Qustions & Answers
What is a temporary account?
Answer: A temporary account is a general ledger account that begins each accounting year with a zero balance. At the end of the accounting year any balance in the account will be transferred to another account. This is referred to as closing the account. An example of a temporary account is the Sales account. The Sales account is used to keep a log of the sales occurring only in the current accounting year. After the sales for the year have been reported, the balance in the Sales account will be transferred or closed to another account thereby returning the account balance to zero.
Temporary accounts include all of the income statement accounts: revenues, expenses, gains, losses. After the amounts for the year have been reported on the income statement, the balances in the temporary accounts will end up in a permanent account such as a corporation’s retained earnings account or in a sole proprietor’s capital account. (In manual systems, the balances in the temporary accounts will be transferred to an income summary account. Next the income summary account will be transferred to retained earnings or to the owner’s capital account. Hence, the income summary account is also a temporary account.)
A temporary account that is not an income statement account is the proprietor’s drawing account. The balance in the drawing account is transferred directly to the owner’s capital account and will not be reported on the income statement or in an income summary account. Temporary accounts are also referred to as nominal accounts.
What is the difference between interest expense and interest payable?
Answer: Interest expense is an income statement account which is used to report the amount of interest incurred on debt during a period of time.
Interest payable is a current liability account that is used to report the amount of interest that has been incurred but has not yet been paid as of the date of the balance sheet.
How can a company have a profit but not have cash?
Answer: A company can have a profit but not have cash because profit is computed using revenues and expenses, which are different from the company’s cash receipts and cash disbursements. In other words, there is a difference between revenues and receipts. There is also a difference between expenses and expenditures.
To illustrate, a company might have a profit of $60,000 in its first year, but during its first year it uses $65,000 of cash to acquire equipment that will be put into service at the beginning of the second year. This company will have a profit, but will not have the cash.
Other examples where cash is paid out, but the profits are not reduced at the time of the payment, include prepayments of insurance, payments to increase the inventory of merchandise on hand, and payments to reduce liabilities.
Where does the purchase of equipment show up on a profit and loss statement?
Answer: The purchase of equipment that will be used in a business is not reported on the profit and loss statement. However, the depreciation of the equipment will be reported as depreciation expense on the profit and loss statements during the years that the equipment is used.
For example, if a company buys equipment for $100,000 and it is expected to be used for 10 years, the company’s profit and loss statements will report depreciation expense of $10,000 in each of the 10 years (assuming the straight-line method of depreciation is used).
The purchase of equipment is shown on the statement of cash flows for the period in which the purchase took place. The equipment will also be reported on the company’s balance sheets at its cost minus its accumulated depreciation.
The profit and loss statements are also known as income statements, statements of operations, and statements of earnings.
Why are sales a credit?
Answer: The account Sales is credited because a corporation’s sales of products will cause its stockholders’ equity to increase. A sole proprietorship’s sales will cause the owner’s equity to increase.
The Sales account is used in order to keep a tally of the sales made during an accounting year. However, when the accounting year is completed, the credit balance will be moved via closing entries to the corporation’s Retained Earnings account or to the sole proprietorship’s Owner’s Capital account.
Recall that asset accounts will likely have debit balances and the liability and stockholders’ equity accounts will likely have credit balances. To confirm that crediting the Sales account is logical, think of a cash sale. The asset account Cash is debited and therefore the Sales account will have to be credited. Also the accounting equation will remain in balance because the asset Cash is increased with a debit, and through the closing entries an owner’s or stockholders’ equity account will be increased with a credit.
What is petty cash?
Answer: Petty cash is a small amount of cash on hand that is used for paying small amounts owed, rather than writing a check. Petty cash is also referred to as a petty cash fund. The person responsible for the petty cash is known as the petty cash custodian.
Some examples for using petty cash include the following: paying the postal carrier the 28 cents due on a letter being delivered, reimbursing an employee $19 for supplies purchased, or paying $13 for bakery goods delivered for a company’s early morning meeting.
The amount in a petty cash fund will vary by organization. For some, $50 is adequate. For others, the amount in the petty cash fund will need to be $200.
When the cash in the petty cash fund is low, the petty cash custodian requests a check to be cashed in order to replenish the cash that has been paid out.
How do I start a petty cash fund?
Answer: To start a petty cash fund you need to open a general ledger account entitled Petty Cash. This will be an additional cash account that you could report either separately or have its balance included with other cash accounts when preparing a balance sheet.
Next you need to write a check for the amount that you believe is the amount needed for making small payments in your office. Let’s assume that the amount will be $100. When processing the check you would indicate the account code for Petty Cash, so that the new account will be debited for $100.
You also need to designate one person to be the petty cash custodian. This person’s name will be the payee of the $100 check. This person will then be accountable for the $100. At all times the custodian must have a combination of cash and petty cash receipts which add up to $100.
Just prior to issuing financial statements, the petty cash custodian should request cash for the petty cash receipts. This is known as replenishing the petty cash fund. This allows for the expenses to be included in the income statement and will result in the custodian having the $100 of cash that will be reported in the balance sheet. The custodian can also replenish the petty cash fund when there is little cash on hand due to a large amount of petty cash payments.
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