AccountingQA Latest Questions

Bonnie
BonnieCurious
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Compound EntryLedger
  2. Simerpreet Helpful CMA Inter qualified
    This answer was edited.

    When in a single transaction two or more accounts are involved, such kinds of transactions are termed as Compound entries. Example 1, Johnson Co. purchased goods worth 5,000, and half of the amount was paid in cash and the other half by cheque. So here three accounts are involved: Purchase account-Read more

    When in a single transaction two or more accounts are involved, such kinds of transactions are termed as Compound entries.

    Example 1, Johnson Co. purchased goods worth 5,000, and half of the amount was paid in cash and the other half by cheque.

    So here three accounts are involved:

    Purchase account- That is to be debited.

    Cash account- That is to be credited.

    Bank account- That is to be credited.

    Journal entry:

    Now posting the above journal entry in a ledger account.

    In the Journal, the Purchase account has been debited. So in the ledger, the purchase account will also be debited. Since the purchase account is debited in the ledger, the corresponding two credit accounts of this entry i.e. the cash and the bank will be written on the debit side in the particulars column. So while posting, the amount to be considered would be the amount individually paid in cash and bank as shown in the journal entry.

    Cash a/c is credited with the purchase account.  In the ledger, purchase a/c will be posted on the credit side. So while posting, the amount to be considered would be the amount individually paid in cash.

    Bank a/c is credited with the purchase account. In the ledger, purchase a/c will be posted on the credit side. So while posting, the amount to be considered would be the amount individually paid in Bank a/c.

    Example 2,  Johnson Co purchased goods and made payment in cash 2,000. Along with it, it also paid commission and interest of 1,000 and 500 respectively.

    So here four accounts are involved:

    Purchase account- That is to be debited.

    The commission allowed account- That is to be debited.

    Interest allowed account- That is to be debited.

    Cash account- That is to be credited.

    Journal Entry:

    Now posting the above journal entry in a ledger account.

    In the journal entry, the cash account has been credited. So in the ledger, the cash account will also be credited. Since the cash account is credited in the ledger, the corresponding three accounts will also be credited in the particulars column. As in the journal entry the three debit accounts viz. Purchase, the commission allowed, and interest allowed, the amounts written against them shall be entered in the respective accounts in the amount column on the credit side of the cash account.

    Purchase a/c is debited with a cash account.  In the ledger, Cash a/c will be posted on the debit side. So while posting, the amount to be considered would be the amount individually paid in the Purchase account.

    The commission allowed a/c is debited with a cash account.  In the ledger, cash a/c will be posted on the debit side. So while posting, the amount to be considered would be the amount individually paid in Commission allowed a/c.

    Interest allowed a/c is debited with a cash account.  In the ledger, cash a/c will be posted on the debit side. So while posting, the amount to be considered would be the amount individually paid in Interest allowed a/c.

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Simerpreet
SimerpreetHelpful
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AmortizationDifference BetweenImpairment
  2. Astha Leader Pursuing CA, BCom (Hons.)
    This answer was edited.

    Let us first understand the concepts of Amortization and Impairment. Amortization refers to the expense recorded on the decline of the value of intangible assets of a company. Intangible assets include goodwill, patents, copyrights, etc. It reflects the reduction in the value of Intangible assets ovRead more

    Let us first understand the concepts of Amortization and Impairment.

    Amortization refers to the expense recorded on the decline of the value of intangible assets of a company. Intangible assets include goodwill, patents, copyrights, etc. It reflects the reduction in the value of Intangible assets over its life span.

    Amortization is similar to Depreciation, however, while depreciation is over tangible assets amortization is over Intangible assets of the company.

    For example, Cipla Ltd. acquired a patent over a new drug for a period of 10 years. The cost of creating the new drug was 80,000 and the company must record its patent at 80,000. However, the company must amortize this cost by dividing the cost over the patent’s life, i.e., the amortization cost would be 8,000 (80,000/10) p.a. for the next 10 years.

    Impairment means a decline in the value of fixed assets due to unforeseen circumstances. Assets are impaired when the carrying value of assets increases its market value or “realizable value” and such increase is recorded as an impairment loss.

    Now suppose, Cipla Ltd. had existing machinery which suffered physical damage and is recorded at 50,000 in the books but the realizable value of the asset would only be 20,000. Hence, the asset would be written down to 20,000 and an impairment loss of 30,000 will be recorded.

    Impairment Vs Amortization

    Differences between the two can be shown as follows:

    Amortization Impairment
    Amortization is a reduction in the value of Intangible Assets over their useful life. Impairment is a reduction in the value of assets due to unforeseen circumstances.
    Amortization is a continuous process and the value of an asset reduces over time. Value of asset reduces drastically, creating a need to write down the value to its fair market value.
    Amortization is charged annually. Impairment is not an annual charge.
    Amortization is shown as an amortization expense. Impairment is shown as an impairment loss.
    Reasons for amortization includes consumption, obsolescence, etc. Reasons for impairment include damage to the asset, change in preferences, etc.
    Amortization is charged on Intangible assets Impairment is charged on fixed assets whether tangible or intangible.

