What is a prepayment? (Definition, Explanation, Journal Entry, and Example)

Definition

Prepayment is an accounting term referred to the types of expenses not incurred yet but for which payment is made in advance.

As the economic benefits from such resources are not taken yet this is why it is classified as an asset rather than an expense and shown on the face of the balance sheet rather charging in the profit and loss statement.

Explanation

Prepayments are those payments, the benefits of which are expected to flow in the future. Here it is necessary to note the difference between the prepayments and advance payments.

Pre-paid is an amount more often paid for the expenses, the benefits from such payments will flow to the entity in the following financial years however the advance payment is the payment made for goods/services without the receipt of goods/services.

In almost all cases, the payment for goods and services is made after the benefits of such services and goods are taken. For example, a payment to the contractor for building a five-story building is made after the completion of the whole project or on an installments basis as per the stage of completion.

In both of the cases whether payment is made at the end of the project after completion or installments basis are made after taking the benefits from the contractor’s services.

However, there are some services, for which payment is compulsory to be at the beginning of the period before taking economic benefits from such goods/services such as the pre-paid rent and payment made for insurance cover under a contract.

There are certain rules set by the accounting standards-setting organizations, according to which the economic resources owned by the entity must be recorded in books of the entity.

According to these rules, all those economic resources the benefits from which yet to taken are classified as an asset and the benefits of the resources of which are already taken shall be charged in the profit and loss statement.

This is the reason the pre-paid expense is classified as an asset and shown on the face of the balance sheet because the benefits from such payments will flow to the entity in upcoming financial years. Thus in short prepayment is the payment made in advance before its accrual.

There are many types of prepayments these payments are mostly made in a corporate environment but it can also be made on an individual basis.

Prepayments made in a corporate environment are made in one accounting period and it will provide benefit in upcoming accounting periods. The main difference between usual expenses is prepaid expense is the recording of expense i.e the usual expense is charged to profit and loss in a single step.

However the pre-paid expense is two steps, that is first it is recorded on the balance sheet as an asset and then charge to the profit and loss statement upon the fulfillment of conditions attached to the pre-paid expenses.

Journal Entry

The prepayments made for any expense is a business activity, which is needed to be recorded in order to show the true and fair and clear financial picture of the entity.

For example, if we are making a prepayment to any insurance company for ensuring the factory building then we will record the event as a debit to the prepaid insurance account and credit to the cash or bank account.

Such prepaid insurance amount will be classified on the asset side of the balance sheet and charge to the profit and loss account as an expense upon completion of the insured period.

DateAccount TitleDebitCredit
XXPrepaid InsuranceXX 
XXCash XX

Examples

There are many examples where the business entity is required to pay for expenses in advance. Such payments are made in advance and upon the payment it is recorded as an asset, the examples of such payments are listed as under:

  • Advance rent paid for the occupation of a space for carrying on a business activities
  • Payments made for the insurance of a business asset in order to minimise the loss in case of any mishap
  • Assets acquired in order to complete the business operations and preparation of goods and services
  •  Salaries paid to the employees if paid in advance according to the terms of contract defined in the employment contract
  • Any payments made to the authorities in advance under the law or regulation
  • Payments made for the utilities in advance; and
  • Interest payment made in advance

This is not an exhaustive list of the prepayments made by the business entities, there may be many other examples of payments made for the expenses according to the nature of the business entity.

Accounting for Consignment Inventory

Definition:

Consignment inventory represents stock legally owned by one company or business but held by another. Usually, the risks and rewards associated with consignment inventory remain with the company that owns it.

Consignment inventory is common in industries where companies transfer their goods to the dealer, which distribute or sell them further. The dealer, in this case, is only responsible for its distribution or retail operations.

As mentioned, there are usually two parties involved in the consignment deal. The first party, the consignor, is the company that provides the goods. The other party, the consignee, is the company or business that holds the physical inventory.

The consignee also has the option to return any unsold or damaged goods to the consigner. Other names used for consignment inventory are consignment goods or consignment sales.

Accounting Treatment:

When it comes to the accounting treatment of consignment inventory, the standards are clear about it. Since the risks and rewards of the goods do not transfer due to the transfer, the consignor cannot record the inventory as sold.

However, some companies may still choose to convert inventory from one account to another to keep their records organized.

With consignment inventory, the consignor transfers the goods to the consignee, which sells the goods to customers. Once the consignee sells the goods, the risk and rewards related to the inventory get transferred.

