AccountingQA Latest Questions

Mehak
Mehak
In: >

  2. Mehak

    Everyone must have heard about the term “cooking the books”. This term is generally associated with Creative accounting. In simple words, Creative accounting is a method of accounting in which the management tries to show a better picture of the business than the reality. Let us now understand thisRead more

    Everyone must have heard about the term “cooking the books”. This term is generally associated with Creative accounting. In simple words, Creative accounting is a method of accounting in which the management tries to show a better picture of the business than the reality. Let us now understand this concept in detail.

    What is Creative accounting?

    Creative accounting is a method of accounting in which the management manipulates the books of accounts by finding loopholes to showcase a better image of the business.

    It is a practice of using accounting loopholes to make a company’s financial position look better than it really is. It is not exactly illegal but it is more of a gray area.

    For example, a business may delay reporting expenses to increase the profits to present a better short-term position.

    The goal of creative accounting is to impress the shareholders, investors, get loans or boost stock prices.

    However, this can also be very risky and have serious consequences. It can reduce the trust of the investors and customers. In some cases, like Enron and WorldCom the world has seen how creative accounting lead to legal consequences.

    Common Techniques of Creative Accounting

    Some of the common techniques used by the business to manipulate the financial position are as follows:

    1. Revenue Recognition: Techniques such as recognizing revenue before it is actually earned is a method of creative accounting.
    2. Expense manipulation: Delaying the recognition of expenses to show a better position of the business in a short-term.
    3. Undervaluing liabilities: Undervaluing the liabilities of the business by not recognizing any future costs such as insurance or warranty etc.
    4. Asset Valuation: Overstating the value of asses or high amount of depreciation can be some ways of manipulating the value of assets.
    5. Tax avoidance: This is a way of reducing the tax liability by manipulating the financial statements to lower the profits.
    6. Cookie jar accounting: This is a method in which profits in the good years are saved in excess to use in the years of difficulty.

    Ethical implications of Creative Accounting

    There are several ethical implications with respect to creative accounting. Some of these are discussed below:

    1. Misleading Stakeholders: Creative accounting is a method to mislead the stakeholders including the investors, creditors, government, etc. This can lead to loss of trust.
    2. Loss of trust: The shareholders will lose trust over the company if the manipulation is discovered. Creative accounting breaches the fundamental of honesty.
    3. Non – compliance: Creative accounting leads to the non-compliance of the rules and regulations of the country which requires the businesses to follow certain accounting and reporting standards.
    4. Unfair competition: Creative accounting can make a company look more profitable and stable than it actually is, misleading investors and customers. This can leave honest businesses, who follow the rules, at a disadvantage.
    5. Moral responsibility: Management and business has the moral responsibility of working in the best interest of the society and the stakeholders.

    Conclusion

    The key takeaways from the above discussion are as follows:

    1. Creative accounting is the practice of using accounting loopholes to make a company’s financial position look better than it really is.
    2. The goal of creative accounting is to impress the shareholders, and investors, get loans, or boost stock prices.
    3. Revenue recognition, expense manipulation, and asset valuation are some of the common techniques of Creative accounting.
    4. The ethical implications of creative accounting include misleading stakeholders, eroding trust, compromising regulatory compliance, promoting unfair competition, neglecting moral responsibility, etc.

     

    See less
    • 0
Simerpreet
SimerpreetHelpful
In: >

Working Capital
  2. Astha Leader Pursuing CA, BCom (Hons.)
    This answer was edited.

    Let us first understand what working capital is. Working capital means the funds available for the day-to-day operations of an enterprise. It is a measure of a company’s liquidity and short term financial health. They are cash or mere cash resources of a business concern. It also represents the exceRead more

    Let us first understand what working capital is.

    Working capital means the funds available for the day-to-day operations of an enterprise. It is a measure of a company’s liquidity and short term financial health. They are cash or mere cash resources of a business concern.

    It also represents the excess of current assets, such as cash, accounts receivable and inventories, over current liabilities, such as accounts payable and bank overdraft.

    working capital formula

    Sources of Working Capital

    Any transaction that increases the amount of working capital for a company is a source of working capital.

    Suppose, Amazon sells its goods for $1,000 when the cost is only $700. Then, the difference of $300 is the source of working capital as the increase in cash is greater than the decrease in inventory.