    Suppose Unilever Ltd. has a patent over one of its products for a period of 5 years. The cost of the patent was 1,00,000. Then after 2 years one of its rivals, say ITC Ltd., launches a new product which is more preferred by the consumers over the one produced by Unilever Ltd. and the fair market value of the patent of Unilever Ltd. changes to 10,000.

    Now in this scenario, Unilever Ltd. would have amortized the patent (costing 1,00,000) at 20,000 (1,00,000/5) p.a. for 2 years and the book value at the end of the 2nd year is 60,000 (1,00,000 – 40,000). Now due to the new launch by ITC Ltd. the drastic change in the value of the asset from the book value of 60,000 to the realizable value of 10,000 will be recorded as an Impairment loss. Hence Impairment loss would be recorded at 50,000 (60,000 – 10,000).

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Simerpreet
SimerpreetHelpful
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Capital ExpenditureRevenue Expenditure
  2. Astha Leader Pursuing CA, BCom (Hons.)
    This answer was edited.

    Capital Expense Capital expenses are incurred for acquiring assets including incidental expenses. Such expenses increase the revenue earning capacity of the business. These are incurred to acquire, upgrade and maintain long term assets such as buildings, machines, etc and are non-recurring in natureRead more

    Capital Expense

    Capital expenses are incurred for acquiring assets including incidental expenses. Such expenses increase the revenue earning capacity of the business. These are incurred to acquire, upgrade and maintain long term assets such as buildings, machines, etc and are non-recurring in nature.

    Revenue Expenses

    Revenue expenses are incurred to carry on operations of an entity during an accounting period. Such expenses help in maintaining the revenue earning capacity of the business and are recurring in nature.

    These include ordinary repair and maintenance costs necessary to keep an asset working without any substantial improvement that leads to an increase in the useful life of the asset.

    Suppose, company Takeaway ltd. purchases machinery for 50,000 and pays installation charges of 10,000. Salary of 15,000 is paid to the employees and existing machinery is painted costing 8,000. Here, the cost of machinery 50,000 and installation charges of 10,000 are treated as capital expenditure and the salary of 15,000 and painting cost of 8,000 is treated as revenue expenditure.

    Identification

    Points to categorize an expenditure as Capital or Revenue are as follows:

    • An expenditure that neither creates assets nor reduces liability is categorized as revenue expenditure. If it creates an asset or reduces a liability, it is categorized as capital expenditure.

    For example, a company Motors ltd. purchases furniture for 65,000, repays loans amounting to 1,00,000 and pays salary of 25,000.

    Here the company creates an asset of 65,000 and reduces liability by 1,00,000 as shown below and therefore is considered as capital expenditure.

    However, payment of salaries neither creates assets nor reduces liability. It only reduces profits and therefore is considered as revenue expenditure.

    • Usually, the amount of capital expenditure is larger than that of revenue expenditure. But it is not necessary that if the amount is small it is revenue expenditure and if the amount is large, it is a capital expenditure.

    For example, a company Stars ltd purchases machinery for 1,20,000, furniture for 35,000 and has a rental expense of 80,000.

    Here, the purchase of machinery is capital expenditure since it results in higher expense. However, the purchase of furniture cannot be regarded as a revenue expense and payment of rent cannot be regarded as a capital expense only because the rental expense is higher than the amount expended for the purchase of furniture.

    • Usually, capital expenditure is not frequent and is made at a time, in lump sum. On the other hand, revenue expenditure is paid periodically. However, it is possible that capital expenditure is paid in installments.

    For example, a company Caps ltd. purchases land for 1,00,00,000 on an equal monthly installment basis. Then such payments cannot be considered as revenue expense only because the payments are recurring. Since the installments are paid in lieu of the purchase of land which is a long term asset, the payments will be considered as capital expenditure.

    • Mostly capital expenditures are met out of capital whereas revenue expenditures are met out of revenue receipts. However, payments can be made vice-versa.
    • If an expenditure is incurred by the payer as a capital expenditure, it will remain a capital expenditure even if the amount may be revenue receipt in the hands of the payee.

    For example, a company Marks Ltd. purchases machinery directly from the manufacturer for 50,000. For the manufacturer, the proceeds from the sale of machine are revenue in nature but the amount expended by Marks Ltd. will be categorized as capital expenditure.

    Following conclusion can be inferred from the above explanation:

    *Such transactions may or may not hold true as explained above.

