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Basic accounting terms - Cont'd
Working Capital
In order to maintain flows of revenue from operation, every firm needs certain amount of current assets. For example, cash is required either to pay for expenses or to meet obligation for service received or goods purchased, etc. by a firm. On identical reason, inventories are required to provide the link between production and sale. Similarly, Accounts Receivable generate when goods are sold on credit. Cash, Bank, Debtors, Bills Receivable, Closing Stock, Prepayments etc. represent current assets of firm. The whole of these current assets form the working capital of a firm which is termed as Gross Working Capital.
Gross Working Capital = Total Current Assets
= Long term internal liabilities plus long term debts plus the current liabilities minus the amount blocked in the fixed assets.
There is another concept of working capital. Working capital is the excess of current assets over current liabilities. That is the amount of current assets that remain in a firm if all its current liabilities are paid. This concept of working capital is known as Net Working Capital which is a more realistic concept.
Working Capital (Net) = Current Assets – Currents Liabilities.
Contingent Liability
It represents a potential obligation that could be created depending on the outcome of an event. E.g. if supplier of the business files a legal suit, it will not be treated as a liability because no obligation is created immediately. If the verdict of the case is given in favour of the supplier then only the obligation is created. Till that it is treated as a contingent liability. Please note that contingent liability is not recorded in books of account, but disclosed by way of a note to the financial statements.
Owner’s Equity
The difference between the value of your assets and the total of your liabilities is the value of your company. As the Accounting Equation states: Assets - Liabilities = Owner’s Equity. Depending on the type of taxable entity you created when you first formed your company, the Owner’s Equity section of your Chart of Accounts and Balance Sheet may have another name.
Balance Sheet
It is the statement of financial position of the business entity on a particular date. It lists all assets, liabilities and capital. It is important to note that this statement exhibits the state of affairs of the business as on a particular date only. It describes what the business owns and what the business owes to outsiders (this denotes liabilities) and to the owners (this denotes capital). It is prepared after incorporating the resulting profit/losses of Income Statement.
Profit and Loss Account or Income Statement
This account shows the revenue earned by the business and the expenses incurred by the business to earn that revenue. This is prepared usually for a particular accounting period, which could be a month, quarter, a half year or a year. The net result of the Profit and Loss Account will show profit earned or loss suffered by the business entity.
Trade Discount
It is the discount usually allowed by the wholesaler to the retailer computed on the list price or invoice price. e.g. the list price of a TV set could be ` 15000. The wholesaler may allow 20% discount thereof to the retailer. This means the retailer will get it for ` 12000 and is expected to sale it to final customer at the list price. Thus the trade discount enables the retailer to make profit by selling at the list price. Trade discount is not recorded in the books of accounts. The transactions are recorded at net values only. In above example, the transaction will be recorded at ` 12000 only.
Cash Discount
This is allowed to encourage prompt payment by the debtor. This has to be recorded in the books of accounts. This is calculated after deducting the trade discount. e.g. if list price is ` 15000 on which a trade discount of 20% and cash discount of 2% apply, then first trade discount of ` 3000 (20% of ` 15000) will be deducted and the cash discount of 2% will be calculated on ` 12000 (`15000 – ` 3000). Hence the cash discount will be ` 240/- (2% of ` 12000) and net payment will be ` 11,760 (`12,000 - ` 240)
Drawings
It is the amount of cash or value of goods withdrawn from the business by the proprietor for his personal use. It is deducted from the capital.
Debtors
A person (individual or firm) who receives a benefit without giving money or money’s worth immediately, but liable to pay in future or in due course of time is a debtor. The debtors are shown as an asset in the balance sheet. For example, Mr. X bought goods on credit from Mr. Y for Rs.10,000. Mr. X is a debtor to Mr. Y till he pays the value of the goods.
Creditors
A person who gives a benefit without receiving money or money’s worth immediately but to claim in future, is a creditor. The creditors are shown as a liability in the balance sheet. In the above example Mr. X is a creditor to Mr. Y till he receive the value of the goods.
Purchases
Purchases refers to the amount of goods bought by a business for resale or for use in the production. Goods purchased for cash are called cash purchases. If it is purchased on credit, it is called as credit purchases. Total purchases include both cash and credit purchases.
Purchases Return or Returns Outward
When goods are returned to the suppliers due to defective quality or not as per the terms of purchase, it is called as purchases return. To find net purchases, purchases return is deducted from the total purchases.
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