The consignee also keeps a percentage of the sale proceeds and pays the consignor a predetermined sales amount.

Once the consignee sells the inventory, the consignor can record the sale amount. As with any other sale transaction, it consists of two double entries to the accounts.

The first double entry is to record the sale made through the consignee, while the second double entry is to record the decrease in inventory. Therefore, the consignor can only reduce its inventory account once it receives the sale proceeds.

On the other hand, if the consignee fails to sell all the goods transferred, they will return those goods to the consignor. In that case, the consignor doesn’t need to pass any double entry since the risks and rewards stay the same.

If the consignor had transferred the inventory into a different account, then they can convert the goods back to their finished goods account.

Journal Entry:

As mentioned, when the consignor transfer goods to the consignee, the risks and rewards still remain. Therefore, the consignor doesn’t need to pass a journal entry to the accounts.

However, some consignors may use the following double entry to transfer inventory into a different account, for organization.

DrConsignment inventoryx
CrFinished goodsx

Once the consignee sells the goods, it will repay the consignor the sale proceeds. It is when the risks and rewards transfer and the consignor can record the sale.

As mentioned, the consignor must use two double entries to record the transaction. The first journal entry used to record the sale proceeds is as follows.

EntryDescriptionAmount
DrCash or Bankx
CrSalesx

The next journal entry is to reduce the inventory. The treatment will differ according to whether the consignor has transferred the goods to a temporary consignment inventory account. The journal inventory is as follows.

EntryDescriptionAmount
DrCost of salesx
CrConsignment inventory / Finished goodsx

In case the consignee returns unsold goods, the consignor doesn’t need any accounting entries. However, if the consignor had transferred the goods to a temporary consignment inventory account, it must reverse the accounting treatment.

Example:

A company, ABC Co., transfers its goods to another company, XYZ Co., which further sells their goods to customers. At the start of the year, ABC Co. sends goods valued at $100,000 to XYZ Co. Subsequently, at the end of the year, XYZ Co. returns $20,000 worth of goods to ABC Co.

For the $80,000 goods sold, XYZ Co. gives ABC Co. $120,000 sale proceeds collected from its customers through a bank transfer.

Firstly, ABC Co. must record the sale proceeds for goods sold by XYZ Co. The accounting treatment will be as follows.

DrBank$120,000
CrSales$120,000

Similarly, ABC Co. must record the transfer of its inventory to customers, which marks a transfer of risks and rewards. The accounting treatment is as follows.

EntryDescriptionAmount
DrCost of sales$80,000
CrFinished goods$80,000

For the goods that XYZ Co. returned, ABC Co. does not need to pass any accounting entries.

Conclusion:

Consignment inventory refers to goods transferred from a company to another party while still holding its risks and rewards.

Therefore, there are two parties in a consignment inventory deal, the consignor and the consignee. The accounting treatment for consignment inventory depends on whether the consignee sells the goods or not.

Accounting for Goods in Transit

What Is Goods In Transit?

Goods in Transit indicates the stock that is bought from the purchaser and delivered through a dealer, nonetheless, the merchandise is in transit but still needs to arrive at the proposed buyer.

Towards the ending of an accounting time frame, such stock items permit exceptional consideration for accounting such merchandise are neither accessible at the dealer’s space nor at the buyer’s location.

Explanation

As a presumable possibility, these items can remain disregarded during the way toward representing overall stock as such products are not genuinely available at both the buyer’s or the vendor’s place.

The accounting of goods on the way demonstrates whether the dealer or the buyer of the products has the proprietorship and who has compensated for conveyance. Normally, there is an organization (dispatching terms) between the vendor and the purchaser with respect to who should record these items in the accounting records.

Goods in transit refer to stock and different sorts of stock that have left the transportation dock of the merchant, yet has not arrived at the receiving end of the purchaser. The idea is utilized to demonstrate whether the purchaser or dealer of products has collected the goods, and who is has to pay for transport.

Preferably, either the vendor or the purchaser should record products on the way in its accounting records. The standard for doing so depends on the delivery terms related to the goods, which are:

  • FOB shipping point. In case the shipment is assigned as freight on board (FOB) shipping point, proprietorship moves to the purchaser when the shipment departs the dealer.
  • FOB destination. In case of the shipment assigned as freight on board (FOB) destination, proprietorship moves to the purchaser when the shipment shows up at the purchaser.

