AccountingQA Latest Questions

AbhishekBatabyal
AbhishekBatabyalHelpful
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  2. Ayushi Curious Pursuing CA

    Introduction Internal reconstruction refers to the process of restructuring a sick company’s balance sheet by certain methods to turn it financially healthy, thus saving it from potential liquidation. Explanation When a company has been making losses for many years, it has a huge amount of accumulatRead more

    Introduction

    Internal reconstruction refers to the process of restructuring a sick company’s balance sheet by certain methods to turn it financially healthy, thus saving it from potential liquidation.

    Explanation

    When a company has been making losses for many years, it has a huge amount of accumulated losses due to which the reserve and surplus appear at a very low or negative amount in the balance sheet.

    Also, such a company is said to be overcapitalised as it is not able to generate enough returns to its capital.

    As the company is overcapitalised, the assets are also overvalued. The balance sheet also contains many fictitious assets and unrepresented intangible assets.

    The balance sheet of such a ‘sick’ company looks like the following:

    Hence, to save the company from liquidation,

    • its assets and liabilities are revalued and reassessed,
    • its capital is reduced by paying off part of paid-up capital to shareholders or cancelling the paid-up capital.
    • the right of shareholders related to preference dividends is altered,
    • agreements are made with creditors to reduce their claims and
    • fictitious assets and accumulated losses are written off.

    In this way, its balance sheet gets rid of all undesirable elements and the company gets a new life without being liquidated.  This process is known as internal reconstruction.

    Legal compliance

    The internal reconstruction of a company is governed by the provisions of the Companies Act, 2013.

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Aadil
AadilCurious
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  2. Aditi
    This answer was edited.

    Deferred Tax Liability A deferred tax liability represents an obligation to pay taxes in the future. These taxes are owed by a company but are not due to be paid until a future date. Companies that incur such an obligation prepare and maintain two financial reports every year: a tax statement and anRead more

    Deferred Tax Liability

    A deferred tax liability represents an obligation to pay taxes in the future. These taxes are owed by a company but are not due to be paid until a future date.

    Companies that incur such an obligation prepare and maintain two financial reports every year: a tax statement and an income statement.

    This is because companies maintain their books as per book accounting rules (GAAP/IFRS), but they have to pay taxes according to tax accounting rules, and they each have to follow their own guidelines.

    For example, a tax statement follows the cash basis of accounting, and an income statement follows the accrual basis of accounting.

    Companies calculate their profit as per the accounting rules as well as tax laws known as accounting income and taxable income, respectively. Some differences arise due to the application of different provisions of law.

    These temporary differences are accounted for, recognized, and carried forward in the books of accounts and create deferred tax.

     

    Example

    Here is an example of deferred tax liability.

    In the given example, tax as per income statement is 70,000, whereas as per tax statement it is 56,000. This temporary difference is termed as deferred tax liability of 14,000.

    When accounting income is more than taxable income, it creates Deferred Tax Liability. It will be adjusted in the books of accounts during one or more subsequent year(s).

     

     

    How Does it Arise?

    There are several instances under which a company creates a deferred tax liability. Some other instances are:

    Depreciation Methods

    • One of the most common reasons for deferred tax liability is when a company uses different depreciation methods in the Income and Tax Statement.
    • Assets are depreciated by calculating the straight-line method in the Income Statement, while the written-down value method is used in the Tax Statement.
    • Since the straight-line value method produces lower depreciation when compared to the WDV method, accounting income is temporarily higher than taxable income.
    • The company recognises deferred tax liability as this difference between accounting income and taxable income.

    Treatment of Revenue & Expenses

    • Deferred tax liability can also arise when there is a difference in the way revenue and expenses are treated in books of accounts.
    • As mentioned earlier, accounting rules follow the accrual basis of accounting while tax laws follow the cash basis of accounting.
    • Meaning in the tax statement, income and expenses are recorded when they are received or paid, not when they are incurred or realised.
    • This difference in the treatment of revenue and expenses creates deferred tax liability.

