Year: 2020

Capital Receipt

Capital receipts are the income received by the company which is non-recurring in nature. They are part of the financing and investing activities rather than operating activities. The capital receipts either reduces an asset or increases a liability. The receipts can be generated from the following sources:

• Issue of Shares
• The issue of debt instruments such as debentures.
• Loan taken from a bank or financial institution.
• Government grants.
• Insurance Claim.
• Additional capital introduced by the proprietor.

Revenue Receipt

Revenue Receipts are the receipts which arise through the core business activities. These receipts are a part of normal business operations that is why they occur again and again however its benefit can be enjoyed only in the current accounting year as its effect is short term. The income received from the day to day activities of business includes all the operations that bring cash into the business like:

• Revenue generated from the sale of inventory
• Services Rendered
• Discount Received from the creditors or suppliers
• Sale of waste material/scrap.
• Interest Received
• Receipt in the form of dividend
• Rent Received

An expenditure represents a payment with either cash or credit to purchase goods or services. An expenditure is recorded at a single point in time (the time of purchase), compared to an expense which is allocated or accrued over a period of time. This guide will review the different types of expenditures used in accounting and finance.

Expenditure vs Expense

It’s important to understand the difference between an expenditure an expense. Though they seem similar, they’re actually different and have some important nuances you must know about.

Expenditure: This is the total purchase price of a good or service. For example, a company buys a $10 million piece of equipment that it estimates to have a useful life of 5 years. This would be classified as a $10 million capital expenditure.

Expense: This is the amount that is recorded as an offset to revenues or income on a company’s income statement. For example, the same $10 million piece of equipment with a 5-year life has a depreciation expense of $2 million each year.

Types of Expenditures in Accounting

Expenditures in accounting comprise two broad categories: capital expenditures and revenue expenditures

1. Capital Expenditure

A company incurs a capital expenditure (CapEx) when it purchases an asset with a useful life of more than 1 year (a non-current asset).

In many cases, it may be a significant business expansion or an acquisition of a new asset with the hope of generating more revenues in the long run. Such an asset, therefore, requires a substantial amount of initial investment and continuous maintenance after that to keep it fully functional.  As a result, many companies often finance the project using either debt financing or equity financing.

Because the investment is a capital expenditure, the benefits to the business will come over several years. As a consequence, it cannot deduct the full cost of the asset in the same financial year.  Therefore, it spreads these deductions over the useful life of the asset. The value of this asset will be shown on the balance sheet, under non-current assets, as part of plant, property, and equipment (PP&E).

Example 1

Let’s say Company Y deals with iron sheet manufacturing. Due to the increase in demand for its high profiled iron sheets, the company executives decide to buy a new minting machine to revamp production. They estimate the new machine will be able to improve production by 35%, thus closing the gap in the demanding market. Company Y decides to acquire the equipment at the cost of $100 million. The useful life of the machine is expected to be 10 years.

In this case, it is evident that the benefit of acquiring the machine will be greater than 1 year, so a capital expenditure is incurred. Over time, the company will depreciate the machine as an expense (depreciation).

2. Revenue Expenditure

A revenue expenditure occurs when a company spends money on a short-term benefit (i.e., less than 1 year). Typically, these expenditures are used to fund ongoing operations which, when they are expensed, are known as operating expenses. It is not until the expenditure is recorded as an expense that income is impacted.

Deferred Revenue

Deferred Revenue Expenditure is an expense which is incurred while accounting period. And the result and benefits of this expenditure are obtained over the multiple years in the future. For example, revenue used for advertisement is deferred revenue expenditure because it will keep showing its benefits over the period of two to three years. Thus, the profit and loss account statement is prepared as a periodic statement.

Capital expenditure leads to the purchase of an asset or which increases the earning capacity of the business. The organization derives benefit from such expenditure for a long-term.

For example, the purchase of building, plant and machinery, furniture, copyrights, etc.

On the other hand, revenue expenditure is that from which the organization derives benefit only for a period of one year and it only helps in maintaining the earning capacity of the business.

