Unit-6: Preparing Final Accounts

Notes
Structure
6.1 Introduction
6.2 Adjustments
6.2.1 Types of Adjustments
6.3 Preparing Income Statement
6.3.1 Trading Account
6.3.2 Profit & Loss Account
6.4 Preparing Balance Sheet
6.5 Linkage Between Income Statement and Balance Sheet
6.6 Proforma Balance Sheet as per Schedule VI
6.7 Relevant Accounting Standards
6.8 Summary

Objectives
Objectives of this unit is to make student aware of the process of preparing
Income Statement (Trading & Profit and Loss accounts) and Balance sheet.
Student have also been given brief exposure to the important Accounting
Standards.

6.1 Introduction
Microeconomics is the study of human behavior and choices as they relate to
relatively small units, such as an individual, a firm, an industry, or a single market.
Macroeconomics is the study of human behavior and choices as they relate to an
entire economy. Economic analysis attempts to explain why problems arise in the
economy and how these problems can be dealt with. It is, therefore, indispensable
for formulating and conducting economic policy. However, before studying
macroeconomic theory and policy, one must know the macroeconomic goals of
the economy. There is no point in formulating a policy without definite objectives.
Macroeconomic policy operates within a framework of goals and constraints. The
most important goals of economic policy are;
i. Full employment- full utilization of human and non-human resources
ii. High living standards
iii. Price Stability
iv. Reduction of economic inequality and removal of poverty
v. Rapid economic growth

Final accounts consists of trading a/c P&L a/c and balance sheet. All the amounts
from trial balance are taken to prepare these accounts. In Trading a/c all the
transactions which are related to a factory are recorded such as sales purchases wages
etc. the profit in this a/c is known as gross profit and it is carried forwarded to P&L a/c.
In P&L a/call the transactions which are related to administration or office are recorded.
Such as office expenses salaries interest on investments. The profit in this a/c after
balancing is known as net profit which is added to the capital in thebalance sheet. If
there's loss its known as net loss and it is deducted from the capital. In balance sheet
there are assets & liabilities assets include buildings investments debtors etc. Liabilities

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include loan creditors bills payable etc. P&L a/c shows whether a firm has earned profit
or not where as balance sheet shows us the over all position of the firm. Notes

6.2 Adjustments
1. It is necessary to emphasize again that all accounts are prepared on 'Accrual'
basis. In other works all expenses paid for or not are to be accounted if they
relate to the period. Similarly, all incomes earned and due are credited to Income
statements whether they are actually received or not. Before an accountant can
proceed to prepare the financial statements from the Trial Balance, he has to
process some additional information, which he either already knows or receives
from some other agencies. The following are a few examples showing where
adjustments entries would be required.

(a) The accountant would ascertain that the salary of three workers of January is
unpaid at the end of the audit period.
(b) The accountant is informed by the storekeeper that the goods lying unsold in
the store (representing closing stock) is worth Rs. 17,000 at cost.
(c) The accountant knows that the insurance premium was paid for the whole year,
whereas the accounts are being prepared after six months.
6.2.1 Types of Adjustments
1. In view of the above information certain "Adjustments" will have to be made in the
books of accounts. Adjustment usually represents the recording of additional
information to reflect true affair of the profitability of business and not actual
transactions. Different types of Important adjustments are discussed below.

(a) Closing lnventorv Under the periodic verification method, the closing inventory
of every item is arrived at by physically counting the inventory available and
assigning a value to the same. In the business organisations, the value of
closing inventory will be brought into the books of accounts of Business by
debiting Closing Inventory AIC and crediting the Trading A/C. While the closing
inventory appears on the credit side of the Trading Account to reduce the cost
of goods sold, it also appears as an asset in the Balance Sheet.

(b) Outstanding or Accrued Expense. Prior to the preparation of the financial

statements, it must be ensured that all expenses which have fallen due to
be paid but which have not been paid during the accounting period are also
brought into the books to help in the proper matching of revenues and
expenses. The adjustments to record any outstanding or accrued expense is
debit the <related expense> AIC and credit the outstanding < related expense>
A/C . For example, M/S Smita & Co has the practice of paying the salaries of
the employees on the 1st of the subsequent month. During the financial year
ending 31st March 2005 the salaries account shows a debit balance of Rs.
55,000. The salaries of Rs. 6,000 pertaining to March 2005 were paid on 1st
April 2005. While preparing the financial statements for the year ending 31st
March 2005, the salaries of Rs. 6,000 of March must also be included. This is
done with the adjustments of debiting Salaries A/C by Rs 6,000 and crediting
outstanding salaries AIC with the same amount. While the amount of expense
taken from the Trial Balance will be increased by the amount outstanding
and shown in the Trading and Profit and Loss account, the actual amount
outstanding will be shown as a liability in the Balance Sheet. In the subsequent
accounting period, the outstanding expense liability will be transferred to the
expense or nominal account and will be set-off by the entry of actual payment
when it is made.

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(c) Prepaid Expense. Certain expenses paid m ay relate to more than one
Notes accounting period. In such cases, it is necessary to identify that portion of
the expenditure of which the benefit is yet to be received by the concern and
treat that part of the expenditure as prepaid. The adjustments to record any
prepaid expense is debit the <related expense> prepaid A/C and credit the <
related expense> A/C. For example - X Ltd , took an insurance cover for all
assets against fire on 1st October, 2005 and paid the annual premium of Rs.
2,400 on the same day. Since the benefit of the entire expenditure will expire
only on 30th September, 2006, it becomes necessary to recognize this aspect
while preparing the financial statements as on 31st March, 2006. The amount of
expense prepaid on 31st March, 2006= (1/2) 2,400=Rs. 1,200. This is adjusted
by debiting prepaid insurance A/C with an amount of Rs 1,200/- and crediting
Insurance A/C by the same amount. This entry ensures that the insurance
expense is reported at the correct figure of Rs. 1,200 in the profit and loss
account and the prepaid amount is shown as an asset in the Balance Sheet.

(d) Outstanding or Accrued Income. An income appearing in the ledger account

may not represent the income that must have been received during the year.
If a portion of an income has not yet been received or is outstanding as at the
end of the accounting period then the outstanding amount must be brought
into books. To record any outstanding income in the books of accounts, the
entry is debit the < related > outstanding income A/C and credit the <related>
income A/C. For example: M/S X Ltd has the investment in a Bank for Rs
10, 00,000 at 07 percent interest. The interest is payable on 31st December
of every year. The Investments have been made on 01 Jan 2005. M/S X Ltd
would be receiving the interest of Rs. 70,000 on 31st Dec 05. However, while
preparing the financial statements, the total interest revenue to be recognized
is the amount of Rs. 35,000 pertaining to the period 1st January 2005 to 3Qth
June 2005. This will be adjusted by debiting the outstanding interest A/C and
crediting the interest received A/C by Rs 35,000/. While the interest received
will increase to the Rs. 35,000 and shown in the Profit and Loss account, the
outstanding interest account will be listed as an asset in the Balance Sheet. In
the subsequent accounting period, the amount in the outstanding Interest A/C
will be transferred to interest received AJC and the actual receipt of the interest
will offset the former transfer entry.

(e) Income Received in Advance. While preparing the financial statements,

adjustments may be necessary in respect of any incomes received in advance.
The entry to record the adjustment of any income received in advance is debit
the <related> income AJC and credit the <related> income received in advance
AJC. For Example- M/s Y Ltd has received subscriptions amounting to Rs.
50,000 during the financial year ending 31st December, 2005. Out of this Rs.
2,500 represent subscription relating to the next financial year. The entry
to adjust for the income received in advance will be debiting the subscription
AJC and crediting subscription received in advance A/C by Rs 2,500.With the
posting of the above entry, the subscription account will be shown in the Profit
and Loss account at the correct figure of Rs. 47,500 and in the Balance Sheet,
the subscription received in advance will be listed as a liability. Any income
received in advance is a liability as benefits are yet to be conferred to the
person from whom the amount has been received.

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6.3 Preparing Income Statements
1. While preparing the Trading and Profit and Loss A/C, it is necessary to remember Notes
that at the end of accounting period all the items shown in Trial Balance do not
necessarily figure in these account . Only such items which represent income and
expenses including opening stock are taken to Trading and Profit and Loss Account.
Other items representing assets and liabilities (including Capital ) go to the Balance
Sheet. All adjustments as discussed in the last section are given double-entry effect.
Usually one of the effects of double entry due to adjustments is reflected in Profit
and Loss account and the other in Balance Sheet. (However, there could be some
particular cases where both effects are reflected either in Profit and Loss account or
in Balance Sheet). It is pertinent to mention here that net of Income and expenditures/
losses is either merged in the Capital (added or subtracted as the case may be)or
shown separately in the Balance Sheet , and all assets, liabilities and Capital (after
adjustments) are transferred next year after preparing Balance Sheet and again the
equation -Assets= Capital + External Liabilities satisfies.

16. From a given Trial Balance we can prepare a Trading and Profit and Loss Account
to determine the profit or loss made by a business organisation during a particular
period. At the time of preparation of these, the following points may be kept in
mind:

(a) All expenses are debited in these accounts & respective losses & expenses are
credited at the end of year thereby closing the A/C.

(b) All incomes are credited in these account & respective incomes are debited &
closed.

(c) The value of stock on hand at the end of the final period will have to be properly
ascertained and all other adjustments as discussed in the last chapter are
accounted for.

(d) All losses must be written-of by debiting there A/C.

(e) A fair amount should be written -off by way of depreciation on assets, such as
furniture, fitting etc as per rates applicable.

(f) In addition to treating the incomes and expenses found in the Trial Balance, we
may have to give special treatment to certain 'Adjustments' also .

(g) Profit is credited to Capital and net loss is debited to Capital AJC as it belongs
to owner. However, in case of companies these can be shown separately.

6.3.1 Trading Account

In the trading organisation, Trading Account is prepared to ascertain the Gross
Profit. In case of the manufacturing companies 'Manufacturing Account' is prepared.
Gross profit is the difference between sales and cost of goods sold. It is prudent to
first determine the gross profit (arising out of trading operations) and then deduct all
administrative and selling expenses form gross profit, add all non trading incomes to
determine the net profit. Profit and Loss Account is prepared to ascertain net profit.

