A trial balance is a worksheet, which also can be described as a book-keeping system in which the balance of all the ledgers is recorded under the debit and credit account column. A company that prepares a trial balance periodically, usually does this at the end of every reporting period. The purpose of producing a trial balance is to ensure that the entries in a company's bookkeeping system are mathematically correct and appropriate.
Preparing this trial balance for a company detects any mathematical errors that have occurred in the double-entry accounting system. The total of the debits is required to be equal to the total of credits, then the trial balance is considered to be balanced, also it confirms that there are no mathematical errors in the ledgers. Well, this does not mean there are no errors in a company's accounting system.
Different types of organizations be it - a non-trading firm or a non-profit organization is involved in providing services to its customers. To provide their specialized services, the organization may incur expenses and then earn some revenue by providing the services. The details of Income and expenditure that are generated in such an organization should be accounted for, and that’s why an income and expenditure account is required to be created.
The necessity of creating an income and expenditure account is to calculate that deficit or surplus that is generated by the difference between the current income and the expenditure of the organization.
The Income and expenditure account is prepared from the Payments and Receipt account, while this at times is prepared from the trial balance.
The income and expenditure account is quite similar to the Trading and Profit and Loss Account that is prepared by the trading organizations.
The format of an income and expenditure account based on a particular trial balance is as follows:
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The role of a non-trading firm is to provide services to its members. Also, to do the same, it needs to earn some revenue and incur required expenditures. Thus, when these types of firms do so, it requires to prepare an income and expenditure account, that will help in ascertaining the surplus that is earned or the deficiency which is incurred during a period.
The Income and Expenditure Account is a summary of all the items of income and expenses which are related to the current accounting year. This is prepared with the objective of finding out the surplus or deficit that is arising out of the current incomes over the current expenses. This is more or less similar to the Trading and Profit and Loss Account of a trading firm.
The Income and Expenditure Account is prepared on an accrual basis method. All incomes and expenses relating to the current accounting year, whether they are received and paid or not, are taken into consideration here. The expenses of the firm are recorded on the debit side and then the income is recorded on the credit side. An accurate distinction is made between the capital and the revenue items in this case.
Income and Expenditure Account is a type of nominal account, and thus the rule of a nominal account which is to debit all expenses and losses and credit all the incomes and gains is followed here at the time of preparing this account. Only the items of revenue nature are recorded and all the items of capital nature are ignored here. For example, the profit which is earned or loss that is suffered on the sale of an asset is to be recorded in it but the amount that is received from the sale of an asset will not be recorded in this.
The closing balance of this account will show a surplus or a deficit for the year. When the credit side exceeds the debit side, it gives rise to a surplus. While, if the debit side exceeds the credit side, then there is a deficit. The surplus is added to the Capital Fund and the deficit is deducted from the Capital Fund.
For preparing the income and expenditure account, the following are the steps used:
Include all the items of the revenue receipts and expenses, on the respective side of the account.
Also, ensure that no items of capital incomes and expenses are included in this type of account.
Adjustment is required for the amounts that are prepaid and are outstanding, with respect to each item.
Further, items that are included are the receipts, payment account, depreciation, provisions, profit, and loss on the sale of assets are to be included in this account.
After putting down all these items of revenue and expenses, we get a balance. This balance represents the surplus or deficit for the period.
1. Why is the Income and Expenditure Account Called a Nominal Account?
Ans. Nominal Accounts are those accounts that record losses, expenses, income, or gains. The result of a nominal account is either profit or loss, after which it is transferred to the capital account.
So, the Income and Expenditure Account of a company determines the net profit or loss of the concern for a particular financial year hence this account is specified as the Nominal account. The Income and Expenditure account for the business expenditures and incomes that are flowing in the current year, and this is the work of a nominal account.
2. How Does a Non-Trading Firm Work?
Ans. A non-trading organization is priorly concerned with importing goods for resale. They trade only with the wholesalers, thereby making maximum profit for the owner of such business by providing various services for its members.
Their main aim is to serve the society at large.
Profit is not their sole criteria.
They have a surplus that is not distributed by the members.
They have a separate entity.
They are managed by elected members among them.
They get the major funds from donations.
3. Explain the Accrual Basis Method.
Ans. The Accrual accounting method is a popular accounting method where the revenue or the expenses are recorded when a transaction occurs rather than when the payment takes place or has been made. The method goes by the matching principle, which says that the revenues and the expenses are to be recognized in the same period.