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This book is designed for students pursuing CA Foundation course, who are
appearing for Paper 1: Accounting exam May’24 or thereafter. Every effort has
been made to avoid errors and omissions. Despite this, errors may still occur. Any
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Edition 1 – Dec 2022
Edition 2 – Dec 2023
 INDEX
Chapter Name Page no

1 Theorotical Framework
Unit 1:Meaning and scope of accounting 1.1 - 1.10
Unit 2:Accounting concepts,principles and conventions 1.11 - 1.17
Unit 3:Capital and Revenue expendiatures and receipts 1.18 - 1.19
Unit 4:Contingent assets and contingent liabilities 1.20 - 1.21
Unit 5:Accounting policies 1.22 - 1.23
Unit 6:Accounting as a measurement discipline 1.24 - 1.25
Unit 7:Accounting standards 1.26 - 1.29

2 Accounting process
Unit 1:Basic accounting standards 2.1 - 2.9
Unit 2:Ledgers 2.10 - 2.11
Unit 3:Trial balance 2.12 - 2.15
Unit 4:Subsidiary books 2.16 - 2.19
Unit 5:Cash book 2.20 - 2.24
Unit 6:Rectification of errors 2.25 - 2.31

3 Bank Reconciliation statement 3.1 - 3.14

4 Inventories 4.1 - 4.12
5 Depreciation and amortisation 5.1 - 5.19
6 Bills of exchange and promissory note 6.11 - 6.14

7 Preparation of final accounts of sole proprietors

Unit 1:Final accounts of non manufacturing entities 7.1 - 7.18
Unit 2:Final accounts of manufacturing entities 7.19 - 7.21

8 Fianancial statements of not for profit organisations 8.1 - 8.14

9 Accounts from incomplete records 9.1 - 9.33

10 Partnership and LLP accounts

Unit 1:Introduction to partnership accounts 10.1 - 10.13
Unit 2:Treatment of goodwill in partnership accounts 10.14 - 10.23
Unit 3:Admission of a new partner 10.24 - 10.32
Unit 4: Retirement of a Partner 10.33 - 10.39
Unit 5: Death of a Partner 10.40 - 10.43
Unit 6: Dissolution of Partnership Firms and LLPs 10.44 - 10.76

11 Company accounts
Unit 1: Introduction to Company Accounts 11.1 - 11.11
Unit 2: Issue, Forfeiture and Re-Issue of Shares 11.12 - 11.36
Unit 3: Issue of Debentures 11.37 - 11.51.
Unit 4: Accounting for Bonus Issue and Right Issue 11.52 - 11.61
Unit 5: Redemption of Preference Shares 11.62 - 11.85
Unit 6: Redemption of Debentures 11.86 - 11.104
 Chapter 1 – Theoretical Framework
OBJECTIVES

The lists of topics which will be covered in this chapter are as follows:

1.1 Meaning and Scope of Accounting:

- Meaning and significance of Accounting.

- Difference between Book-Keeping and Accounting.

- Limitations of Accounting.

1.2 Accounting Concepts, Conventions and Principles:

- Understanding various accounting concepts, conventions, principles and assumptions which

govern Accounting.

- Characteristics of Financial Statements.

1.3 Capital and Revenue Expenditure and Receipts:

- Capital and Revenue Expenditure

- Capital and Revenue Receipts

1.4 Contingent Assets and Contingent Liabilities:

- Contingent Liabilities

- Contingent Liabilities Vs Liabilities

- Contingent Liabilities Vs Provisions

- Contingent Assets

1.5 Accounting Policies:

- Meaning of Accounting Policies

- Selection of Accounting Policies

- Changes in Accounting Policies

1.6 Valuation Principles and Accounting Estimates:

- 4 Valuation Principles

- Accounting Estimates

1.7 Accounting Standards:

1FIN BY INDIGOLEARN 1.1

 - What are Accounting Standards

- Benefits and Limitations of Accounting Standards

1.8 Indian Accounting Standards:

- Need for Convergence towards Global Standards

- International Financial Reporting Standards

- Benefits of Convergence with IFRS

- Indian Accounting Standards (Indian AS)

Meaning of Accounting:

American Institute of Certified Public Accountant defined Accounting as “Accounting is the art of
recording, classifying and summarizing in a significant manner and in term of Money, transactions
and events which are, in part at least, of a financial character and interpreting the results
thereof.”

In simple terms Accounting can be stated as the process of recording and maintaining the Financial
Information.

Procedures of Accounting:

Broadly the accounting procedures are divided into two categories:

1. Generating Financial Information

2. Using the Financial Information.

Procedure to Generate Financial Information comprises of the following 6 steps:

1. Recording:

This is the first step of accounting. All the transactions are recorded in the respective account
book which is called as a “Journal”.

For Eg: All the transactions done by the company during a particular month will be recorded in the
Journal on a daily basis.

2. Classifying:

Classifying involves systematically analyzing and segregating the transactions recorded in the
Journal.

This is done by transferring the journal entries in the Ledger which clubs all the similar
transactions to a particular account.

For Eg: All the journal entries related to sales will be recorded in the Sales Ledger.

1FIN BY INDIGOLEARN 1.2

3. Summarizing:

Under this step all the ledger balances are summarized and prepared in manner that is useful to
the users of the Financial Statements.

A company carries on hundreds and thousands of transactions in a financial year and the journal
and ledger balances for all the transactions can run into hundreds of pages which will be lot time
consuming and confusing for the users of the Financial Statements.

Therefore, to avoid this problem a summary of all the transactions and ledger balances is
presented. The preparation of this summary leads to the creation of the Financial Statements
which includes the following:

i) Trial Balance

ii) Profit and Loss Statement

iii) Balance Sheet

iv) Cash Flow Statement

4. Analyzing:

The financial statements need to be presented in a meaningful and usable way for the users
whereby they can analyze and draw the relationship among the various items of the Financial
Statements.

For Eg: All items relating to a particular type of Asset can be found in the Balance Sheet Asset
side such as Fixed Asset, Current Asset, Investments, etc. This classification makes it easier for
the users to analyze the information presented in the Financial Statements in a systematical
manner and analyze various important ratios and other meaningful information as per their
requirement.

5. Interpreting:

This step is stated as the Final Step of Accounting whereby the financial statements are
interpreted in a manner that enables the end users of the Financial Statements to derive useful
information about the company’s Financial Condition and profitability of the Business.

It is important from the point of view of interpretation that the companies provide an in depth
explanation the conditions under which the important transactions have happened, the impact of
its occurrence, what is the likelihood of its occurrence.

6. Communicating:

This step is not concerned with the generation of the Financial Statements, but it deals with
communicating the Financial Statements prepared using the above steps.

1FIN BY INDIGOLEARN 1.3

The Financial Statements are communicated through the distribution of annual accounting reports,
mandatory fillings with the various statutory authorities.

Using the Financial Information and Users of Financial Statements (Accounting Information):

With the advancement of the global trade and rising interest of various parties in an organizations
business there has been an increase in the number of stakeholder’s who are interested in the using
the company’s Financial Statements to fulfill their various interests.

Broadly speaking the users of financial statement can be classified into 2 categories:

User’s of Financial Statements

Internal Users External Users

Management and Owners Investors, Lenders, Statutory

of the Business Authorities, Employees, etc.

Type of Financial Information needed by the users

Every information which Key information about

can affect the operations 1. Assets
of the business 2. Liabilities
3. Profitability
4. Capital
Users of Accounting Information/Financial Statements:

As seen in the previous diagram the users of the Accounting Information are classified into 2
categories Internal Users and External Users.

Let us try to understand the usability of the Financial Statement to the various users:

Internal Users:
1. Management:
The Management of the entity needs to take various decisions with respect to budgeting,
forecasting based on the past trends and market analysis for the sake of which they need to
evaluate their financial statements to get an understanding of their business has been
performing and the details of their financial position which assist them in taking better
decisions.

1FIN BY INDIGOLEARN 1.4

 Also, they need the various financial information to identify the shortcomings and weaknesses
in their business so that they can design and act on corrective measures to improve the
deficiencies.

External Users:

1. Investors:
The investors of the company want to understand how the company has been performing
and how is their investment growing.

Based on that information they can take various investment related decisions such as
whether to invest further or disinvest from their existing investment.

2. Employees:
Employees of any company are interested in understanding how the growth of the company
is?

This is because their career growth depends on the growth of the organization at least
till the time they are associated with the company.

3. Lenders:
Lenders are interested in knowing how profitably the company is performing.

This is to ensure that their loans and interest are safe with the company and will be repaid
as per the contracts.

4. Suppliers and Creditors:

Suppliers and Creditors are interested in using the financial information of the company
with the same intention as the lenders.
They are keen to know whether the credit balances owed to them by the company will be
paid on timely basis.

Also, they try to estimate that how long they can expect to be in business with the
company in future.

5. Customers:
Many of customers of any business are probably their repeat customers and if the
business goes into trouble and cannot continue then it also causes hassle to the customer
who needs to find a replacement of the product.

This is especially true if the customer used the company’s product as an input for its own
business.

For Eg: If ABC Company was a steel manufacturer and its customer Mr. D had a steel
factory. Mr. D used to procure majority of his raw material from ABC Company.
If for some reason ABC Company shuts down, then it would be a lot of hassle for Mr. D to
find a new supplier for the same input especially if it was a customizable product.

1FIN BY INDIGOLEARN 1.5

 6. Statutory Authorities:
Statutory Authorities make sure that the business is operating within the laws and
regulations and defined framework and for accomplishing this objective they need to rely
on the Financial Statements submitted by the companies as per the rules and acts.

Objectives of Accounting:

The objectives of Accounting and the method through which they are achieved can be understood
with the help of the following diagram:

Objectives of Accounting

Systematic Determining Determining Providing Understandi

ally results of financial the users ng Solvency
recording recorded position of with the position of
all transactions the required the
transaction company information company
s

How the Objectives are achieved?

Through By By Annual Determining

Journal preparation preparation Reports and Liquidity
entries, of Profit & of Balance Statutory position in
Ledger and Loss Sheet Fillings long run and
Trial Accounts near future
Balance

Book-Keeping:

Book-Keeping can be stated as the process/activity to record the various transactions entered by
the entity in a systematic and timely manner.

By properly recording all the transactions in an orderly manner, organizations can prepare the
Financial Statements which are true and correct and useful to their users.

1FIN BY INDIGOLEARN 1.6

The main objective of Book-Keeping is to provide proper summary of all the financial and non-
financial transactions entered by the company which would help the company in systematic
preparation of the Financial Statements.

The main objective of Book-Keeping is to maintain a Complete Record of all the Transactions in a
systematic manner which is useful in determining the Financial Results on the business.

Often, Book-Keeping is confused with Accounting. It is important to note that Book-Keeping is a part
of Accounting. Accounting in itself is a big domain and not restricted to Book-Keeping.

