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  2. SidharthBadlani CA Inter Student

    No, forensic accounting and auditing are not the same thing. Forensic accounting is a much more detailed task that is normally done when fraud or other illegal activity is suspected. The evidence collected by forensic accountants is used in the court of law. Forensic accounting is mostly done when aRead more

    No, forensic accounting and auditing are not the same thing. Forensic accounting is a much more detailed task that is normally done when fraud or other illegal activity is suspected.

    The evidence collected by forensic accountants is used in the court of law. Forensic accounting is mostly done when a suit has already been filed or is likely to be filed.

     

    How Forensic Accounting Differs from Auditing?

    Auditing means an inspection of financial statements done by experts with a view to obtaining reasonable assurance as to whether or not the financial statements correctly state the financial position and financial performance of the entity during the period under audit.

    Forensic accounting is the use of accounting skills to detect any fraud, embezzlement or other illegal activity that may have occurred within the entity.

    This is how forensic accounting differs from auditing:

    • Forensic accounting is different from auditing in that forensic accounting is done with an intention to identify and uncover frauds while auditing is normally done to provide the users of financial statements reasonable assurance that the statements are correct and true.
    • Auditing usually identifies only those misstatements that are material. Materiality is the one of the main concerns of auditors. However, in forensic auditing every type of misstatement is scrutinized as material. The forensic accountants try to identify fraud in every misstatement.
    • Forensic accounting is usually done only when fraud and other illegal activities are suspected and some suit has been filed or is likely to be filed while auditing of annual financial statements is mandatory for firms meeting certain threshold limits of turnover/gross receipt/revenue.

    Importance of Forensic Accounting

    • Forensic accounting is used to detect frauds, forgery, misappropriation of assets and other illegal activities.
    • The evidence collected during forensic accounting can be used in a court of law. Often, those conducting forensic accounting are also called upon to testify as experts in a court.
    • Forensic accounting identifies loopholes in the internal controls of an entity that has been or may be exploited for conducting frauds and other illegal activities.
    • Forensic accountants suggest different measures that an entity can take to make it’s internal controls more effective and prevent illegal activities in the future.

    Conclusion

    Forensic accounting and auditing are very different from each other. While auditing is done to identify only material misstatement, forensic accounting is done with an objective of detecting possible fraud or other illegal activity. Auditing of financial statements is mandatory for firms exceeding certain threshold limits of turnover/gross receipts/revenue while financial accounting is usually done when a suit for fraud, embezzlement etc has been filed or is likely to be filed.

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  2. Ishika Pandey Curious ca aspirant
    This answer was edited.

    Definition Bad debts are a debt owed to an enterprise that is considered to be irrecoverable or we can say that it is owed to the business that is written off because it is irrecoverable. Bad debts will be treated in the following ways : On the debit side of the profit and loss account. In the curreRead more

    Definition

    Bad debts are a debt owed to an enterprise that is considered to be irrecoverable or we can say that it is owed to the business that is written off because it is irrecoverable.

    Bad debts will be treated in the following ways :

    On the debit side of the profit and loss account.

    In the current assets side of the balance sheet, these are deducted from sundry debtors.

    For example loans from banks are declared as bad debt, sales made on credit and amounts not received from customers, etc.

    Now I will show you an extract of the profit and loss account and balance sheet   

    Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or the rendering of services in the ordinary course of business.

    For example,  debtors exist to convert them into cash i.e., receive the amount from them, bills receivable exist again for receiving cash against it, etc.

     

    Current liabilities are defined as liabilities that are payable normally within 12 months from the end of the accounting period or in other words which fall due for payment in a relatively short period.

    For example bills payable, short-term loans, etc.

     

    Accounting treatment

    Now let me try to explain to you the accounting treatment for bad debts which is as follows :

    • Balance sheet
      • In the balance sheet either it can be shown on the asset side under head current assets by reducing from that specific assets.
      • For example, if credit sales are made to a customer who says it’s not recoverable or is partially recoverable then the amount is bad debt. It’s a loss for the business and credited to the personal account of debtors or we can say reduced from debtor those are current assets of the balance sheet.