     

     

    Impact on Financial Statements

    Recognising deferred tax liability and its subsequent effect on the company’s financial statement is important as it simplifies the process of auditing and analysing financial reports.

    Balance Sheet

    • Deferred tax liabilities are recorded on the liability side of the balance sheet under non-current liabilities.

    Cash Flow Statement

    • The deferred tax liability is added back to the net income in calculating cash flow from operating activities to show the actual cash flow.
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Anushka Lalwani
Anushka Lalwani
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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.

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A_Team
A_Team
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  2. SidharthBadlani CA Inter Student
    This answer was edited.

    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.

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Simerpreet
SimerpreetHelpful
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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.

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Aadil
AadilCurious
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  2. Manvi Pursuing ACCA
    This answer was edited.

    The sole proprietorship is a business that is unincorporated and owned by a single person. The owner of the business invests capital in the business in the form of cash, any asset or stock, or in any other form. In, sole proprietorship owner and business are inseparable. Interest on capital is the aRead more

    The sole proprietorship is a business that is unincorporated and owned by a single person. The owner of the business invests capital in the business in the form of cash, any asset or stock, or in any other form. In, sole proprietorship owner and business are inseparable.

    Interest on capital is the amount paid by the entity/business to the owners. It is an expense to the business and income for the proprietor, and interest is adjusted in the owner’s capital account. It is calculated on an agreed percentage and for a certain period. It is paid before calculating net profit.

    If there is a loss, no interest will be paid on capital.

    Journal Entry for Interest on Capital in Sole Proprietorship:

    1. Interest on capital entry
    Interest on Capital A/c Debit Debit the increase in expense.
        To Owner’s Capital A/c Credit Credit the increase in income.

     

    2. Closing interest on capital account

    Profit and Loss A/c Debit Debit the increase in expense.
        To Interest on Capital A/c Credit Credit the increase in income.

    In sole proprietor’s Profit and Loss A/c interest will be recorded as an expense on the debit side and will be added to the owner’s capital in the Balance Sheet is considered as an adjustment to the capital account.

    For example, A invested Rs 1,00,000 in a business. He wants to adjust 5% interest on his capital, then the entry will be:

    1. Interest on capital entry
    Interest on Capital A/c 5,000
        To Owner’s Capital A/c 5,000

     

    2. Closing interest on capital account

    Profit and Loss A/c 5,000
        To Interest on Capital A/c 5,000

    In the case of a partnership, the treatment is the same as done in a sole proprietorship. The interest rate is agreed upon by the partners and is mentioned in the partnership deed. No interest is provided on the capitals of the partners if not mentioned in the deed.

    If in a particular period, the partnership firm incurs a loss, then no interest will be provided to the partners.

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SidharthBadlani
SidharthBadlani
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  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.

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Vijay
VijayCurious
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  2. Radha M.Com, NET
    This answer was edited.

    Outstanding expenses are those expenses that have been incurred during the accounting period but are yet to be paid. Basically, any expense which has become due for payment but is not paid will be called an outstanding expense. Outstanding expenses are treated as a liability as the business is yet tRead more

    Outstanding expenses are those expenses that have been incurred during the accounting period but are yet to be paid. Basically, any expense which has become due for payment but is not paid will be called an outstanding expense.

    Outstanding expenses are treated as a liability as the business is yet to make payment against them. Examples of outstanding expenses include outstanding rent, salary, wages, etc.

    At the end of the accounting year, outstanding expenses have to be accounted for in the book of accounts so that the financial statements reflect the accurate profit/loss of the business.

    Journal entry for recording outstanding expenses:

    Expense A/c Debit
       To Outstanding Expenses A/c Credit
    (Being expenses outstanding at the end of the year)

    The concerned expense A/c is debited as there is an increase in expenses. Outstanding expenses are a liability, hence they are credited.

    Let me give you a simple example,

    Max, a sole proprietor pays 1,00,000 as salary for his employees at the end of every month. Due to the Covid-19 lockdown, he could not pay his employees’ salaries for March month. So the salary for March (1,00,000) will be treated as an outstanding expense. The following entry is made to record outstanding salaries for the year.