The following table will enable you to understand the important points of Distinction between Book-
Keeping and Accounting:

Point of Distinction Book-Keeping Accounting

Objective Systematic Recording of Summarizing of Recorded
Transactions Transactions
Basis for It is basis for preparation of It is the basis for communicating the
Financial Statements results of operations
Are Financial Financial Statements do not form a Financial Statements are part of
Statements parts of it? part of Book-Keeping Accounting
Basis for Managerial Managerial Decisions cannot be made Managerial Decisions are made based
Decisions on the basis of Book-Keeping on the statements prepared under
Accounting
Sub-Fields There is no Sub-Field of Book- Accounting has various sub-fields
Keeping such as Managerial Accounting,
Financial Accounting, Cost
Accounting, etc.

Sub-Fields of Accounting:

Book-Keeping can be stated as the process/activity to record the various transactions entered

Accounting is not just restricted to the preparation and presentation of the Financial Statements
to the users. It has various domains which are designed to serve the various purposes:

1. Financial Accounting:
This field of Accounting deals in preparation and presentation of the financial statements to
the users. The Financial Accounting main objective is determining profitability and financial
position of the business at a particular point of time.

2. Management Accounting:
This field of Accounting is specifically designed to provide customized and specialized
information to the managers of the organization which would assist them in planning and
taking appropriate steps in achieving the goals of the organization.

3. Cost Accounting:
This field of Accounting is specifically designed to determine the cost and its allocation which
is crucial in determining profitability of the business.

1FIN BY INDIGOLEARN 1.7

 4. Social Responsibility Accounting:
With the increasing awareness about the social issues and involvement of the various business
houses in view to work for profit and support a cause along with the advancement in the laws
relating the CSR there has been a significant increase in the spending towards social causes.

The companies who are spending towards CSR are highly interested in knowing whether the
amount spent by them is able to fulfill the cause and generate the impact it had expected
through the spending.

The measurement of the social benefits created and the lives impacted is the main objective
of the Social Responsibility Accounting.

For Eg: If Company ABC had spent Rs.1.00 Cr during F.Y.2017-2018 for promoting education
among the low income kids. It would like to know the number of kids who got enrolled in the
schools via their programs for which they had spent amount of Rs.1.00 Cr.

5. Human Resource Accounting:

Of all the expenditure incurred by the businesses they can be measured by using the
standards, measurements and valuation principles provided by various laws, regulations and
AS.

Except for the Human Resource, which is the only expenditure incurred by the company to
develop and maintain the human resource which will be able to provide the company benefits
across the years. However, it is written off as expense in the year it is incurred.

Human Resource Accounting attempts to identify measure and report the investment made
in the Human Resource of the entity.

Relationship of Accounting with other disciplines:

i. Accounting and Economics:

Accounting Economics
 It is viewed as a system, which provides It is viewed as a science of rational
data to the users to permit informed decision-making about the use of scarce
judgement and decisions. resources.
 Non-accounting data are also relevant for
decision-making
Contributed a lot improving the management economic theories influenced the
decision-making process. development of the decision-making tools
used in accounting.
At the macro-level, accounting provides the database over which the economic decision models
have been developed; micro-level data arranged by the accounting system is summed up to get
macro-level database.
ii. Accounting and Statistics:
Accounting Statistics
Accounting information is very precise; it is exact For decision-making purposes such precision
to the last paisa is not necessary for which this is used.
All values are important individually because they It is concerned with the typical value,
relate to business transactions. behavior or trend over a period of time or

1FIN BY INDIGOLEARN 1.8

 the degree of variation over a series of
observations.
It records generally take a short-term view of It is more useful if a longer view is taken
events and are confined to a year for the purpose
Several accounting and financial calculations are Statistical methods are helpful in
based on statistical formulae. developing accounting data and in their
interpretation.
The functional relations showing mathematical relations of one variable with one or more other
variables are based on statistical work.

iii. Accounting and Mathematics:

 Knowledge of arithmetic and algebra is a pre-requisite for accounting computations and
measurements.
 Accounting data are also presented in ratio form.
 The fundamental accounting equation will be discussed in detail under ‘Dual Aspect Concept’
of this chapter.
 Since accounting is meant for providing information to the users, to be effective,
accounting data should feed the information requirements of such statistical, econometric and
operations research models.
 Understanding mathematics has become a must to grasp the decision models framed by
statisticians, econometricians and the O.R. experts.

iv. Accounting and Law:

 An economic entity operates within a legal environment.
 Transactions and events are always guided by laws of the land. Very often the accounting
system to be followed has been prescribed by the law.
 The legal prescription about the accounting system is the product of developments in
accounting knowledge.
 Accounting influences law and is also influenced by law.

v. Accounting and Management

 Management is a broad occupational field, which comprises many functions and encompasses
application of many disciplines.
 Accountants are well placed in the management and play a key role in the management team.
 A large portion of accounting information is prepared for management decision-making.
 So the accounting system can be molded to serve the management purpose.

Limitations of Accounting:

Accounting has some limitations which are important to be aware of. Since the Financial
statements are the basis of communicating the performance and financial position it is important
to be aware of the limitations in the presence of which the Financial Statements have been
prepared:

The Limitations of Accounting are as follow:

1. Non-Monetary items are not considered:

1FIN BY INDIGOLEARN 1.9

 The most important factor to determine the worth of a business is their employee, their
skill and dedication which are nowhere found on the Financial Statements.

2. Balance Sheet is valid only for a particular point of time:

The Balance Sheet which reflects the financial position of the business is valid only for a
particular point of time. A single additional transaction can alter the balance sheet
drastically.

However, to overcome this limitation the auditors disclose the events occurring after the
balance sheet date.

3. Time Value of Money:

The Monetary factors such as Inflation, Time value of Money, etc. are ignored in
preparation of Accounting.

4. Use of Estimates:
Some Accounting Estimates such as provision for doubtful debts, useful life of the Fixed
Asset, etc. depends on the estimates and judgments made by the management and
accounting personnel.

Since human judgment is involved it can lead to error in estimation of the same which can
have an impact on the Financial Statements.

Questions:

1. Identify whether the following are transactions which would be recorded in the Financial
Statement or not?

i.Mr. A asked for Quotation of goods and received a quotation of Rs.5.00/- Lac from Mr. B.
Will this be recorded as purchase in the Books of Mr. A?
Will not be recorded

ii.Mr. B received an order for Rs.10.00/- Lac and raised an invoice to Mr. C for the same. Will
this be recorded as sales in the books of Mr. B?
Will be recorded

2. Which of the following is not an internal user of the Company’s Financial Statement?

i.CEO of the company

ii.Employees of the company – Not an internal user
iii.CFO of the company
iv.Directors of the company

3. Limitation of Accounting is that it:

i.It does not use estimates.

ii.It accounts only for Monetary Items – Is a Limitation
iii.Accounts for time value of Money
iv.Balance Sheet is valid throughout the year.

1FIN BY INDIGOLEARN 1.10

Unit-2 Accounting for Concepts, Conventions and principles
Need for Accounting Concepts, Conventions and Principles:

Accounting is stated as the Language through which the results of the operations of the
company are communicated to the various stakeholders.

How would the Financial Statements of various companies look like when they are prepared by various
accountants based on their understanding of the norms and notions of accounting due to absence of
any standardized policy? It would literally cause chaos because the result of operations prepared by
two different accountants for the same set data would be showing different results rendering it
useless.

To avoid this issue and establish uniformity and comparability among the financial statements of
various entities and across the period of time for same entity framework of GAAP “Generally
Accepted Accounting Principles” have been established.

GAAP provides all the concepts, conventions and principles on the basis of which the Financial
Statements of the entity needs to be prepared.

Accounting Concepts:

Accounting Concepts defines the assumptions which form the basis of preparation of Financial
Statements.

Accounting Principles:

Accounting principles provide explanation of current practices and a guide for selection of practices
where alternative treatments exist.

Accounting Principles need to satisfy the following conditions:

1. They should be based on real assumptions.

2. They must be simple, understandable and explanatory.
3. They must be followed consistently.
4. They should be able to reflect future predictions.
5. They should be informational for the users.

Accounting Conventions:

Accounting Conventions are the conventions which arise in the company Accounting Process due to
the application of the principles and practices over a period of time.

Let us look at the Concepts, Conventions and Principles:

1. Entity Concept:

1FIN BY INDIGOLEARN 1.11

 Entity Concepts states that the business enterprise and the owner of the enterprise are two
separate entities and have their own identities. The transactions occurring between the two
should be clearly recorded as transaction between two different persons.

For Eg: If an amount of Rs.10,000/- is withdrawn by Mr. A from his business, it should be
treated as a Drawings from business and not as a Expense of the Business.

2. Money Measurement Concept:

As per this Concept only those transactions which can be measured in Monetary Terms are
to be recorded.

Any transaction which cannot be measured in monetary terms should not be recorded even
though it may be materially significant in value.

For Eg: The Human Resource of any organization is its biggest strength but it will not be
recorded anywhere in the Financial Statement because it cannot be measured in Monetary
Terms.

3. Periodicity Concept:
As per this Concept companies need to prepare their accounts at a regular interval comprising
of fixed period of time and not at the end of the life of the business.

Using this concept only the Financial Statements of the company are prepared for every 12
months also known as “Financial Year”.

It can be stated that the periodicity concept helps in achieving the following objectives:
 Comparing financial statements of different periods of time.
 Uniform and consistent accounting treatment for ascertaining the profit/loss and
assets/liabilities of the business.
 Matching current period revenues with current period expenses for getting correct
results of the business operations during a given period of time.

4. Accrual Concept:

As per the Accrual Concept of Accounting all transactions and events of business are
recognized o a Mercantile Basis.

It means that all expenses and losses are recognized in the period during which they have
occurred irrespective of the fact whether they have been paid or not and all income and gains
are recognized in the period during which they have been earned irrespective of the fact
whether they have been received or not.

5. Matching Concept:
As per the Matching Concept all the expenses incurred should be matched to the
corresponding revenue earned from those expenses. In Simple words it can be stated that
for all the revenue recognized during a period the corresponding expenses should be recorded
during that period.

1FIN BY INDIGOLEARN 1.12

 For Eg: ABC Company had purchased 1000 quantity of goods for reselling and had sold 600 of
those in the current financial year.

Then at the end of the Financial Year the Cost of Goods Sold will be booked only for 600
units and the balance 400 will be transferred to Ending Inventory which will be transferred
to COGS when they are sold.

6. Going Concern Concept:

As per the Going Concern Concept it is assumed that the entity intends to continue its
operations for the foreseeable future and has no intentions of drastically reducing its scale
of operations.

If it has any intention to scale down its operations materially or it is intending to close down
its operation then it is liable to disclose the same to the users of the Financial Statements.

7. Cost Concept:
As per the Cost Concept the assets are supposed to be measured at their historical cost i.e.
their original cost of purchase.

