Accounts receivables are classified as Current Assets.

For recording a journal entry for a sale on account, one must Receivables A/C .DR To, Revenue A/C When the customer pays off their accounts, one Cash A/C ..DR To Receivables A/C

Debit Memos
When you enter a debit memo in the Transactions window, Receivables creates the following journal entries:
DR Receivables CR Revenue (if you enter line amounts) CR Tax (if you charge tax) CR Freight (if you charge freight) CR Finance Charges

DR Receivables

Receipts
When you enter a receipt and fully apply this receipt to an invoice, Receivables creates the following journal entry:
DR Cash CR Receivables

When you enter an unapplied receipt, Receivables creates the following journal entry:
DR Cash CR Unapplied

When you enter an unidentified receipt, Receivables creates the following journal entry:
DR Cash CR Unidentified

Credit Memos
When you credit an invoice, debit memo, or chargeback through the Credit Transactions window, Receivables creates the following journal entry:
DR Revenue DR Tax (if you credit tax) DR Freight (if you credit freight) CR Receivables (Credit Memo) DR Receivables (Credit Memo) CR Receivables (Invoice)

Accrued income is income which has been earned but not yet received. Income must be recorded in the accounting period in which it is earned. Therefore, accrued income must be recognized in the accounting period in which it arises rather than in the subsequent period in which it will be received. As income will be credited to record the accrued income, a corresponding receivable must be created to account for the debit side of the transaction. The accounting entry to record accrued income will therefore be as follows: Debit Income Receivable (Balance Sheet) Credit Income (Income Statement) Example ABC LTD receives interest of $10,000 on bank deposit for the month of December 2010 on 3rd January 2011. ABC LTD has an accounting year end of 31st December 2010. ABC LTD will recognize interest income of $10,000 in the financial statements of year 2010 even though it was received in the next accounting period as it relates to the current period. Following accounting entry will need to be recorded to account for the interest income accrued: Debit - Interest Income Receivable $10,000 Credit - Interest on Bank Deposit (Income) $10,000 On the date of receipt of interest (i.e. 3rd January of the next year) following accounting entry will need to be recorded in the subsequent year: Debit - Bank $10,000 Credit - Interest Income Receivable $10,000

Accrued Expense
Accrued Income Accrued Expense Prepaid Income Prepaid Expense

Accrued expense is expense which has been incurred but not yet paid. Expense must be recorded in the accounting period in which it is incurred. Therefore, accrued expense must be recognized in the accounting period in which it occurs rather than in the following period in which it will be paid.

As expense will be debited to record the accrued expense, a corresponding payable must be created to account for the credit side of the transaction. The accounting entry to record accrued expense will therefore be as follows: Debit Expense (Income Statement) Credit Expense Payable (Balance Sheet) Example ABC LTD pays loan interest for the month of December 2010 of $10,000 on 3rd January 2011. ABC LTD has an accounting year end of 31st December 2010. ABC LTD will recognize interest expense of $10,000 in the financial statements of year 2010 even though it was paid in the next accounting period as it relates to the current period. Following accounting entry will need to be recorded to account for the interest expense accrued: Debit - Interest Expense $10,000 Credit - Interest Payable $10,000 On the date of payment of interest (i.e. 3rd January of the next year) following accounting entry will need to be recorded in the subsequent year: Debit - Interest Payable Credit - Cash $10,000 $10,000

Prepaid Income
Prepaid income is revenue received in advance but which is not yet earned. Income must be recorded in the accounting period in which it is earned. Therefore, prepaid income must be not be shown as income in the accounting period in which it is received but instead it must be presented as such in the subsequent accounting periods in which the services or obligations in respect of the prepaid income have been performed. Entity should therefore recognize a liability in respect of income it has received in advance until such time as the obligations or services that are due on its part in relation to the prepaid income have been performed. Following accounting entry is required to account for the prepaid income: Debit Cash/Bank Credit Prepaid Income (Liability) Example