     

    • Profit and loss account
      • Bad debts are treated as an expense and debited to the profit and loss account.
      • For example, as I have explained above, but before transferring to the balance sheet, bad debt will be debited to the profit and loss account as an expense.

     

    Reasons for bad debts

    There are several reasons why businesses may have bad debts some of them are as follows:-

    • Offered credit to customers who were unable to pay them back, or they may have been the victim of fraud.

     

    • When there is conflicts or dispute arise with respect to product size, color, quality, delivery, credit term, price, etc therefore debts becomes bad.

     

    • Debtors have poor financial management or they are not able to pay debts on time.

     

    • Debtors’ unwillingness to pay is also a reason for debts to become bad.

     

    • Or there can be more cases where debtors are unable to collect debts and debts turns out to be bad.

     

    Accounting methods

    There are two methods for accounting for bad debts which are mentioned below:-

    • First, is the direct written-off method which states that bad debts will be directly treated as expenses and expensed to the income statement, which is called the profit and loss account.

     

    • Second, is the allowance method which means we create provisions for doubtful debts accounts and the debtor’s account remains as it is since the debtor’s account and provision for doubtful debts account are two separate accounts.

     

      • Debts that are doubtful of recovery are provided estimating the debts that may not be recovered .amount debited to the profit and loss account reduces the current year’s profit and the amount of provision is carried forward to the next year.
      • Next year, when debts actually become bad debts and are written off, the amount of bad debts is transferred ( debited ) to the provision for doubtful debts account.
      • The amount of bad debts is not debited to the profit and loss account since it was already debited in earlier years.
      • Provision for doubtful debts is shown in the debit side of the profit and loss account as well as shown as a deduction from sundry debtors in the assets side of the balance sheet. 

     

    Related terms

    So there are a few related terms whose meanings you should know

    • Further bad debts :
      • It means the amount of sundry debtors in the trial balance is before the deduction of bad debts. in this situation, entry for further bad debts is also passed into the books of account.
      • That is bad debts are debited and the debtor’s account is credited. And the accounting treatment for them is the same as bad debts which I have shown you above.

     

    • Bad debts recovered :
      • It may happen that the amount written off as bad debts is recovered fully or partially.
      • In that case, the amount is not credited to the debtor’s (personal) account but is credited to the bad debts recovered account because the amount recovered had been earlier written off as a loss.
      • Thus amount recovered is a ‘gain’  and is credited to the profit and loss account.

     

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  2. SidharthBadlani CA Inter Student
    This answer was edited.

    Bad debts mean the money owed by customers who have gone bankrupt or the likelihood of who's ever returning the money is significantly low. Bad debt is a nominal account. A nominal account is an account that records the business transactions belonging to a certain category of income, expense, profitRead more

    Bad debts mean the money owed by customers who have gone bankrupt or the likelihood of who’s ever returning the money is significantly low. Bad debt is a nominal account.

    A nominal account is an account that records the business transactions belonging to a certain category of income, expense, profit or loss. The balances on nominal accounts are normally written off at the end of each financial year. For example, sales A/c, purchases A/c, interest income, loss from the sale of assets etc.

    Why are bad debts A/c classified as a nominal account?

    First of all, let us understand the other two types of accounts – personal accounts and real accounts.

    Personal accounts deal with the records of the business’ transactions with a particular person or entity. For example Mukesh A/c, Mahesh A/c, Reliance A/c, Suresh and Co. A/c etc.

    Real accounts deal with transactions and records related to assets. The balance in these accounts is normally carried forward from one period to another. For example “Furniture A/c “, ” Building A/c ” etc.

    Now that we have understood the basic definitions of all three types of accounts, we can discuss the reason behind the classification of bad debts as nominal accounts.

    A bad debt is a loss that the company has incurred. It may be due to bankruptcy of customers, customer fraud etc. The company isn’t going to receive that money. The bad debts are written off at the end of the year by transferring them to profit and loss A/c.