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lllustration-2
Notes 4. Format of Trading account is given below as an illustration:
Dr. Cr.

ParliCL!Iars Rs. PartiCL!Iars Rs.

To Opening lnveni.ory 4,00,000 By Sales 7,90,000

Less: Returns 10,000
To Purchases 5,00,000
Less: Reil!rns 15,000
-----------
7,80,000
-----------4,85,000
By closing lnveni.ory 4,20,000
To Cartridge 10 , 000
To Wages 40, 000
To Factory 20,000
Expenses
To Fuel and Power 5,000
To Trading 15,000
Expenses
To Gross Profit 2,25,000
Transferred oi
P & L A/C
--------- -----------
12,00,000 12,00,000
--------- ------------
6.3.2 Profit and Loss Account.
1. Given below is a simple example of a Profit and Loss Account. You may notice that
it starts with gross profit (on credit side). If there is no separate Trading account
all the debits and credits of Trading Account appear individually in the Profit and
Loss Account. When a separate Trading Account is prepared, only the figure of
gross profit (or loss as the case may be) appears in the Profit and Loss Account
as a starting point. What is shown below is not an exhaustive list of expenses and
incomes. It is a simplified version of a typical Profit and Loss Account without taking
any "adjustments" to be made into account.

Profit and Loss Account for the period ending 31.3.2005

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Dr Cr
Notes
To Salaries 30,000 By Gross profit 2,25,000
To Printing & Stationery 15,000 By Rent received 2,000
To Postage & Telephone 2,500 By other income 10,000
To Audit Fee 4,000
To Office Rent 5,000
To Insurance 10,000
To Repairs and Main enance 5,000
To General Expenses 4,000
To Interest on Loans 8,000

To Net Profit transferred 1,53,500

To Reserves or Capital

2,37,000 2,37,000

2. While preparing a Profit and Loss A/C, it is necessary to remember that all the items
shown in Trial Balance do not necessarily figure in Profit and Loss Account. Only
such items which represent income and expenses are taken to Profit and Loss
Account. Other items representing assets and liabilities (including capital) go to the
Balance Sheet.

Illustration 3

7. From the following Trial Balance of a M/S SMITA, prepare a Profit and Loss account
for the year ended March 31, 2005.
Dr Cr

To Salaries 30,000 By Gross profit 2,25,000

To Printing & Stationery 15,000 By Rent received 2,000
To Postage & Telephone 2,500 By other income 10,000
To Audit Fee 4,000
To Off ice Rent 5,000
To Insurance 10,000
To Repairs and Main enance 5,000
To General Expenses 4,000
To Interest on Loans 8,000

To Net Profit transf erred 1,53,500

To Reserves or Capital

2,37,000 2,37,000

Adjustments:

(a) Inventory was valued on March 31, 2005 at Rs. 95,000

(b) Depreciate properties by Rs. 10,500/-.
(c) Provide for following outstanding expenses:
Wages Rs. 10,000
Salaries Rs 7,000
General expenses Rs. 5,000
(d) Insurance was prepaid to the extent of Rs. 3,000.
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(e) A sum of Rs. 3,000 represents Discount received in advance but not yet due.
Notes
Solution
What we are attempting in this illustration is only Profit and Loss Account. In the
next chapter we will prepare Balance Sheet based on the same data.

MIS Smita & Co., Trading and Profit and Loss Account for the year ended March 31,2005

Dr Cr
Rs. Rs. Rs. Rs.

To Opening Inventory 60,000 By Sales 6,00,000

To Purchases 3,70,000 Less: Returns 20,000
Less: Returns 10,000
5,80,000

3,60,000 By closing Inventory 95,000

To Wages 15,000
Add: Outstanding due 10,000

25,000

To freight 20,000
To Gross Profit c/d 2,10,000

6,75,000

To Insurance 10,000 6,75,000

Less: Prepaid 3,000

By Gross Profit b/d 2,10,000

7,000

To Petty expenses 6,000

To salaries 15,000 By D. received 20,000

Add: Outstanding due 7,000 Less:
received in
advance 3,000
22,000
To Postage and 20,000
Telephones 17,000
To General 34,000
Expenses
Add: Outstanding due 5,000

39,000
To Depreciation on 10,500
Properties:
To Net profit 1,22,500
transferred to Capital.

Total 2,27,000
Total 2,27,000

6.4 Preparing Balance Sheet

1. A Balance Sheet is a statement of assets and liabilities of an NPF at any particular
date. At the end of each accounting period, every organization prepares a Balance

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Sheet to have a clear understanding of its assets and liabilities, which indicate the
financial position of the concern. Notes
2. The Balance Sheet is prepared from the point of view of the business (as a separate
entity, distinguished from its owners). Another way to understand a Balance Sheet
is to consider it as a statement of M/s Smita, of funds (i.e., liabilities) and utilization
of funds (i.e., assets). A simplified version of a typical Balance Sheet is given. The
registered companies are required to follow Part 1 of schedule VI of Companies
Act, 1956 for recording assets and liabilities in the Balance Sheet. But there
is no such law for the order of writing assets and liabilities in case of sole trader
and partnership firms. Even then they may also record the assets and liabilities
on (a) liquidity basis and (b) fixity basis. When assets and liabilities are arranged
according to their reabiasibility and payment reference, it is liquidity order basis.
When fixed assets and liabilities are arranged on the assumption that these will be
sold and paid only on the liquidation of business it is fixity basis. Taking the example
of M/S SMITA given above we will now prepare a Balance Sheet.

Illustration 4

Balance Sheet of MIS SMITA, as on 311 December 2005

Liabilities Rs Rs Assets Rs Rs
GMF 2,30,000 Properties 2,80,000

Net Prom 1,22,000 3,52,000

Less: 10,500
Depreciation
2,69,000
Current Current
Liabilities A ssets
C ash at 20,000
Bank
S. Creditors 1,10,000 Sundr y 1,00,000
Debtors
Outstanding
E xpense s:
W ages 10,000
S alaries 7,000 Sto c k 95,000
General Prepaid 3,000
Expense s 5,000 Expens es
22,000 (Ins ur anc e)
Discount 3,000
received in
advance

----------- -----------
4,87,500 4,87,500

6.5 Linkage Between Trial Balance, Profit & Loss Account and
Balance Sheet
It is necessary to understand the linkage between Trial Balance, Profit and Loss
Account and Balance Sheet as shown in Fig down

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Notes Trial Balance

I
I I
Item s relating to Items relating
Income and to Assets and
Expenses Liabilities

Double
Entry
Profit and Loss Effect
Account Balance
Sheet

Res ult : Net

Profit or Loss

Tr ansferred to
I Balance Sheet
-

6.6 Performa Of Balance Sheet In HorizontalForm According To

The Requirements Of Schedule Vi Of The Companies Act 1956.

-
Figures f or Figures Figures for Figures for
the forthe the the current
previous current prev ous year

IlL IlL FIL

year year year

(1) Share Capi (11AXED ASSE-tS:

Authorised Cap1t,.

XXX ... Shares of As. each 2. Land.

XXX ...Equity Shares of As ..each XXX

XXX XXX
... Preference Share of Rs. ..each
6.Rl!nt and Machinery
Subscribed Capit,.

7.Furniture and Fittings

,.. Equity Shares of Rs ...each As. ...
CAd up XXX

B. Oevdt>pment of Property
...Preference Share of As ...each Rs.. ..
CAd up XXX

9.Patents,Trade Mal1<s and Designs

Less caUnpaid XXX

(i) By directors XXX

(11) By Olhera XXX 11. Vohldoseli:.

XXX XXX (ZIINYE8tt11EN-t6:

Add Foneited shares
(3) CURRENT ASSETS,LOANS AND
(2) RESERVES AND SURPLUS: ADVANCES:

XXX XXX (A) Current Assets:

1.CapiueReserve. not avcta!Al for
Dividend
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XXX 2.Capital Redemption Reserve XXX 1.1ntersst accrued on iiMIIIIments

XXX 3.Share Premium Account XXX 2.Stores and Spare parlB

Notes
XXX 4.0ther ReseiV8s specifying the nature of XXX 3.Loose Tools
resarveand the amount in respectthareof.
Less:Debit balance In Profit & Loss account
[rfany)

XXX 5.Surplus, that Is balance In Prom and Loss XXX 4.Stock In trade
account after providing for proposed
allocation namely:
Dividend,Bonus or Reserves

XXX 6. Proposed addition to reserves XXX 5.Workln progress

XXX 7.Sinking Funds XXX 6.Sundry Debtors:

a. Debts outstanding lor a period
alfCBBding 6 months
b. Other Debts
1988:Provision

(3) SECURED LOANS: 7.(a) Cash balance in hand

(b) Bank balance:
Wrth scheduled Banks
ii. Wrth others

XXX 1. Debenturee XXX (B) latina end Advenr:u:

XXX 2.Loans and Advances from Banks. XXX B.(a) Advances and loans to subsiciaries
(b) advances and loans to partnership firma in
whichthe Company or anyoflts subsidaries
is a partner

XXX 3.Loans and Advances from subsidiaries XXX 9.Bills ofExchange

XXX 4.0ther loans and Advances XXX 10.Advances recoverableincash orin kind
(e.g.Rates,Taxes,Insurance ,etc.prepaid)
XXX 5.1nterest accrued and due on secured XXX 11.Balances with customs,Port Trusts,and
loans excise authorities etc.
(4)UNSECURED LOANS: (4) MISCELLANEOUSEXPENDmJRE:
XXX 1. Fixed Deposits XXX 1. Preliminary Expenses
XXX 2. Loans and Advances from subsidiaries XXX 2. Expenses ,including commission or
Brokerage on under writingofSharesor
Debentures
XXX 3. Short Term loans and Advances XXX 3. Discount allowed on the issue of Shares or
a. From Banks Debentures
b. From Others
XXX 4.0ther loans and Advances XXX 4.1nterestpaid out of capital during
a. From Banks construction period
b. From Others
(5) CURRENT LIABILmES AND 5. Development expenciture not adjusted
PROVISIONS:
(A) Currant liabiiHiea: 6.0ther sums (specif)ling nature)
XXX 1. Acceptances XXX 5. PROFIT a LOSS ACCOUNT{This Is
shown only when Hs debit balance count not
be written off out of others reserves)
XXX 2. Sundry Creditors XXX
XXX 3. SubsidiaryCompanies XXX
XXX 4. Unclaimed Dividends XXX
XXX 5.1nterest accrued but not due on loans XXX
XXX 6.Advance payments and unexpired XXX
discounts for the portionfor which value has
strll to be given,e.g.lnthe case of the
followingclasses of companies:Newspaper,
Fire lnsurance ,Theatres ,Ciubs,Banking,
Steamship Companies etc.