ABC LTD receives advance rent from its tenant of $10,000 on 31st December 2010 in respect of office rent for the following year. ABC LTD has an accounting year end of 31st December 2010. ABC LTD will recognize a liability of $10,000 in the financial statements of year 2010 in respect of the prepaid income to acknowledge its obligation to make the office space available to the tenant in the following year. Following accounting entry will be recorded in the books of ABC LTD in the year 2010: Debit - Cash $10,000 Credit - Prepaid Rent Income (Liability) $10,000

The prepaid income will be recognized as income in the next accounting period to which the rental income relates. Following accounting entry will be recorded in the year 2011: Debit - Prepaid Rent Income (Liability) $10,000 Credit - Rent Income (Income Statement) $10,000

Prepaid Expense
Prepaid expense is expense paid in advance but which has not yet been incurred. Expense must be recorded in the accounting period in which it is incurred. Therefore, prepaid expense must be not be shown as expense in the accounting period in which it is paid but instead it must be presented as such in the subsequent accounting periods in which the services in respect of the prepaid expense have been performed. Entity should therefore recognize an asset in respect of expense it has paid in advance until such time as the services that are due in relation to the prepaid expense have been performed by the suppliers/contractors. Following accounting entry is required to account for the prepaid expense: Debit Prepaid Expense (Asset) Credit Cash Example ABC LTD pays advance rent to its landowner of $10,000 on 31st December 2010 in respect of office rent for the following year. ABC LTD has an accounting year end of 31st December 2010. ABC LTD will recognize an asset of $10,000 in the financial statements of year 2010 in respect of the prepaid expense to recognize its right to use office space in the following year. Following accounting entry will be recorded in the books of ABC LTD in the year 2010: Debit - Prepaid Rent

 $10,000 Credit - Cash/Bank $10,000

The prepaid expense will be recognized as expense in the next accounting period to which the rental expense relates. Following accounting entry will be recorded in the year 2011: Debit - Rent Expense (Income Statement) Credit - Cash/Bank $10,000 $10,000

Capital and Revenue Expenditure

Expenditure on fixed assets may be classified into Capital Expenditure and Revenue Expenditure. The distinction between the nature of capital and revenue expenditure is important as only capital expenditure is included in the cost of fixed asset. Capital Expenditure Capital expenditure includes costs incurred on the acquisition of a fixed asset and any subsequent expenditure that increases the earning capacity of an existing fixed asset. The cost of acquisition not only includes the cost of purchases but also any additional costs incurred in bringing the fixed asset into its present location and condition (e.g. delivery costs). Capital expenditure, as opposed to revenue expenditure, is generally of a one-off kind and its benefit is derived over several accounting periods. Capital Expenditure may include the following:

Purchase costs (less any discount received) Delivery costs Legal charges Installation costs Up gradation costs Replacement costs

As capital expenditure results in increase in the fixed asset of the entity, the accounting entry is as follows: Debit Fixed Assets Credit Cash/Payable Test Your Understanding Which of the following are examples of capital expenditure?

Cost incurred in testing whether a newly installed asset is functioning properly Cost incurred in relocating a machine to a new factory Cost incurred in replacing an old engine of the aircraft with a new one Revenue Expenditure Revenue expenditure incurred on fixed assets include costs that are aimed at 'maintaining' rather than enhancing the earning capacity of the assets. These are costs that are incurred on a regular basis and the benefit from these costs is obtained over a relatively short period of time. For example, a company buys a machine for the production of biscuits. Whereas the initial purchase and installation costs would be classified as capital expenditure, any subsequent repair and maintenance charges incurred in the future will be classified as revenue expenditure. This is so because repair and maintenance costs do not increase the earning capacity of the machine but only maintains it (i.e. machine will produce the same quantity of biscuits as it did when it was first put to use). Revenue costs therefore comprise of the following:

Repair costs Maintenance charges Repainting costs Renewal expenses

As revenue costs do not form part of the fixed asset cost, they are expensed in the income statement in the period in which they are incurred. The accounting entry to record revenue expenditure is therefore as follows: Debit Revenue Expense (Income Statement) Credit Cash/Payable

Depreciation
Depreciation is systematic allocation the cost of a fixed asset over its useful life. It is a way of matching the cost of a fixed asset with the revenue (or other economic benefits) it generates over its useful life. Without depreciation accounting, the entire cost of a fixed asset will be recognized in the year of purchase. This will give a misleading view of the profitability of the entity. The observation may be explained by way of an example. Example

ABC LTD purchased a machine costing $1000 on 1st January 2001. It had a useful life of three years over which it generated annual sales of $800. ABC LTD's annual costs during the three years were $300. If ABC LTD expensed the entire cost of the fixed asset in the year of purchase, its income statement would present the following picture the end of the three years: Income Statement 2001 $ Sales Cost of Sales Fixed Asset Cost Net Profit (Loss) 800 (300) 1000 (500) 2002 $ 800 (300) 500 2003 $ 800 (300) 500

As you can see, income statement of ABC LTD shows net loss in the first year even though it earned the same revenue as in the subsequent years. Conversely, no fixed asset will appear in ABC LTD's balance sheet although it had earned revenue from the machine's use through out its useful life of 3 years. If ABC LTD, instead of charging the entire cost of fixed asset at once, depreciates the capital expenditure over its useful life, its income statement and balance sheet would present the following picture at the end of the three years: Income Statement 2001 $ Sales Cost of Sales Fixed Asset Cost Net Profit (Loss) 800 (300) 333.3 (166.7) 2002 $ 800 (300) 333.3 (166.7) 2003 $ 800 (300) 333.3 (166.7)

Balance Sheet (Extract)

2001

2002

2003

Fixed Assets

1000

1000

1000

Accumulated Depreciation

(333.3)

(666.7)

(1000)

Net Book Value

666.7

333.3

Nil

As you can see, the process of relating cost of a fixed asset to the years in which the economic benefits from its use are realized creates a more balanced view of the profitability of the company. Hence, depreciation is an application of the matching principle whereby costs are matched to the accounting periods to which they relate rather than on the basis of payment. Accounting Entry Double entry involved in recoding depreciation may be summarized as follows: Debit Depreciation Expense (Income Statement) Credit Accumulated Depreciation (Balance Sheet) Every accounting period, depreciation of asset charged during the year is credited to the Accumulated Depreciation account until the asset is disposed. Accumulated depreciation is subtracted from the asset's cost to arrive at the net book value that appears on the face of the balance sheet. Using the last example, following double entries will be recorded in respect

Disposal of Fixed Assets

Fixed assets may be sold anytime during their useful life. This gives rise to the need to derecognize the asset from balance sheet and recognize any resulting gain or loss in the income statement. The accounting for disposal of fixed assets can be summarized as follows:

Record cash receive or the receivable created from the sale: Debit Cash/Receivable Remove the asset from the balance sheet Credit Fixed Asset (Net Book Value) Recognize the resulting gain or loss Debit/credit Gain or Loss (Income Statement)

Example ABC LTD purchased a machine for $2000 on 1st January 2001 which had a useful life of 5 years and an estimated residual value of $500. The machine was being depreciated on straight line basis. However, ABC LTD decided to sell the asset on1 January 2003 for $1500 in order to raise cash for the purchase of a new machine. The disposal of the fixed asset will be recorded as follows:

Record cash received or the receivable arising from the sale: Debit Cash $1500

Remove the asset from the balance sheet As a fixed asset is recognized in the balance sheet at the Net Book Value (i.e. Cost less Accumulated Depreciation), the machine will be removed from the accounts of ABC LTD in two parts: First, the Machine Cost must be removed by crediting the ledger: Credit Machine Cost $2000 Second, the Accumulated Depreciation in respect of the machine must be removed by debiting the ledger: Debit Accumalated Depreciation $600* *Accumulated Depreciation: (2000 - 500)/5 x 2 Years The combined effect of the above two transactions would be to remove the machine's net book value of $1400 (2000 - 600) from the balance sheet.

