Similarly, someone asked Are loose tools current assets
Similarly, someone asked Are loose tools current assets
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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:
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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.
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All expenses whose benefits are received over the years or the expenses or losses that are to be written off over the years are classified as Deferred revenue expenses. It includes fictitious expenses like preliminary expenses, loss on issue of debentures, advertising expenses, loss due to unusual oRead more
All expenses whose benefits are received over the years or the expenses or losses that are to be written off over the years are classified as Deferred revenue expenses. It includes fictitious expenses like preliminary expenses, loss on issue of debentures, advertising expenses, loss due to unusual occurrences like loss due to fire, theft, and research and development expenses, etc.Â
DEFERRED REVENUE EXPENSES
There are certain expenses which are revenue in nature (i.e. expenses incurred to maintain the earning capacity of the firm and generate revenue) but whose benefits are received over a period of years generally between 3 to 7 years. It means its benefit is received not only in the current accounting period but over a few consecutive accounting periods.
CHARACTERISTICS
- Revenue in nature
- Benefits received for more than one accounting period.
- Huge expenditure (large amount is involved)
- Affects the profitability of the business (since a large amount is involved if charged in the same accounting period, then it will decrease the profitability for the year)
- Written off over the years either partially or entirely.
- Fictitious asset It doesn’t result in the creation of any asset but is shown as an asset (fictitious asset) on the Balance Sheet till fully written off.
EXAMPLES
ADVERTISING EXPENSES refers to the expenses incurred for promoting the goods or services of the firm through various channels like TV, Social media, Hoardings, etc.
As the benefit of advertising is not received not only in the period when such expenses were incurred but also in the coming few years, it is classified as Deferred revenue expense.
For example –Â Suppose the company incurred $10 lakh on advertising to introduce a new product in the market and estimated that its benefit will last for 4 years. In this case, $250,000 will be written off every year, for 4 consecutive years.
EXCEPTIONAL LOSSESÂ are losses that are incurred because of some unusual event and don’t happen regularly like loss from fire, theft, earthquake, flood or any other natural disaster, confiscation of property, etc.
Since these losses can’t be written off in the year they occurred they are also treated as Deferred revenue expenditure and are written off over the years.
RESEARCH AND DEVELOPMENT EXPENSESÂ are expenses incurred on researching and developing new products or improving the existing ones. Its benefits are received for many years and thus are classified as Deferred revenue expenses.
For example –Â Expenses incurred on the creation of intangible assets like patents, copyrights, etc.
PRELIMINARY EXPENSESÂ are those expenses which are incurred before the incorporation and commencement of the business. It includes legal fees, registration fees, stamp duty, printing expenses, etc.
These expenses are fictitious assets and are written off over the years.
TREATMENT
It is debited to the P&L amount (amount written off that year) and the remaining amount on the Aeest side of the Balance Sheet.
In the above example of advertising expenses, in Year 1, $250,000 will be debited in the P&L A/c and the remaining amount of $750,000 is shown on the Asset side of the Balance Sheet.
In Year 2, $250,00 in P&L A/c and the remaining $500,000 in Balance Sheet.
In Year 3, $250,000 in P&L A/c and the remaining $250,000 in the Balance Sheet and in the last Year 4, only the remaining amount of $250,000 in P&L A/c and nothing in the Balance Sheet.
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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:Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Rs
9% preference shares due for redemption (1,000 x 10) – 1,00,000
Less: Amount of new shares issued (8,000 x 10)Â Â Â Â Â Â –Â Â Â Â Â 80,000
Amount to be transferred to CRRÂ Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 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.
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Outstanding Income is the income that is due and is being earned but not yet received. The person/ firm has the legal rights to receive that part of the income which it has earned. Outstanding Income is an Asset Account for the business/ the person. According to the modern approach, for Asset AccounRead more
Outstanding Income is the income that is due and is being earned but not yet received. The person/ firm has the legal rights to receive that part of the income which it has earned.
Outstanding Income is an Asset Account for the business/ the person.
According to the modern approach, for Asset Account:
- When there is an increase in the Asset, it is Debited.
- When there is a decrease in Asset, it is Credited.
So the journal entry  will be-
For Example, Mr. Rashid works as a laborer in a factory and he earns wages @Rs 500/day.
So by the end of the week, he receives a payment of Rs 3000 of Rs 3500 i.e. he receives payment of 6 days instead of 7 days. So here Rs 500 would be an outstanding income of Mr. Rashid as he has earned that income but has not received it yet.
Journal Entry –
Another example, Yes Bank gave a loan of Rs 10,00,000 to company Ford @ 10% as interest payable monthly. The interest for one month i.e. Rs 1,00,000 has not been received by Yes Bank which is being due. So it will be outstanding income for Yes Bank since it is due but not yet received.
Journal entry-
Accounting Treatment for Outstanding Income-
- Treatment in Income Statement
The Outstanding Income is shown on the credit side of the income statement as the income is earned for the current year but not yet received.
- Treatment in Balance Sheet
Outstanding Income is an Asset for the business and hence shown on the Assets side of the balance sheet.
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The term ‘bad debt’ and ‘write off’ are often used together in a sentence but they have different meanings. First, we will discuss them in brief to understand the differences between them. Bad debts We know, debtors for a business are their assets because the business has the right to receive moneyRead more
The term ‘bad debt’ and ‘write off’ are often used together in a sentence but they have different meanings. First, we will discuss them in brief to understand the differences between them.
Bad debts
We know, debtors for a business are their assets because the business has the right to receive money from the debtors due to the goods supplied to them.
But if due to circumstances, there appears no probability that the amount due to one or more debtors will be realised to the business, then such debts are categorised as bad debts.
In short, bad debts refer to the amount of money that will not be received from some debtors of the business due to some circumstances like insolvency of debtor etc.
Bad debt is deducted from debtors account by the following journal entry:
Bad debts A/c Dr. Amt To Debtors A/c Cr. Amt (Being bad debts written off from debtors) As bad debts are losses to a business, it is ultimately written off from the profit and loss account.
Profit and loss A/c Dr. Amt To Bad debts A/c Cr. Amt (Being bad debts written off to profit and loss account) Write off
In layman terms, write off means to deduct something out from something. In accounting, write off means to deduct or reduce value of assets by crediting it to a liability account which is usually a reserve account or the profit and loss account.
It also refers to the elimination of an item from the books of accounts particularly losses and expenses.
Generally, writing off is associated with the following:
- Bad debts.
- Damaged Inventories.
- Loss on issue or redemption of debentures.
- Preliminary expenses.
- Bad loans and advances.
Write off can be done in one of the following methods:
- Direct write-off: The write off is directly done by crediting asset account or loss account and debiting the reserve or P/L account.
- Indirect write-off: Here, an intermediate account is involved between the asset account and liabilities account. A common example is writing off of bad debts where the bad debts account is the intermediate account.
Hence, the following differences can be observed between bad debts and write off or writing off:
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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.
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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:-
- Accounts payable ( trade creditors and bills payables)
- Loan taken from outsiders
- Loan from bank
- Debentures
- Public deposits accepted
- Outstanding expenses
- Outstanding salary
- Outstanding rent
- Outstanding tax
- 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.
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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.
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 Sources
Long Term Sources
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.
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