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XXX 7. Other Liabilities (if any) XXX

(B) Pruv10ns:
Notes XXX B. Proposed Dividends XXX
XXX 9. Provision for Taxation XXX

XXX 10. Provision for Contingencies XXX

XXX 11. Provision for Provident Fund schemes XXX
XXX 12. Provision tor insurance, pens1on and XXX
similar staff benef t schemes.
XXX 1S. Oller Prov soons XXX
(6) CONTINGENT LIABILITIES {by way of
footnote only):

!.Uncalledliabilities on partly paid shares

2.Uabihties under Guarantee

3.Arrears of dividends on cumulative

preference shares
4.Ciaim against the oompany now
acknowledged as debts

5.Liabihties on Bills Receivable d1soounted

but not matured.

XXX

6.6 Relevant Accounting Standards

6.6.1 Accounting Standard 6: Depreciation Accounting
1. Standard does not apply to depreciation in respect of forests, plantations and
similar regenerative natural resources, wasting assets including expenditure
on exploration and extraction of minerals, oils, natural gas and similar non-
regenerative resources, expenditure on research and development, goodwill and
livestock. Special considerations apply to these assets.

2. Allocate depreciable amount of a depreciable asset on systematic basis to each

accounting year over useful life of asset.

3. Useful life may be reviewed periodically after taking into consideration the expected
physical wear and tear, obsolescence and legal or other limits on the use of the
asset.

4. Basis for providing depreciation must be consistently followed and disclosed. Any
change to be quantified and disclosed.

5. A change in method of depreciation be made only if required by statute, for

compliance with an accounting standard or for appropriate presentation of the
financial statements. Revision in method of depreciation be made from date of use.
Change in method of charging depreciation is a change in accounting policy and be
quantified and disclosed.

5. In cases of addition or extension which becomes integral part of the existing asset
depreciation to be provided on adjusted figure prospectively over the residual useful
life of the asset or at the rate applicable to the asset.

6. Where the historical cost undergoes a change due to fluctuation in exchange rate,
price adjustment etc. depreciation on the revised unamortized amount should be
provided over the balance useful life of the asset.

7. On revaluation of asset depreciation should be based on revalued amount over

balance useful life. Material impact on depreciation should be disclosed.

8. Deficiency or surplus in case of disposal, destruction, demolition etc. be disclosed

separately, if material.
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9. Historical cost, amount substituted for historical cost, depreciation for the year and
accumulated depreciation should be disclosed. Notes
10. Depreciation method used should be disclosed. If rates applied are different from
the rates specified in the governing statute then the rates and the useful life be also
disclosed.

6.6.2 Accounting Standard 9: Revenue Recognition

1. Standard does not deal with revenue recognition aspects of revenue arising from
construction contracts, hire-purchase and lease agreements, government grants
and other similar subsidies and revenue of insurance companies from insurance
contracts. Special considerations apply to these cases.

2. Revenue from sales and services should be recognised at the time of sale of goods
or rendering of services if collection is reasonably certain; i.e., when risks and
rewards of ownership are transferred to the buyer and when effective control of the
seller as the owner is lost.

3. In case of rendering of services, revenue must be recognised either on completed

service method or proportionate completion method by relating the revenue with
work accomplished and certainty of consideration receivable.

4. Interest is recognised on time basis, royalties on accrual and dividend when

owner's right to receive payment is established.

5. Disclose circumstances in which revenue recognition has been postponed pending

significant uncertainties.

6.6.3 Accounting Standard 10: Accounting for Fixed Assets

Fixed asset is an asset held for producing or providing goods and/or services and is
not held for sale in the normal course of the business.

Cost to include purchase price and attributable costs of bringing asset to its working
condition for the intended use. It includes financing cost for period up to the date of
readiness for use.

Self-constructed assets are to be capitalised at costs that are specifically related to

the asset and those which are allocable to the specific asset.

Fixed asset acquired in exchange or part exchange should be recorded at fair

market value or net book value of asset given up adjusted for balancing payment,
cash receipt etc. Fair market value is determined with reference to asset given up
or asset acquired.

Revaluation, if any, should be of class of assets and not an individual asset.

Basis of revaluation should be disclosed.

Increase in value on revaluation be credited to Revaluation Reserve while the

decrease should be charged to P & L A/c.

Goodwill should be accounted only when paid for.

Assets acquired on hire purchase be recorded at cash value to be shown with

appropriate note about ownership of the same. (Not applicable for assets acquired
after 1st April, 2001 in view of AS 19 - Leases becoming effective).

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Gross and net book values at beginning and end of year showing additions,
Notes deletions and other movements, expenditure incurred in course of construction and
revalued amount if any be disclosed.

Assets should be eliminated from books on disposal/when of no utility value.

Profit/Loss on disposal be recognised on disposal to P & L statement.

6.7 Summary
Accounts made up only at the end of a firm's financial year. For a manufacturing
firm, the final accounts consist of (1) manufacturing account, (2) trading account, (3)
profit and loss account, and (4) Balance Sheet A trading firm's final accounts will
include all of the above except the manufacturing account. Together, these accounts
generate the gross profit, net income, and distribution of net income figures of the firm.

Check Your Progress

1. Depreciation is .............. in the Profit& Loss Account.
2. Revenue is recognised when collection is .
3. Capital is shown in the .............side of the Balance Sheet.
4. ------Expenses are debited in the Trading Account.
5. As per the Accounting Standard the method of depreciation can be changed from-
--------effect.
6. account enables the trader to find out Gross Profit or Loss
7. account enables the trader to find out the Net Profit or Loss.
8. Direct Expenses appears on side of ;account.
9. Indirect Expenses appears on side of account.
10. Wages and Salaries appear on account
11. Salaries and wages appear on account.
12 Trade Expenses will appear on side of P & L Ale.
13. If the Trail Balance contains both Trade Expenses and Office Expenses, The Trade
Expenses Posted to account and office Expenses posted to
account.
14. shows the Financial Position of a Trader.
15. Assets- Liabilities = _
16. Assets- Capital = ------
17. Capital + Liabilities=------

Questions and Excercises

1. State whether the following are true or false:
(a) Balance Sheet is a ledger Ale
(b) Land is an intangible asset
(c) Patent is a tangible asset
(d Stock is a floating asset.
(e) Bills payable is a long term liabilities

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Accounting for Managers 79
0.2. Give the headings under which the following items will be shown in a company's
balance sheet as per Schedule VI, Part 1: Notes
(a) Sundry Creditors
(b) Debentures Sinking Fund
(c) Bills Receivable
(d) Discount on Issue of Debentures
(e) Motor Car

3. Given below is the trial balance of Mr. Mohan as on 31st March 2002. You are
required to prepare Trading and Profit & Loss Account for the year ended 31st
March 2002 and Balance Sheet as on that date.
Trial Balance
Particulars Debit Credit
Purchases and Sales 1 '18,0 1 ,54,5
Debtors and 00 00
Creditors
Returns 42,000 30,000
Furniture
Building 2,000 1,000
Cash in hand
Cash at bank 25,000
Salaries
Discount 60,000
Printing and
Stationary 1,250
Stock as on 250
01.04 .2001 6,750
Postage and
telegram 14,000
Advertisement
Carriage inward 500
Carriage outward
Drawings and 2,000 1 ,58,7
Capital 50
Rent received 12,500
Machinery 1,500
750
3,46,0
4,500 00

1,500

1,250

4,000

50,000
3,46,0
00 Adjustments:

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80 Accounting for Managers

1. Closing stock was valued at Rs. 28,500

Notes 2. Outstanding salaries Rs. 2000
3. Depreciate machinery by 5% and furniture by 10%
4. Following information is available from records kept by Mr. Akash on Single Entry
basis.

1.1.2006 31.12.2006
Cash 40,000 36,000
Bank 60,000 66,000
Debtors 34,000 50,000
Stock 80,000 1,20,000
Fixed Assets 58,000 58,000
Creditors 1,04,000 64,000
Loan 20,000 20,000

Rs. 10,000 p.m. was withdrawn by the proprietor for household expenses during
2006. Interest on drawing is charged on total amount withdrawn during the year@ 18%
p.a. for six months. Rs. 60,000 realised by the proprietor as maturity value of National
Saving Certificates was invested in the business. He further introduced in the business
Rs. 30,000 borrowed from his wife. Manager was given salary for the month of January,
2007 in advance. Manager is entitled to a salary@ Rs. 12,000 p.m.

An unrecorded liability of Rs.10,000 relating to year 2005 was paid during the year
2006.

Depreciate fixed assets@ 15% p.a. ProvideRs. 2,000 for doubtful debts.

Prepare a statement showing Net Profit (or net loss) for the year 2006 and prepare
Balance Sheet as at 31.12.2006.

Further Readings
1. Accounting Principles. Robert N Anthony.