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Astha
AsthaLeader
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CapexCapital ExpenditureOperating ExpenditureOpex
  2. Simerpreet Helpful CMA Inter qualified
    This answer was edited.

    Let me first explain the meaning of both the terms CapEx and OpEx Capital expenditure (in short CapEx) is basically incurred for Fixed assets like building, furniture, machinery, etc., or an intangible asset like Goodwill, patent, etc. This expenses are incurred in order to acquire a new asset or imRead more

    Let me first explain the meaning of both the terms CapEx and OpEx

    Capital expenditure (in short CapEx) is basically incurred for Fixed assets like building, furniture, machinery, etc., or an intangible asset like Goodwill, patent, etc. This expenses are incurred in order to acquire a new asset or improve an existing one or maintain the asset in use.

    Capital expenditure is commonly found in the Cash flow statement under Investing activities as Investment in plant, machinery, equipment, etc.

    Operating Expenditure (in short OpEx) are day-to-day expenses incurred by a firm in order to carry its normal business.

    Expenses such as rent, advertisement, inventory costs, etc.

    Operating Expenses are shown in the income statement of the company as expenses incurred during the period.

    For Example: If a company purchases a printer, the printer would be a capital expenditure and the papers used for the printer would be operating expenditure.

    Difference between CapEx and OpEx

    Example 1: A company wants to lease machinery instead of buying it, in this case buying machinery would be capital expenditure, and leasing the machinery would be an Operating expense.

    Example 2: Buying machinery would cost a company for 50000 and leasing the same would cost 35000. So in this case leasing will be more preferred by a company which means operating expenditure would be preferred instead of a capital expenditure.

    From the point of view of tax treatment operating expenditure is more preferred over Capital expenditure because the expenses incurred during the year are deducted during the same year which reduces the tax levied on net income.

    Some real Examples from the Company Amazon

    This is the cash flow statement of Amazon, where the investing activities shows the capital expenditure incurred by the company during the years.

    This is the income statement of Amazon, it shows the operating expenditure incurred by the company during the year.

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Simerpreet
SimerpreetHelpful
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Impairment
  2. Astha Leader Pursuing CA, BCom (Hons.)
    This answer was edited.

    What is Impairment of Assets? Impairment of assets means a decline in the value of assets due to unforeseen circumstances. Assets are impaired when the carrying value of assets increases its market value or “realizable value”. Impairment can be caused due to factors that are internal or external toRead more

    What is Impairment of Assets?

    Impairment of assets means a decline in the value of assets due to unforeseen circumstances. Assets are impaired when the carrying value of assets increases its market value or “realizable value”.

    Impairment can be caused due to factors that are internal or external to the firm. Internal factors such as physical damage, obsolescence or poor management and external factors such as a change in legal or economic circumstances, increased competition or reduction in asset’s fair value in the market result in impairment.

    Impairment Vs Depreciation

    Asset impairment is often confused with asset depreciation, which is rather a recurring and expected event, unlike impairment that reflects an abrupt decrease in the value of the asset.

    Impairment Loss

    Impairment is always treated as a loss in accounting. It is the amount by which the carrying value or the asset’s book value exceeds its fair market value.

    Before recording Impairment loss, a company must determine the recoverable value of the asset which is higher of the asset’s net realizable value or value in use. Then it is to be compared with the book value of the asset.

    If the carrying value exceeds the recoverable value then the impairment loss is to be recorded at the exceeding value i.e. difference of carrying value and realizable value.

    Example

    Suppose a company Royal Ltd. has an asset with a carrying value of 50,000, which has suffered physical damage. According to the company’s calculation, the asset has a net realizable value of 30,000 and a value in use of 25,000.

    Then, the recoverable value would be higher of the asset’s net realizable value or value in use, i.e., 30,000 which is still lower than the carrying amount of 50,000. Therefore, Royal ltd. will have to record 20,000 (50,000-30,000) as impairment loss.

    This is will increase Royal Ltd’s expenses by 20,000 and decrease the asset’s value by the same amount.

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Astha
AsthaLeader
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Revaluation
  2. Simerpreet Helpful CMA Inter qualified
    This answer was edited.

    Revaluation of Assets is an adjustment made in the carrying value of the fixed asset in case the company finds there is a difference between the current price and the market value of the asset. Generally, the value of the asset decreases due to depreciation but in some cases like inflation in the ecRead more

    Revaluation of Assets is an adjustment made in the carrying value of the fixed asset in case the company finds there is a difference between the current price and the market value of the asset. Generally, the value of the asset decreases due to depreciation but in some cases like inflation in the economy, it may increase. so, in order to know the correct value of the asset Revaluation is to be done.

    Accounting standard allows two models.

    • Cost model
    • Revaluation model

    Under the cost model, the carrying value of fixed assets equals their historical cost less accumulated depreciation and accumulated impairment losses.

