HOW TO CLOSE BOOKS OF ACCOUNTS – AT THE END OF AN ACCOUNTING PERIOD

Closing entries are those entries which are made at the end of the period to close the temporary accounts and transfer the balance in to the permanent Account. In other words closing the temporary account and transfer the balance to the permanent Account.

Temporary Account

During the time of closing books of accounts, we need to close all temporary accounts such as income accounts of that period, Expenses Accounts of that period, drawing account of that period or dividend account of that period etc.

Sales - 2015, sales - 2016 ,rent in 2015, telephone- 2016,scrap sales-2016,other income-2015 etc are some of the examples of temporary Accounts.

 Income Summary Account

For closing the books of accounts of particular period , we need to transfer all temporary accounts in to income summary account and balance of income summary account to ‘’Retained Earnings Accounnt’’.

After doing the below mentioned journal entries, only assets and liabilities remain in the books of Accounts.

1)    Journal Entry for transferring sales Account and other income account in to Income summary Account.

                     Sales A/C                         DR                            XXX

                     Other Income                   DR                                                XXX       

                            TO   Income Summary A/C                                               XXX

2)    Journal Entry for transferring Expenses Account in to Income summary Account.

Income Summary A/c                        DR           XXX

                              TO Salary expenses                                      XXX

                     TO Rent Expenses                                                  XXX

    

3)    Balance of income summary Account transferred to Retained Earnings Account.

4)    Journal entry for closing dividend paid Account to Retained Earnings Account.

          Retained Earnings A/c                        Dr              xx

                     TO Divident paid                                                    xxx

PERCENTAGE OF COMPLETION METHOD UNDER CIVIL CONSTRUCTION CONTRACTS

Percentage of completion method is a method used  in civil constrution contract to recognise the revenue of a particular period.  Percentage of contract cost incurred against the total estimated contract cost is base to  determine the percentage of completion.

The percentage-of-completion method is generally the required method of financial and tax accounting of larger construction companies for long-term contracts. Its justification relies largely on the matching principle in accounting, where revenues and expenses are matched in the applicable accounting period.

The percentage-of-completion method attempts to recognize revenues and gross profit in the applicable periods of construction, and not soley in the period when the construction has been completed, as in the completed contract method. 

The degree of completion of the construction, i.e., the percentage-of-completion, is typically estimated by dividing the total construction costs incurred to date by the total estimated costs of the contract, or job.

% complete = Total construction costs to date/Total estimated costs of contract

Total estimated revenues or gross profit is then multiplied by this percentage of completion to derive the total revenues or gross profit that have been earned to date.

Gross profit to date = % complete X Total estimated gross profit

The journal entry required to recognize the current year's revenues or gross profit is the difference between total revenues or gross profit earned to date less revenues or gross profit recognized in prior years.

Current year's gross profit = Gross profit to date - Gross profit in prior years

  

For eg.

Total contract price of project A is  AED 1,000,000, Period of contract 3 years starting  from 2015. Estimated total cost AED 800,000. Incurred cost up to 2015  AED 300,000 and up to 2016 AED 700,000. Then

Percentage of completion in  2015 =  300,000/800,000 *100 = 37.50%

So corresponding revenue in 2015 = 1,000,000 *37.50% = AED 375,000

Profit  of 2015  = 375,000 - 300,000 = 75,000

Percentage of completion in  2015 =  700,000/800,000 *100 = 87.50%

So corresponding revenue in 2015 = 1,000,000 *87.50% = AED 875,000

Cumulative  Profit of   = 875,000 - 700,000 =     1,75,000

Less: Profit in 2015                                            =    75000

Profit in 2016 (175,000-75,000)                  =      Aed  100,000/-

UNDER BILLING AND OVER BILLING IN CONSTRUCTION BUSINESS

Under biling and over billing are terms which are popularly used in construction business. Revenue recognition is the base for this under billing and over billing calculation.

Some of the details of Over billing and under billing and it’s Accounting t treatment  are as follows

OVER BILLING

Over billing means billing of the revenue more than that of the revenue  actually earned( from % of completion method) . In construction business , percentage of completion method used for  identify and recognise the revenue for a particular period.

Due to over billing, customers  or client need to pay more cash to contractor(excess billed portion) so contractor get more money and it help to create more liquidity.  