This concept is mainly applied to long term assets such as Fixed Assets. Because current
assets are valued at cost or market value whichever is realizable.

For Eg: If ABC company had acquired a Machinery worth Rs.10.00 Lacs 10 years back and had
spend Rs.2.00 Lac towards its installation. Then the cost of the machine will be carried over
across the years at Rs.12.00 Lac Less Accumulated Depreciation.

8. Realization Concept:
As per the Realization Concept any change in the value of the assets is to be recognized only
when the asset has been sold and the amount has been realized.

This means that companies do not need to revalue their assets every year as per the realizable
value. However, they need to adjust the cost of the asset when they are sold.

For Eg: ABC Company had machinery with book value of Rs.5.00 Lac as on August 2018 whose
market value was Rs.6.00 Lac which was sold for Rs.5.50 Lac. In Sep 2018.

Here ABC Co. would not revalue the asset at Rs.6.00 Lac in August 2018 and then record the
sale in Sep recognizing a loss of Rs.50 thousand.

ABC Co. would be directly booking the asset value at Rs.5.00 Lac and a gain of Rs.50 thousand
when asset is sold in September.

9. Dual Aspect Concept:

This concept is the basis on which the Double Entry System of Book-Keeping is based on. As
per this concept every transaction has 2 effects.

This can be summarized in the following manner:

1FIN BY INDIGOLEARN 1.13

 Effect of Changes in Asset
In one Asset, in other Asset.
In one Asset, in Liability.

Effect of Changes in Liability

In one Liability, in other Liability.
In one Liability, in Asset.
For Eg: When the business pays of dues to its creditors, it results in reduction of Asset (Cash
& Bank) and reduction of liability (Creditors Balance).

10. Conservatism Concept:

This Concept states that accountants should not record anticipated income but they need to
record the anticipated losses.

As the name itself suggest this concept is based on Conservatism principle which means that
all the possible expenses and losses are reported which have not even occurred yet but the
income and gains are reported only once they are realized. Resulting in preparation of most
conservative Financial Statements.

11. Consistency Concept:

This Concept states that the enterprises should follow the accounting policies on a consistent
basis from one period to another and should change their accounting policy only when the
exceptional circumstances arise.

The intention of this concept is to ensure the comparability of financial statements across a
period of time. Financial Statements can be compared across a period of time only when they
are prepared using the same accounting policies and principles for the period being
compared.

The exceptional circumstances under which the companies can change the accounting policies
are as stated below:

i. To prepare the accounts in line with the newly issued Accounting Standards.
ii. To comply with the provisions of Law.
iii. If the circumstances have changed and it is felt that only by the adoption of the New
Accounting Standards the company’s financial results will be shown in a true and fair
manner.

12. Materiality Concept:

This Concept allows the accountant to ignore all the other concepts of accounting which have
been discussed till now under the condition that the result of ignoring all the other concepts
will not make the financial statements materially misstated.

According to the Materiality concept all the items which have significant effect on the
financial statements should be disclosed and all the items which are insignificant in value and
will only increase the work of the accountant but are not relevant to the users should be
ignored.

1FIN BY INDIGOLEARN 1.14

 For Eg; When the business purchases some stationery items such as calculator which are
going to be used for a more than a year, they are not classified as Fixed Asset and
depreciated accordingly. They are expensed off as a Expense under Printing and Stationery
for the year.

This is because the cost of calculator is no material enough to impact the decision of the
users of the Financial Statement.

Characteristics of Financial Statements.

The 4 qualitative characteristics of Financial Statement that make them useful to their users are
as follow:

1. Understandability:
The Financial Statements should be easily understandable by the users.

It is assumed that the users of these Financial Statements have a basic understanding of the
Business and Accounting to study the information presented in them.

The Financial Statements contain information about complex matters that are to be supposed to be
reported. However, they should not be omitted just because they are complex in nature to
understand.

2. Relevance:
The information presented in the Financial Statement should be relevant to the users.

It means that the users should be able to use the information presented in making their economic
decisions.

3. Reliable:
The information presented in the Financial Statements should be reliable.

Quality of reliability is established when the Financial Statements are free from material errors
and bias and represents all the information in a faithful manner.

4. Comparable:
The information presented should be comparable. It should be comparable with the entities past
performance as well as with the different entities across the same and other industries.

Comparability can be established when the financial statements are presented using the consistent
principles and policies across the years.

The other characteristics which enhance the value of the Financial Statements are as follow:

5. Materiality:
The information is said to be material if its misstatement either by way of omission of wrong
presentation can influence the economic decision of the user which is based on the financial
statements.

1FIN BY INDIGOLEARN 1.15

Therefore, it is important the Financial Statements present all the material information.
6. Substance over Form:
The information presented should be indicating the true nature or intention of the transactions
rather than focusing on the legality of the transaction.

For Eg: if the ABC Co. had purchased a asset of Rs.10.00 Lac by paying an advance amount of Rs.1.00
Lac. However, the official transfer is not made in the name of the ABC Co.

In this situation ABC Co. will record the asset in its balance sheet and create a creditor for the
balance amount. Even though the official transfer is not made by considering the substance over the
form the asset is recorded in the books of ABC Co.

7. Neutrality:
If the financial statement are prepared and presented with a view to influence the decision of the
user they are said to be biased and not neural.

A neutral financial statement is the one which presents the information as it is without any intention
to influence the decision of the users.

8. Prudence:
Quality of Prudence states that the Financial Statements have been prepared using professional
judgment needed in determining the estimates needed in the preparation of the financial
statements.

However, by using prudence one should not resort to unethical practices such as creation of hidden
reserves, overstatement or understatement of assets and liabilities, incomes and expenses, etc.

9. Faithful Representation:
Financial Statements should faithfully represent all the transactions and events related to the
period for which the financial statements are being presented.

10. Full, Fair and Adequate Disclosure:

Full disclosure states that nothing should be omitted from the Financial Statements.

Fair disclose states that all the transactions should be accounted for in manner that presents the
financial statement in a true and fair manner.

Adequate disclosure states that all the information which could influence the decision of the user
should be presented in adequate detail.

11. Completeness:
To establish reliability it is important that the information presented is complete in all material
aspects. Information can be false or misleading and thus irrelevant and reliable if it is not complete
in all material aspects.

1FIN BY INDIGOLEARN 1.16

Questions:

1. Identify the effect on Asset and Liability of the following transactions.

i.Mr. A paid outstanding creditors balance of Rs.10,000

Asset decreases, Liability Decreases.

ii.Mr. B sold goods worth Rs.10,000 for cash?

Asset decreases (Inventory), Asset Increases (Cash/Bank).

2. Which of the following is not a qualitative characteristic of Financial Statement?

i.Comparability
ii.Completeness – Not an qualitative characteristics
iii.Relevance
iv.Reliability

3. A company needs to apply same method of depreciation due to which accounting concept:

i.Consistency – For Consistency

ii.Money Measurement
iii.Periodicity
iv.Accrual

4. What are the situations under which company can change its Accounting Policy?

1FIN BY INDIGOLEARN 1.17

Unit-3 Capital and revenue expenditure and receipts
Capital Expenditure:
Capital Expenditure is that expense whose benefits last for more than one accounting period.

For Eg: Purchase of Fixed Assets is a capital expenditure since its benefit is going to be lasting for
more than 1 accounting period.

Revenue Expenditure:
Revenue Expenditure is that expense whose benefit is going to expire within a single accounting
period or is incurred in relation to the sales made during the accounting period.

For Eg: Cost of Goods Sold in relation to the sales made.

Factors determining whether expenditure is CAPITAL or REVENUE in nature:

1. Nature of Business:
The Nature of business is an important factor in determining whether a expense is capital or
revenue in nature.

For Eg: For a company dealing in sale of computers, purchase of computer will be a part of
revenue expenditure. However, for company dealing in groceries purchase of computer will be
capital expenditure.

2. Is the Expenditure Recurring or Not?

The expenditure which are recurring on a fixed basis and whose benefit is exhausted within a
single accounting period is revenue expenditure. For eg: Salaries paid on monthly basis.

The Expenses which are incurred once in a while such as purchase of Fixed Asset is a capital
expenditure.

3. Purpose of Expense:
If the expense helps in generating income over more than one accounting period it is a capital
expenditure.

If the expense is useful in generating income in the current accounting period, then it is
revenue expenditure.

4. Materiality:
The most important factor is the materiality of the amount involved. If the amount of
expenditure is not material enough to be classified as a capital expenditure it will be written
off as a Revenue Expenditure in the current period itself.

Revenue Receipts:
Revenue Receipts are the receipts which are received in the normal course of the business
operations. It is important to note that the revenue receipt is not equal to cash receipts.

Revenue receipts are credited to the profit & loss account.

1FIN BY INDIGOLEARN 1.18

For Eg: Collection from Debtors for the sales made.

Capital Receipts:
Capital Receipts are the receipts which are not revenue in nature. Capital receipts realized from sale
of asset are first utilized to reduce the outstanding value of the asset in the company’s balance
sheet and any surplus or deficit is transferred to Profit & Loss Account.

For Eg: An asset whose value is Rs.1.00 Lac in the books of Accounts is sold for Rs1.10 Lac.
Here the Rs.1.00 lac out of the proceeds will be credited to the asset value to make it 0. And the
balance Rs.10 thousand will be transferred to credit side of Profit & Loss Account.
Questions:

1. Identify which of the following is Capital/Revenue Expenditure or Capital/Revenue Receipt.

i.Purchase of Computer worth Rs.1.00 lac by company dealing in computers for maintaining its
accounts.
Capital Expenditure (Even though it is dealing in computers it is purchased the
computer for maintaining its accounts and not for sale).

ii.Payment of Rent in advance for 2 years.

Rent Expense for current year is revenue expense but the rent paid for the next
year is capital expense.

iii.Cash Sale of Rs.1.00 Lac

Revenue Receipt

iv.Sale of old Fixed Asset by the company at a loss of Rs. 50 thousand.

Capital Receipt

1FIN BY INDIGOLEARN 1.19

Unit-4 Contingent assets and contingent liabilities
A contingent liability is an obligation which may arise in future depending on occurrence of one or
more uncertain events in the future. This obligation would be arising due to some past events.

Contingent Liabilities Vs Liabilities:

Point of Distinction Contingent Liabilities Liabilities

Status of obligation Uncertain Obligation. It may or may Fixed present Obligation
not arise in future
Outflow of Resources Outflow of Resources to settle the Outflow of Resources to settle the
obligation is not fixed or probably obligation is fixed.
estimable
Recognition in the Not Recognized in the Financial Recognized in the Financial
Financial Statements. Statements. Statements.
Example Ongoing legal dispute, guarantee Amount due to Creditors
given in respect of third parties

Contingent Liabilities Vs Provisions:

Point of Distinction Contingent Liabilities Provisions

Status of obligation Uncertain Obligation. It may or may Obligation is present. However,
not arise in future amount of obligation is measured
by estimate since it is not fixed
Recognition in the Not Recognized in the Financial Outflow of Resources to settle the
Financial Statements. Statements. obligation probable and estimable.
Hence, recognized in the Financial
Statements.
Example Ongoing legal dispute, guarantee Provision for Doubtful debts,
given in respect of third parties provision for depreciation.

