows;

Bad Debts Recovered A/C  Debit
 To Profit and Loss A/C  Credit

(Transferring bad debts recovered to the income statement)

Related Topic – Journal Entry for Credit Sales and Cash Sales

 

Journal Entry for Bad Debts Recovered
Treatment of Bad Debts Recovered in the Accounting Books

 

Bad Debts Recovered Shown Inside a Financial Statement

Income statement showing bad debts recovered

Related Topic – What is Provision for Discount on Debtors?

 

Example – Journal Entry for Recovery of Bad Debts

Unreal corp was declared insolvent last year and an amount of 70,000 was shown as bad debts in the books of ABC corp, this year Unreal corp decided to pay cash 70,000 against the same debt.

In the books of ABC Corp.

Cash A/C 70,000
 To Bad Debts Recovered A/C 70,000

(Cash received from Unreal corp previously written off as bad debt)

 

Bad Debts Recovered A/C 70,000
 To Profit & Loss A/C 70,000

(Transferring bad debts recovered to the income statement)

 

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What is the Difference Between Revenue and Profit?

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Revenue vs Profit

Revenue and Profit are terms often used interchangeably however they are different and are calculated in a different way before being shown in the books of accounts. In a nutshell, the difference between revenue and profit is that Revenue can be termed as money a business makes by selling its main goods/services whereas profit is what is left after paying all the bills.

Revenue Profit
Money earned by selling main goods and/or services to customers Net Earnings of a business left after deduction of all expenses
Revenue = Total Sales – Total Returns Profit = Total Revenue – Total Expenses
Also known as Sales, Sales Revenue, Turnover, Gross Income Also known as Bottom Line, Net Profit, Net Earnings
It is shown in Trading Account It is shown in Income Statement

 

Revenue

Also known as Sales, Sales Revenue, Turnover, Gross Income, Top Line. It is the amount of money a business earns by selling its main goods & services to its customers. All proceeds gathered only from the company’s core business operations are eligible to be part of a company’s revenue.

For example, Ford Motor Company’s core business is selling cars so whatever amount it earns over a fixed period of time from the sale of cars will be its revenue for that period. Now, if Ford Motor Company has an investment of 100 Million and earns 1 Million every year from that it will not be counted towards its direct revenue rather it is termed as “income from other sources”.

Below is a trading account showing (red highlighted) Revenue of a business. (Sales – Returns)

Sales Revenue Shown in Trading Account

 

Profit

Also known as Bottom Line, Net Profit or Net Earnings. Profit is what is left after the deduction of all expenses from revenue. Profits can be calculated at various levels e.g. Gross Profit, Net Profit etc. From a broader perspective Profit = Revenue – Expenses.

Gross Profit is the difference between total revenue earned from selling products/services and the total cost of goods/services sold. Gross Profit = Total Revenue – COGS (Cost of Goods Sold)

Below is an income statement showing (in red highlighted) profit earned by a business during a particular period

Profit Shown in Profit and Loss Account

 

 

What is Operating Cash Flow Ratio?

Ahuja Sahil
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Operating Cash Flow Ratio

Operating cash flow ratio also known as cash flow from operations ratio is calculated by dividing cash flow from operations by current liabilities. All cash generated from firm’s core business operations is termed as operating cash.

It is different from cash generated through investing and financing in a way that it doesn’t take into account any extra cash generated apart from a business’ core operations. This ratio determines a firm’s liquidity by evaluating its operating cash with respect to its current liabilities.

Inside a cash flow statement, non-cash charges are adjusted from a business’ net income which then increases or decreases the working capital. This adjustment results in the final operating cash flow of a company.

 

Formula to Calculate Operating Cash Flow Ratio

Operating Cash Flow Ratio

Cash Flow From Operations: Revenue from operations + Non-cash based expenses – Non-cash based revenue

Current Liabilities: It includes Creditors, B/P, Accrued Expenses, Provisions, Short-Term Loans etc.

 

Example of Operating Cash Flow Ratio

From the below details of Unreal corporation calculate their operating cash flow ratio for the quarter ending 30th June 2018

  Net Cash Flow From Operations Current Liabilities
Q2 2018 200,000 150,000
Operating Cash Flow Ratio Q2 2018 1.33  

 

Cash flow from operations ratio of 1.33 shows that for every unit of current liability the company had 1.33 units of cash flow from operations during the second quarter of 2018.

 

High & Low Operating Cash Flow Ratio

High cash flow from operations ratio indicates better liquidity position of the firm. There is no standard guideline for operating cash flow ratio, it is always good to cover 100% of firm’s current liabilities with cash generated from operations. So a ratio of 1 & above is within the desirable range.

Low cash flow from operations ratio i.e. below 1 indicates that firm’s current liabilities are not covered by the cash generated from its operations. This is not a desirable state for a business and shows a stressed liquidity position.

 

Short Quiz for Self-Evaluation

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>Read What is Super Quick Ratio?

 

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