Examples:

Example 1

ABC Inc. is the wholesaler and XYZ Inc. is the buyer. ABC Inc. ships stock worth $50,000 on March 15, 2020, and it still has to arrive at XYZ Inc. Figure out the organization that may record the merchandise on the way in the accounting books in case the conditions of the delivery freight on board (FOB) transporting point.

FOB delivering point implies that XYZ Inc. (buyer) will take responsibility for stock when it departs ABC Inc’s. transporting area. Thus, ABC Inc. will record a sales transaction on March 15, 2020, while XYZ Inc. may note it as transit inventory on a similar date.

Example 2

Here, ABC Inc. is the dealer and XYZ Inc. is the buyer, however, the terms of conveyance have been changed to FOB destination, and the shipment still has to arrive at XYZ Inc.’s. dock. The goods are required to be conveyed on April 5, 2020.

Figure out the organization that may note the goods in transit in their accounting books for such situation.

Under FOB destination, the buyer will note the sale contract on April 5, 2020, rather than March 15, 2020. Hence, for such a situation, XYZ Inc. will record the journal entry in the books of record on April 5, 2020.

Subsequently, there will be a contrast between the dealer and the buyer’s book attributable to the terms of shipment. While XYZ Inc. will note the exchange on April 5, 2020, however, ABC Inc. will record a similar exchange on March 15, 2020.

Goods In Transit Valuation

Recording stock relies upon the agreement with the vendor. Nevertheless, another concern is the goods in transit valuation, which should be perceived in the balance sheet. It is required to account for insurance, transport fees, freight in, shipping into the stock valuation. The issue is should the costs be accrued with goods in transit or wait until they show up.

This relies upon the arrangement of the capable individual over each cost. In case the purchaser is answerable for it, at that point he should assess the expense to make accrue costs as a component of the goods in transit. The purchaser will make accrue when we have a commitment to the provider, consequently not all the costs will be recorded simultaneously with goods in transit.

Treatment of Goods in Transit

The consolidated financial statement consolidates the parent and subsidiary balance sheet and income statement. In case there are goods in transit throughout the reporting date, it must be guaranteed that both parties account effectively for those goods.

The goods in transit actually have a place with the group (parent and subsidiary); hence, the balance must be in the consolidated balance sheet. Nonetheless, the goods should not be counted as double. This may occur if the parent doesn’t record the sale of products however subsidiary records stock and accounts payable.

The accounting treatment is outlined as follows:

When the forwarding specialist arranges the transportation archives, (for example, the bill of filling, receipt, or air waybill), at that time the journal entry can be:

DescriptionDrCr
Goods in transit recordXXXX 
Goods/ Invoice receipt record XXXX

At the point of the goods in transit but to get from the buyer client, then the journal entry can be:

DescriptionDrCr
Goods/ Invoice receipt recordXXXX 
Supplier recordXXXX

At the point the product is gotten by the buyer, then the journal entry can be:

DescriptionDrCr
Stock accountXXXX 
Goods in transit account XXXX

For goods in transit accounting, the foremost problem to answer is if a deal has occurred, bringing about the entry of title to the purchaser. If so, the dealer records a sale and a receivable or money and excludes the good in the ending stock.

The buyer records the payable or the installment of money, the purchase, and takes account of the item for the completion stock. Alternately, if the title has not changed or transferred, no purchase or sale has occurred, and consequently, the inventory is included for the seller’s ending inventory.

Conclusion

In short, goods in transit indicate at the time when the label of possession and threat goes from the vender to the purchaser.

Is cash debit or credit?

Explanation:

Cash is the company’s current assets holding for small expenses in the office or for a certain large amount of cash transactions. For example, the company holds petty cash for making payments on small office expenses.

Sometimes, the company might keep a large amount of cash for making payments to certain suppliers that accept only cash rather than bank transactions like bank transfers or check.

The company might also holding the cash that its collect from customers but these kind of cash will be deposit into the company’s bank account in the following day.

It does not matter whether the cash is used for small or large payment and it does matter if the cash is collected from customers or from whatever sources, from an accounting perspective, cash is considered as assets and it is classified as current assets which are reported in the balance sheet.

Is cash debit or credit?

Before dive into the debit or credit, we need to assess what kind of financial statements element that cash belongs to. Once we know the exact element, then we can clearly know whether cash is debit or credit.

As we mentioned above, cash is the assets and clearly it is belonging to the assets element of the financial statements.

