What is a General Reserve?

When any amount is kept aside by a company out of its profit for future purpose then that is called as general reserves. In other words the general reserves are the retained earnings of a company which are kept aside out of company’s profits to meet future known or unknown obligations. General reserves are the part of Profit and Loss Appropriation Account.

In other words the general reserve is a free reserves which can be utilized for any purpose after fulfilling certain conditions.

On the basis of above definitions general reserve may be utilized for following purposes:-

• To settle any unknown future contingencies
• To increase the working capital
• To strengthen the financial position of the company
• To pay dividends to shareholders more than specified limits
• General reserves kept  to offset some specific future losses.
• General reserves includes the money kept aside for litigation or revaluation.

General reserves are shown in liabilities side of balance sheet.

What is a Letter of Credit?

A binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be transferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods. In order for the payment to occur, the seller has to present the bank with the necessary shipping documents confirming the shipment of goods within a given time frame. It is often used in international trade to eliminate risks such as unfamiliarity with the foreign country, customs, or political instability.

What are MIS reports and why do you prepare it?

MIS or Management Information System is a computer-based system used by most organizations worldwide for transforming data into useful information for better decisionmaking. It helps management make better plans and carefully organize business operations. Management information system is used for generating reports including inventory status reports, financial statements, performance reports etc. These reports are essential for analyzing different aspects of business. These reports also help to answer 'what-if' questions like what would be the effect on cash flows of a company if the credit term were changed for its customers etc. MIS reports also support decision-making and it helps to integrate the decision maker and the quantitative model being used. These automated systems allow managers to make decisions for smooth & successful operation of businesses. The system includes computer resources, people, and procedures used in the modern business enterprise. R

What is the difference between a contingent liability and an estimated liability?

A contingent liability is a potential liability (and a potential loss). It is dependent upon a future event occurring or not occurring. For instance, if someone files a lawsuit against ABC, ABC will have a contingent liability. The lawsuit liability is dependent upon Jay Corp losing the lawsuit. (Some lawsuits are nuisance suits and will not cause a loss and liability.) When a contingent liability and loss are probable and the amount can be estimated, an estimated amount will be recorded as a liability.

Some liabilities are not contingent liabilities but are estimated liabilities. For example, the electricity consumed, property taxes, worker compensation insurance premiums, repairs, etc. are absolutely owed because the services or goods were delivered. There is nothing contingent about these. However, the precise amounts may not be known at the time that the financial statements are prepared. Therefore, these liabilities had to be recorded by using estimated amounts. I suspect that many of the accrual-type adjusting entries involve estimated liabilities.

What is a contingent liability?

A contingent liability is a potential liability...it depends on a future event occurring or not occurring.

Contingent liabilities are liabilities that may be incurred by an entity depending on the outcome of an uncertain future event such as a court case.

A potential obligation that may be incurred depending on the outcome of a future event. A contingent liability is one where the outcome of an existing situation is uncertain, and this uncertainty will be resolved by a future event. A contingent liability is recorded in the books of accounts only if the contingency is probable and the amount of the liability can be estimated.

When to Recognize a Contingent Liability

There are three scenarios for contingent liabilities, all involving different accounting treatments. They are:

• High probability. Record a contingent liability when it is probable that the loss will occur, and you can reasonably estimate the amount of the loss. If you can only estimate a range of possible amounts, then record that amount in the range that appears to be a better estimate than any other amount; if no amount is better, then record the lowest amount in the range. “Probable” means that the future event is likely to occur. You should also describe the liability in the footnotes that accompany the financial statements.
• Medium probability. Disclose the existence of the contingent liability in the notes accompanying the financial statements if the liability is reasonably possible but not probable, or if the liability is probable, but you cannot estimate the amount. “Reasonably possible” means that the chance of the event occurring is more than remote but less than likely.
• Low probability. Do not record or disclose the contingent liability if the probability of its occurrence is remote.

GAAP requires that you report contingent liabilities as unspecified expenses on the income statement. You must disclose all contingencies that could significantly alter the company's estimated earnings. Explain any obscure or potentially misleading items in the footnotes. You should also use the footnotes to discuss any contingent liabilities incurred between the initial creation of the financial statements and publication of the final version.

Example - For example, a company may be facing a lawsuit from a rival firm for patent infringement. If the company's legal department thinks that the rival firm has a strong case, and the company estimates that the damages payable if the rival firm wins the case are $2 million, it would book a contingent liability of this amount on its balance sheet. If, on the other hand, the company's legal department is of the opinion that the lawsuit is frivolous and very unlikely to be won by the rival company, no contingent liability would be necessary.

Journal Entry

Example of a Contingent Liability

For example, ABC Company files a lawsuit against Unlucky Company for $500,000. Unlucky’s attorney feels that the suit is without merit, so Unlucky merely discloses the existence of the lawsuit in the notes accompanying its financial statements. Several months later, Unlucky’s attorney recommends that the company should settle out of court for $75,000; at this point, the liability is both probable and can be estimated, so Unlucky records a $75,000 liability. A possible entry for this transaction might be:

	Debit	Credit
Legal expense	75,000
Accrued liabilities		75,000

When Unlucky later pays ABC company in the out-of-court settlement, the final entry is:

	Debit	Credit
Accrued liabilities	75,000
Cash		75,000

Accounting Questions and Answers

1.Why do capital expenditures increase assets (PP&E), while other cash outflows, like paying salary, taxes, etc., do not create any asset, and instead instantly create an expense on the income statement that reduces equity via retained earnings?

Answer:- Capital expenditures are capitalized because of the timing of their estimated benefits – the lemonade stand will benefit the firm for many years. The employees’ work, on the other hand, benefits the period in which the wages are generated only and should be expensed then. This is what differentiates an asset from an expense.

2. Walk me through a cash flow statement.

Answer:- Start with net income, go line by line through major adjustments (depreciation, changes in working capital and deferred taxes) to arrive at cash flows from operating activities.

• Mention capital expenditures, asset sales, purchase of intangible assets, and purchase/sale of investment securities to arrive at cash flow from investing activities.
• Mention repurchase/issuance of debt and equity and paying out dividends to arrive at cash flow from financing activities.
• Adding cash flows from operations, cash flows from investments, and cash flows from financing gets you to total change of cash.
• Beginning-of-period cash balance plus change in cash allows you to arrive at end-of-period cash balance             

3.What is working capital?

Answer:-Working capital is defined as current assets minus current liabilities; it tells the financial statement user how much cash is tied up in the business through items such as receivables and inventories and also how much cash is going to be needed to pay off short term obligations in the next 12 months.