    Sources of working capital can be classified as follows:

    short term and long term sources of working capital

    Short Term Sources

    • Trade credit: Credit given by one business firm to the other arising from credit sales. It is a spontaneous source of finance representing credit extended by the supplier of goods and services.
    • Bills/Note payable: The purchaser gives a written promise to pay the amount of bill or invoice either on-demand or at a fixed future date to the seller or the bearer of the note.
    • Accrued expenses: It refers to the services availed by the firm, but the payment for which is yet to be done. It represents an interest-free source of finance.
    • Tax/Dividend provisions: It is a provision made out of current profits to meet the tax/dividend obligation. The time gap between provision made and payment of actual payment serves as a source of short-term finance during the intermediate period.
    • Cash Credit/Overdraft: Under this arrangement, the bank specifies a pre-determined limit for borrowings. The borrower can withdraw as required up to the specified limits.
    • Public deposit: These are unsecured deposits invited by the company from the public for a period of six months to 3 years.
    • Bills discounting: It refers to an activity wherein a discounted amount is released by the bank to the seller on purchase of the bill drawn by the borrower on their customers.
    • Short term loans: These loans are granted for a period of less than a year to fulfil a short term liquidity crunch.
    • Inter-corporate loans/deposits: Organizations having surplus funds invest with other organizations for up to six months at rates higher than that of banks.
    • Commercial paper: These are short term unsecured promissory notes sold at discount and redeemed at face value. These are issued for periods ranging from 7 to 360 days.
    • Debt factoring: It is an arrangement between the firm (the client) and a financial institution (the factor) whereby the factor collects dues of his client for a certain fee. In other words, the factor purchases its client’s trade debts at a discount.

    Long Term Sources

    • Retained profits: These are profits earned by a business in a financial year and set aside for further usage and investments.
    • Share Capital: It is the money invested by the shareholders in the company via purchase of shares floated by the company in the market.
    • Long term loans: These loans are disbursed for a period greater than 1 year to the borrower in his account in cash. Interest is charged on the full amount irrespective of the amount in use. These shareholders receive annual dividends against the money invested.
    • Debentures: These are issued by companies to obtain funds from the public in form of debt. They are not backed by any collateral but carry a fixed rate of interest to be paid by the company to the debenture holders.

    Another point I would like to add is that, although depreciation is recorded in expense and fixed assets accounts and does not affect working capital, it still needs to be accounted for when calculating working capital.

    See less
    • 0
Radha
Radha
In: >

  2. PriyanshiGupta Graduated, B.Com
    This answer was edited.

    Yes, Capital Work in Progress is Tangible Asset. To attain an understanding of the same, we first need to understand what are tangible assets. Assets that have a physical existence, that is they can be seen, touched are called Tangible Assets. Capital work in progress is the cost incurred on fixed aRead more

    Yes, Capital Work in Progress is Tangible Asset.

    To attain an understanding of the same, we first need to understand what are tangible assets. Assets that have a physical existence, that is they can be seen, touched are called Tangible Assets.

    Capital work in progress is the cost incurred on fixed assets that are under construction as on the balance sheet date. Since the asset cannot be used for operation it cannot be classified as a Fixed Asset.

    For example:

    If an asset takes 1.5 years to be constructed as on 1.4.2020 then on the balance sheet date 31.3.2021, the cost incurred on the asset will be classified as Capital Work in Progress.

    Common examples of Capital Work in Progress include immovable assets like Plant and Machinery, Buildings.

    It is shown under the head Non-Current Assets in the balance sheet. Examples of cost included in Capital Work in Progress can be:

    • Advance payment to the contractor
    • Material used/purchased
    • Cost of labor incurred, etc.

    Since the assets under the head Capital Work in Progress are in the process of completion and not completed, hence they are not depreciable until completed. Once the asset is completed it is moved under the head Fixed Assets.

    Capital Work in Progress is shown in the Balance Sheet as:

     

    See less
    • 0
Anushka Lalwani
Anushka Lalwani
In: >

ReservesRevenue Reserve
  2. Rahul_Jose Aspiring CA currently doing Bcom
    This answer was edited.