    Thus, bad debts relate to loss and are normally not carried forward from one period to another. Hence, they are classified as nominal accounts.

    Treatment of Bad Debts

    Bad debts are written off at the end of each year by debiting them to the profit and loss A/c. The amount of bad debts is reduced from the amount of debtors that the company has.

    A company may also choose to create a provision for bad debts for the balance amount of debtors that the company has after adjusting for bad debts. This provision represents a rough estimate of the amount due to debtors that the business expects to not receive. In other words, it is an estimate of customer bankruptcy that the business expects.

    Conclusion

    We can conclude that

    • There are primarily three types of accounts – real, personal and nominal.
    • Bad debts are a nominal account.
    • Bad debts is a loss that the business has incurred
    • It may be due to bankruptcy of customers, fraud etc
    • Bad debts are written off each year by transferring them to the income statement
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  2. Ishika Pandey Curious ca aspirant
    This answer was edited.

    Definition Bad debts are a debt owed to an enterprise that is considered to be irrecoverable or we can say that it is owed to the business that is written off because it is irrecoverable. Sometimes debtors are unable to pay the amount due either partially or fully. the amount that is not receivableRead more

    Definition

    Bad debts are a debt owed to an enterprise that is considered to be irrecoverable or we can say that it is owed to the business that is written off because it is irrecoverable.

    Sometimes debtors are unable to pay the amount due either partially or fully. the amount that is not receivable is a loss and is called bad debt.

    Bad debts are neither assets nor liabilities they are expenses that are debited to the profit and loss account and reduced from debtors in the balance sheet.

    For example loans from banks are declared as bad debt, sales made on credit and amounts not received from customers, etc.

     

    Related terms

    So there are a few related terms whose meanings you should know

    • Further bad debts :
      • It means the amount of sundry debtors in the trial balance is before the deduction of bad debts. in this situation, entry for further bad debts is also passed into the books of account.
      • That is bad debts are debited and the debtor’s account is credited. And the accounting treatment for them is the same as bad debts which I have shown you above.

     

    • Bad debts recovered :
      • It may happen that the amount written off as bad debts are recovered fully or partially.
      • In that case, the amount is not credited to the debtor’s (personal) account but is credited to the bad debts recovered account because the amount recovered had been earlier written off as a loss.
      • Thus amount recovered is a ‘gain’  and is credited to the profit and loss account.

     

    Accounting methods

    There are two methods for accounting for bad debts which are mentioned below:-

    • First, is the direct written-off method which states that bad debts will be directly treated as expenses and expensed to the income statement, which is called the profit and loss account.

     

    • Second, is the allowance method which means we create provisions for doubtful debts accounts and the debtor’s account remains as it is since the debtor’s account and provision for doubtful debts account are two separate accounts.

     

      • Debts that are doubtful of recovery are provided estimating the debts that may not be recovered .amount debited to the profit and loss account reduces the current year’s profit and the amount of provision is carried forward to the next year.
      • Next year, when debts actually become bad debts and are written off, the amount of bad debts is transferred ( debited ) to the provision for doubtful debts account.
      • The amount of bad debts is not debited to the profit and loss account since it was already debited in earlier years.
      • Provision for doubtful debts is shown in the debit side of the profit and loss account as well as shown as a deduction from sundry debtors in the assets side of the balance sheet. 

     

    Accounting treatment

    Now let me try to explain to you the accounting treatment for bad debts which is as follows :

    • Balance sheet

     

      • In the balance sheet either it can be shown on the asset side under the head, current assets by reducing from that specific assets.
      • For example, if credit sales are made to a customer who says it’s not recoverable or is partially recoverable then the amount is bad debt. It’s a loss for the business and credited to the personal account of debtors or we can say reduced from debtor those are current assets of the balance sheet.

     

    • Profit and loss account

     

      • Bad debts are treated as expenses and debited to the profit and loss account.
      • For example, as I have explained above, before transferring to the balance sheet, bad debt will be debited to the profit and loss account as an expense.