As long as it is belong to assets element, the rule of debit or credit is apply the same.

Assets reporting in the balance sheet or statement of financial position. Decreasing asset result in credit records and increasing assets result in debiting to assets.

For example, if the company purchase new computer, then asset is increasing. We need to debit assets.

The same as asset,

In financial statements, cash is debit when there is increasing in it. For example, the company receives the payment from the customers in cash. In this case, cash is increased and we need to debit it. If the cash is decreasing, then we need to record it on the credit side of the cash account.

For example, the company makes the payment to its supplier in cash. The cash is decreasing since the company making payments to its supplier through cash.

Cash journal entries:

The journal entries of cash transactions are similar to the journal entries of others assets account.

Here is how we record cash when it is increasing due to correct from customers,

AccountDrCr
CashXXXX 
Account recievable/sales XXXX

For example, the company receives the cash payment from its credit customer amounting to $1,000. Then, the entries are as below:

AccountDrCr
CashUSD1,000 
Account recievable/sales USD1,000

Here is how we record cash when it is decreasing due to payment to suppliers,

Example, the company purchase office supplies amouting to USD500 and it pays its supplies throught petty cash, then the entries are as blow:

AccountDrCr
Office suppliesUSD5000 
Petty cash USD5000

Cash as an asset:

An asset is defined as the resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity. Another criterion is:

  • The inflow of economic benefits to the entity is probable
  • The cost/value can be measured reliably.

Similarly, the value of cash can be measured reliably since it can be easily counted. Cash is always in the control of the company either with itself or its custodian as a bank. Cash is classified as a current asset. Current assets are assets that can be easily converted to cash and cash equivalents within a year or working capital cycle.

Cash can be also classified into tangible assets since it has a physical presence and can be touched. Cash can be defined as an operating asset since it is required in the daily operation of the business. In another sense, they are used to generate revenue from the company’s core operations.

Features of cash:

  • Durability: Cash is highly durable and lasts long unless torn. It can be exchanged from banks if torn.
  • Portability: It can be taken from one place to another easily. It is light weighted.
  • Divisibility: Cash can be easily divided into smaller values. For example, a thousand-rupee note can be easily divided into 10 hundred-rupee notes.
  • Limited supply: Cash is printed by central banks as per requirement and is in limited supply in the markets.
  • Uniformity: Cash of different values comes in the same shape, size, and value.
  • Acceptability: Since currency notes are printed and allowed for use by central banks, they are accepted everywhere.

Uses of cash:

Cash can be used for various purposes. Such uses can be categorized into three main uses viz.

  1. Operating use:

Cash is used for payment of operating expenses. The different expenses    used for cash payments are:

  • Payment to account payables and creditors
  • Payment of business expenses
  • Payment of interest to lenders
  • Payments for purchase of raw materials
  • Payment for income taxes
  • Cash paid to vendors and suppliers
  • Receipt from sales and debtors
  1. Investment use:

Cash is used for investment purpose. The different investment activities are:

  • Purchase of fixed assets
  • Investment in securities
  • Selling or leasing of fixed assets
  • Selling off securities
  1. Financing use:

Cash is used for the payment of loans, dividends. It is used for transactions involving debt, equity, dividends. It is used to manage the capital structure of the company. Cash moves here between a firm and its owners, investors, and creditors. The financing use of cash involves:

  • Issue of stock equity, debt
  • Payment of loan, dividend
  • Raising loans and debentures
  • Redemption of debt
  • Stock repurchases

Conclusion: The item ‘cash’ is therefore DEBIT. It is shown as an asset owing to the advantage it brings to the business. It is therefore shown under the Current Assets of the Asset side of the Balance sheet.

How to Safeguard Company Assets?

Your success in business does not just depend only on your ability to make sales profits. You have to also learn how to properly manage and safeguard your company assets; they are what makes the profits for you.

Company assets are the valuable properties that your company owns. They include tangible physical business properties like lands and buildings, vehicles, office equipment, inventory, etc.

Also, intangible valuables such as brand, trademarks, patents, and intellectual properties all count as intangible business assets.

Your assets determine your business value. So, it is only wise that you learn how to maintain these assets for maximum business output.

Why Do You Need to Safeguard Your Assets

Your business assets help your company to generate revenue and add to your business value. You also need them for the efficient running of your day-to-day activities.