    A revenue reserve is a type of reserve where a portion of the net profit is set aside for future requirements. It serves as a great source of internal finance for the company to meet its short term requirements. The funds put into this reserve are earned from the daily operations of a company. RevenRead more

    A revenue reserve is a type of reserve where a portion of the net profit is set aside for future requirements. It serves as a great source of internal finance for the company to meet its short term requirements. The funds put into this reserve are earned from the daily operations of a company. Revenue reserves are shown on the liabilities side of a balance sheet under reserves and surplus. Some examples of revenue reserve are :

    • General Reserve: This reserve is used for no specific purpose, but the general financial growth of the company. It is a free reserve which means the company is not compelled to make one. It helps to curb future losses which may arise in the future.
    • Specific Reserve: These are those reserves that can only be used for specific purposes. This money cannot be used for any other requirement. It is not a free reserve. A reserve created to redeem debentures would be called a debenture redemption reserve.
    • Secret Reserve: This is a type of reserve whose existence is not disclosed in the balance sheet. This type of reserve cannot be created by joint-stock companies. However, banks and financial institutions are allowed to create such secret reserves.

    Retained Earnings is that part of the net profit which is left after the distribution of dividends to shareholders. This amount can be invested in the company to gain profits. It is not technically a reserve as it is held after distribution of dividends but it can still be used as one.

    On the other hand, a capital reserve is not a part of the revenue reserve. It is created from capital profits to finance long term projects of a company. It is used for specific purposes only.

    See less
    • 0
Karan
Karan
In: >

Difference BetweenFixed CapitalFluctuating Capital
  2. Radhika
    This answer was edited.

    Capital Accounts record transactions of owners of a business and typically includes amount invested, retained, and withdrawn from the business. In the case of a partnership firm, there are multiple capital accounts as multiple people own the business. Capital Accounts in a partnership firm can be ofRead more

    Capital Accounts record transactions of owners of a business and typically includes amount invested, retained, and withdrawn from the business. In the case of a partnership firm, there are multiple capital accounts as multiple people own the business.

    Capital Accounts in a partnership firm can be of two types:

    • Fixed Capital Account
    • Fluctuating Capital Account

    A fixed Capital Account is one where only non-recurring transactions related to capital accounts are recorded. For example:

    • Capital introduced
    • Capital withdrawn/ Drawings

    For transactions that are recurring in nature like interest on capital, the interest of drawings a separate account called Partner’s Current Account is created.

    Fluctuating Capital Accounts are the ones where there is a single account to record all types of transactions related to the partner’s capital account, whether recurring or nonrecurring.

    Fixed Capital Accounts are usually created in cases where there are numerous recurring transactions and partners want to keep a record of the fixed amount invested in the business by all the partners at any point in time.

    Fluctuating Capital Account is usually created in cases where the number of recurring transactions is not high or partners want to keep a record of the amount due to all the partners in business at any point in time.

    However, the decision to choose what kind of capital account should be implemented in the firm is complete with the partners. They may choose whatever they think is a more suitable fit.

    To summarise the difference between the two following table can be used:

    Fixed Capital Account Fluctuating Capital Account
       
    Non-recurring transactions are recorded. Recurring transactions are recorded.
    Created where the number of recurring transactions is high to maintain a separate record. Created where the number of recurring transactions is low.
    Examples:

    ·       Capital introduced

    ·       Capital withdrawn

    		 Examples:

    ·       Interest on capital

    ·       Interest in drawings

     

     

    See less
    • 0
SidharthBadlani
SidharthBadlani
In: >

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

    Definition Net profit is defined as the excess of revenues over expenses during a particular period. For a business i.e. company/firm, it is a liability towards shareholders/promoters/partners/proprietors, etc. as it is their capital that has earned these profits. When the result of this computationRead more

    Definition

    Net profit is defined as the excess of revenues over expenses during a particular period.
    For a business i.e. company/firm, it is a liability towards shareholders/promoters/partners/proprietors, etc. as it is their capital that has earned these profits.

    When the result of this computation is negative it is called a net loss.

    Net profit may be shown before or after tax.

    Formula :
    Total Revenues – Expenses
    Or
    Total Revenues – Total Cost ( Implicit And Explicit Cost )

    Liabilities

    It means the amount owed (payable) by the business. liability towards the owners ( proprietor or partners ) of the business is termed an internal liability.