ACCOUNTING TREATEMENT  -  OVER BILLING

For  Eg.  In the case of Project A, monthly billed amount  AED 200,000/- and the actual revenue recognized is  Aed  170,000/- Accounting treatment is as follows-:

1) WHEN RAISING MONTHLY BILLING

PARTY  A/C                                                       DR                    200,000

TO  CONTRACT REVINUE                                                                     200,000

2)WHEN  RECOGNISING REVENUE UNDER PERCENTAGE OF COMPLETION METHOD AND BVALANCE TRANSEFERRED TO EXCESS BILLING A/C

CONTRACT REVENUE A/C                              DR                        30,000

                                                   TO    EXCESS BILLING A/C                                      30,000

 DISCLOSURE OF FINANCIAL STATEMENT

1)Recognised  Revenue for that period showing  as ‘’Contract Revenue ‘’ in P&L A/c.

2)Party A/c  showing as ‘’Debtors’’ under ‘’current asset’’.

3)’’Excess billing’’ amount showing as liability under the head ‘’current Liability’’.

ASSUMPTIONS OF OVER  BILLLING

1)Non booking of cost or less booking of cost will result in to Over billing .

2)Due to over billing, contractor getting more than that of cash which they deserved from the client.

UNDER BILLING

Under billing means billing of the revenue less than that of the revenue actually earned( from % of completion method) . In construction business , percentage of completion method used for  identify and recognise the revenue for a particular period.

Due to under billing, customers  or client only  pay less cash to contractor(less  billed portion) so contractor only get less money than that of deserved.  

ACCOUNTING TREATEMENT  -  UNDER BILLING

For  Eg.  In the case of Project A, monthly billed amount  AED 170,000/- and the actual revenue recognized is  Aed  200,000/- Accounting treatment is as follows-:

1)WHEN RAISING MONTHLY BILLING

PARTY  A/C                                                       DR                    170000

TO  CONTRACT REVINUE                                                                     170000

2)WHEN  RECOGNISING REVENUE UNDER PERCENTAGE OF COMPLETION METHOD AND BVALANCE TRANSEFERRED TO EXCESS BILLING A/C

WORK IN PROGRESS                  DR                        30,000

                                    TO    CONTRACT  REVENUE                                    30,000

DISCLOSURE OF FINANCIAL STATEMENT

1)Recognised  Revenue for that period showing  as ‘’Contract Revenue ‘’ in P&L A/c.

2)Party A/c  showing as ‘’Debtors’’ under ‘’Current asset’’.

3)’Less billing’’ amount showing as Work in progress (WIP)  under the head ‘’current Aset’’.

ASSUMPTIONS OF UNDER  BILLLING

1)Excess booking of cost or variantion work but not certified by client of consultant will result in to underbilling .

2)due to under billing, contractor getting  only less cash  than that  they deserved from the client.

Verification aspects of Undated security cheque with signature verification letter and Bank Guarantees

Most of the business deals , customers required to give advance payment to the suppliers as per the payment term mentioned in the LPO. In these cases, customers will ask for Advance payment bank guarantee or Undated security cheque with signature verification from cheque issuing bank, if such terms are mentioned in the LPO.

Most of these cases customers prefer to collect Advance Payment bank guarantee from the suppliers because in this case the customer can easily and directly raise claims to bank for any  deviation from the LPO terms, such as fails to deliver the goods to customer, goods delivered but it is not as per the terms of the LPO and suppliers not willing to re-supply the goods as per the LPO. Etc. More over collecting Bank guarantee is more authentic than that of collecting Undated security cheque from suppliers.

In the case of undated security cheque , any deviations or discrepencies happens, then the customer can present the cheque to the  supplier’s bank clear the cheque.

Sometimes  supplier’s bank A/c  have no balance or the suppliers bank balance is not enough to honour the cheque, then the bank will dishonor the cheque.In such situation, the customer required to file legal case against the supplier to get the cheque amount and bouncing of cheque with some compensation for the damages.

Verification aspects of undated security cheque

While collecting the undated security cheque with signature verification , Customers required to consider  the following  points to verify the authenticity of the undated security cheque .such as:-

1)Ensure that the cheque is an undated one other wise it’s validity will restricted for a period of 6 months. So always ensure that security cheque should be undated one.