2. Accounting For Managers. Maheshwari and Maheshwari.

3. Introduction to Accountancy.T S Grewal. S Chand & CO.

4. Advanced Accounting, Sehgal Ashok, Sehgal Deepak .Taxman Allied Services (P)
Ltd., New Delhi

5. Advanced Accountancy, Jain S.P. , Narang K. L .Kalyani Publishers, Ludhiana.

6. Advanced Accounts, Shukla M.C., Grewal T.S.: S. Chand & Company Ltd., New
Delhi.

7. Advanced Accountancy, Gupta R.L., M. Radhaswamy: Sultan Chand & Sons, New
Delhi.

8. Financial Accounting, Tulsian. Tata McGraw-Hill, New Delhi

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Accounting for Managers 191

Unit-16: Company Accounts

A company form of organisation is the third stage in the evolution of
forms of organisation. Its capital is contributed by a large number of
persons called shareholders who are the real owners of the
company. But neither it is possible for all of them to participate in the
management of the company nor considered desirable. Therefore,
they elect a Board of Directors as their representative to manage
the affairs of the company. In fact, all the affairs of the company are
governed by the provisions of the Companies Act, 1956. A company
means a company incorporated or registered under the Companies
Act, 1956 or under any other earlier Companies Acts. According to
Chief Justice Marshal, "a company is a person, artificial, invisible,
intangible and existing only in the eyes of law. Being a mere
creation of law, it possesses only those properties which the charter
of its creation confers upon it, either expressly or as incidental to its
very existence". A company usually raises its capital in the form of
shares (called share capital) and debentures (debt capital.) This
chapter deals with the accounting for share capital of companies.

1.1 Features of a Company

A company may be viewed as an association of person who
contribute money or money's worth to a common inventory and
uses it for a common purpose. It is an artificial person having
corporate legal entity distinct from its members (shareholders) and
has a common seal used for its signature. Thus, it has certain
special features which distinguish it from the other forms of
organisation. These are as follows:

Body Corporate: A company is formed according to the provisions

of Law enforced from time to time. Generally, in India, the
companies are formed and registered under Companies Law except
in the case of Banking and Insurance companies for which a
separate Law is provided for.

Separate Legal Entity: A company has a separate legal entity

which is distinct and separate from its members. It can hold and
deal with any type of property. It can enter into contracts and even
open a bank account in its own name.

Limited Liability: The liability of the members of the company is

limited to the extent of unpaid amount of the shares held by them. In
the case of the companies limited by guarantee, the liability of its
members is limited to the extent of the guarantee given by them in
the event of the company being wound up.

Perpetual Succession: The company being an artificial person

created by law continues to exist irrespective of the changes in its
membership.
A company can be terminated only through law. The death or
insanity or insolvency of any member of the company in no way

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affects the existence of the company. Members may come and go

but the company continues.

Common Seal: The company being an artificial person, cannot

sign its name by itself. Therefore, every company is required to
have its own seal which acts as official signatures of the company.
Any document which does not carry the common seal of the
company is not binding on the company.

Transferability of Shares: The shares of a public limited company

are freely transferable. The permission of the company or the
consent of any member of the company is not necessary for the
transfer of shares. But the Articles of the company can prescribe the
manner in which the transfer of shares will be made.

May Sue or be Sued: A company being a legal person can enter

into contracts and can enforce the contractual rights against others.
It can sue and be sued in its name if there is a breach of contract by
the company.

1.2 Kinds of Companies

Companies can be classified either on the basis of the liability of its

members or on the basis of the number of members.
On the basis of liability of its members the companies can be
classified into the following three categories:

(i) Companies Limited by Shares: In this case, the liability of its

members is limited to the extent of the nominal value of shares held
by them. If a member has paid the full amount of the shares, there is
no liability on his part whatsoever may be the debts of the company.
He need not pay single paise from his private property. However, if
there is any liability involved, it can be enforced during the existence
of the company as well as during the winding up.

(ii) Companies Limited by Guarantee: In this case, the liability of its

members is limited to the amount they undertake to contribute in the
event of the company being wound up. Thus, the liability of the
members will arise only in the event of its winding up.

(iii) Unlimited Companies: When there is no limit on the liability of its

members, the company is called an unlimited company. When the
company's property is not sufficient to pay off its debts, the private
property of its members can be used for the purpose. In other
words, the creditors can claim their dues from its members. Such
companies are not found in India even though permitted by the
Companies Act, 1956.

On the basis of the number of members, companies can be divided

into two categories as follows:

(i) Public Company: A public company means a company which (a)

is not a private company, (b) has minimum paid up capital of Rs. 5
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 Accounting for Managers 193
lakh rupees or such higher paid-up capital, as may be prescribed
and (c) is a company which is not a subsidiary of a private company.

(ii) Private Company: A private company is one which has a

minimum paid up capital of Rs. 1 Lakh rupees or such higher paid-
up share capital as may be prescribed, and which by its articles: (a)
restricts the right to transfer its shares; (b) limits the number of its
members to fifty (excluding its employees); (c) prohibits any
invitation to the public to subscribe for any shares in or debentures
of the company. (d) Prohibits any invitation or acceptance of
deposits from person other than its members, directors, and
relatives.

1.3 Share Capital of a Company

A company, being an artificial person, cannot generate its own

capital which has necessarily to be collected from several persons.
These persons are known as shareholders and the amount
contributed by them is called share capital. Since the number of
shareholders is very very large, a separate capital account cannot
be opened for each one of them. Hence, innumerable streams of
capital contribution merge their identities in a common capital
account called as 'Share Capital Account'.

1.3.1 Categories of Share Capital

From accounting point of view the share capital of the company can
be classified as follows:

Authorised Capital:
Authorised capital is the amount of share capital which a company
is authorised to issue by its Memorandum of Association. The
company cannot raise more than the amount of capital as specified
in the Memorandum of Association. It is also called Nominal or
Registered capital. The authorised capital can be increased or
decreased as per the procedure laid down in the Companies Act. It
should be noted that the company need not issue the entire
authorised capital for public subscription at a time. Depending upon
its requirement, it may issue share capital but in any case, it should
not be more than the amount of authorised capital.

Issued Capital:
It is that part of the authorised capital which is actually issued to the
public for subscription including the shares allotted to vendors and the signatories to the
company's memorandum. The authorised capital which is not offered for public
subscription is known as 'unissued capital'. Unissued capital may be offered for public
subscription at a later date.

Subscribed Capital:
It is that part of the issued capital which has been actually
subscribed by the public. When the shares offered for public
subscription are subscribed fully by the public the issued capital and
subscribed capital would be the same. It may be noted that
ultimately, the subscribed capital and issued capital are the same
because if the number of share, subscribed is less than what is
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194 Accounting for Managers
offered, the company allot only the number of shares for which
subscription has been received. In case it is higher than what is
offered, the allotment will be equal to the offer. In other words, the
fact of over subscription is not reflected in the books.

Called up Capital:
It is that part of the subscribed capital which has been called up on
the shares. The company may decide to call the entire amount or
part of the face value of the shares. For example, if the face value
(also called nominal value) of a share allotted is Rs. 10 and the
company has called up only Rs. 7 per share, in that scenario, the
called up capital is Rs. 7 per share. The remaining Rs. 3 may be
collected from its shareholders as and when needed.

Paid up Capital:
It is that portion of the called up capital which has been actually
received from the shareholders. When the shareholders have paid
all the call amount, the called up capital is the same to the paid up
capital. If any of the shareholders has not paid amount on calls,
such an amount may be called as 'calls in arrears'. Therefore, paid
up capital is equal to the called-up capital minus call in arrears.

Uncalled Capital:
That portion of the subscribed capital which has not yet been called
up. As stated earlier, the company may collect this amount any time
when it needs further funds.

Nature and Classes of Shares

Shares, refer to the units into which the total share capital of a
company is divided. Thus, a share is a fractional part of the share
capital and forms the basis of ownership interest in a company. The
persons who contribute money through shares are called
shareholders. The amount of authorised capital, together with the
number of shares in which it is divided, is stated in the
Memorandum of Association but the classes of shares in which the
company's capital is to be divided, along with their respective rights
and obligations, are prescribed by the Articles of Association of the
company. As per Section 86 of The Companies Act, a company can
issue two types of shares (1) preference shares, and (2) equity
shares (also called ordinary shares).

1. Preference Shares
According to Section 85 of The Companies Act, 1956, a preference
share is one, which fulfills the following conditions:
(a) That it carries a preferential right to dividend to be paid either as
a fixed amount payable to preference shareholders or an amount
calculated by a fixed rate of the nominal value of each share before
any dividend is paid to the equity shareholders. (b) That with respect
to capital it carries or will carry, on the winding up of the company,
the preferential right to the repayment of capital before anything is
paid to equity shareholders. However, notwithstanding the above
two conditions, a holder of the preference share may have a right to
participate fully or to a limited extent in the surpluses of the
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company as specified in the Memorandum or Articles of the
company.
Thus, the preference shares can be participating and non-
participating. Similarly, these shares can be cumulative or non-
cumulative, and redeemable or irredeemable.

2 Equity Shares

According to Section 85 of The Companies Act, 1956, an equity

share is a share which is not a preference share. In other words,
shares which do not enjoy any preferential right in the payment of
dividend or repayment of capital, are termed as equity/ordinary
shares. The equity shareholders are entitled to share the
distributable profits of the company after satisfying the dividend
rights of the preference share holders. The dividend on equity
shares is not fixed and it may vary from year to year depending
upon the amount of profits available for distribution. The equity
share capital may be (i) with voting rights; or (ii) with differential
rights as to voting, dividend or otherwise in accordance with such
rules and subject to such conditions as may be prescribed.

Issue of Shares
A salient characteristic of the capital of a company is that the
amount on its shares can be gradually collected in easy installments
spread over a period of time depending upon its growing financial
requirement. The first installment is collected along with application
and is thus, known as application money, the second on allotment
(termed as allotment money), and the remaining installment are
termed as first call, second call and so on.
The word final is suffixed to the last installment. However, this in no
way prevents a company from calling the full amount on shares right
at the time of application.
The important steps in the procedure of share issue are :

Issue of Prospectus:
The company first issues the prospectus to the public. Prospectus is
an invitation to the public that a new company has come into
existence and it needs funds for doing business. It contains
complete information about the company and the manner in which
them money is to be collected from the prospective investors.