    On the other hand, liability towards outsiders, i.e., other than owners ( proprietors or partners ) is termed as an external liability. For example – taxes owned, trade payables, etc.
    For example creditors, bank overdrafts, etc.

    Assets

    An asset is a resource owned or controlled by a company and will benefit the business in current and future periods.
    In other words, it’s something that a company owns or controls and can use to generate profits today and in the future.

    For example – cash, building, etc.

    Why debtors are treated as a liability?

    Now let me explain to you why net profits are treated as a liability and not as an asset because of the following characteristics :

    • Net Profit shows the credit balance of the Profit And Loss Account.

    • It is treated directly in the balance sheet by adding or subtracting from the capital.

    • Net Profit is a measure of the profitability of the company after taking into consideration all costs incurred during the accounting period.

    • Net profit is the last line in an income statement and is the figure that concerns most people who use such a statement.

    • Net income is reported on the income statement (profit and loss account) and forms a key indicator of a company’s performance.

    Importance Of Net Profit

    Now I will let you know the importance of net profit which is as follows :

    Owners
    Net profit allows owners to calculate the tax to be paid and how much earnings need to be distributed to the business owners.

    Investors
    Investors need to see net profit as they need to access the risk before investing they basically judge the revenue-generating capacity of a firm based on net profit.

    Competitors
    For making the comparison competitors tend to look at the net profit of the company to know how are they performing in the industry so that they can build themselves strong.

    Creditors
    Creditors look at the net profit for the purpose of obtaining business loans or we can say that determines a prospective debtor’s capacity to pay future debts.

    Conclusion

    Now after the above explanation, we can say that,
    Net Profit is shown on the liability side as it belongs to shareholders so the company has to give it to shareholders so we are showing it under the liability side.

    Net Profit with respect to the company is a liability as it has to pay it to shareholders.

    Net Profit with respect to shareholders is an asset.

    See less
    • 0
Anushka Lalwani
Anushka Lalwani
In: >

ReservesRevenue Reserve
  2. PriyanshiGupta Graduated, B.Com
    This answer was edited.

    Profits earned by a firm are not completely distributed to its owners, some of the profits are retained for various purposes. Reserves are profits that are apportioned or set aside to use in the future for a specific or general purpose. Reserves follow the Conservative Principle of accounting.  ReveRead more

    Profits earned by a firm are not completely distributed to its owners, some of the profits are retained for various purposes. Reserves are profits that are apportioned or set aside to use in the future for a specific or general purpose. Reserves follow the Conservative Principle of accounting. 

    Revenue reserve is created from the net profits of a company during a financial year. Revenue reserve is created from revenue profit that a company earns from the daily operations of the business.

    Various types of reserves are:

    • Capital Redemption Reserve: It is created to issue fully paid bonus shares or reduction of capital in accordance with Article 3 of the Companies Act, 2013.
    • General Reserve: It is a reserve created to provide for various requirements of the company from time to time.
    • Debenture Redemption Reserve: It is required by the Companies Act, 2013 to transfer the amount of debentures that are going to be redeemed in the following year to minimize the risk of default.
    • Securities Premium Reserve: When shares and debentures are issued at a price higher than the book value, then such higher amount is transferred to Securities Premium Reserve
    • Revaluation Reserve: It is created to revalue the assets and liabilities and provide for gain or loss.

    Different parts of profit are apportioned to create a different reserve and those reserves can only be used for purposes as defined.

    While accounting for Revenue Reserve, the profit decided to transfer to Revenue Reserve are first transferred to Profit and Loss Appropriation Account and then to Revenue Reserve Account. In the balance sheet, Revenue Account is shown under the Capital and Reserves head.

    Liabilities Amount Amount
    Share Capital
    Reserve and Surplus
    General Reserve
    Capital Redemption Reserve
    Securities Premium Account
    Profit and Loss Account

    Uses of Revenue Reserve:

    • Revenue Reserves are created to expand business or for meeting contingencies that may arise in the future.
    • It can also be used to distribute dividends or bonus shares to its shareholders.

    Example:

    Given that Revenue Reserve Account stands at Rs 1,00,000 and the company wants to distribute Rs. 40,000 as dividend to its shareholders. The treatment of this transaction in the financial statements will be-

    Particulars                                                                                                                           Amount (Rs.)