    Now let me show you the extract of the profit and loss account and balance sheet showing bad debts and bad debts recovered which are as follows:-

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  2. Ishika Pandey Curious ca aspirant
    This answer was edited.

    Definition Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business. Or in other words, we can say that the expected realization period is less than the operating cRead more

    Definition

    Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.

    Or in other words, we can say that the expected realization period is less than the operating cycle period although it is more than the period of 12 months from the date of the balance sheet.

    For example, goods are purchased with the purpose to resell and earn a profit, debtors exist to convert them into cash i.e., receive the amount from them, bills receivable exist again for receiving cash against it, etc.

     

    List of current assets

    The list of current assets is as follows:-

    • Cash in hand
    • Cash equivalents
    • Bills receivables
    • Sundry debtors
    • Prepaid expenses
    • Accrued income
    • Closing stock
    • Short-term investments ( marketable securities )
    • Other liquid assets

     

    Now here are a few definitions for the above list of current assets which are as follows:-

    • Cash in hand

    Cash comprises cash on hand and demand deposits with banks.

     

    • Cash equivalents

    Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value.

     

    • Bills receivables

    It means a bill of exchange accepted by the debtor, the amount of which will be received on the specific date.

     

    • Sundry debtors

    A debtor is a person or entity who owes an amount to an enterprise against credit sales of goods and/or services rendered.

     

    • Prepaid expenses

    Expense that has been paid in advance and benefit of which will be available in the following years or year.

     

    • Accrued income

    Income that has been earned in the accounting period but in respect of which no enforceable claim has become due in that period by the enterprise.

     

    • Closing stock

    Stock or inventory at the end of the accounting period which is shown in the balance sheet and which is valued on the basis of the “ cost or net realizable value, whichever is lower “ principle is called closing stock.

     

    • Short term investment

    Investments that are also known as marketable securities and are held for a temporary period of time i.e, for less than 12 months, and can be easily converted into cash are called short-term investments.

     

    Criteria for classification

    Now let us see the classification of assets in the case of companies as per Schedule III of the Companies act 2013.

    An asset is a current asset if it satisfies any one of the following criteria which are as follows:-

    • It is held primarily for the purpose of being traded.

     

    • It is expected to be realized in or is intended for sale or consumption in the company’s normal operating cycle.

     

    • It is expected to be realized within 12 months from the reporting date.

     

    • It is cash and cash equivalent unless it is restricted from being exchanged or used to settle a liability for at least 12 months after the reporting date.

     

    Here is an extract of the balance sheet showing current assets 

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  2. Ishika Pandey Curious ca aspirant
    This answer was edited.

    Definition Prepaid expenses are those expenses whose payments are done in advance which can be for the goods or services whose benefit will accrue in the subsequent accounting period. A prepaid expense is a current asset. prepaid expenses are classified under the head current assets in the balance sRead more

    Definition

    Prepaid expenses are those expenses whose payments are done in advance which can be for the goods or services whose benefit will accrue in the subsequent accounting period.

    A prepaid expense is a current asset. prepaid expenses are classified under the head current assets in the balance sheet.

    This is because they provide future economic benefits to the company. As such, they are assets that can be used to generate revenue in the future.

    For example prepaid rent, prepaid insurance, etc.

     

    Current assets are defined as cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.

    Or in other words, we can say that the expected realization period is less than the operating cycle period although it is more than the period of 12 months from the date of the balance sheet.

    For example, goods are purchased with the purpose to resell and earn a profit, debtors exist to convert them into cash i.e., receive the amount from them, bills receivable exist again for receiving cash against it, etc.

     

    Current liabilities are liabilities that are payable generally within 12 months from the end of the accounting period or in other words which fall due for payment in a relatively short period.

    For example bills payable, short-term loans, etc.

     

    Why current assets and not a  current liability?