Contingent Assets:
A contingent Asset is possible asset that may arise in future due past events. The occurrence of
Asset is dependent on one or more future uncertain events in Future.

As per the Accounting Standards, A Contingent Asset is not supposed to be recognized in the
Financial Statements. This is because recognition of any anticipated gains is not allowed in the
Financial Statements.

A Contingent Assets should be disclosed in the Board of Directors Report, if the realization of the
assets is probable.

When the future event on the basis of which the Contingent Asset was dependent has occurred and
it is certain that the contingent asset is realizable by the entity, then it is no longer a contingent
asset and it is supposed to be recognized in the Financial Statement.

1FIN BY INDIGOLEARN 1.20

Questions:

1. Identify which of the following is Contingent Liability.

i.Ongoing Legal proceeding, the company expects to win the case.

Not a Contingent Liability. (It’s a Contingent Asset)

ii.Liability in respect of Bill Discounted by the company.

Contingent Liability.

iii.Company is planning to make an appeal against Income Tax demand of Rs.5.00 Lac and has
estimated that it has 70% probability of winning the same.
Not a Contingent Liability. (Since it has not yet made the appeal, as of now it is a
liability due against the demand)

iv.Company expects additional bad debts of 5% during the current year as compared to the
average of the past 3 years.
Not a Contingent Liability. (It’s a provision)

Illustration

State with reasons whether the following statements are ‘True’ or ‘False’.
1. Overhaul expenses of 2nd hand machinery purchased are Revenue Expenditure
2. Money spent to reduce working expenses is Revenue Expenditure
3. Legal fees to acquire property is Capital Expenditure
4. Amount spent as lawyer’s fee to defend a suit claiming that the firm’s factory site
belonged to the plaintiff ’s land is Capital Expenditure
5. Amount spent for replacement of worn out part of machine is Capital Expenditure

1FIN BY INDIGOLEARN 1.21

 Unit-5 Accounting policies
Accounting Policies:
Accounting Policies are the specific accounting principles and the methods of applying those
principles adopted by the organization sin preparation of their Financial Statements.

There isn’t any single set of accounting policy applicable to all the organizations. Selection of
Accounting Policies needs extreme judgment on part of the Key Management personnel of the
organization.

Selection of Accounting Policies:

The Accounting Policies which are selected and on the basis of which the Financial Statements will
be prepared play a major role in preparing and presenting the Financial Statements in a true and fair
manner.

There are 3 main considerations in selection of Accounting Policies which are as presented below:

Selection of Accounting Policy

Prudence Substance over Materiality

Form

Use of degree of Accounting Policies Accounting Policies

caution and should be selected in should be selected in
making an such a manner that such a manner that
educated they disclose the they disclose all the
judgment in intention of the transaction and events
selection transaction rather than which are material
accounting the legality of the enough to influence
policies same. the economic decision
of the users.
Examples of Accounting Policy
 Valuation of inventory
 Accounting for Depreciation
 Valuation of Investments
Changes in Accounting Policies:
Although the Accounting policies which are adopted once are supposed to be followed every year as
per the principle of consistency to present the financial statements in a comparable manner.

1FIN BY INDIGOLEARN 1.22

There are exceptional circumstances under which the companies can change the accounting policies
which are as stated below:

i. To prepare the accounts in line with the newly issued Accounting Standards.
ii. To comply with the provisions of Law.
iii. If the circumstances have changed and it is felt that only by the adoption of the New
Accounting Standards the company’s financial results will be shown in a true and fair manner.

1FIN BY INDIGOLEARN 1.23

 Unit-6 Valuation principles and contingent assets
Valuation Principles:
There are 4 valuation principles on the basis of which the amounts which are to be presented in the
Financial Statements are measured. These 4 principles are:

1. Historical Cost:
Under this principle the Assets Acquired are recorded at the original acquisition price or the original
cost at which they were acquired.

For Eg: If ABC Co. had acquired a plant & machinery worth Rs.20.00 Lac in 2000 and had spent
Rs.5.00 Lac towards its installation and other charges to bring to its usable condition.

Its value as per Historical cost would be Rs.25.00 Lac.

2. Current Cost:
Under this principle the cost of an asset is measured at the current amount of cash or cash
equivalents to be paid to acquire the same.

For Eg: If ABC Co. had acquired a plant & machinery worth Rs.20.00 Lac in 2000 and had spent
Rs.5.00 Lac towards its installation and other charges to bring to its usable condition. The Current
Cost to acquire the machinery as of August 2018 was Rs. 45.00 Lacs.

Then as per the current cost principle it value would be Rs. 45.00 Lacs.

3. Realizable Value:
Under this principle the cost of an asset is measured at the amount of cash or cash equivalents which
could be obtained by selling the asset in its present condition.

For Eg: If ABC Co. had acquired a plant & machinery worth Rs.20.00 Lac in 2000 and had spent
Rs.5.00 Lac towards its installation and other charges to bring to its usable condition. It can sell the
machinery in the market as on today for Rs.30.00 and it can buy new machine for Rs.45.00 Lacs.

Then as per the Realizable Value principle it value would be Rs. 30.00 Lacs.

4. Present Value:
Under this principle the asset is value at the present value of all the future net cash flows expected
to be received from the asset over its course of life.

For Eg: If ABC Co. had acquired a plant & machinery worth Rs.20.00 Lac in 2000 and had spent
Rs.5.00 Lac towards its installation and other charges to bring to its usable condition. It had
expected that over its useful life of 20 years it will generate an output of Rs.2.00 Lac each year.
Its expected rate of return is 10%.

Then as per the Present value Principle, it will be valued at Rs. 17,02,800/-
As per the PV Annuity table PV of Rs.1 received for 20 years at 10% rate of interest is 8.514.
Therefore Rs.2.00 lac received for 20 years at 10% is Rs.17,02,800/-.

1FIN BY INDIGOLEARN 1.24

Accounting Estimate:
Till now we have seen how to value the transaction which have already taken place in past. But in the
Financial Statements there are certain items which are based on future events which are uncertain.

The value of these future assets and liabilities is based on estimates. Therefore, it is important to
select the estimates with a reasonable prudence and intelligence.

Organizations need to constantly evaluate the circumstances on the basis of which the estimates
were made and revise their estimates as needed.

For Eg: When the company buys machinery it has to estimate its useful life. But in the evolving
technological world it is highly possible that the circumstances on the basis of which the management
had estimated life of 20 years have changed and now the machine has a useful life of only 15 years.

Then the management needs to revise its estimate of life of the machine and depreciation
accordingly to bring it to the revised life.

Questions:

1. ABC Co. bought a machine in 2013 for Rs. 50.00 Lacs and spent another Rs. 10Lacs to install
the machine and put it to its intended usage.

After 5 years it found that the machine has Book value of Rs.45 Lacs and can be sold for
Rs.48 Lacs in its present condition. The same machine cost Rs. 75 Lacs today.

When it had bought the machine it had estimated that the machine had useful life of 20
years and its expected rate of return was 10%. The machine was expected to provide an
annual cashflow of Rs.10 Lacs.

Determine the value of Machine as per

i.Historical Cost
Rs.60/- Lacs

ii.Current Cost.
Rs.75/- Lacs.

iii.Realizable Value.
Rs.48/- Lacs

iv.Present Value.
Rs.85,14,000/- (10 Lacs X 8.514) [Using present value formula for annuity]

1FIN BY INDIGOLEARN 1.25

 UNIT 7: ACCOUNTING STANDARDS

Accounting Standards deal with the issues of

1. Recognition of events and transactions

2. Measurement of transactions and events
3. Presentation of transactions and events
4. Disclosure requirements

Formulation of Accounting Standards

Identification of area

Constitution of study group

Preparation of draft and its circulation

Ascertainment of views of different bodies on draft

Finalisation of exposure draft (E.D)

Comments received on exposure draft (E.D)

Modification of the draft

Issue of AS

Introduction of Accounting standards

Accounting as a ‘language of business’ communicates the financial results of an enterprise to

various stakeholders by means of financial statements. If the financial accounting process
is not properly regulated, there is possibility of financial statements being misleading,
tendentious and providing a distorted picture of the business, rather than the true. To ensure
transparency, consistency, comparability, adequacy and reliability of financial reporting, it is
essential to standardize the accounting principles and policies. Accounting Standards (ASs)

1FIN BY INDIGOLEARN 1.26

provide framework and standard accounting policies for treatment of transactions and events
so that the financial statements of different enterprises become comparable.

Accounting standards are written policy documents issued by the expert accounting body or
by the government or other regulatory body covering the aspects of recognition, measurement,
presentation and disclosure of accounting transactions and events in the financial statements.

Objectives of Accounting Standards

The whole idea of accounting standards is centered around harmonisation of accounting policies
and practices followed by different business entities so that the diverse accounting practices
adopted for various aspects of accounting can be standardised. Accounting Standards
standardise diverse accounting policies with a view to:

(i) eliminate the non-comparability of financial statements and thereby improving the
reliability of financial statements; and

(ii) provide a set of standard accounting policies, valuation norms and disclosure
requirements.

Benefits and limitations of accounting standards

Accounting standards seek to describe the accounting principles, the valuation techniques and
the methods of applying the accounting principles in the preparation and presentation of
financial statements so that they may give a true and fair view. By setting the accounting
standards, the accountant has following benefits:

(i) Standards reduce to a reasonable extent or eliminate altogether confusing variations in

the accounting treatments used to prepare financial statements.

(ii) There are certain areas where important information are not statutorily required to be
disclosed. Standards may call for disclosure beyond that required by law.

(iii) The application of accounting standards would, to a limited extent, facilitate comparison
of financial statements of companies situated in different parts of the world and also of
different companies situated in the same country. However, it should be noted in this
respect that differences in the institutions, traditions and legal systems from one
country to another give rise to differences in accounting standards adopted in different
countries.
However, there are some limitations of accounting standards:

(i) Difficulties in making choice between different treatments: Alternative solutions to

certain accounting problems may each have arguments to recommend them. Therefore,
the choice between different alternative accounting treatments may become difficult.

(ii) Restricted scope: Accounting standards cannot override the statute. The standards are
required to be framed within the ambit of prevailing statutes.

Process of formulation of accounting standards in India

1FIN BY INDIGOLEARN 1.27

The Institute of Chartered Accountants of India (ICAI), being a premier accounting body in the
country, took upon itself the leadership role by constituting the Accounting Standards Board
(ASB) in 1977. The ICAI has taken significant initiatives in the setting and issuing procedure of
Accounting Standards to ensure that the standard-setting process is fully consultative and
transparent.