Receipt of Applications: When prospectus is issued to the public,

prospective investors intending to subscribe the share capital of the
company would make an application along with the application
money and deposit the same with a scheduled bank as specified in
the prospectus. The company has to get minimum subscription
within 120 days from the date of the issue of the prospectus. If the
company fails to receive the same within the said period, the
company cannot proceed for the allotment of shares and application
money should be returne within 130 days of the date of issue of
prospectus.

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196 Accounting for Managers

Allotment of Shares: If minimum subscription has been received,

the company may proceed for the allotment of shares after fulfilling
certain other legal formalities. Letters of allotment are sent to those
whom the shares have been allotted, and letters of regret to those to
whom no allotment has been made. When allotment is made, it
results in a valid contract between the company and the applicants
who now became the shareholders of the company.

Accounting Treatment

On application: The amount of money paid with various installments

represents the contribution to share capital and should ultimately be
credited to share capital. However, for the sake of convenience,
initially individual accounts are opened for each installment. All
money received along with application is deposited with a scheduled
bank in a separate account opened for the purpose.
The journal entry is as follovvs:

Bank Ale Dr.

To Share Application Ale
(Amount received on application for-shares @ Rs. per
share)

On allotment: When minimum subscription has been received and

certain legal formalities on the allotment of shares have been duly
compiled with, the directors of the company proceed to make the
allotment of shares.
The allotment of shares implies a contract between the company
and the applicants who now become the allottees and assume the
status of shareholders or members.

The journal entries with regard to allotment of shares are as follovvs:

1. For Transfer of Application Money

Share Application Ale Dr.
To Share Capital Ale
(Application money on Shares allotted/ transferred to Share
Capital)

2. For Money Refunded on Rejected Application

Share Application Ale Dr.
To Bank Ale
(Application money returned on rejected application for _shares)

3. For Amount Due on Allotment

Share Allotment Ale Dr.
To Share Capital Ale

4. For Adjustment of Excess Application Money

Share Application Ale Dr.
To Share Allotment Ale
(Application Money on _Shares @ Rs_per shares adjusted to the
amount due on allotment).
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5. For Receipt of Allotment Money
Bank Ale Dr.
To Share Allotment Ale
(Allotment money received on _Shares @ Rs. - per share
Combined Account)

Note:- The journal entries (2) and (4) can also be combined as
follows:
Share Application Ale
To Share Allotment Ale
To Bank Ale
(Excess application money adjusted to share allotment and balance
refunded)

Sometimes a combined account for share application and share

allotment called 'Share Application and Allotment Account' is
opened in the books of a company.
The combined account is based on the reasoning that allotment
without application is impossible while application without allotment
is meaningless.
These two stages of share capital are closely inter-related. When a
combined account is maintained, journal entries are recorded in the
following manner:

1. For Receipt of Application and Allotment

Bank Ale Dr.
To Share Application and Allotment Ale
(Money received on applications for shares @ Rs. per
share).

2. For Transfer of Application Money and Allotment Amount Due

Share Application and Allotment Ale Dr.
To Share Capital Ale
(Transfer of application money to Share Capital Account for amount
due or allotment of- Share @ Rs. per share)

3. For Money Refunded on Rejected Applications

Share Application and Allotment Ale Dr.
To Bank Ale
(Application money returned on rejected application for_ shares)

4. On Receipt of Allotment Amount

Bank Ale Dr.
To Share Application and Allotment Ale
(Balance of Allotment Money Received)

On Calls: Calls play a vital role in making shares fully paid-up and
for realizing the full amount of shares from the shareholders. In the
event of shares not being fully called up till the completion of
allotment, the directors have the authority to ask for the remaining
amount on shares as and when they decide about the same. It is
also possible that the timing of the payment of calls by the

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198 Accounting for Managers

shareholders is determined at the time of share issue itself and

given in the prospectus.
Two points are important regarding the calls on shares. First, the
amount on any call should not exceed 25% of the face value of
shares. Second, there must be an interval of at least one month
between the making of two calls unless otherwise provided by the
articles of association of the company.

When a call is made and the amount of the same is received, the
journal entries are as given below:

1. For Call Amount Due

Share Call AJc Dr.
To Share Capital AJc
(Call money due on _Shares@ Rs. per share)

2. For Receipt of Call Amount

Bank AJc Dr.
To Share Call AJc
(Call money received)

The word/words First, Second, or Third must be added between the

words
"Share" and 'Call' in the Share Call account depending upon the
identity of the call made. For example, in case of first call it will be
termed as 'Share First Call
Account', in case of second call it will be 'Share Second Call
Account' and so on.

Another point to be noted is that the words 'and Final' will also be
added to the last call, say, if second call is the last call it will be
termed as 'Second and Final
Call' and if it is the third call which is the last call, it will be termed as
'Third and Final Call'. It is also possible that the whole balance after
allotment may be collected in one call only. In that case the first call
itself, shall be termed as the 'First and Final Call'.

Forfeiture of Shares
It may happen that some shareholders fail to pay one or more
instalments, viz. allotment money and/or call money. In such
circumstances, the company can forfeit their shares, i.e. cancel their
allotment and treat the amount already received thereon as forfeited
to the company within the framework of the provisions in its articles.
These provisions are usually based on Table A which
authorise the directors to forefeit the shares for non-payment of calls
made. For this purpose, they have to strictly follow the procedure
laid down in this regard.

Following is the accounting treatment of shares issued at par,

premium or at a discount. When shares are forefeited all entries
relating to the shares forfeited except those relating to premium,
already recorded in the accounting records must be reversed.
Accordingly, share capital account is debited with the amount
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Accounting for Managers 199
called-up in respect of shares are forfeited and crediting the
respective unpaid calls accounts's or calls in arrears account with
the amount already received.

Thus, the journal entry will be as follows:

(a) Forfeiture of Shares issued at Par:

Share Capital A/c..........(Called up amount) Dr.
To Share Forfeiture A/c...........(Paid up amount)
To Share Allotment Ale
To Share Calls Ale (individually)
(..... shares forfeited for non-payment of allotment money and call
made)

It may be noted here that when the shares are forfeited, all entries
relating to the forfeited shares must be reversed except the entry
relating to share premium received, if any. Accordingly, the share
capital is debited to the extent to called-up capital and credited
to (i) respective unpaid calls account i.e., calls in arrears and (ii)
share forfeiture account with the amount already received on
shares.
The balance of shares forfeited account is shown as an addition to
the total paid-up capital of the company under the head 'Share
Capital' under title 'Equity and Liabilities' of the Balance Sheet till
the forfeited shares are reissued.

Summary
Company: An organisation consisting of individuals called
'shareholders' by virtue of their holding the shares of a company,
who can act as legal person as regards its business through board
of directors.

Share: Fractional part of the capital, and forms the basis of

ownership in a company.
Shares are generally of two types, viz. equity shares and preference
shares, according to the provisions of the Companies Act, 1956.
Preference shares again are of different types based on varying
shades of rights attached to them. Share Capital of a company is
collected by issuing shares to either a select group of persons
through the route of private placements and/or offered to the public
for subscription. Thus, the issue of shares is basic to the capital of a
company.
Shares are issued either for cash or for consideration other than
cash, the former being more common. Shares are said to be issued
for consideration other than cash when a company purchases
business, or some asset/assets, and the vendors have agreed to
receive payment in the form of fully paid shares of a company.

Stages of Share Issue: The issue of shares for cash is required to

be made in strict conformity with the procedure laid down by law for
the same. When shares are issued for cash, the amount on them
can be collected at one or more of the following stages:
(i) Application for shares
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(ii) Allotment of shares

(iii) Caii/Calls on shares.

Calls in Arrears: Sometimes, the full amount called on allotment

and/or call (calls) is not received from the allottees/shareholders.
The amount not so received are cumulatively called 'Unpaid calls' or
'Calls in Arrears'. However, it is not mandatory for a company to
maintain a separate Calls-in-Arrears Account. There are also
instances where some shareholders consider it discreet to pay a
part or whole of the amount not yet called-up on the shares allotted
to them. Any amount paid by a shareholder in the excess of the
amount due from him on allotment/call (calls) is known as 'Calls in
Advance' for which a separate account is maintained. A company
has the power to charge interest on calls in arrears and is under an
obligation to pay interest on calls-in-advance if it accepts them in
accordance with the provisions of Articles of Association.

Over Subscription: It is possible for the shares of some companies

to be oversubscribed which means that applications for more shares
are received than the number offered for subscription.
If the amount of minimum subscription is not received to the extent
of 90%, the issue dissolves. In case the applications received are
less than the number of shares offered to the public, the issue is
termed as 'under subscribed'.

Issue of Shares at Premium: Irrespective of the fact that shares

have been issued for consideration other than cash, they can be
issued either at par or at premium.
The issue of shares at par implies that the shares have been issued
for an amount exactly equal to their face or nominal value. In case
shares are issued at a premium, i.e. at an amount more than the
nominal or par value of shares, the amount of premium is credited to
a separate account called 'Securities Premium Account', the use of
which is strictly regulated by law.

Issue of Shares at Discount: Shares can as well be issued at a

discount, i.e. for an amount less than the nominal or par value of
shares provided the company fully complies with the provisions laid
down by law with regard to the same. Apart from such compliance,
shares of a company cannot ordinarily be issued at a discount.
When shares are issued at a discount, the amount of discount is
debited to 'Discount on Issue of Share Account', which is in the
nature of capital loss for the company.

Forfeiture of Shares: Sometimes, shareholders fail to pay one or

more instalments on shares allotted to them. In such a case, the
company has the authority to forfeit shares of the defaulters. This is
called 'Forfeiture of Shares'. Forfeiture means the cancellation of
allotment due to breach of contract and to treat the amount already
received on such shares as forfeited to the company. The precise
accounting treatment of share forfeiture depends upon the
conditions on which the shares have been issued-at par,
premium or discount. Generally speaking, accounting treatment on
forfeiture is to reverse the entries passed till the stage of forfeiture,
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Accounting for Managers 201
the amount already received on the shares being credited to
Forfeiture Shares Account.