    Now let me try to explain to you that prepaid expenses are classified as current assets  and not as a current liability which is as follows :

      • we can say that the expected realization period is less than the operating cycle period although it is more than the period of 12 months from the date of the balance sheet.
      • expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.
      • In the business prepaid expense are treated as an asset which we can see on the asset side of the balance sheet.
      • Or in other words, we can say that it is initially recorded as a prepaid expense as an asset in the balance sheet and subsequently its value is expensed over time in the profit and loss account.

     

    Example

    Now let us take an example for explaining prepaid expenses which are mentioned below.

    An insurance premium of Rs 50000 has been paid for one year beginning (previous year). The financial year ends on 31st  march YYYY.

    It means the premium for 6 months i.e., 1st April, YYYY(current year) to 30th September, YYYY(current year) amounting to Rs 25000 is paid in advance.

    Thus, of premium paid in advance (Rs 25000)  is a Prepaid Expense. It will be accounted as an expense in the financial year ending  31st  march next year. In the balance sheet as of 31st march YYYY ( current year ) it will be shown as Current Asset.

    Here is an extract of the profit /loss account and balance sheet of the above example:

     

    Key points

    There are a few things to keep in mind when dealing with prepaid expenses.

    • First, is that the expenses are actually prepaid. This means that the expenses were paid for before they were used.

     

    • Second, it is essential to track the number of prepaid expenses that have been used. That is to make sure that the prepaid expenses are not overstated on the company’s financial statements. This can happen if the company pays for more goods or services than it actually

     

    • Last but not least it is important to keep in mind that changes in the value of prepaid expenses can impact the company’s net income. For example, if the company’s prepaid insurance increases in value, this will increase the company’s net income.

     

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  2. SidharthBadlani CA Inter Student
    This answer was edited.

    Prepaid expense means a service to be rendered in the future period for which the business has already paid the remuneration. Prepaid expenses are classified as assets. The benefits of this payment will accrue to the business at a later period.  For example, insurance is often paid for annually on tRead more

    Prepaid expense means a service to be rendered in the future period for which the business has already paid the remuneration. Prepaid expenses are classified as assets. The benefits of this payment will accrue to the business at a later period. 

    For example, insurance is often paid for annually on the basis of the calendar year. A business may pay insurance every year on 1st January for that entire year. While preparing the financial statements on 31st March, it will recognize the insurance premium for the period 1st April to 31st December of the next financial year as a prepaid insurance expense. 

    Why are prepaid expenses classified as assets? 

    First of all, let us understand what an asset is. An asset is anything over which the business has ownership rights and which it can sell for money. The benefits of this asset should accrue to the business. 

    In light of this definition, let us analyze prepaid expenses as an asset. As the business has already paid for these goods or services, it becomes a legal right of the business to receive the relevant goods or services at a later date. As the benefit of this expense would accrue to the business only at a later date, the prepaid expenses are classified as an asset. 

    Some examples of prepaid expenses are prepaid insurance, prepaid rent etc

    Treatment of Prepaid Expenses

    Prepaid expenses are recorded in the balance sheet under the heading “Current Assets” and sub-heading “Other Current Assets”

    As per the Generally Accepted Accounting Principles or GAAP, expenses must be recognized in the accounting period to which they relate or in which the benefit due to them is likely to arise. Thus, we cannot recognize the prepaid expenses in the accounting period in which they are incurred. 

    Prepaid assets are classified as assets and carried forward in the balance sheet to be debited in the income statement of the accounting period to which they relate. 

    Adjusting Entries

    Adjusting entries are those entries that are used to recognize prepaid expenses in the income statement of the period to which they relate. These entries are not used to record new transactions. They ensure compliance with GAAP by recognizing the expenses in the period to which they relate. 

    Conclusion

    The GAAP and basic definition of an asset govern the treatment of prepaid expenses as an asset. The business incurs them in an accounting period different from the accounting period in which their benefit would accrue to the business. The business has a legal right to receive those goods or services. 

    The business carries them as a current asset on the balance sheet. In the relevant accounting period, they are recognized in the income statement. 

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