The ASB considers International Financial Reporting Standards (IFRSs) while framing Indian
Accounting Standards (ASs) in India and try to integrate them, in the light of the applicable
laws, customs, usages and business environment in the country. The composition of ASB
includes, representatives of industries (namely, ASSOCHAM, CII, FICCI), regulators,
academicians, government departments etc. Although ASB is a body constituted by the Council
of the ICAI, it (ASB) is independent in the formulation of accounting standards and Council of
the ICAI is not empowered to make any modifications in the draft accounting standards
formulated by ASB without consulting with the ASB.
The standard-setting procedure of Accounting Standards Board (ASB) can be briefly outlined
as follows:

 Identification of broad areas by ASB for formulation of AS.

 Constitution of study groups by ASB to consider specific projects and to prepare

preliminary drafts of the proposed accounting standards. The draft normally includes
objective and scope of the standard, definitions of the terms used in the standard,
recognition and measurement principles wherever applicable and presentation and
disclosure requirements.
 Consideration of the preliminary draft prepared by the study group of ASB and
revision, if any, of the draft on the basis of deliberations.

 Circulation of draft of accounting standard (after revision by ASB) to the Council

members of the ICAI and specified outside bodies such as Department of Company
Affairs (DCA), Securities and Exchange Board of India (SEBI), Comptroller and Auditor
General of India (C&AG), Central Board of Direct Taxes (CBDT), Standing Conference
of Public Enterprises (SCOPE), etc. for comments.

 Meeting with the representatives of the specified outside bodies to ascertain their
views on the draft of the proposed accounting standard.

 Finalisation of the exposure draft of the proposed accounting standard and its issuance
inviting public comments.

 Consideration of comments received on the exposure draft and finalisation of the draft
accounting standard by the ASB for submission to the Council of the ICAI for its
consideration and approval for issuance.

 Consideration of the final draft of the proposed standard and by the Council of the
ICAI, and if found necessary, modification of the draft in consultation with the ASB is
done.

 The accounting standard on the relevant subject (for non-corporate entities) is then
issued by the ICAI. For corporate entities the accounting standards are issued by The

1FIN BY INDIGOLEARN 1.28

 Central Government of India.

List of Accounting Standards in India

Sl. Number of the Title of the Accounting Standard
No. Accounting Standard
(AS)
1. AS 1 Disclosure of Accounting Policies
2. AS 2 (Revised) Valuation of Inventories
3. AS 3 (Revised) Cash Flow Statements
4. AS 4 (Revised) Contingencies and Events Occurring after the Balance
Sheet Date
5. AS 5 (Revised) Net Profit or Loss for the Period, Prior Period Items
and Changes in Accounting Policies
6. AS 7 (Revised) Accounting for Construction Contracts
7. AS 9 Revenue Recognition
8. AS 10 Property, Plant and Equipment
9. AS 11 (Revised) The Effects of Changes in Foreign Exchange Rates
10. AS 12 Accounting for Government Grants
11. AS 13 Accounting for Investments
12. AS 14 Accounting for Amalgamations
13. AS 15 (Revised) Employee Benefits
14. AS 16 Borrowing Costs
15. AS 17 Segment Reporting
16. AS 18 Related Party Disclosures
17. AS 19 Leases
18. AS 20 Earnings Per Share
19. AS 21 Consolidated Financial Statements
20. AS 22 Accounting for Taxes on Income
21. AS 23 Accounting for Investments in Associates in
Consolidated Financial Statements
22. AS 24 Discontinuing Operations
23. AS 25 Interim Financial Reporting
24. AS 26 Intangible Assets
25. AS 27 Financial Reporting of Interests in Joint Ventures
26. AS 28 Impairment of Assets
27. AS 29 Provisions, Contingent Liabilities & Contingent Assets

1FIN BY INDIGOLEARN 1.29

 Chapter 2 – Accounting Process

Unit-1 Journal Entries

Double Entry System:

The Double Entry System of Accounting is the most commonly used system of Accounting.

According to Double Entry System, Every transaction has two aspects a Debit and a Credit.

For every transaction entered into there will be one or more Debit and one or more Credit and the
total of debit will be equal to the total of credit.

Advantages of Double Entry System:

Following are the advantages of Double Entry System due to which it is extensively used in all the
countries.

i. The accuracy of the accounting can be established by the preparation of the trial balance.
ii. The result of the operations carried on during a period of time i.e. either profit or loss can
be ascertained with details.
iii. The financial position of the organization can be ascertained at the end of each period
through the balance sheet.
iv. The accounts can be kept in as much details as required and provides information for the
purposes of control etc.
v. Result of one year may be compared with those of previous years and reasons for the change
may be easily determined.

Debits and Credits:

Debits and Credits are the 2 sides of same coin. For every debit there will always be an equal and
corresponding credit.

The Rules of Debit and Credit can be summarized as follow:

i. Increases in assets = debits & decrease in assets = credits.

ii. Increases in liabilities = credits & decreases in liabilities = debits.
iii. Increases in owner’s capital = credits & decreases in owner’s capital = debits.
iv. Increases in expenses = debits & decreases in expenses = credits.
v. Increases in revenue or incomes = credits & decreases in revenue or incomes = debits.

There are 2 methods of recording every transaction by under the Double Entry System.

Journal Entry – Traditional Approach:

To understand the traditional approach it is important to understand 2 important factors
i.Classification of Accounts.
ii.Golden Rules of Accounting.

1FIN BY INDIGOLEARN 2.1

Classification of Accounts:

Classification of Accounts under traditional accounts is based on Personal and Impersonal Accounts.
[GroupDrawing]

Accounts

Personal Accounts Impersonal Accounts

Real Accounts

Nominal Accounts

Interpretation of the Accounts:

1. Personal Accounts:
These are the accounts which relate to someone who can be identified. All those accounts
that have their own identity either as an individual or as a legal establishment such as Mr.A,
ABC &Co, etc. are classified as Personal Accounts.

2. Real Accounts:
These are the accounts which represent the assets of the firm either tangible or intangible
such as Cash, Bank, Inventory, Trademark, Goodwill, etc.

3. Nominal Accounts:
These are the accounts which are presented in the Profit & Loss account. This includes all
the revenues, expenses, gains & Losses. The important feature of the Nominal Accounts is
that they are temporary accounts and are written off by the end of the accounting period by
transfer to Profit & Loss Account.

Golden Rules of Accounting:

The Golden Rules of Accounting states the rules of debit and credit for every type of accounts. The
summary of Golden Rule of Accounting is as follow:

Type of Account Debit Credit

Personal Account When Receiving When Giving
Real Account When it comes in When it Goes out
Nominal Account All the Expenses and Losses All Incomes and gains

1FIN BY INDIGOLEARN 2.2

Example on Journal Entry:

Prepare the Journal entries for the following transactions:

1. Mr. A Introduced capital of Rs.10.00 lac to start his business.

2. Purchased Machinery worth Rs.2.00 Lac by paying the entire amount.
3. Purchased goods on credit from Mr. B worth Rs. 50 Thousand.
4. Sold goods for Rs. 4.00 Lac to Mr.C and of Rs.1.00 Lac in cash.

The Journal entries for the above transaction are as follow:

Accounting Equation – Modern Approach:

The other approach to record the transactions is the Modern Approach of accounting which
is based on the Accounting Equation. The relationship among the Assets, Liabilities and
Owner’s equity can be expressed in terms of an Equation which is known as the “Accounting
Equation.”

Assets = Liabilities + Owner’s Equity

The owner’s equity is computed as follow:

Contributed Capital
Add: Beginning Retained Earnings (Opening balance in Profit & Loss)
Add: Profit earned during the period (Revenues – Expenses)
Less: Dividends distributed (Drawings made)

1FIN BY INDIGOLEARN 2.3

 The Modern classification of accounts can be summarized in the following table:

Account Type Account shown a Debit when the Credit when the
Normal Balance in account is to be account is to be
ASSET Debit Increase Decrease
LIBAILITES Credit Decrease Increase
CAPITAL Credit Decrease Increase
REVENUE Debit Decrease Increase
EXPENSES Credit Increase Decrease
DRAWINGS Debit Increase Decrease

Example on Modern Classification of Accounts:

Prepare the Journal entries for the following transactions:

1. Mr. A Introduced capital of Rs.10.00 lac to start his business.

2. Purchased Machinery worth Rs.2.00 Lac by paying the entire amount.
3. Purchased goods on credit from Mr. B worth Rs. 50 Thousand.
4. Sold goods for Rs. 4.00 Lac to Mr.C and of Rs.1.00 Lac in cash.

Accounting for GST

GST is a comprehensive Indirect Tax which has subsumed multiple Indirect Taxes such as
Value added Tax (VAT), Excise Duty, Service Tax etc.

GST is a single tax on the supply of goods and services, right from the manufacturer to
consumer.

1FIN BY INDIGOLEARN 2.4

 On introduction of GST, the tax to be levied at all stages right from the manufacture up to
final consumption was a single tax-GST, with credit of taxed paid at previous stages available
as setoff.

Salient features of GST

a. GST is levied on supply.

b. Tax is levied only the value added at each stage of the supply chain.
c. GST is a destination-based consumption tax.
d. There is no tax on tax or cascading of taxes under GST system.
e. There is a hormonization of laws, procedures and rates of tax across the country.

Types of Taxes under GST

a. Intra-state supply: The location of the supplier and the place of supply of goods or services
are in the same state/union territory.

b. Inter-state supply: The location of the supplier and the place of supply of goods or services
are in two different states or two different union territories or a state and a union territory.

1. Central Goods and Service Tax (CGST): Levied and collected by the centre on the Intra-
state supply of goods and services.

2. State Goods and Service Tax (SGST): Levied and collected by the state governments on
Intra State supply of goods and services.

3. Union Territory Goods and Service Tax (UTGST): Levied and collected by Union Territories
without legislatures on Intra-state supply of goods and services.

Union Territories – Andaman and Nicobar Islands, Lakshadweep, Ladakh, Dadra and Nagar
Haveli & Daman and Diu and Chandigarh

4. Integrated Goods and Service Tax (IGST): Levied on the inter state supply of goods and
services and is collected by centre. IGST is equivalent to the sum total of CGST and SGST.

Input and Output GST

Input tax – The tax paid by the recipient on procurement of goods/services.

Entity at each stage is permitted to avail credit of GST paid on the purchase of goods and/or
availment of services and can setoff this credit against the GST payable on the goods and/or
services supplied by him.

Thus, the final consumer bears the GST charged in the supply chain, with set-off benefits at all the
previous stages.

Output tax – The GST charged on supply of goods or services made by the supplier.
Input tax – The credit of Input tax already paid.

