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 neitherassets 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 debtsaccounts 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 baddebts and bad debts recovered which are as follows:-
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
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.
Introduction Definition of prepaid expenses Definition of Current assets and Current Liabilities with examples Current Assets or Current Liabilities How to classify prepaid expenses for business owners and financial professionals. Answer the question "is it a CA or CL and don't forget to explain whyRead more
Introduction
Definition of prepaid expenses
Definition of Current assets and Current Liabilities with examples
Current Assets or Current Liabilities
How to classify prepaid expenses for business owners and financial professionals.
Answer the question “is it a CA or CL and don’t forget to explain why”.
Why are they CA and not why CL this question must be answered.
Accounting treatment of prepaid expenses
How prepaid expenses are recorded in financial statements
The impact of classifying prepaid expenses as current assets or current liabilities on a company’s financial statements
Conclusion
Recap of the main points discussed
Importance of proper classification of prepaid expenses for accurate financial reporting
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side. The profit is shown as the credit balance of profit and loss A/c. When the sum of itRead more
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side.
The profit is shown as the credit balance of profit and loss A/c. When the sum of items on the debit side of a profit and loss account is less than the sum of those on the credit side, it implies profit while when the sum of the items on the credit side is less than the sum of those on the debit side, it implies a loss for the entity.
The Reason for Credit
Profit is recorded as an increase in equity
To understand the reason why profit is recorded as a credit balance, we must first understand the basic principle of debit and credit.
The basic principle of debits and credits is that debits increase asset accounts and decrease liability and equity accounts while credits decrease asset accounts and increase liability and equity accounts.
The revenue that a company earns is credited to the income account and increases equity.
The expenses that a company incurs to earn that revenue are debited to the expense account and decrease equity.
The difference between revenue and expenses is the profit, which is recorded as an increase in equity.
Increase in equity due to revenue – decrease in equity due to expense = profit
Gross Profit Vs Net Profit
Revenue is the total income that a business or profession earns. Profit is the excess revenue that remains after reducing all expenses from it.
Gross profit is the profit that a company earns after reducing the cost of goods sold from sales revenue while net profit is the profit that a business earns after reducing the total of all its direct and indirect expenses from its direct as well as indirect allowable business income.
Conclusion
The basic principle of debit and credit governs the classification of profit as a debit or credit. Since profit increases our equity, it is a credit.
In the case of a company, it belongs to the shareholders. It is usually recorded in the retained earnings account. Profit can be reinvested in the business or can be distributed as a dividend. In the case of a sole proprietorship, the profit belongs to the owner and is recorded in the owner’s capital account.
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and otherRead more
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs.when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and other such things.
Instructions – you can delete it after done with the answer. Points which can be covered, not necessary to cover all but you can take what you want leave out rest. Introduction: Definition of trial balance Importance of trial balance in accounting Purpose of trial balance: To verify the arithmeticalRead more
Instructions – you can delete it after done with the answer.
Points which can be covered, not necessary to cover all but you can take what you want leave out rest.
Introduction:
Definition of trial balance
Importance of trial balance in accounting
Purpose of trial balance:
To verify the arithmetical accuracy of the ledger
To ensure that all transactions are recorded
To identify any unbalanced entries in the ledger
How trial balance is prepared:
Step 1: Gather all ledger accounts and their balances
Step 2: Arrange the accounts in order of their nature (assets, liabilities, equity, income, and expenses)
Step 3: Total the debit balances and credit balances separately
Step 4: Compare the total debit balances with the total credit balances
Types of trial balance:
Unadjusted trial balance: prepared before adjusting entries are made
Adjusted trial balance: prepared after adjusting entries are made
Post-closing trial balance: prepared after closing entries are made
Is bad debt an asset?
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
Accounting methods
There are two methods for accounting for bad debts which are mentioned below:-
Accounting treatment
Now let me try to explain to you the accounting treatment for bad debts which is as follows :
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:-
See lessCan you share a list of current assets?
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:-
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:-
Here is an extract of the balance sheet showing current assets
See lessAre prepaid expenses an asset?
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.
See lessPrepaid expenses is current assets or current liabilities?
Introduction Definition of prepaid expenses Definition of Current assets and Current Liabilities with examples Current Assets or Current Liabilities How to classify prepaid expenses for business owners and financial professionals. Answer the question "is it a CA or CL and don't forget to explain whyRead more
Introduction
Current Assets or Current Liabilities
Accounting treatment of prepaid expenses
Conclusion
See lessProfit is debit or credit?
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side. The profit is shown as the credit balance of profit and loss A/c. When the sum of itRead more
The profit earned by an entity is determined through the profit and loss account. All the expenses are recorded on the debit side of the profit and loss account while all the incomes are recorded on the credit side.
The profit is shown as the credit balance of profit and loss A/c. When the sum of items on the debit side of a profit and loss account is less than the sum of those on the credit side, it implies profit while when the sum of the items on the credit side is less than the sum of those on the debit side, it implies a loss for the entity.
The Reason for Credit
Profit is recorded as an increase in equity
To understand the reason why profit is recorded as a credit balance, we must first understand the basic principle of debit and credit.
The basic principle of debits and credits is that debits increase asset accounts and decrease liability and equity accounts while credits decrease asset accounts and increase liability and equity accounts.
The revenue that a company earns is credited to the income account and increases equity.
The expenses that a company incurs to earn that revenue are debited to the expense account and decrease equity.
The difference between revenue and expenses is the profit, which is recorded as an increase in equity.
Increase in equity due to revenue – decrease in equity due to expense = profit
Gross Profit Vs Net Profit
Revenue is the total income that a business or profession earns. Profit is the excess revenue that remains after reducing all expenses from it.
Gross profit is the profit that a company earns after reducing the cost of goods sold from sales revenue while net profit is the profit that a business earns after reducing the total of all its direct and indirect expenses from its direct as well as indirect allowable business income.
Conclusion
The basic principle of debit and credit governs the classification of profit as a debit or credit. Since profit increases our equity, it is a credit.
In the case of a company, it belongs to the shareholders. It is usually recorded in the retained earnings account. Profit can be reinvested in the business or can be distributed as a dividend. In the case of a sole proprietorship, the profit belongs to the owner and is recorded in the owner’s capital account.
See lessWhat is the meaning of accrual in accounting with example?
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and otherRead more
Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made. The most common accrual accounting examples are sales on credit, purchases on credit, rent paid, electricity expense, depreciation, audit fees, and other such things.
See lessWhy is trial balance prepared?
Instructions – you can delete it after done with the answer. Points which can be covered, not necessary to cover all but you can take what you want leave out rest. Introduction: Definition of trial balance Importance of trial balance in accounting Purpose of trial balance: To verify the arithmeticalRead more
Instructions – you can delete it after done with the answer.
Points which can be covered, not necessary to cover all but you can take what you want leave out rest.