For example, the cost of raw materials, labour expenses, depreciation on assets, etc. However, there is also one more category of expenses, often referred to as Deferred Revenue Expenditure.

These expenses are revenue in nature but the business derives benefits from these expenses for a period of more than one year.

Though the benefit of these expenses lasts for a number of years, these do not fall under the Capital expenditure. Because these are heavy expenses but do not result in the acquisition of an asset.

The charge of these expenses is proportionately deferred over the period for which its benefits are derived. This is as per the Matching Principle.

Characteristics of Deferred Revenue Expenditure

1. It is revenue in nature.
2. The benefit of this expenditure lasts for a period of more than one accounting year.
3. It pertains wholly or partly for the future years.
4. It is a huge amount of expense and thus, is deferred over a period of time.

Classification of Deferred Revenue Expenditure

1. Expenses partly paid in advance: It is when the firm derives a portion of the benefit in the current accounting year and will reap the balance in the future years. Thus, it shows the balance of the benefit that it will reap in future on the Assetsof the Balance Sheet. For eg. advertising expenditure.
2. Expenditure in respect of services rendered: Such expenditure is considered as an asset as it cannot be allocated to one accounting year. For example, discount on issue of debentures, the cost of research and experiments, etc.
3. Amount relating to exceptional loss: We treat the exceptional losses also as deferred revenue expenditure. For eg. Loss by earthquake or floods, loss by confiscation of property, etc.

Cash Book

A cash book is a financial journal that contains all cash receipts and payments, including bank deposits and withdrawals. Entries in the cash book are then posted into the general ledger. Larger firms usually divide the cash book into two parts: the cash disbursement journal that records all cash payments, such as accounts payable and operating expenses, and the cash receipts journal, which records all cash receipts, such as accounts receivable and cash sales.

A cash book is set up as a ledger in which all cash transactions are recorded according to date. It is a book of original entry and final entry. That is, the cash book serves as the general ledger. There is no need, as in a cash account, to transfer to a general ledger.

Prepare Cash Book           

To prepare a cash book, use the following steps:

1. Download the entity bank statements from online banking. Bank statements usually download as comma separated files so save the file type as an excel workbook.
2. Take out unnecessary columns that you are not going to use.
3. Take out any blank lines between the headers and content so that you have a continuous body of text.
4. Highlight the headers, which should now be in row A, and select the filter option.
5. Filter the data by selecting one type of transaction at a time. For example bank charges may be designated a code such as ‘bnkchg’ on the statement.
6. Now there are two options:

(a) Allocate each type of transaction to a cost code in the first blank column available after the block of text by giving it a name in that row. For example, next to a row with bank charges in, type “Bank charges” in the first blank cell of that row. Now copy this description to all the rows with bank charges in them. Give this column a header and add the filter option to it. Once all the transactions have been allocated, highlight the block of text and create a pivot table by selecting “Pivot Table” from the “Insert” menu. Select the Transaction type as the Row header and the gross amount of the payment as the “Sum of amount” value. This will form a summary of all the bank transactions in a trial balance format.

(b) Instead of allocating a description to each row, create new columns immediately after the block of text to designate each amount to a column, such as ‘bank charges’. Add up the total of each new column and in a second tab, list the columns and their totals to form the base Trial Balance.

Sales Book and Sales Return Book

Sales are a very important aspect of all organizations. Depending on the size of the organization there could be dozens to thousands of sales per day. And so it makes sense to maintain a separate sales book and sales return book.

Sales Book

A Sales Book is a Subsidiary Book and is, therefore, also a book of Original Entry. A Sales Book or Sales Day Book contains the records of all-credit sales of goods. While a Cash Book holds the records of all-cash sales of goods.

We don’t keep record sold assets in the Sales Book. One records that in Journal Proper. We record entries from Source Documents in the Sales Book. Source Documents are Invoices or bills received from the suppliers of goods.

The entries in the Sales Book are also made with the net amount of the invoice. Therefore, Sales Book does not contain a Trade Discount and other details are given on the invoice.