1FIN BY INDIGOLEARN 2.5

Utilisation of Input Tax Credit under GST

Tax credit of CGST, SGST and IGST can be utilized in the following manner:

Utilization of IGST credit:

a. First utilized against IGST liability
b. If any balance is still available – Utilized against CGST or/and SGST in any order and in any
proportion

Utilization of CGST credit:

a. First utilized against CGST liability
b. If any balance available – Same can be utilized against IGST.
c. CGST credit cannot be utilized against SGST.

Utilisation of SGST credit

a. First utilized against SGST liability.
b. If any balance available – Same can be utilized against IGST.
c. SGST credit cannot be utilized against CGST.

Input GST Output GST

Nature At the time of purchase of goods At the time of sale of
or services goods/assets or supply of
Input GST A/c is debited. services
Output GST A/c is credited.
Intra-state CGST paid is debited to Input CGST charged is credited to
transaction CGST A/c output CGST A/c
SGST paid is debited to Input SGST charged is credited to
SGST Output SGST A/c
Inter-state IGST paid is debited to Input IGST charged is credited to
transaction IGST A/c Output IGST A/c
Reversal of GST Input GST paid at the time of Reversed when the goods are
purchase are reversed in following returned by the purchaser.
situations
i. Purchase Return
ii. Drawings
iii. Free samples distribution
iv. Goods distributed as gift
v. Goods lost in fire or theft
vi. Input tax credit not
allowed to be availed by
recipient
Utilization of Input GST A/c is credited when
Input tax credit tax is paid by utilizing input tax.

1FIN BY INDIGOLEARN 2.6

Journal entries

The Double entry book-keeping records need to show the GST values separately so that the
purchases, expenses and sales are posted without the addition of GST.

Sale of Goods or Services

Account Receivable/Debtors A/c Dr Gross Amount(Include GST)

To sales A/c Net Amount
To Output GST Ampunt of GST

Purchase of Goods or Services

Purchases A/c Dr Net Amount

Input GST A/c Dr Amount of GST
To Account payable/Creditors Gross Amount

Utilization of Input Tax Credit towards payment of Output Tax

Output CGST A/c Dr Amount of GST liability

Output SGST A/c Dr Amount of GST liability
Output IGST A/c Dr Amount of GST liability
To Input CGST A/c Amount of output GST liability paid utilizing input CGST
To Input SGST A/c Amount of output GST liability paid utilizing input SGST
To Input IGST A/c Amount of output GST liability paid utilizing Input IGST

Questions:

Show the effect of the following transactions using the Traditional approach as well as the Modern
Approach.

i.Mr. A Introduced capital of Rs.25.00 lac to start his business.

ii.Purchased Machinery worth Rs.10.00 Lac by paying the Rs.5.00 Lac in cash and balance in
credit from XYZ &Co.
iii.Purchased goods on credit from Mr. C worth Rs. 50 Thousand and in cash for Rs.1.50 Lacs
iv.Sold goods for Rs. 2.00 Lac to Mr.D and received amount of Rs.1.00 lac from him after 20
days.
v.Mr. A asked deposited amount of Rs.2.00/- Lac from his savings in Bank.

Illustration 1
Develop the accounting equation from following information available at the beginning of accounting
period:
Particulars Amount (Rs.)
Capital 51,000,000
Loan 11,500,000
Trade payables 5,700,000
Fixed Assets 12,800,000

1FIN BY INDIGOLEARN 2.7

Inventory 22,600,000
Trade 17,500,000
receivables
Cash and Bank 15,300,000

At the end of the accounting period the balances appear as follows:

Particulars Amount (Rs.)
Capital ?
Loan 11,500,000
Trade payables 5,800,000
Fixed Assets 12,720,000
Inventory 22,900,000
Trade receivables 17,500,000
Cash and Bank 15,600,000

a. Reset the equation and find out profit.

b. Prepare Balance Sheet at the end of the accounting period.

Illustration 2
Mr. Dravid has provided following details related to his financials. Find out the missing figures-
Particulars Amount (Rs.)
Profits carved during the year 5,000,000
Assets at the beginning of year A
Liabilities at the beginning of 12,000,000
year
Assets at the end of the year B
Liabilities at the end of the year C
Closing capital 35,000,000
Total liabilities including capital 50,000,000
at the end of the year

Illustration 3
From the following information, state the nature of account and state which account will be
Debited and which will be Credited.
 Started business with a capital of Rs. 50,00,00
 Wages and salaries paid Rs. 50,000
 Rent received Rs. 2,00,000
 Purchased goods on credit Rs. 9,00,000
 Sold goods for Rs. 8,16,000 and received payment in cheque.
Illustration 4
Pass journal entries for the following:
Mohan Brought in Capital of Rs. 50,00,000
Out of the above, Rs. 25,000 is withdrawn from the bank.
Furniture is purchased for Rs. 12,00,000.
Purchased goods for cash Rs. 4,00,000.

1FIN BY INDIGOLEARN 2.8

Purchased goods for Rs. 10,00,000 on credit from M/s Ram Narain
Bros.
Sold goods to Ramesh on credit for Rs. 13,00,000.
Received cheque from Ramesh Rs. 13,00,000.

Illustration 5
Journalise the following transactions. Also state the nature of each account involved
in the Journal entry.
Following figures are given in (‘000)
Ajith started business with capital Rs. 4,00,000
He withdrew cash for business from the Bank Rs. 2,000
He purchased goods making payment through bank Rs. 15,000
He sold goods Rs. 16,000 and received payment through bank.
He purchased furniture and paid by cheque Rs. 2,500

1FIN BY INDIGOLEARN 2.9

 Unit-2 Ledgers
What is a Ledger?

Once all the transactions are recorded through Journal Entries, they need to be classified and
grouped by preparing the accounts. The book in which all the accounts are prepared is known as
“LEDGER”.

Format of LEDGER:

The process of transferring the Journal Entries in the Ledger is known as “POSTING”.

Important rules to be noted while posting:

1. All the Accounts which have been entered in the Journal should have Ledger Account.
2. Whenever any account is mentioned in the Debit side of the Ledger it is supposed to use
the word “TO” before the name of the account
3. Whenever any account is mentioned in the Credit side of the Ledger it is supposed to use
the word “BY” before the name of the account
4. At a fixed interval of time the accounts needs to be balanced. Wherein the accounts are
totaled and the balance on either side is carried forward to the next period for assets and
liabilities. (Refer example to understand the concept of Balancing a Ledger). The balance in
income and expenses ledgers are transferred to final accounts.

Example on Ledger:

Prepare the Purchase Account for the following transactions:

1. 10/08/2018 - Purchased goods of Rs.5.00 lac on credit from Mr. A.

2. 12/08/2018 - Purchased goods of Rs.1.00 lac in cash.
3. 15/08/2018 – Returned goods of Rs.1.00 lac Purchased from Mr. A

1FIN BY INDIGOLEARN 2.10

Note:
1. Whenever the Purchase account was debited in the Journal the corresponding credit account
is mentioned on the debit side of the journal with the word “TO” before it.

2. Whenever the Purchase account was credited in the Journal the corresponding credit account
is mentioned on the debit side of the journal with the word “BY” before it.

3. At the end of the month the total of both the sides is done. The deficit amount on the lower
side is mentioned as Balance c/d which is known as Balancing of the Account.

Questions:

1. Prepare the Ledgers for the various transactions entered into by the company as follow:
i.Mr. A Introduced capital of Rs.25.00 lac to start his business.
ii.Purchased Machinery worth Rs.10.00 Lac by paying the Rs.5.00 Lac in cash and balance in
credit from XYZ &Co.
iii.Purchased goods on credit from Mr. C worth Rs. 50 Thousand and in cash for Rs.1.50 Lacs
iv.Sold goods for Rs. 2.00 Lac to Mr.D and received amount of Rs.1.00 lac from him after 20
days.
v.Mr. A asked deposited amount of Rs.2.00/- Lac from his savings in Bank.

(Hint – Use the Journal entries created while solving the exercise for chapter 2.1)

1FIN BY INDIGOLEARN 2.11

 Unit-3 Trial Balance
What is a Trial Balance?

After the entire ledger accounts for the various transactions which were recorded via Journal
Entries is completed. The Next step is the creation of the Trial balance.

Trial Balance contains the debit and credit balance of the various ledgers. It is important to note
that the total of debit column and credit column needs to be equal for the trial balance to be
complete.

Objectives of Preparing a Trial Balance:

The Objectives of preparing a Trial Balance are as mentioned below:

i. Trial balance helps to establish arithmetical accuracy of the books of Accounts.

ii. Financial statements are normally prepared on the basis of agreed trial balance otherwise
the work may be cumbersome. So it can be stated that the preparation of trail balance eases the
preparation of Financial Statements.
iii. The trial balance serves as a summary of all the ledger balances.

LIMITATIONS OF TRIAL BALANCE:

The agreement of Trial Balance is not a final evidence of the accuracy of the trial balance. The
Arithmetical accuracy shows the fact that all the debit balance equals the credit balances.
However, there are certain possibilities whereby even though the trial balance is agreed upon it is
still inaccurate.

It is possible that the following types of errors still exist and the trial balance is agreed upon.

i. Transaction has not been entered at all in the journal. Hence, is not entered in Ledger and
not accounted for in Trial balance.
ii. A journal recorded with wrong Amount.
iii. A journal recorded with wrong Accounts.
iv. Omitting to record a Journal entry in the Ledger.
v. Posting the same journal entry twice in the ledger.

It is to be noted that the preparation of trial balance still cannot be omitted due to the above
mentioned limitations.

1FIN BY INDIGOLEARN 2.12

Format of TRIAL BALANCE:

Adjusted Trial Balance:

Sometimes it may happen that the trial balance does not agree even after entering all the amounts
correctly from the Ledgers. In such situations the entities use suspense account to balance the trial
balance. Wherein they transfer the difference in the suspense account and agree the trial balance.
This kind of trial balance which has suspense account in it is known as Agreed Trial Balance.

Methods of preparing Trial Balance:

There are 3 different methods of preparing Trial Balance. The only difference in these 3 methods
is the manner of presenting the ledger balances.

1. TOTAL METHOD:
Under this method, every ledger account is totaled and that total amount of debit side and credit
side is transferred to trial balance. In this method, trial balance can be prepared as soon as ledger
accounts are totaled. There is no need to balance the ledger Accounts.

2. BALANCE METHOD:
Under this method, only the ledger balances of the various ledger accounts are transferred to trial
balance. This is the most commonly used method of creating trial balance. Also, it is to be noted that
the Financial Statements are prepared on the basis of the Ledger Account Balances.

3. TOTAL AND BALANCE METHOD:

This is a combination of the above mentioned 2 methods. Under this method the trial balance shows
the total columns as well as the balance columns.

Example on Trial Balance:

The Balances of the various ledgers and the total of the ledger columns are as presented below:
Prepare the Trial Balance for the following Ledger Accounts as per the 3 different methods.