Reissue of Shares: The management of a company is vested with

the power to reissue the shares once forfeited by it, subject of
course, to the terms and conditions in the articles of association
relating to the same. The shares can be reissued even at a discount
provided the amount of discount allowed does not exceed the credit
balance of Share forfeiture account relating to shares being
reissued. Therefore, discount allowed on the reissue of forfeited
shares is debited to Share forfeiture account.
Once all the forfeited shares have been reissued, any credit balance
on Share forfeiture account is transferred to Capital Reserve
representing profit on forfeiture of shares. In the event of all forfeited
share not being reissued, the credit amount on Share forfeiture
account relating to shares yet to be reissued is carried forward
and the remaining balance on the account only is credited to capital
reserve account.

Issue and Redemption of Debentures:-

A company raises its capital by means of issue of shares. But the

funds raised by the issue of shares are seldom adequate to meet
their long term financial needs of a company. Hence, most
companies turn to raising long-term funds also through debentures
which are issued either through the route of private placement or by
offering the same to the public. The finances raised through
debentures are also known as long-term debt. This chapter deals
with the accounting treatment of issue and redemption of
debentures and other related aspects.

2.2 Meaning of Debentures

Debenture: The word 'debenture' has been derived from a Latin
word 'debere' which means to borrow. Debenture is a written
instrument acknowledging a debt under the common seal of the
company. It contains a contract for repayment of principal after a
specified period or at intervals or at the option of the company and
for payment of interest at a fixed rate payable usually either half-
yearly or yearly on fixed dates. According to section 2(12) of The
Companies Act,1956 'Debenture' includes Debenture Inventory,
Bonds and any other securities of a company whether constituting a
charge on the assets of the company or not.

Bond: Bond is also an instrument of acknowledgement of debt.

Traditionally, the Government issued bonds, but these days, bonds
are also being issued by semi-government and non-governmental
organisations. The terms 'debentures' and 'Bonds' are now being
used inter-changeably.

2.2 Distinction between Shares and Debentures

Ownership: A 'share' represents ownership of the company whereas
a debenture is only acknowledgement of Debt. A share is a part of
the owned capital whereas a debenture is a part of borrowed
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202 Accounting for Managers

Return: The return on shares is known as dividend while the return

on debentures is called interest. The rate of return on shares may
vary from year to year depending upon the profits of the company
but the rate of interest on debentures is prefixed. The payment of
dividend is an appropriation of profits, whereas the payment of
interest is a charge on profits and is to be paid even if there is no
profit.

Repayment: Normally, the amount of shares is not returned during

the life of the company, whereas, generally, the debentures are
issued for a specified period and repayable on the expiry of that
period. However, in the year 1998, the amendements (Section 77A
and 77 B sub Section 2) in the Companies Act,
1956 permitted companies to buy back its shares specially when
market value of shares are less than its book value.

Voting Rights: Shareholders enjoy voting rights where debenture

holders do not normally enjoy any voting right.

Rate of Discount on issue: Both shares and debentures can be

issued at a discount. However, shares can be issued at discount in
accordance with the provisions of Section 79 of The Companies Act,
1956 which stipulates that the rate of discount must not exceed 10%
of the face value while debentures can be issued at any rate of
discount.

Security: Shares are not secured by any charge whereas the

debentures are generally secured and carry a fixed or floating
charge over the assets of the company.

Convertibility: Shares cannot be converted into debentures whereas

debentures can be converted into shares if the terms of issue so
provide, and in that case these are known as convertible
debentures.

2.3 Types of Debentures

A company may issue different kinds of debentures which can be
classified as under:

2.3.1 From the Point of view of Security

(a) Secured Debentures: Secured debentures refer to those

debentures where a charge is created on the assets of the company
for the purpose of payment in case of default. The charge may be
fixed or floating. A fixed charge is created on a specific asset
whereas a floating charge is on the general assets of the company.
The fixed charge is created against those assets which are held by
a company for use in operations not meant for sale whereas floating
charge involves all assets excluding those assigned to the secured
creditors

(b) Unsecured Debentures: Unsecured debentures do not have a

specific charge on the assets of the company. However, a floating

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Accounting for Managers 203
charge may be created on these debentures by default. Normally,
these kinds of debentures are not issued.

2.3.2 From the Point of view of Tenure

(a) Redeemable Debentures: Redeemable debentures are those

which are payable on the expiry of the specific period either in lump
sum or in Instalments during the life time of the company.
Debentures can be redeemed either at par or at premium.

(b) Irredeemable Debentures: Irredeemable debentures are also

known as Perpetual Debentures because the company does not
give any undertaking for the repayment of money borrowed by
issuing such debentures. These debentures are repayable on the
winding-up of a company or on the expiry of a long period.

2.3.3 From the Point of view of Convertibility

(a) Convertible Debentures: Debentures which are convertible into

equity shares or in any other security either at the option of the
company or the debenture holders are called convertible
debentures. These debentures are either fully convertible or partly
convertible.

(b) Non-Convertible Debentures: The debentures which cannot be

converted into shares or in any other securities are called
nonconvertible debentures. Most debentures issued by companies
fall in this category.

2.3.4 From Coupon Rate Point of view

(a) Specific Coupon Rate Debentures: These debentures are issued
with a specified rate of interest, which is called the coupon rate. The
specified rate may either be fixed or floating. The floating interest
rate is usually tagged with the bank rate.

(b) Zero Coupon Rate Debentures: These debentures do not carry

a specific rate of interest. In order to compensate the investors,
such debentures are issued at substantial discount and the
difference between the nominal value and the issue price is treated
as the amount of interest related to the duration of the debentures.

2.3.5 From the view Point of Registration

(a) Registered Debentures: Registered debentures are those

debentures in respect of which all details including names
addresses and particulars of holding of the debenture holders are
entered in a register kept by the company. Such debentures can be
transferred only by executing a regular transfer deed.

(b) Bearer Debentures: Bearer debentures are the debentures which

can be transferred by way of delivery and the company does not
keep any record of the debenture holders Interest on debentures

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204 Accounting for Managers

is paid to a person who produces the interest coupon attached to

such debentures.

2.4 Issue of Debentures

The procedure for the issue of debentures is the same as that for
the issue of shares.
The intending investors apply for debentures on the basis of the
prospectus issued by the company. The company may either ask for
the entire amount to be paid on application or by means of
instalments on application, on allotment and on various calls.
Debentures can be issued at par, at a premium or at a discount.
They can also be issued for consideration other than cash or as a
collateral security.

2.4.1 Issue of Debentures for Cash

Debentures are said to be issued at par when their issue price is

equal to the face value. The journal entries recorded for such issue
are as under:

(a) If whole amount is received in one instalment:

(i) On receipt of the application money

Bank Nc Dr.
To Debenture Application & Allotment Nc

(ii) On Allotment of debentures

Debenture Application & Allotment Nc Dr.
To Debentures Nc

(b) If debenture amount is received in two instalments:

(i) On receipt of application money

Bank Nc Dr.
To Debenture Application Nc

(ii) For adjustment of applications money on allotment

Debenture Application Nc Dr.
To Debentures Nc

(iii) For allotment money due

Debenture Allotment Nc Dr.
To Debentures Nc

(iv) On receipt of allotment money

Bank Nc Dr.
To Debenture Allotment Nc

(c) If debenture money is received in more than two instalments

Additional entries:

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Accounting for Managers 205
(i) On making the first call
Debenture First Call Ale Dr.
To Debentures Ale

(ii) On the receipt of the first call

Bank Ale Dr.
To Debenture First Call Ale

Note: Similar entries may be made for the second call and final call.
However, normally the whole amount is collected on application or
in two instalments, i.e., on application and allotment.

Terms of Issue of Debentures:-

When a company issues debentures, it usually mentions the terms

on which they will be redeemed on their maturity. Redemption of
debentures means discharge of liability on account of debentures by
repayment made to the debenture holders Debentures can be
redeemed either at par or at a premium.
Depending upon the terms and conditions of issue and redemption
of debentures, the following six situations are commonly found in
practice.

(i) Issued at par and redeemable at par

(ii) Issued at discount and redeemable at par
(iii) Issued at a premium and redeemable at par
(iv) Issued at par and redeemable at a premium
(v) Issued at a discount and redeemable at a premium
(vi) Issued at a premium and redeemable at a premium

2.11 Redemption of Debentures

Redemption of debentures refers to extinguishing or discharging the

liability on account of debentures in accordance with the terms of
issue. In other words redemption of debentures means repayment
of the amount of debentures by the company. There are four ways
by which the debentures can be redeemed.
These are:

1. Payment in lump sum

2. Payment in instalments
3. Purchase in the open market
4. By conversion into shares or new debentures.

Payment in lump sum : The company redeems the debentures by

paying the amount in lump sum to the debenture holders at the
maturity thereof as per terms of issue.

Payment in instalments: Under this method, normally redemption of

debentures is made in instalments on the specified date during the
tenure of the debentures. The total amount of debenture liability is
divided by the number of years. It is to note that the actual
debentures redeemable are identified by means of drawing
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206 Accounting for Managers

the requisite number of lots out of the debentures outstanding for

payment.

Purchase in open market: When a company purchases its own

debentures for the purposes of cancellation, such an act of
purchasing and cancelling the debentures constitutes redemption of
debentures by purchase in the open market.

Conversion into shares or new debentures: A company can redeem

its debentures by converting them into shares or new class of
debentures. If debenture holders find that the offer is beneficial to
them, they can exercise their right of converting their debentures
into shares or new class of debentures. These new shares or
debentures can be issued at par, at a discount or at a premium.
It should be noted that only the actual proceeds of debentures are to
be taken into account for ascertaining the number of shares to be
issued in lieu of the debentures to be converted. If debentures were
originally issued at discount, the actual amount realised from them
at the time of issue would be used as the basis for computing the
actual number of shares to be issued. It may be noted that this
method is applicable only to convertible debentures.

2.12 Redemption by Payment in Lump Sum

When the company pays the whole amount in lump sum, the
following journal entries are recorded in the books of the company:

1. If debentures are to be redeemed at par

(a) Debentures Nc Dr.