Every month the total of the Sales Book is posted on the Credit side of the Sales A/c. Sales A/c is a ledger A/c. However, the individual accounts of the customers can be posted daily. Also, where the volume of transactions is too large, the entries in the Sales A/c can be posted weekly or fortnightly.

Preparation of Purchase book

Purchase Book

It is also known as a Purchase journal, Invoice book or Purchase day book. Purchase book is a special purpose subsidiary book prepared by a business to record all credit purchases. Nowadays all these recordings occur in ERPs and only small firms resort solely to notebooks or MS-Excel.

Few things to note are,

• Purchases recorded are only for goods or items related to core business operations of a company i.e. goods procured for resale.
• Example: If a grocery business purchases office furniture it will not be posted in the purchases book as it is considered as “purchase of an asset” and not goods.
• Cash purchases are recorded in cash book and credit purchases are recorded in purchase book.

Sample Format of Purchase Book

Capital receipt and revenue receipt, both are the very important components of accounting. It is important to correctly differentiate between the two. Classification of these transactions reflects in the final statements of the company.

Capital Receipt

These have a nature of non-recurrence, besides that, they are situated in the balance sheet in the liabilities portion of them. The capital receipt is always in the interchange for the income. The capital receipt is a kind of cash-flow in the business that does not occur over and over again and this eventually, leads to the creation of liabilities in the future and also, the decrement of assets takes place in the future.

All of the capital receipts are free from taxation unless there is a provision to tax it. Various types of Gifts and loans are the types of the capital receipts that do not attract tax and are tax-free. So, in addition to non-recurring, Capital receipts are those non-routine receipts which either becomes a load and responsibility or cause a vivid depletion in the assets of the government or any organization and business.

The following sources are the generators of the capital receipt:

• Additional capital and mentioned assets introduced by the owner or the possessor
• Debentures and the other  issues of debt instruments
• Loans borrowed from a bank or from a financial institution.
• Various insurance Claims.
• Issue of Shares

So, basically, capital receipts are those that are the derivation of the not so normal operations of a business. Besides that, the effect of capital receipt is depicted in the balance sheet. These receipts are not at all a part of normal operations of government business. For example, a sale of fixed assets, etc.

Revenue Receipt

These receipts are a major source of income for any kind of a business and without it, a business can’t survive for long. This is a result of the normal and core business activities. Being a normal business result is the reason for its recurring nature. However, there is a little shortcoming associated with it. The benefits of revenue receipts are enjoyable only for the current accounting year and not possibly after that.

The income received from the daily and periodic activities of business includes all the operations that indulge cash into the business like:

• The sale of any kind of an inventory
• Income from services rendered
• Different types of discount Received from the suppliers
• Sale of scrap
• Interest received.
• Rent received

To sum it all, Revenue receipts are recurring receipts and their effect is shown on the income statement. For a successful business, both receipts play a prominent role as they both compliments each other.

Opening entry

An opening entry is the initial entry used to record the transactions occurring at the start of an organization. The contents of the opening entry typically include the initial funding for the firm, as well as any initial debts incurred and assets acquired.

When next financial year begins, the accountant passes one journal entry at the beginning of every financial year in which he shows all the opening balance of assets and all the liabilities include capital. After that, the journal entry is called an opening journal entry. Because all assets have a debit balance, so these are debited in an opening journal entry and all liabilities have a credit balance, hence these are credited in an opening journal entry.

Date                                        Particulars                             Amount                   Amount

                                                   Assets A/c                       Dr.      XX      

                                                   Liabilities A/c                                                           XX

                                                   Capital A/c                                                                XX

In case all assets exceed all liabilities, the excess will be the value of capital which is showed credit side in the opening journal entry. If however, liabilities are more than the value of all assets, then the resulting excess will be goodwill and it will be debited in the opening journal entry.

Usually, different of assets and liability will be positive and the excess value of assets will be shown as capital on the credit of journal entry. Figures of opening balances can be obtained by taking a look at the balance sheet of the previous year

Closing entries

A closing entry is a journal entry that is made at the end of an accounting period to transfer balances from a temporary account to a permanent account.

