When you’re dealing with long term shipments which take about more than 2-3 days, it’s always the question of when the risks and rewards have been delivered from the supplier to you as the buyer. The reason it’s important is the pure fact of when you should recognize the goods as in transit and on your balance sheet.
If you’re not dealing with long term shipments as often, the easiest thing to do is just right when you make the order and if applicable, also sign the agreement, just make sure that at that time you already know the terms of shipment and delivery. If you’re obliged to take care of the shipment itself, pay for it and say even insure the goods, its definite the risks have already transferred, so they are your goods.
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You have inventory for your business on your balance sheet and every now and then you need to purchase extra to keep the business going obviously. As it happens, the goods are never recognized in bulks, but in single units with their own unit price. Why? Because when you sell them, you mostly sell single units. Keeping that in mind, you have a unit selling price, so you must have the cost price for this single unit as well.
Regardless of this, you need to make sure the unit price is always right. It’s not just getting the right amount from the invoice, but also making sure you’ve added all the extra costs, like duties, transport fees etc. to the unit price. Normally those expenses are just spread across units the expense was made for (i.e. transport invoice is for a larger shipment, which includes like 1,000 units – the invoice amount is divided with the units and the result is added to a single unit price), or in case of bigger differences in unit own prices, you just take the proportion and then spread across units (i.e. 50% of the shipment was just 1 unit whereas the other 50% is like 500 units – the cost needs to be proportioned).
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As we already mentioned in our previous post, on occasions when some of your expenses are being compensated, there’s one key question you must ask. Do you know it for certain? The most important element when it comes to recognizing anything on your financial statements is the level of certainty – is it below or above 50%. As it is hard to determine, it’s something the management has to estimate.
So in a situation where the management has estimated that it’s definite the compensation is received, it needs to be recognized on the financial statements. The expenses themselves are recognized as always – debit the expense account and credit the liabilities. When the payment is done later on, you debit the liabilities and credit cash. Sounds easy enough, right?
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There are numerous businesses, where some of their expenses are being compensated by another party (i.e. party they are made for or who gets something out of it). Simply put you make an expense and this very same expense is later on either in full or partly being paid up by this someone else. You are the one paying for the supplier and you will receive compensation for it. Now the question is however, how do you recognize it all in your accounting?
Your expense is obviously an expense and should be recognized the same – under the income statement group it has always belonged under to. Hence also the liabilities and eventual cash payment is still done the same.
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In case you receive prepayments on a regular basis (i.e. gift cards etc.) there’s a high chance that the prepayments balance on your balance sheet is increasing and is most probably a considerable amount. I’m pretty sure that you have been wondering about what to do with this balance.
Generally when you receive prepayments, you on one hand increase “Cash and cash equivalents”, but you also take a liability called “Prepayments received” to your balance sheet. This liability cannot be turned into an income not until actual service has been provided.
However, what to do when you either know definitely (you keep record of all prepayments received and their date) or in case you do not keep specific track on the prepayments and have just a hunch that some of those are years old.
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Just recently we received a question about prepayments. Now imagine a situation – you received a prepayment from your client (either invoiced separately or charged as extra to compensate on extra services (like commercial space etc.), but due to whatever reasons you were unable to provide the actual service during the period or at year end. This in result means that you essentially received the money, but you didn’t do what you promised for it.
Yes, to start off, it’s not a nice place to be in, but it happens. It’s life and it’s business. Now, as we said, be the reasons what they may, we have the accounting for it to worry about. Normally, when you receive prepayments from your clients (say a 100 in our example), you should account them as follows:
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As we have mentioned already, every now and then it’s a must to send your excess cash to your bank. It’s this “cash in transit” – not yet arrived to bank, but already sent from your part.
Do it as regularly as needed to avoid any excess cash lying around. People have heightened temptations when it comes to cash and why first off give them that and secondly why not just avoid the trouble and risks. So try as often as possible to make sure the cash is transferred to your bank account.
Keep a good track record of how much money, when and by who was transferred and received. This way you can go back in time in case needed (i.e. in case of any dispute or something), you know at all times how much money should have been transferred to bank and how much actually was received and all in all it’s always good to have an overview of your assets and their movement.
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In a way it’s kind of like planning for stock count. There are teams, instructions and the time. While there isn’t much else to add, it’s just this one little thing to watch out for – temptation that money creates.
To kick it off you have to plan the time the count takes place – plan it as close to year-end as possible and make sure you have gotten rid of all excessive cash by that time. Make sure you have the people available for the time planned and inform them of this count as soon as practicable.
Another thing to watch out is the people themselves. When we say that money creates temptation, the first thing you have to consider, is the trustworthiness of them. Can you trust them with money?
With the time and people selected and planned, make sure your instructions are up-to-date and that they include everything that you want to be included. Are the instructions clear and not confusing? Make all those who are going to be counting aware of the instructions and make sure they have read and understood everything.
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The obvious answer to such a question is of course “all”. And as you might guess, it’s obviously the right answer, but there’s a little more to it. Whilst counting all is a “must”, surely you can see that for practical reasons the smaller the amount, the better.
When we say practical reasons, we mean the saving of time, resources (i.e. people and expenses to extra work time) and reducing any risks. Risks which arise are obvious – exposure to temptations that money creates, human error that occur when counting etc.
So to save all the hassle, make sure your risks are as minimal as possible, make sure the cash amount to be counted is as little as possible – transfer it to the bank, pay off creditors etc. Reduce the physical amount to as low as practicable to your business model (i.e. shops need certain amount of free cash for an example).
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In case you have loan contracts which include some sort of covenants, there are a few things you want to keep in mind. Since often times the loan liabilities are considerable, proper dealings are a “must”.
First and foremost you have to agree with the bank on how various covenants are measured, what is and isn’t included into the calculations and how exactly the bank understands one-off deals. You want to agree on this to ensure you’re both on the “same page”. Creating a situation where you would think that everything is okay and the bank is on a different opinion is not a place you want to be.
In case you are not meeting the agreed covenants, you do want to inform the bank as soon as you became aware of it and try to negotiate getting a waiver from the bank. A waiver usually means that the bank is not exercising its right to call back the loan in full.
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