    Revenue Reserve Account                                                                                                    1,00,000

    (less) Dividend distributed                                                                                                    (40,000)

    The amount shown in Balance Sheet                                                                                    60,000

     

     

    See less
    • 0
Jayesh Gupta
Jayesh GuptaCurious
In: >

  2. AbhishekBatabyal Helpful Pursuing CA, BCOM (HONS)
    This answer was edited.

    Capital Redemption Reserve is a statutory reserve, which means it is mandatory for a company to create such reserve when it decides to redeem its preference shares. Capital Redemption Reserve cannot be utilised for any purpose other than the issue of bonus shares. Now let’s understand the reason behRead more

    Capital Redemption Reserve is a statutory reserve, which means it is mandatory for a company to create such reserve when it decides to redeem its preference shares. Capital Redemption Reserve cannot be utilised for any purpose other than the issue of bonus shares.

    Now let’s understand the reason behind it.

    We know preference shares are those shares that carry some preferential rights:

    • Dividend at a fixed rate
    • Right to get repaid before equity shareholders in event of winding up of the company
    • Other rights as specified in the Articles of Associations.

    Also, unlike equity shares, preference shares are redeemable i.e. repaid after a period of time (which cannot be more than 20 years).

    Generally, the creditors of a company have the right to be repaid first. So, in event of redemption of preference shares, the preference shareholders are repaid before creditors and the total capital of the company will but the total debt of the company is unaffected.

    The gap between the debt and equity of the company will further widen and this will also increase the debt-equity ratio of the company. It will be perceived to be a risky scenario by the creditors and lenders of the company because the

    So to protect the creditor and lender, Section 55 of the Companies Act comes to rescue.

    Section 55 of the Companies Act ensure that the creditors and lenders of a company do not find themselves in a riskier situation when the company decides to redeem its preference shares by making it mandatory for a company to either

    • issue new shares to fund the redemption of preference shares

    OR

    • create a capital redemption reserve if it uses profits for redemption

    OR

    • a combination of both

    This will fill up the void created by the redemption of preference shares and the debt-equity ratio will remain unaffected. Keeping an amount aside in Capital Redemption Reserve ensures that such amount will not be used for dividend distribution and capital will be restored because it can be only used to issue bonus shares.

    In this way the debt-equity ratio remains the same, the interest of the creditors and lenders secured.

    Bonus shares are fully paid shares that are issued to existing shareholders at no cost.

    Let’s take a numerical example for further understanding:

    ABC Ltd wants to redeem its 1,000 9% Preference shares at a face value of Rs 100 per share. It has decided to issue 8,000 equity shares @Rs 10 per share and use the profit and reserves to fund the deficit.

    The journal entries will be as follows:

    Working note:                                                                            Rs

    9% preference shares due for redemption (1,000 x 10) – 1,00,000

    Less: Amount of new shares issued (8,000 x 10)           –      80,000

    Amount to be transferred to CRR                                              20,000

    Hence, the reduction of total capital by Rs 1,00,000 due to the redemption of preference shares is reversed by issuing equity shares of Rs 80,000 and creating a Capital Redemption Reserve of Rs 20,000.

     

    See less
    • 0
Jayesh Gupta
Jayesh GuptaCurious
In: >

  2. Ayushi Curious Pursuing CA

    External liabilities are the amounts which a business is obliged to pay to the outsiders (who are not owners of the business). Here is the list of external liabilities:- Accounts payable ( trade creditors and bills payables) Loan taken from outsiders Loan from bank Debentures Public deposits accepteRead more

    External liabilities are the amounts which a business is obliged to pay to the outsiders (who are not owners of the business).

    Here is the list of external liabilities:-

    1. Accounts payable ( trade creditors and bills payables)
    2. Loan taken from outsiders
    • Loan from bank
    • Debentures
    • Public deposits accepted
    1. Outstanding expenses
    • Outstanding salary
    • Outstanding rent
    • Outstanding tax
    1. Interest due on loans taken from outsiders

    The list is not exhaustive.

    Just for more understanding, internal liabilities are those liabilities which a business is supposed to pay back to its owners.  Such as capital balance, profit surplus etc.

    See less
    • 0

Most Helping Users

Astha

Astha

Leader
Simerpreet

Simerpreet

Helpful
AbhishekBatabyal

AbhishekBatabyal

Helpful