The combined effect of the above two transactions would be to remove the machine's net book value of $1400 (2000 - 600) from the balance sheet.

Recognize the resulting gain or loss on the sale of machine ABC LTD received $1500 for an asset with a balance sheet worth of $1400. It therefore earned a gain of $100. The gain will be recorded as follows: Credit Gain on Disposal $100

Disposal Account acts as a control account for the entries involving the disposal of fixed assets. Balances from all relevant fixed asset account are pooled into the disposal account and the balancing figure is the gain or loss on disposal which is transferred to the income statement.

Accounting for Inventory

Opening inventory is brought forward from the previous period's ledger account and charged to the income statement as follows: Debit Income Statement Credit Inventory Closing inventory at the period end is recorded as follows: Debit Inventory Credit Inocme Statement The Inventory Ledger Account therefore would appear as follows: Inventory

Debit

Credit

Balance c/d

xxx

Income Statement

xxx

Income Statement

yyy

Balance c/d

yyy

xyz

xyz

The inventory adjustments in respect of opening and closing inventory appear in the Cost of Goods Sold as follows: Opening Inventory Add: Purchases Less: Closing Inventory Cost of Goods Sold xxx yyy (yyy) xyz

Note that the cost of goods sold is not simply the cost of purchases during the period. This is the application of the Matching Concept which requires expenses to be recognized against periods from which associated revenue from the expense is expected to be earned. Therefore, as closing inventory is not consumed at any given accounting period end, it must not be part of expense which is why it is deducted from the cost of sale. Similarly, as opening inventory is consumed in the current accounting period, it must therefore be added to the cost of goods sold.

Bad Debts / Irrecoverable Debts

An entity may not be able to recover its balances outstanding in respect of certain receivables. In accountancy we refer to such receivables as Irrecoverable Debts or Bad Debts. Bad debts could arise for a number of reasons such as customer going bankrupt, trade dispute or fraud. Every time an entity realizes that it unlikely to recover its debt from a receivable, it must 'write off' the bad debt from its books. This ensures that the entity's assets (i.e. receivables) are not stated above the amount it can reasonably expect to recover which is in line with the concept of prudence. Accounting entry required to write off a bad debt is as follows: Debit Bad Debt Expense Credit Receivable The credit entry reduces the receivable balance to nil as no amount is expected to be recovered from the receivable. The debit entry has the effect of cancelling the impact on profit of the sales that were previously recognized in the income statement. Example

ABC LTD sells goods to DEF LTD for $500 on credit. ABC LTD subsequently finds out that DEF LTD is being liquidated and therefore the prospects of recovering its dues are very low. ABC LTD should write off the receivable from DEF LTD in view of the circumstances. The double entry will be recorded as follows: Debit - Bad Debt Expense $500 Credit - DEF LTD (Receivable) Bad Debt Recovered Occasionally, a bad debt previously written off may subsequently settle its debt in full or in part. In such case, it will be necessary to cancel the effect of bad debt expense previously recognized up to the amount settlement. Example ABC LTD sells goods to DEF LTD for $500 on credit. ABC LTD subsequently finds out that DEF LTD is being liquidated and therefore the prospects of recovering its dues are very low. ABC LTD therefore writes off the receivable from its books. However, the administrator appointed to oversee the liquidation of DEF LTD instructs the company to pay $300 to ABC LTD in full settlement of its dues. As $300 of the bad debt has been recovered, it is necessary to cancel the effect of previously recognized bad debt expense up to this amount. The accounting entry will therefore be as follows: Debit - cash $500 Credit - Bad Debt Recovered (Income) $500 $500

Accounting for Doubtful Debts

Allowance for doubtful debts is created by forming a credit balance which is netted off against the total receivables appearing in the balance sheet. A corresponding debit entry is recorded to account for the expense of the potential loss. Accounting entry to record the allowance for receivable is as follows: Debit Allowance for Doubtful Debts (Expense) Credit Allowance for Doubtful Debts (Balance Sheet) Once an allowance for doubtful debts has been created, only the movement in the allowance will need to be charged to the income statement in future accounting period. So if estimated allowance for doubtful debt is same as last accounting period, no accounting entry will be required in the current period as the total receivables will be reduced by the amount of allowance which has already been created.