    Salary A/c   1,00,000
       To Outstanding Salaries A/c   1,00,000
    (Being salaries outstanding at the end of the year)

    At the end of the year, outstanding salary will be adjusted in the P&L A/c and it will be shown as a Current Liability in the Balance Sheet.

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AbhishekBatabyal
AbhishekBatabyalHelpful
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  2. Ayushi Curious Pursuing CA

    Introduction A capital reduction account is an account used to pass entries related to the internal reconstruction of a company. During reconstruction, paid-up capital reduced is credited to this account; hence its name is capital reduction account. It is also known as the reconstruction account. TyRead more

    Introduction

    A capital reduction account is an account used to pass entries related to the internal reconstruction of a company. During reconstruction, paid-up capital reduced is credited to this account; hence its name is capital reduction account. It is also known as the reconstruction account.

    Type of account

    A capital reduction account is a temporary account open just to carry out internal reconstruction. It represents the sacrifices made by the shareholders, debenture holders and creditors. Also, any appreciation in the value of assets is credited to this account. It is closed to capital reduction when internal reconstruction is completed.

    Entries passed through capital reduction account

    When paid-up capital is cancelled.

    When paid-up capital is cancelled, the share capital account is debited and the capital reduction account is debited as share capital is getting reduced.

    Share Capital A/c Dr. Amt
    To Capital Reduction A/c Cr. Amt

    When assets and liabilities are revalued

    At the time of internal reconstruction, the gain or loss on revaluation is transferred to the capital reduction account instead of the revaluation reserve.

    Writing off of accumulated losses and intangible assets

    The credit balance of the capital reduction account is used to write off the accumulated losses and intangible assets like goodwill, patents etc which are unrepresented by capital. The capital reduction account is debited and profit and loss account and intangible assets accounts are credited.

    Capital Reduction A/c Dr. Amt
    To Profit and loss A/c Cr. Amt
    To Goodwill/ Patents A/c Cr. Amt

    Treatment in books of account

    The balance in the capital reduction account, whether debit or credit, it is transferred to the capital reduction account. Hence, it doesn’t appear on the balance sheet.

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Aditi
Aditi
In: >

  2. Mehak
    This answer was edited.

    Every business requires research and development to create innovative products for consumers. More innovative and creative products and services are more popular among customers, leading to increased revenue and profits for the business. Creating new products or designing changes and testing existinRead more

    Every business requires research and development to create innovative products for consumers. More innovative and creative products and services are more popular among customers, leading to increased revenue and profits for the business.

    Creating new products or designing changes and testing existing products also forms a part of research and development.

    Examples of Research and Development costs are –

    1. Salaries of employees
    2. Cost of making prototypes
    3. Cost of raw material
    4. Overhead expenses

    Let us now understand how research and development costs are treated in Financial Statements.

    Research and Development Costs are generally shown as an expense in the Income Statement.

    IAS-38

    IAS-38 majorly governs the accounting of research and development costs. There are two phases in R&D:

    • Research: During this phase, costs are incurred for understanding or designing the product. These costs are expensed as incurred costs as there is an uncertainty of a future benefit.
    •  Development: Economic value can be ascertained during this phase and hence, the costs incurred can be capitalized as Intangible assets. To be recognised as intangible assets, the following conditions shall be satisfied:

    1. it is developed with the intention of putting it to use in the future

    2.  the asset shall hold an economic value

    3. the costs can be measured reliably

    Treatment of R&D costs in the Financial statements:

      1. Income statement: Research costs are shown as expenses in the income statement. However, development costs if capitalized as intangible assets can be amortised over time.
      2. Balance Sheet: Capitalised development costs are shown as intangible assets under the Assets head of the Balance Sheet.

    Conclusion

    The above discussion can be summarised as follows:

    1. Research and development is essential for creating innovative and creative products and services.
    2. Accounting standard IAS-38 governs the accounting for Research and Development.
    3. Research costs are usually shown as an expense in the Income statement of the business.
    4.  Development costs when capitalised can be shown as Intangible assets in the Balance Sheet.
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