1FIN BY INDIGOLEARN 2.13

Note:
1. The Total Amount represents the total of the Ledger Accounts.
2. The Balance Amount represents the amounts remaining after the balancing of the respective
ledgers which are carried forward.

TRIAL BALANCE AS PER TOTAL METHOD:

Table image

Note: Here we have considered only the amount from the total column.

1FIN BY INDIGOLEARN 2.14

TRIAL BALANCE AS PER BALANCE METHOD:

Note: Here we have considered only the amount from the BALANCE column.

TRIAL BALANCE AS PER TOTAL & BALANCE METHOD:

1FIN BY INDIGOLEARN 2.15

 Unit-4 Subsidiary Books
What is Subsidiary Book?

All the transactions incurred by business on a daily basis can be classified into few major activities
which are Receipt and Payment of Cash, Sale of Goods and Purchase of Goods.

To facilitate ease of work a separate register is maintained which records all the transactions for
each such class of transactions. For the entries mentioned in such registers there wouldn’t be any
Journal Entries. The balances from these registers in respect of the particular items will be directly
posted in the Ledger.

This separate registers where the entries are first made are known as “SUBSIDIARY BOOKS”.

The following Subsidiary Books are commonly prepared and maintained by the businesses:

1. Cash Book:
Records all transactions related to receipts and payments.

2. Purchase Book
Records credit purchase of goods which are required by the entity in its daily operations.

3. Purchase Return Book

Records the return of the goods purchased on credit.

4. Sales Book
Records Credit sales of goods made by the entity.

5. Sales Return Book

Records sales return made by the customers.

6. Bills Receivable & Bills Payable

If the entity deals in promissory notes they record it in a separate subsidiary book for all
the Bill Receivable and Bills Payable.

7. Journal Book
This is the book where if any transaction cannot be recorded in the above 7 books they are
recorded in this book.
Advantages of Subsidiary Book:
The following are the advantages of the Subsidiary Books:

1. Division of Work:
Every Subsidiary book deals in a specific area of business. Therefore, it is possible to allocate
resources on a specific of work based on the volume

2. Specialization of Work:
Since the work is divided into different areas of business, it can be specialized by allocating
and training resources on a particular domain.

1FIN BY INDIGOLEARN 2.16

 3. Time Saving:
Since the need to maintain the Journal is eliminated for the transactions entered into the
subsidiary books and there are various accountants involved for different work areas, it leads
to Time Savings.

4. Information Availability:
Since all the common areas of work are identified and maintained in separate books it is easy
to access information about a specific area of work without going through all the different
records.

5. Easiness in Locating errors:

If the Trial Balance does not agree, it is easy to identify the area where there might be an
issue due to the maintenance of various subsidiary books.

Difference between Principal Books and Subsidiary Books:

The book in which transactions are recorded first for further processing is called Subsidiary Books.
The details entered into subsidiary books are transferred to the Ledgers and from the Ledgers to
the trial balance and ultimately to the Financial Statements.

The Ledger and the Cash Book are called the Principal Books. This is because they facilitate the
information needed to prepare the trial balance and financial statements.

Example on Subsidiary Book (Purchase Books):

Prepare the Purchase Book from the following transactions and post their balances in Ledger.

1FIN BY INDIGOLEARN 2.17

The purchase book for the above transactions is as follow:

The ledger posting for the above transactions recorded in the Purchase Book is as Follow:

1FIN BY INDIGOLEARN 2.18

Questions:

1. Prepare the Sales Subsidiary Books for the following transactions and prepare the Ledger
posting for the same.

Hint:
1. The sale of Computer is a sale of Fixed Asset and not normal sale made in the course of
business.
2. The Cash Sales will be recorded in Cash Book. Only credit sales are recorded in Sales
Book.

1FIN BY INDIGOLEARN 2.19

 Unit-5 Cash Books
What is CASH Book?

As discussed in the Subsidiary Books, Under Cash Book all the transactions wherein cash has been
received or paid are recorded.

Cash Book plays a dual role as a Principal as well as a Subsidiary Book also.
This is because all the transactions related to payment and deposit of cash is recorded in the cash
book directly. Therefore, it is treated as Subsidiary Book. But cash book also serves as a basis for
preparing the trial balance thereby serving as a Ledger also. Hence, it is a principal book.

Different Kinds of Cash Book.

There are mainly 3 kinds of Cash Book.

i. Simple Cash Book

ii. Two Column Cash Book
iii. Three Column Cash Book

Some organizations also maintain another form of cash book known as Petty Cash Book.

1. Simple Cash Book:

This is like a simple Cash Ledger Account. Wherein the deposits are recorded on the debit
side and the payments are recorded on the credit side.

Important points to be noted in this regard are:

i.Only Cash receipts and payments are recorded.
ii.The cash receipts total is always greater than cash payments total. Since payments cannot
be greater than the amount of cash available.
iii.Simple cash book is the ordinary cash ledger account.

Example on Simple Cash Book:

Record the following transactions in the simple cash book:

1FIN BY INDIGOLEARN 2.20

 2. Double Column Cash Book:
When an additional column is added to the simple cash book which shows either discount
allowed or discount received. Alternatively, the new column can also show payments made
through the Bank and deposits received in the bank. It is known as a Double Column Cash
Book.

Important points to be noted in this regard are:

i.The discount columns if prepared are not balanced. They are just totaled to reflect the total
discount received and total discount given.
ii.If the bank Column is prepared then the cash and bank column are recorded in the same
manner as the simple cash book. The balancing figure of the bank balance will be the Balance
in the Bank.

Example on double Column Cash Book:

Record the following transactions in the Double Column cash book preparing the discount column:

1FIN BY INDIGOLEARN 2.21

 3. Three Column Cash Book:
Most of the organizations keep most of their balances in the Bank and the money can be
deposited and withdrawn at any point of time as per their requirements.

The only difference between cash in hand and money in bank is the location of the cash
amount. But it is important to track the moment in both of them. That purpose is served by
the three column cash book.

Another column is added to the Cash and discount column which is the Bank Column. All the
deposits and payment made in Bank are entered in the Bank Column.

The most important factor to be noted in the three column cash book is the method of
recording contra entries.

For instance when cash is deposited in the bank the Receipt Column on the bank side is debited
and the cash column on the credit side is credited. This shows the increase in the bank balance
and decrease in the cash balance due to depositing cash in Bank.

Example on Three Column Cash Book:

Record the following transactions in the Three Column cash book:

1FIN BY INDIGOLEARN 2.22

IMPEREST SYSTEM OF PETTY CASH BOOK:

Sometimes business have to make a lot of petty payments in cash as a part of their operational and
miscellaneous expenses.

It would be highly inconvenient for the main cashier to deal in such transactions on a daily basis. For
the sake of convenience companies install the Petty Cash System.

Under the system of petty cash, a small imprest amount of cash is always maintained in the petty
cash balance. The petty cashier pays all the petty expenses during the given period and at the
beginning of the next period may be a week or month the petty cashier is provided the deficit to
bring the petty cash balance to the originally decided amount.

For instance, if the company decides to maintain a petty cash balance of 10,000 on a weekly basis.
And the petty cashier incurs an expense of Rs. 5,000 during the given week. Then at the beginning
of the next week he will be reimbursed Rs.5,000 of the expenses incurred by him to bring the petty
cash balance to the decided amount of Rs.10,000.

Example on Petty Cash Book:

Record the following transactions in the Petty cash book:

Record the following transactions in the Petty cash book:

1FIN BY INDIGOLEARN 2.23

1FIN BY INDIGOLEARN 2.24
 Unit-6 Rectification of Errors
What are ERRORS?

Since Accounting involves a huge amount of recurring and record-keeping task it is highly possible
that sometimes unintentional omission or commission of amounts and accounts may happen during the
preparation of the accounts while recording them. This is known as ERROR in ACCOUNTING.

It is also possible that there may be due to mathematical mistake due to which the trial balance may
not agree.

Whatever kind of error has occurred it is important to rectify the error that have occurred and
been detected so that the Financial Statements show a True and Fair view of the various
transactions and events.

How the errors can occur?

1. Wrong Entry of amounts in the books of accounts.

For Eg: Sales of Rs. 15650/- recorded as sales of Rs.15065/-

2. Wrong posting of the Subsidiary Books.

For Eg: As per the Purchase Books the total purchases for the month of August 18 was of Rs.
19250/- recorded as purchases of Rs.19520/- while posting it in the Ledger.

3. Posting the entries in the wrong account:

For Eg: Purchases from Mr. A are posted as purchases from Mr.B

STAGES OF ERRORS:

Till now we have been able to see that accounting involves multiple processes from recording a
transaction to posting ledger to preparation of the Financial Statements.

An error can occur at any stage; broadly speaking the error can occur during any of the following
stages based on the flow of the process:

1. When recording the transaction in Journal.

2. While posting entries in the Ledger.
3. Balancing the Ledger Accounts.
4. Preparing the Trial Balance.

1FIN BY INDIGOLEARN 2.25

TYPES OF ERRORS:
Classification of errors can be understood from the following table:

TYPES OF ERROR

PRINCIPLE ERROR CLERICAL ERROR

Error of Error of Compensating

Omission Commission Error

Error of Principle:
This error occurs when the transactions are recorded in a fundamentally wrong manner ignoring the
principles of Accounting.
For Eg: When the purchase of Computer (Fixed Asset) is recorded as office expense.

Clerical errors:

1. Error of Omission:
This error occurs when the recording of transactions is omitted from the books of accounts.
For Eg: Omitting to record a purchase entry from the journal or omitting to record the journal entry
in the ledger.

2. Error of Commission:
This error occurs when the amounts are posted in the wrong account, or a debit amount is written
on the credit side, or the amounts are written wrong.

3. Compensating Errors:
These are the errors whose combine effect cancels out each other. For Eg: if salaries account is
overbooked by Rs. 1000/- and the office expense is under booked by the same amount i.e. Rs.1000/-
then the final profit remains unaffected. These types of errors are known as “COMPENSATING
ERRORS”.

Apart from the above mentioned classification based on principle of error or clerical error there is
also another category of error which can occur which is based on whether they affect the trial
balance or not.

The errors which affect the trial balance are as stated below:
i. Wrong casting of the subsidiary books.

1FIN BY INDIGOLEARN 2.26

 ii. Wrong balancing of an account.
iii. Posting an amount on the wrong side.
iv. Posting the wrong amount.
v. Omitting to post an amount from a subsidiary book.
vi. Omitting to post the totals of subsidiary book.
vii. Omitting to write the cash book balances in the trial balance.
viii. Omitting to write the balance of an account in the trial balance.
ix. Writing a balance in wrong column of the trial balance.
x. Totaling the trial balance wrongly.

The errors which do not affect the trial balance are as stated below:
i. Omitting an entry altogether from the subsidiary book.
ii. Making an entry with the wrong amount in the subsidiary book.
iii. Posting an amount in a wrong account but on the correct side, e.g., an amount to be debited
to A debited to B, the trial balance will still agree.