2) Name of the cheque should in the name of the customer who give advanced cash to customer.

3)Verify the signature with the signature letter from the bank.

4)Cheque amount should be  equal to the advance amount paid to the suppliers.

5)Verify the Bank Account and ensure that the said bank A/c is active and valid in all aspects 

           

Verification aspects of undated Bank Guarantee

While collecting the bank guarantee , Customers required to consider  the following  points to verify the authenticity of the bank guarantee such as:

 1) Bank guarantee should addressed to the customer’s name.

          2) Bank Guarantee should mention guaranteed amount.

      3) Bank guarantee should mention the validity date or expiry date of the  guarantee.

      4)Bank guarantee should mention the LPO NO and other document details  relevant for the transaction.
         

              

ELECTRONIC TRANSFER OF FUND – Benefits & Limitation

Electronic payment is an innovative mode of payment to suppliers, subcontractors, others etc. by exploring the capability  of internet and online banking .Electronic payment method fully wipe out the traditional cheque printing and cheque signing method. Electronic payment otherwise we can termed as ‘’Paper less payment‘’

Benefits  of Electronic payment

Some of the important benefits of electronic fund transfer are mentioned below:-

1)   Paperless payment

 Electronic payments are paperless payment so no need to file and keep the paper documents  in the office, instead  can keep all documents in digital format and  can save the office file storage space.     

2)    Quick payment

Distribution of payment is very easy and quick. Because when the payer  initiate and  approve the payment then in the same time the money transferred from the payer bank Account to the payee bank Account and relevant supporting documents of payments are also transferred to payee’s email id as reference.

3)   Better control

In electronic payment, the payer can fix various levels of apparoval such as 1^st approval.2^nd approval, final approval, final release of fund etc. hence payer can exercise better control over payments.

4)   Time saving

Once the payment is approved by the payer , then the same time the  fund will  transfer to the payee’s bank Account. so no required to come and collect the cheque from the payer and deposit in  to bank. Likewise  electronic payment save  the time of  cheque collection and deposit in to bank Account.

Limitations of Electronic Fund Transfer

Some of the important limitations of electronic fund transfer are mentioned below:-

1)   Costly method of payment

Good computers , high speed internet facility and e-banking facility are basic requirements to carry out electronic transfer of funds. That means to get the facility of electronic transfer requires some investment for basic needs so it is costly.

More over bank would charge some additional amount as online banking charges and electronic   fund transfer charges from the payer. So it’s cost comparatively high than the traditional cheque method.

   

2)   Computer & Internet knowledge required

The staff who handling electronic fund transfer require good computer and internet knowledge to carry out the electronic fund transfer.

3)   Technical Fault

 When any technical fault happens on internet, e-banking facility,etc, then electronic transfer is not possible.

DELIVERY ORDER (DO) AND IT’S RELEVANCE

Delivery order ( DO) is a document prepared by the seller as a proof of the physical delivery of goods to the buyer. The seller will handed over the DO to the buyer at the time of real physical  delivery of goods to the buyer and get signature of the buyer or authorized person of buyer in the DO.

DO should be atleast 3 sets one for the buyer one for seller and another for store section.

DO includes the following informations, such as-;

1) Buyer names and address.

2) Local purchase Order No

3) Seller name and address

4) Date of DO

5) Invoice No, If available

6)Name and signature of Receiver with contact no

7)Name and signature of seller’s authorized person.etc

RETENTION BANK GUARANTEE - AN OVER VIEW

The main intention of submitting Retention bank guarantee is for the earlier release of retention money from the client or contractor as the case may be.

As a common practice, and as per the  contract agreement ( letter of acceptance /Local purchase order)  , the client can release the fund to the main contractor can  release the fund to the sub contractor only after deducting certain amount b which known as Retention money.

Volume of retention money would specified  in the contract agreement. Normally it is 5% or 10% of the contract value. client will release such retention money to the contractor as per the clause mentioned in the contract agreement for eg. after two years of completion of the work, or after defect liability period(DLP),after 6 months from defect liability period.etc..

By submitting retention bank guarantee , the contractor can get the retention money earlier than the retention maturity period. So the contractor can utilize this fund for the business. hence it helps to create additional liquidity of fund to the business.