To Debentureholders

(b) Debentureholders Dr.

To Bank Nc

2. If debentures are to be redeemed at premium

(a) Debentures Nc Dr.
Premium on Redemption of Debentures Nc Dr.
To Debentureholders

(b) Debentureholders Dr.

To Bank Nc

As per the provisions of the Companies Act, 1956, the company

must set aside a portion of profits every year and transfer it to
Debenture Redemption
Reserve for redemption of debentures until the debentures are
redeemed. The journal entry recorded for the purpose is as follows :
As per provisions of Section 117C of the Companies Act, 1956 (as
ameded in 2000).

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Accounting for Managers 207
(a) Where a company issued debentures after the commencement
of this Act, it shall create a Debenture Redemption Reserve for the
redemption of such debentures, to which adequate amount shall be
credited, from out of its profit every year until such debentures are
redeemed.

(b) The amount credited to the Debenture Redemption Reserve

shall not be utilised by the company except for the purpose of
redemption of debentures.

SEBI's Guidelines
Securities and Exchange Board of India (SEBI) has issued
guidelines for redemption of debentures. The salient points of these
guidelines are:

1. Every company shall create Debenture Redemption Reserve in

case of issue of debenture redeemable after a period of more than
18 months from the date of issue.

2. The creation of Debenture Redemption Reserve is obligatory only

for non-convertible debentures and non-convertible portion of partly
convertible debentures.

3. A company shall create Debenture Redemption Reserve

equivalent to at least 50% of the amount of debenture issue before
starting the redemption of debenture.

4. Withdrawal from Debenture Redemption Reserve is permissible

only after 10% of the debenture liability has already been reduced
by the company.

SEBI guidelines would not apply under the following situations:

(a) Infrastructure company (a company wholly engaged in the
business of developing, maintaining and operating infrastructure
facilities); and

(b) A company issuing debentures with a maturity period of not

more than 18 months.

2.12.1 Clarifications regarding creation of Debenture

Redemption
Reserve
The Department of Company Affairs, Government of India, vide their
Circular
No .9/2002, dated 18.04.2002 has issued the following clarifications
regarding creation of Debenture Redemption Reserve (ORR):

(a) No ORR is required for debentures issued by All India Financial

Institutions, regulated by RBI and Banking Companies for both
public as well as privately placed debentures.

(b) No ORR is required in case of privately placed debentures.

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208 Accounting for Managers

(c) Section 117C apply to debentures issued and pending to be

redeemed and, therefore, ORR will also be created for debentures
issued prior to 13.12.2000 and pending redemption.

(d) Section 117C will apply to non-convertible portion of debentures

issued whether they are fully or partly paid.
The Debenture Redemption Reserve account appears on the
liability side of the Balance sheet under the head "Reserves and
Surpluses." When the debentures are redeemed, the requisite
amount of Debenture Redemption Reserve
is transferred to General Reserve.

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Accounting for Managers 209

Financial Reporting & Revised

Schedule VI

Financial Statements of a Company

Having understood how a company raises its capital, we have to

learn the nature, objectives and types of financial statements it has
to prepare including their contents, format, uses and limitations. The
financial statements are the end products of accounting process.
They are prepared following the consistent accounting concepts,
principles, procedures and also the legal environment in which the
business organisations operate. These statements are the outcome
of the summarising process of accounting and are, therefore, the
sources of information on the basis of which conclusions are drawn
about the profitability and the financial position of a company.
Hence, they need to be arranged in a proper form with suitable
contents so that the shareholders and other users of financial
statements can easily understand and use them in their economic
decisions in a meaningful way. 3.1 Meaning of Financial Statements
Financial statements are the basic and formal annual reports
through which the corporate management communicates financial
information to its owners and various other external parties which
include investors, tax authorities, government, employees, etc.
These normally refer to: (a) the balance sheet (position statement)
as at the end of accounting period, and (b) the statement of profit
and loss of a company. Now-a-days, the cash flow statement is also
taken as an integral component of the financial statements of a
company.

3.2 Nature of Financial Statements

The chronologically recorded facts about events expressed in
monetary terms for a defined period of time are the basis for the
preparation of periodical financial statements which reveal the
financial position as on a date and the financial results obtained
during a period. The American Institute of Certified Public
Accountants states the nature of financial statements as, "the
statements prepared for the purpose of presenting a periodical
review of report on progress by the management and deal with the
status of investment in the business and the results achieved during
the period under review. They reflect a combination of recorded
facts, accounting principles and personal judgements". The
following points explain the nature of financial statements:

1. Recorded Facts:
Financial statements are prepared on the basis of facts in the form
of cost data recorded in accounting books. The original cost or
historical cost is the basis of recording transactions. The figures of
various accounts such as cash in hand, cash at bank, trade
receivables, fixed assets, etc., are taken as per the figures recorded
in the accountina books . The assets purchased at different times
Amity Directorate of Distance and Online 8fucation
210 Accounting for Managers

and at different prices are put together and shown at costs. As these
are not based on market prices, the financial statements do not
show current financial condition of the concern.

2. Accounting Conventions:
Certain accounting conventions are followed while preparing
financial statements. The convention of valuing inventory at cost or
market price, whichever is lower, is followed. The valuing of assets
at cost less depreciation principle for balance sheet purposes is
followed. The convention of materiality is followed in dealing with
small items like pencils, pens, postage stamps, etc. These items are
treated as expenditure in the year in which they are purchased even
though they are assets in nature. The stationery is valued at cost
and not on the principle of cost or market price, whichever is less.
The use of accounting conventions makes financial statements
comparable, simple and realistic.

3. Postulates:
Financial statements are prepared on certain basic assumptions
(pre-requisites) known as postulates such as going concern
postulate, money measurement postulate, realisation postulate, etc.
Going concern postulate assumes that the enterprise is treated as a
going concern and exists for a longer period of time. So the assets
are shown on historical cost basis. Money measurement postulate
assumes that the value of money will remain the same in different
periods. Though there is drastic change in purchasing power of
money, the assets purchased at different times will be shown at the
amount paid for them. While, preparing statement of profit and loss
the revenue is included in the sales of the year in which the sale
was undertaken even though the sale price may be received over a
number of years. The assumption is known as realisation postulate.
4. Personal Judgements:
Under more than one circumstance, facts and figures presented
through financial statements are based on personal opinion,
estimates and judgements. The depreciation is provided taking into
consideration the useful economic life of fixed assets. Provisions for
doubtful debts are made on estimates and personal judgements. In
valuing inventory, cost or market value, whichever is less is being
followed. While deciding either cost of inventory or market value of
inventory, many personal judgements are to be made based on
certain considerations. Personal opinion, judgements and estimates
are made while preparing the financial statements to avoid any
possibility of over statement of assets and liabilities, income and
expenditure, keeping in mind the convention of conservatism. Thus,
financial statements are the summarised reports of recorded facts
and are prepared the following accounting concepts, conventions
and requirements of Law.

3.3 Objectives of Financial Statements

Financial statements are the basic sources of information to the
shareholders and other external parties for understanding the
profitability and financial position of any business concern. They
provide information about the results of the business concern during
a soecified period of time in terms of assets and liabilities, which
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Accounting for Managers 211
provide the basis for taking decisions. Thus, the primary objective of
financial statements is to assist the users in their decision-making.

The specific objectives include the following:

1. To provide information about economic resources and obligations

of a business: They are prepared to provide adequate, reliable and
periodical information about economic resources and obligations of
a business firm to investors and other external parties who have
limited authority, ability or resources to obtain information.

2. To provide information about the earning capacity of the

business: They are to provide useful financial information which can
gainfully be utilised to predict, compare and evaluate the business
firm's earning capacity.

3. To provide information about cash flows: They are to provide

information useful to investors and creditors for predicting,
comparing and evaluating, potential cash flows in terms of amount,
timing and related uncertainties.

4. To judge effectiveness of management: They supply information

useful for judging management's ability to utilise the resources of a
business effectively.

5. Information about activities of business affecting the society: They

have to report the activities of the business organisation affecting
the society, which can be determined and described or measured
and which are important in its social environment.

6. Disclosing accounting policies: These reports have to provide the

significant policies, concepts followed in the process of accounting
and changes taken up in them during the year to understand these
statements in a better way.

3.4 Types of Financial Statements

The financial statements generally include two statements: balance
sheet and statement of profit and loss which are required for
external reporting and also for internal needs of the management
like planning, decision-making and control. Apart from these, there
is also a need to know about movements of funds and changes in
the financial position of the company. For this purpose, a statement
of changes in financial position of the company or a cash flow
statement is prepared.

3.4.1 Form and Content of Balance Sheet :

Balance sheet of a company is prepared and presented in the form
prescribed in (Revised) Schedule VI of the Companies Act, 1956.
The form prescribed is vertical and is given in Exhibit 3.1. Every
company registered under the Act shall prepare its balance sheet,
statement of profit and loss and notes to account thereto in
accordance with the manner prescribed in the revised Schedule VI
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212 Accounting for Managers

to the Companies Act, 1956 to harmonise the disclosure

requirement with the accounting standards and to converge with
new reforms. With regard to this, the Ministry of Corporate Affairs
(MCA) has prescribed a (Revised) Schedule VI to the Companies
Act, 1956 (vide Notification dated 28.02.2011). It is applied to the
financial statements prepared for all financial periods beginning on
or after April 01, 2011 by the Indian Companies. The revised
Schedule VI has introduced many disclosure requirements. It has
also done away with several statutory disclosure requirements.

Forms and Contents of the Balance Sheet and Profit and Loss
Account

Sec 211(1) of the Companies Act, 1956 requires that every

balance-sheet of a company shall
-give a true and fair view of the state of affairs of the company

-as at the end of the financial year and shall,

-subject to the provisions of this section,

-be in the form set out in Part I of Schedule VI, or

-in such order form as may be approved by the Central

Government.
Every profit and loss account and balance-sheet of the company
shall comply with the accounting standards

Where the profit and loss account and the balance-sheet of the
company do not comply with the accounting standards, such
companies shall disclose in its profit and loss account and balance-
sheet, the following, namely:-
(a) The deviation from the accounting standards;
(b) The reasons for such deviation; and
(c) The financial effect, if any, arising due to such deviation.