Companies use closing entries to reset the balances of temporary accounts accounts that show balances over a single accounting period to zero. By doing so, the company moves these balances into permanent accounts on the balance sheet. These permanent accounts show a company’s long-standing financials.

Temporary accounts can either be closed directly to the retained earnings account or to an intermediate account called the income summary account. The income summary account is then closed to the retained earnings account. Both ways have their advantages.

Closing all temporary accounts to the income summary account leaves an audit trail for accountants to follow. The total of the income summary account after the all temporary accounts have been close should be equal to the net income for the period.

Closing all temporary accounts to the retained earnings account is faster than using the income summary account method because it saves a step. There is no need to close temporary accounts to another temporary account (income summary account) in order to then close that again.

Both closing entries are acceptable and both result in the same outcome. All temporary accounts eventually get closed to retained earnings and are presented on the balance sheet.

Example of a Closing Entry

Below are examples of closing entries that zero the temporary accounts in the income statement and transfer the balances to the permanent retained earnings account. This is done using the income summary account.

1. Close Revenue Accounts

Clear the balance of the revenue account by debiting revenue and crediting income summary.

2. Close Expense Accounts

Clear the balance of the expense accounts by debiting income summary and crediting the corresponding expenses. 

3. Close Income Summary

Close the income summary account by debiting income summary and crediting retained earnings.

4. Close Dividends

Close the dividends account by debiting retained earnings and crediting dividends. 

Journal

Double entry system of bookkeeping says that every transaction affects two accounts. There is a proper procedure for recording each financial transaction in this system, called as accounting process. The process starts from journal followed by ledger, trial balance, and final accounts. Journal and Ledger are the two pillars which create the base for preparing final accounts. The Journal is a book where all the transactions are recorded immediately when they take place which is then classified and transferred into concerned account known as Ledger.

Journal is also known as book of primary entry, which records transactions in chronological order. On the other hand, Ledger, or otherwise known as principal book implies a set of accounts in which similar transactions, relating to person, asset, revenue, liability or expense are tracked. In this article, we have compiled all the important differences between Journal and Ledger in accounting, in tabular form.

The Journal is a subsidiary day book, where monetary transactions are recorded for the first time, whenever they arise. In this, the transactions are regularly recorded in an orderly manner, so that they can be referred in future. It highlights the two accounts which are affected by the occurrence of the transaction, one of which is debited and the other is credited with an equal amount.

A short note is given in support of each entry, which gives a brief description of the transaction, known as Narration. The complete process of recording the entries in the journal is known as Journalizing. It has five columns which are Date, Particulars, Ledger Folio, Debit, and Credit. A journal can be:

• Single Entry: Entry having one debit and a corresponding credit.
• Compound Entry: Entry having one debit and more than one credit or entry having more than one debit for a single debit or two or more debit and two or more credits. In the case of compound entry, it should be kept in mind that the total of debit and credit will tally.

Ledger

Ledger is a principal book which comprises a set of accounts, where the transactions are transferred from the Journal. Once the transactions are entered in the journal, then they are classified and posted into separate accounts. The set of real, personal and nominal accounts where account wise description is recorded, it is known as Ledger.

While posting entries in the ledger, individual accounts should be opened for each account. The format of a ledger account is ‘T’ shaped having two sides debit and credit. When the transaction is recorded on the debit side the word ‘To’ is added, however, if the transaction is to be recorded on the credit side, then the word ‘By’ is used in the particular column along with the account name.

At the end of the financial year, the ledger account is balanced. For this purpose, first of all, the totals of the two sides is determined, after that, you need to calculate the difference between the two sides. If the amount on the debit side is more than the credit side, then there is a debit balance, but if the credit side is higher than the debit side, then there is a credit balance. Suppose if an account has a debit balance, then you have to write “By Balance c/d” on the credit side with the difference amount. In this way both the sides will tally.

Now, at the beginning of the new period, you have to transfer the opening balance to the opposite side (i.e. On the debit side as per our example) as “To Balance b/d”. Here c/d refers to carried down, and b/d means brought down.

Despite so many similarities, there are some differences between journal and ledger which are shown below;