    For Example, Amazon ltd purchased a Plant for 5,00,000 on January 1, 2010, with a useful life of 10 years, and uses straight-line depreciation.

    Here, the journal entry would be passed as

    As the useful life of the asset is 20 years, so the yearly depreciation would be

    5,00,000/10 i.e. 50,000.

    So the accumulated depreciation at the end of December 31, 2012, would be 50,000×2= 1,00,000 and

    the carrying amount would be 5,00,000-1,00,000= 4,00,000.

    Under the Revaluation method, the assets are revalued at their current market value. If there is an increase in the value of an asset, the difference between the asset’s market value and current book value is recorded as a revaluation surplus.

    For Example, Amazon ltd purchased an asset two years ago at a cost of 2,00,000. Depreciation @ 10% under straight-line method.

    Therefore, the accumulated depreciation for two years would be 40,000,

    i.e. 20,000 for a year.

    Carrying cost of the asset = 1,60,000

    Assuming, the company revalues its assets and finds that the worth of assets is 1,85,000.

    Under this method, the company needs to record 25,000 as a surplus.

    Accounting entry for the above will be

    Depreciation calculated during the third year would be based on the new carrying value of 1,60,000.

    Therefore, Depreciation for the 3rd year= 1,60,000/3

    = 53,333.33

    Accounting entry:

    Alternatively, the incremental depreciation due to the revaluation i.e. 13,333.33 can be charged to the revaluation surplus account.

    In case, if there is a revaluation loss, the entries would be interchanged.

    In case of admission of a partner, the new partner may not agree with the value of assets as stated in the balance sheet, with time the values may have arisen or may have fallen, so in order to bring them to their correct values revaluation is done so that the new partner doesn’t suffer.

    Where the assets and liabilities are to be shown in the books at the revised (new) values after the admission of the new partner.

    The accounting entries are

    1. For Increase in the value of an asset

    2. For a decrease in the value of an asset

    3. For transfer of profit on revaluation i.e. if the total of credit side exceeds the debit side.

    4. For transfer of loss on revaluation i.e. if the total of debit side exceeds the credit side.

    Note: If the total of both sides is equal it signifies that there is no profit or loss on the revaluation of assets. Hence no entry is to be passed.

    After preparing for the journal entry, a revaluation ledger account is also prepared wherein the accounts carrying a debit balance are transferred to the debit side and the accounts carrying a credit balance are transferred to the credit side.

    In the case of retirement of a partner, the same journal entries are to be passed as in the case of Admission of a partner for revaluation of assets.

    Generally, the value of an asset decreases with time but it may increase in certain circumstances especially in inflationary economies.

    Conclusion

    An entity should do the revaluation of its assets because revaluation provides the present value of assets owned by an entity and upward revaluation is beneficial for the entity and hence the company can charge more depreciation on upward revaluation and can get tax benefits.

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Simerpreet
SimerpreetHelpful
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Cash FlowDepreciation
  2. Astha Leader Pursuing CA, BCom (Hons.)
    This answer was edited.

    Depreciation refers to that portion of the value of an asset that a company uses in an accounting year to generate revenue. Assets are written off in form of depreciation over time also called the useful life of the asset. It denotes the wear and tear of an asset over time. Suppose, a company namedRead more

    Depreciation refers to that portion of the value of an asset that a company uses in an accounting year to generate revenue. Assets are written off in form of depreciation over time also called the useful life of the asset. It denotes the wear and tear of an asset over time.

    Suppose, a company named Johnson ltd. purchases machinery for 50,000 that has a useful life of 5 years with nil salvage value. Then the yearly depreciation to be charged can be calculated as:

    Depreciation calculation with formula

    Is Depreciation a Cash Flow?

    Cash flows are inflows and outflows of cash and cash equivalents in an entity. The payments made by the entity denote the outflows whereas the revenues or incomes of the entity denote the inflows. Talking about cash flows, depreciation is a non-cash item of expense which means it neither results in inflow nor outflow of cash resources.

    In the adjacent Profit and Loss statement, a cash payment of 7,000 for electricity implies outflow of cash however, depreciation of 10,000 is merely an imputed cost to write off an asset or we can say, a part of profits set aside each year so that there are sufficient funds available to procure a new asset after the currently available asset is discarded.

    showing depreciation in profit and loss account

    However, cash flow statements are affected by depreciation. Depreciation is added back to the net profits while calculating cash flows from operating expenses since it is a non-cash item and has been deducted while calculating net profits in the profit and loss statement.

    Depreciation shown in cash flow statement

    Depreciation does not directly impact the amount of cash generated or expended by a business but it is tax-deductible and will reduce the cash outflows related to income taxes. Thus, depreciation affects cash flow by reducing the amount of cash a business has to pay for income taxes.

    depreciation effect on cash flow indirectly

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