Retention money normally hold by the client to set aside the losses happens during the  DLP period or any retention maturity period. If no such losses happens, then the client can release the retention money on the maturity date.

On submission of the bank guarantee, the contractor can get the retention money earlier than the maturity period. and if any losses is happens during guaranteed period, then the client can submit the Retention guarantee to the bank and can claim the compensation from the bank and subsequently bank will recover this amount from the contractor.

PERFORMANCE BANK GUARANTEE - PRACTICAL ASPECT

A performance bank guarantee provides a secure promise of compensation amount  by the bank  to the customer in the event that a supplier or sub contractor  does not meet delivery terms or other provisions in the contract. 

As per the agreement between the supplier and the customer, the supplier submit  the performance guarantee to the customer as a security for the proper performance of the contract.

If any breach of provisions of performance of contract or subcontract, then the customer can submit this performance guarantee to the bank and can claim for the compensation amount mentioned in the Performance Guarantee from the bank.

 Normally the customer will return the performance bank guarantee to the sub -contractor or supplier only after completing  the defect liability period (DLP) of that  particular contract and after particular agreed period  after completing the delivery of goods respectively.

Performance bank guarantee amount normally equal to 10% or 5% of total contract amount or LPO amount of the subcontract  or supplier respectively. It also depend on the negotiation and agreement between the parties concerned  in the contract.

Example.  A Ltd ordered 100 TV from B Ltd for AED 100,000/-  and A Ltd asked for a performance bank guarantee for AED 10,000/- ( as 10% of LPO amount)  for a period of 1year after the delivery of T.V.

 BLtd submit the performance bank guarantee to A Ltd. And out of the 100 TVs 5 Tvs are not working and A Ltd asked to B Ltd to replace it. And B Ltd not willing to replace it. Then A Ltd submit this performance guarantee to the Bank and can claimed for compensation amount of that 5 TVs.

Based on A Ltd’s claim for compensation  and documents verified, bank will award the compensation to A Ltd and bank will recover this  amount from B Ltd. This is the working aspect of performance Bank Guarntee.

ADVANCE PAYMENT BANK GUARANTEE - MEANING

Advance Payment Bank Guranatee  used as a security against Advance Amount paid. For Example, when any customer give any advance amount to their supplier and then that customer have no surety that supplier will deliver the goods or render the service on time and as per the agreement.

In such cases as per the agreement between the supplier and the customer, when the customer give advance amount to the supplier at the same time the supplier required to submit the Advance payment bank guarantee  to the customer  carrying the same amount of advance paid.

In this case , if supplier did any breach of contract, then the customer can submit this  Bank Guarantee to the bank and can claim for the amount mentioned in the bank guarantee.

Normally the customer  will return this advance payment bank guarantee to the supplier , when the supplier delivered the goods or render the services equal to the advance amount received.

BANK GUARANTEE - INTRODUCTION

Bank guarantee is a promise from bank or any  finanacial institution that they will honour  the  agreed finanacial  obligation incase the clinet not full fill the same. It is actually a facility provided by banks to it’s clients  and this facility have some agreed  maximum limit say 1 million or 2 million etc.

Bank Guarantee  issuing  for a specific period of time. For eg  3 months, 6 months , 1 year etc… or up to certain specific date (  eg.up to 31march 2017 ). Once the bank guarantee completed  it’s  validity period or maturity period, then such bank guarantee required to  renewed for further period  , if  required.

Once the validity of bank Guarantee expired, then such Bank Guarantee have no legal validity and the holder of that bank guarantee can’t claim to the bank for the  guaranteed amount  for  the breach of duty  or non performance from client. So validity of bank guarantee is one of the most important thing while maintaining a bank guarantee.

Bank guarantee should be for a specific person. That means in the bank guarantee it’s self mention the name of the ‘’beneficiary of the bank guarantee ‘’. So only that specific beneficiary can claim for the guaranteed amount from the bank.

Advance payment bank Guarantee,  Performance Bank Guarantee,  Retention bank guarantee, Tender Bond etc are some of the commonly used bank guarantees.

Each type of bank guarantees are used for separate specific purposes. 

Examples:-

1)Tender Bonds used for submitting tenders for getting any new contract  or project.

2)Advance Payment Bank Guranatee  used as a security against Advance Amount paid.