The Schedule VI to the Companies Act, 1956

Prior to revision Schedule VI had been in existence for almost five
decades
In 1960, Section 21, which provided for Forms and Contents of
Balance Sheet and Profit and Loss Account, was modified by the
Companies (Amendment) Act, 1960
The sub-section (1) and (2) of the said section require that every
Balance Sheet and Profit and Loss should be in the form specified
in the Part I and II of the Schedule VI
It is not essential to amend the Act itself for any amendment
required in the Schedule VI
The power to amend Schedule VI is conferred upon the Central
Government by the section 641(1) of the Act.

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Accounting for Managers 213
Revised Schedule VI
Revised Schedule VI introduces some significant conceptual
changes such as
-current/non-current distinction,
- primacy to the requirements of the accounting standards,
Corporate disclosures closer to international practices
Applicable to all companies
Applies to Consolidated Financial Statements
Clause 41 & Revised Schedule VI
Interim Financial Statement as per AS 25
Only Vertical format allowed
Introduction of Format for P&L also
Existing Part Ill & Part IV are done away with
The narrative descriptions or disaggregation to be presented in
Notes instead of schedule format.
Each item of BS and P&L to be cross referenced to related
information in notes.
Minimum requirements for disclosure on the face of financial
statements or in the notes
Line & sub-line items & subtotals can be presented as an addition
Additional disclosures under accounting standards & in the Act
Additional disclosures in the notes to accounts
Act and/ or accounting standards prevail over the Schedule VI
Corresponding amounts for the immediately preceding period
Terms will carry meaning as defined by the applicable AS
Requirement to use the same unit of measurement uniformly
throughout the financial statements

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214 Accounting for Managers

Part 1-Format of Balance Sheet and General

Instructions

Name of the Company

Balance Sheet as at 31 March, 20XX

I
Particulars Note As at 31 As at 31
No. March, 20X2 March, 20X1

' '

8. EQUITY AND LIABILITIES

1 hareholders' funds
(a) Share capital
(b) Reserves and surplus
(c) Money received against
share warrants

2 hare application money pending

llotment

3 Non-current liabilities
(a) Long-term borrowings
(b) Deferred tax liabilities (net)
(c) Other long-term liabilities
(d) Long-term provisions

4 urrent liabilities
(a) Short-term borrowings
(b) Trade payables
(c) Other current liabilities
(d) Short-term provisions

TOTAL

I
. SSETS

I
Amity Directorate of Distance and Online Education
 1 Non-current assets
Accounting for M '"Y"''" LIP
(a) Fixed assets
(i) Tangible assets
(ii) Intangible assets
(iii) Capital work-in-progress
(iv) Fixed assets held for sale

I II
(b) Non-current investments
(c) Deferred tax assets (net)
(d) Long-term loans and
advances
(e) Other non-current assets

2 purrent assets
(a) Current investments
(b) Inventories
(c) Trade receivables
(d) Cash and cash equivalents
(e) Short-term loans and
advances
(f) Other current assets

TOTAL
ee accompanying notes forming
part of the financial statements

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 216 Accounting for Managers

Part 2-Format of Profit & Loss account and

General Instructions

Name of the Company

Statement of Profit and Loss for the year ended 31
March, 20XX
Ref No. Particulars Note No. For the year
Gl3 ended
GN 6.10 31 March, 20X2
Gl4 '
GN 6.14
A CONTINUING OPERATIONS

1 Revenue from operations (gross)

AS 9.10 Less: Excise duty
Revenue from operations (net)

2 Other income

3 Total revenue (1+2)

4 Expenses
(a) Cost of materials consumed
(b) Purchases of stock-in-trade
(c) Changes in inventories of finished goods,
work-in-progress and stock-in-trade
(d) Employee benefits expense
(e) Finance costs
(f) Depreciation and amortisation expense
(g) Other expenses

Total expenses

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 5 Profit I (Loss) before exceptional and extraordinary items and tax ( 3 - 4)
Accou ling for Mana ers 217
6 Exceptional items

7 Profit I (Loss) before extraordinary items and tax (5 + 6)

8 Extraordinary items

9 Profit I (Loss) before tax (7 + 8)

10 rrax expense:
(a) Current tax expense for current year
(b) (Less): MAT credit (where applicable)
(c) Current tax expense relating to prior years
(d) Net current tax expense
(e) Deferred tax

11 Profit I (Loss) from continuing operations (9 +10)

B DISCONTINUING OPERATIONS

12.i Profit I (Loss) from discontinuing operations (before tax)

12.ii ainI (Loss) on disposal of assets I settlement of liabilities attributable

o the discontinuing operations

12.iii ddI (Less): Tax expense of discontinuing operations

(a) on ordinary activities attributable to the discontinuing operations
(b) on gain I (loss) on disposal of assets I settlement of liabilities

13 Profit I (Loss) from discontinuing operations (12.i + 12.ii + 12.iii)

c OTAL OPERATIONS

14 Profit I (Loss) for the year (11+ 13)

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218 ccounting for Managers

Comparative Balance Sheet

A comparative balance sheet presents side-by-side information
about an entity's assets, liabilities, and shareholders' equity as of
multiple points in time. For example, a comparative balance sheet
could present the balance sheet as of the end of each year for the
past three years. Another variation is to present the balance sheet
as of the end of each month for the past 12 months on a rolling
basis. In both cases, the intent is to provide the reader with a
series of snapshots of a company's financial condition over time,
which is useful for developing trend line analyses (though this
works better when the reader has the entire set of financial
statements to work with and not just the balance sheet).

The comparative balance sheet is not required under GAAP for a

privately-held company or a nonprofit entity, but the SEC does
require it in numerous circumstances for the reports issued by
publicly-held companies, particularly the annual Form 10-K and
the quarterly Form 10-Q. The usual SEC requirement is to report a
comparative balance sheet for the past two years (with additional
requirements for quarterly reporting).

There is no standard format for a comparative balance sheet. It is

somewhat more common to report the balance sheet as of the
least recent period furthest to the right, though the reverse is the
case when you are reporting balance sheets in a trailing twelve-
month's format.

FEATURES OFCOMPARITlVE STAlEMENTS:-

1) A comparative statement adds meaning to the financial data.

2) It is used to effectively measure the conduct of the business
activities.
3) Comparative statement analysis is used for intra firm analysis
and irters firm analysis.
4) A comparative statement analysis indicates change
in amount as well as change in percentage.
5) A positive change in amount and percentage indicates an
increase and a negative change in amount and percentage
indicates a decrease.
6) If the value in the first year is zero then change in
percentage cannot be indicated. This is the limitation of
comparative statement analysis. While interpreting the results
qualitative inferences need to be drawn.
7) It is a popular tool useful for analysis by the financial analysts
8) A comparative statement analysis cannot be used to compare
more than two years financial data.

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Accounting for Manag 219

Here is an example of a comparative balance sheet that contains

the balance sheet as of the end of a company's fiscal year for each
of the past three years:

ABC International
Statement of Financial Position

as of as of as of
12L31L20X3 12L31L20X2 12/31/20X1
Current assets
Cash $1,200,000 $900,000 $750,000
Accounts receivable 4,800,000 3,600,000 3,000,000
Inventory 3,600,000 2,700,000 2 300 000
Total current assets $9,600,000 $7,200,000 $ 6,050,000
Total fixed assets 6,200,000 5,500,000 5 000 000
Total Assets $15,800,000 $12,700,000 $11 050 000

Current liabilities
Accounts payable $2,400,000 $1,800,000 $ 1,500,000
Accrued expenses 480,000 360,000 300,000
Short-term debt 800,000 600,000 400 000
Total current $3,680,000 $2,760,000 $ 2,200,000
liabilities
Long-term debt 9,020,000 7.740,000 7 350 000
Total liabilities 12,700,000 10,500,000 9,550,000
Shareholders' equity 3,100,000 2,200,000 1 500 000
Total liabilities and $15,800,000 $12,700,000 $11 050 000
equity

The comparative balance sheet reveals that ABC has increased

the size of its current assets over the past few years, but has also
recently invested in a large amount of additional fixed assets that
have likely been the cause of a significant boost in its long-term
debt.

Amity Directorate of Distance and Online Education

220 ccounting for Managers

Common Size Balance Sheet

Common Size Balance Sheet Overview

A common size balance sheet includes a column that notes the
percentage of the total assets (for asset line items) or the
percentage of total liabilities and shareholders' equity (for liability
or shareholders' equity line items). This format is useful for
comparing the proportions of assets, liabilities, and equity
between different companies, particularly as part of an industry
analysis or an acquisition analysis.

It is extremely useful to construct a common size balance sheet

that itemizes the results as of the end of multiple time periods, in
order to construct trend lines to ascertain changes over longer
time periods.

For example, if you were comparing the common size balance

sheet of your company to that of a potential acquiree, and the
acquiree had 40% of its assets invested in accounts receivable
versus 20% for your company, that may indicate that aggressive
collection activities could reduce the acquiree's receivables if your
company were to acquire it (subject to the existence of any special
problems with the customers of the acquiree).

Another possible use of this format is within a benchmarking

study. A company could benchmark its financial position against
that of a best-in-class company by using common size balance
sheets to compare the relative amounts of their assets, liabilities,
and equity. Any significant differences would trigger a detailed
review of the reasons for the differences, which may lead to the
implementation of best practices to bring the financial position of
the company into alignment with that of the best-in-class
company.

The common size balance sheet is not required

under GAAP or IFRS. However, being a useful document for
analysis purposes, it is commonly distributed within a company for
review by management, and may be found as a standard report
template in many commercially-available accounting software
packages.

There is no mandatory format for a common size balance sheet,

though percentages are nearly always placed to the right of the
normal numerical results. If you are reporting balance sheet
results as of the end of many periods, you may even dispense
with numerical results entirely, in favor of just presenting the
common size percentages.

Amity Directorate of Distance and Online Education