Damages to or loss of these business assets can affect the general health of your business. Resources spent on replacements and repairs increase business expenses and reduces net profit.

So, if you don’t take proper care of your business assets, you are risking huge business losses.

How to Safeguard Your Assets

Different assets have different kinds of risks associated with them. Since the goal is to prevent or at least minimize those risks, different measures can help safeguard your assets.

Proper Documentation and Monitoring

You must keep records of all your assets and track the activities associated with them.

For example, maintaining accurate inventory records can help you trace any missing or stolen goods. Regular machinery checks can also help you notice faults or potential damage risks more easily and fix them before they result in any serious harm.

Insurance

Physical assets are susceptible to dangers such as robbery, fire outbreaks, and other environmental hazards.

So you might need to get good insurance coverage for your vehicles, buildings, and other tangible assets. That way, you don’t have to worry much about repairing or replacing them.

Regular Maintenance

Machinery can wear and tear with time and consistent usage. You need to have a regular maintenance schedule to keep them in steady proper working conditions.

Even your employees might need vacations, annual assessments, and other routines to maintain high productivity and efficiency.

Intellectual Property Protection

Brand recognition and reputation, for instance, go a long way in determining your competitive edge and even volume of sales.

You can employ professional legal services to help guard against intellectual thefts or copyright infringements.

Physical, Digital, and Data Security

You can employ a viable security team or contract a security company to help protect your physical properties.

The use of security cameras can also help you monitor activities around your company environment right from the comfort of your office. You can also use vehicle tracking systems to monitor your company vehicles or even recover stolen machinery.

Cyber Security should also be given maximum attention. Ensure that sensitive information such as customer passwords, account statements, etc are fully guarded against unauthorized access. You can hire a cybersecurity expert for professional security services.

Bottom Line

If you keep incurring unnecessary expenses due to poor assets management, it will eventually tell on your business’ general performance.

So you need to do everything possible to take care of your assets and safeguard them against possible risks.

How to Safeguard A Company’s Cash?

There are a lot of risks associated with running a business and managing its assets. Learning how to safeguard your company’s cash is one of the viable ways to minimize those risks.

Cash is a very important asset for every business. It provides a quick and reliable means of making and receiving payments without much hurdles. Cash transactions are also less complicated to evaluate and document.

Whether it is cash-in-hand or cash equivalents, it is important you implement useful strategies in guarding against possible cash risks affecting your business.

1) Get a Company Account

As a business owner, it is sometimes hard to separate your business money from your personal finances. This is particularly difficult if your personal money is your major source of business capital.

If you’re running a sole proprietorship where you are in charge of everything, there is a higher tendency for inadequate business records. Maybe because there’s no one else to possibly check and balance your financial activities.

This is where a company account comes in very handy. With that, it is easier for you to accurately monitor your transactions through your company account’s financial statement.

For larger companies, a corporate account offers better restrictions to cash flow and improves account transparency.

2) Reduce Cash Redundancy

Having too much extra cash around your offices can be very tempting. You can be lured into unnecessary spending and can easily misplace money. Your employees can easily be tempted to “borrow”from company cash (and sometimes never return) or even steal them.

To avoid this, always deposit surplus cash into the bank on a regular basis, probably daily or at least once a week.

3) Restrict Access to Cash

The lesser the number of people with access to company cash, the easier it becomes to collate accurate accounts. If anything goes wrong, you would know who exactly should be held accountable.

Also, you can ensure that there are more than one signatory to your corporate account. That way, one person cannot just make transactions anyhow s/he wants. It improves the integrity of the transactions on the account.

4) Establish a Transaction Approval System

Transactions on the company account, especially withdrawals, should always be endorsed by appropriate authorities.

You can set up a system that verifies every transaction for approval before effecting them. The reasons for payments must be authentic and reasonable too.

5) Use Other Means of Payment

One downside of using liquid physical cash is that it is not recorded real-time into the bank statement. This can cause issues in a case where a transaction is recorded but the money was not eventually sent into the account.

You can use other payment methods that can reflect directly on the bank statement, such as bank transfers, cheques etc.

6) Issue / Collect Receipts

A transaction without proof can easily be denied or altered. Whether you’re receiving or giving out cash, always document the receipts.

Bottom Line

Proper management and security of cash assets is very instrumental to the general safety of your business.

Loss or misplacement of cash can reduce both your business value and your purchasing power. So it is only wise that you safeguard your company cash as much as you can.