3)Performance Bank Guatantee used as a security  for the proper performance of the contract or delivery of goods.

4)Retention Bank Guarantee used as a security for the earlier  release of retention money .

BANK FACILITY LETTER ---- AN INTRODUCTION

Bank facility letter is letter issued by the bank to their customer. Every year or periodically  bank will make some amendment  on this letter according to the negotiation of the customer and according to the revised business rules of the banks.

It is an agreement between the bank and any corporation. In this letter bank will mention the details of the bank facilities which are offered to that particular customer. Its terms  varing to customer to customer depends on their credit worthness and financial stability.

In this facility letter bank will explain what are the facilities they are offered to that particular customer and its  maximum monitory limit and how much bank will charge to them by way of bank commission, bank charges , and bank interest ect.

Over draf facility, Bill discounting facility, Letter of credit facility, Bank guarantee facility etc are some of the common bank facilities used in business world. Bank will provide separate maximum limit for each such facilities. And separate bank charges for each facilities.All such details are mentioned in that Bank facility letter.

Before issuing bank facility letter , bank will analyse the financial position ,credit worthness, volume of business,  furure growth potentials,Value of fixed assets etc of that particular organization from their last few years financial statement and current years budgets.

 In short  companies  those companies having good  financial position will get all bank facilities with less cost because bank knows that companies can pay their debts on time without any problems. More over bank will monitor these companies financial position time to time . Most of the banks will ask to these companies to submit their quarterly financial statement  and monthly business details to bank on or before the specified date agreed previously at the time of negotiation.

Normally If any company’s financial position is not good, then the  bank will not provide any bank facilities to them or will  provide only few facilities with minimum monitory limit with high cost( bank charges, bank interest ect). Because bank having only reasonable assurance that  such company can pay their debts on time. So bank will charges high cost due to the high risk.

BANK RECONCILIATION STATEMENT - IMPORTANCE

Bank Reconciliation statement is a statement which shows the reason for difference between bank statement received from bank and bank book balance on a particular date say end of every month  or any  other date…

Here we tried to find out the reason for the difference. And ensure that such reasons are genuine .Most of the  small scale companies will do their bank reconciliation at the end of each month and make agree with the balance of  bank statement. But  in large scale companies required to do the reconciliation every day.

In short duration between two bank reconciliation and  frequency  of bank reconciliation will vary depends  on the number  and volume of  bank transactions in that particular organization or company.

Bank reconciliation gives a clear picture regarding the  banking transactions of that company. It shows that how many cheques are issued but not cleared, how  many  cheques are received but not deposited in the bank, details of stale cheque etc.

Some of the common reasons for the preparation of  bank reconciliation statement are as follows:-

1) C heque received from customer but not submitted in bank for clearance  or submitted but bank not       credited the amount in your Bank Account.

2) Cheque received and deposited in bank Account but same is not recorded in our books of Accounts.

3)Cheque issued to suppier or party  but not submit by supplier in bank.

4) Bank charges not recorded in books of accounts.

5) Bank interest or dividend  ect.  received in bank  but not recorded in books of accounts.

6) Any transaction with bank not recorded in books of accounts.

7) Cheque issued  and  party submitted in bank but dishonoured .

ACCOUNT PAYABLES & ACCOUNT RECEIVABLES ---- DIFFERENCE

Account payables are an amount a company owes to others because of purchase of any goods or services on credit . It is a liability to pay to another one.

Where as  Account Receivable is a current Asset to get the amount from another person. Only credit transaction  can create Account Payable and Account Receivable.

Normally when any goods purchased from any person on credit, then in the books of accounts of purchaser, treat this transaction as Account Payable because there is a liability to make payment to the supplier. Likewise the books of accounts of seller treat this transaction as Account receivable because  is is a receivable amount from purchased.

For Example :- A sells some goods to B  for AED 10,000/- Here B is the purchaser and A is the seller  and ‘’B’’ responsibility is to make payment to ‘’A’’ so  in the books of ‘’B’’ this transaction treated as                        ’’ Account Payables ‘’. And in this transaction, ‘’A’’ is the seller and ‘’A’’ required to get AED 10,000/- from ‘’A’’ so in the books of ‘’A’’ , this transaction treated as Account Receivables