Example ABC LTD has trade receivable of worth $50,000 as at 31 December 2010. XYZ LTD, a receivable owing $10,000 to ABC LTD at the year end, has been recently been wound up. Consequently, ABC LTD does not expect to recover the amount due from XYZ LTD. Based on past experience, ABC LTD estimates that 5% of its receivables will default. Allowance for doubtful debts on 31 December 2009 was $1500. ABC LTD must write off the $10,000 receivable from XYZ LTD as bad debt. Accounting entry to record the bad debt will be as follows: Debit - Bad Debt Expense $10,000 Credit - XYZ LTD Receivable $10,000 A general allowance of $2,000 [( 50,000-10,000) x 5%] must be made. As a general allowance of $1500 has already been created, only $500 additional allowance must be charged to the income statement: Debit - Allowance for Doubtful Debts (Expense) $500 Credit - Allowance for Doubtful Debts (Balance Sheet) $500

Note that $10,000 in respect of receivable from XYZ LTD has been excluded from the calculation of the general allowance as it has already been written off in full.

Accounts Payable
What is accounts payable? Accounts payable is the balance owed by the entity to its suppliers in respect of purchase of goods and services on credit. Accounting for Payables Credit Purchase As credit purchase results in increase in the expense and liabilities of the entity, expense must be debited while accounts payable must be credited. Therefore in case of a credit purchase, the following double entry is recorded: Debit Purchase (Income Statement) Credit Payable When the payable is paid his due, the payable balance will be reduced to nil. The following double entry is recorded: Debit Payable Credit

Cash

Purchases Returns
Purchases returns, or returns outwards, are a normal part of business. Goods may be returned to supplier if they carry defects or if they are not according to the specifications of the buyer. There is need to account for purchase returns as though no purchase had occurred in the first place. Hence, the value of goods returned to the supplier must be deducted from purchases. Where purchase was initially made on credit, the payable recognized must also be reversed by the amount of purchases returned. The following double entry must be made upon purchases returns: Debit Payable (decrease in liability) Credit Purchases Returns (decrease in expense) Example Bike LTD purchases a mountain bike from BMX LTD for $100 on credit. Bike LTD later returns the bike to BMX LTD due to a serious defect in the design of the bike. The initial purchase will be recorded as follows: Debit - Purchases $100 Credit - BMX LTD (Payables) Debit - BMX LTD (Payables) Credit - Purchases Return $100

Upon the return of bike, the following double entry will be passed: $100 $100

No further entry will be required as the payable due to BMX LTD has been reversed

Sales Return
Sales returns, or returns inwards, are a normal part of business. Goods may be returned to supplier if they carry defects or if they are not according to the specifications of the buyer. There is need to account for sale returns as though no sale had occurred in the first place. Hence, the value of goods returned must be deducted from the sale revenue.

Where a sale was initially made on credit, the receivable recognized must be reversed by the amount of sales returned. The following double entry must be recorded upon sales returns: Debit Sales Return (decrease in income) Credit Receivable (decrease in asset) Example Bike LTD sells a mountain bike to XYZ for $100 on credit. XYZ later returns the bike to Bike LTD due to a serious defect in the design of the bike. The initial sale will be recorded as follows: Debit - XYZ (receivable) Credit - Sales $100 $100

Upon the return of bike, the following double entry will be passed: Debit - Sales Return $100 Credit - XYZ (Receivable) $100

No further entry will be required as the receivable due from XYZ has been reversed.