Steps to Locate the Error:

If the trial balance does not agree then it is a first indicator that there are errors in the accounts
and there can be various reasons the existence of errors which needs to be enquired upon and
rectified.

The following steps helps in identifying the errors:

1. The two columns of the Trial Balance should be verified and is there are multiple amounts
which are represented by a single amount in the trial Balance then even those amounts should be
verified again.
For eg: if the trial balance shows only a single amount for Trade Payables for the various
accounts then the list of the trade payables should also be verified.

2. Verify the Cash and Bank Balances written in the trial balance.

3. The exact difference in the trail balance should be determined. All the ledgers should be
scrutinized thoroughly to verify whether any amount of the exact difference has been omitted
from recording in the trial balance.

4. The Ledger accounts should be re balanced.

5. Recheck the casting of subsidiary books.

6. Posting of the amount equal to the difference in the trial balance or the half amount of the
difference should be checked. If the amounts are posted on the wrong side the difference
doubles up.
For Eg: If the amount of Rs.1000 to be posted in the debit side is posted on the credit side
then the trial balance would be showing a difference of Rs. 2000/-. The omission of Debit
of Rs.1000/- and additional credit of Rs.1000/-

1FIN BY INDIGOLEARN 2.27

 7. If the difference still exists a complete checking of the entire books of accounts would be
necessary.

Rectification of an Error:
Errors always need to be corrected in a systematic way such that the effect of the error is nullified
and the correct entry is also shown in the accounts.

The rectification of error depends on which stage the error is detected. The stage at which the
rectification needs to happen depends on the following stages:

1. Before Preparation of Trial Balance

2. After the preparation of Trial Balance but before the preparation of the Final Accounts.
3. After preparation of Final Accounts.

Rectification of error before preparation of trial balance:

These categories of errors are identified during or before preparation of the Trial Balance and
corrective entries need to be made to rectify the same.

The Rectification has to be done in 2 steps:

i. Pass a reverse entry of the wrong entry. This will nullify the effect of the wrong entry.
ii. Pass the correct Journal entry to ensure that proper effect of transactions is accounted.

Example:
Purchase of Fixed Asset for Rs. 1,00,000/- from ABC & Co. has been booked under Purchases.
Rectify the same.

The following states the wrong entries made and the correct entry to be passed for the
rectification.
Wrong Entry Reversal of Wrong entry Correct Entry
Purchase A/c Dr. 100000 ABC & Co. A/c Dr. 100000 Fixed Assets A/c Dr.
To ABC & Co. A/c 100000 To Purchases 100000 100000
To ABC & Co.
A/c 100000

Rectification of error after preparation of trial balance but before preparation of Final
Accounts:
Sometimes when the trial balance does not agree it is made to agree artificially by opening a
Suspense Account. If the debit total of the trial balance is higher than the suspense account is
credited, and it is debited if the total of the credit side of the trial balance is higher.

All those errors which needs to be rectified by a Journal entry but were not able to be rectified
due to the absence of complete journal entry will be rectified with the use of Journal Entry by using
suspense account as the other part of the Journal.

Example:
Pass the rectification entry for the following errors using a Suspense Account:

1FIN BY INDIGOLEARN 2.28

 1. The Sales book total is under casted by Rs.10,000/-
2. Goods Sold to Mr. B for Rs.2000/- But the accountant credited Mr. B instead of Debiting.
3. Discount received from Mr. C for Rs.500/- has been omitted from the discount column of the
cash book. However, the discount is properly accounted in Mr. C Account.

Rectification of error in the next accounting Period:

All the errors discussed so far were on the assumption that these errors have taken place during
the current year. However, sometimes the books of accounts for a particular period are prepared
along with the errors itself. These errors however, need to be rectified in the following year.

For instance the purchase for the year 2017 were over stated by Rs.10000/- but the Financials of
the year 2017 were finalized along with the errors itself and it was only in 2018 the company realized
the presence of error in 2017 financial statements and intended to rectify it.

If the company rectifies the error by reducing the purchases in 2018 by Rs. 10000/- then it would
be reducing the purchases for the year 2018 instead of 2017. It is to avoid these situations a special
account named “PROFIT & LOSS ADJUSTMENT ACCOUNT” is used to rectify the errors of
previous years.

It is to be noted that at the end of the current accounting period the balance of Profit & Loss
Adjustment Account will be transferred to the Profit & Loss Account itself.

1FIN BY INDIGOLEARN 2.29

Rectification of error in the next accounting Period:
All the errors discussed so far were on the assumption that these errors have taken place during
the current year. However, sometimes the books of accounts for a particular period are prepared
along with the errors itself. These errors however, need to be rectified in the following year.

For instance the purchase for the year 2017 were over stated by Rs.10000/- but the Financials of
the year 2017 were finalized along with the errors itself and it was only in 2018 the company realized
the presence of error in 2017 financial statements and intended to rectify it.

If the company rectifies the error by reducing the purchases in 2018 by Rs. 10000/- then it would
be reducing the purchases for the year 2018 instead of 2017. It is to avoid these situations a special
account named “PROFIT & LOSS ADJUSTMENT ACCOUNT” is used to rectify the errors of
previous years.

It is to be noted that at the end of the current accounting period the balance of Profit & Loss
Adjustment Account will be transferred to the Profit & Loss Account itself.

Example:
Mr. A was unable to agree the trial balance for 2017 and directly posted the differences in the
Profit and Loss account. In 2018, the Auditors of the company revealed the following errors
committed in 2017.

Rectify the mistakes noted above and use the Profit & Loss Adjustment Account wherever
necessary:

i. Purchase of a Fixed Asset was debited to Printing & Stationery Account for Rs.5,000.
Depreciation on Fixed Assets is levied at 10%.
ii. Sales account was overstated by Rs.20,000.
iii. A credit sale of goods to Mr. A for Rs.5,000 entered as a purchase.
iv. Rs. 1000 due by Mr. C was omitted from recording into the trial balance.
v. Purchase of goods from Mr. R for 5,000 was omitted to be recorded.
vi. Amount of Rs.2525 of purchase was wrongly posted as Rs.5252.

1FIN BY INDIGOLEARN 2.30

1FIN BY INDIGOLEARN 2.31
 Chapter 3 – Bank Reconciliation System
OBJECTIVES

The lists of topics which will be covered in this chapter are as follows:

3.1 Understand Pass book

3.2 Understand the differences between cash book and bank pass book

3.3 Reconcile the difference between the cash book and bank pass book.

3.4 Intention of preparing the bank reconciliation system and its utility.

SERVICES PROVIDED BY BANK:

In the present time nearly all of the transactions of the organizations are performed through the
banks whether it is a receipt or a payment at local, regional, national or international level. In Fact,
it is legally necessary to carry out the transactions through bank after a certain limit.

Apart from receiving collections and making payments, the following services are also performed by
the bank:

i. Discounting of promissory notes or hundies which enables the entities to receive the cash
before the due date in exchange for a small charges.

ii. Allowing overdraft facilities to their credible customer which enables them to make payments
even when they do not have sufficient balance in their account. These overdraft balances need to
be cleared within a certain period of time.

iii. Providing loans to their customers which provide great financial assistance for their
businesses.

iv. Collecting on behalf of the customer the amount of dividends, interest on securities etc.

v. Making Utility payments such as insurance premium, rent etc. on the due dates as instructed
by their customers.

vi. Remitting money to another place or persons at a low cost.

vii. Providing security or guarantee for its customers whose credit is good, in return for a
consideration,

viii. Issuing letter of credit or traveller’s cheque which facilitates commerce as well as travel.
ix. Provides international banking services.

1FIN BY INDIGOLEARN 3.1

BANK PASS BOOK AND BANK STATEMENT:

Bank pass book and Bank Statements provides the details of the customer’s account in the bank.
Through the Bank Pass Book and Bank Statement the bank keeps its customers informed of the
entries made in their account. It is the customer’s duty to check the entries and immediately inform
the bank of any error that he may notice.
The bank balance shown in the passbook or the statement is known as pass book balance for
reconciliation purpose. The credit balance as per pass book at a particular point of time is the deposit
made by the customer while debit balance as per pass book is the overdraft balance for the
customer.

BANK RECONCILIATION STATEMENT:

The Bank Reconciliation Statement reconciles the difference between the Bank Pass Book and Bank
Balance as per the organization record eliminating any differences arising between them.
Whenever any deposit or withdraws is made from banks, it is always recorded at two places: -
1. Bank column of the cash book and
2. Bank statement or Bank pass book

The cash book is maintained by the customer having who has the bank account and the bank
statement is prepared by the bank.

The balance in both the accounts should be equal and opposite in nature ideally. For e.g. If Mr. Z
deposited 1,000 in his bank account, it should be recorded as Debit entry on the cash book of Mr. Z.
And the same should be recorded as Credit Entry on the Customer Account maintained by the Bank.

In an Ideal world both the accounts should always match but it does not happen in most of the cases
due to several reasons.

There are many reasons for these differences in balances which are explained later. These
differences are reconciled by considering the various facts and figures on the two statements.

The process of reconciling the difference and bringing the two accounts in line with each other is
known as “Reconciliation”, and the statement in which the reconciliation is done is known as “BANK
RECONCILIATION STATEMENT”.

IMPORTANCE OF BANK RECONCILIATION STATEMENT:

Bank reconciliation statement acts as a tool for internal control of cash flows by detecting if any
errors, frauds and irregularities have occurred at the time of passing entries in the cash book or in
the passbook, whether intentionally or unintentionally. The important features of bank reconciliation
statement can be summarized as follow:

i. The reconciliation identifies any errors that may have been committed either in the cash
book or in the pass book.

ii. Any unreasonable delay in the clearance of cheques will be shown up by the reconciliation

1FIN BY INDIGOLEARN 3.2

 iii. A regular reconciliation discourages the accountant of the bank from embezzlement. There
have been many cases when the cashiers merely made entries in the cash book but never
deposited the cash in the bank they were able to get away with it only because of lack of
reconciliation.

iv. It helps in finding out the actual position of the bank balance.
v. It will ensure accounting of all the financial transactions incurred by the company during a
particular financial year.

CAUSES OF DIFFERENCES:
The differences between the balance as per the Bank Pass Book and the Bank Balance as per the
company’s cash book arise mainly due to the following reasons:

1. Timing of recording the transactions:

Due to the difference in the timing of recording the transaction.
For e.g., If M has issued a cheque on 30th March, it will be recorded in the bank column of
cash book on 30th March itself, but it will be recorded by the Bank only when it is presented
for clearance giving rise to the difference.

2. Transactions:
Some transactions are carried out by the bank directly and the customer becomes aware of
it only when they perform the reconciliation.
For e.g. crediting the interest in the customer’s account directly.

3. Errors:
Any kind of Mistake or error made either by the customers or the bank results in
differences.

TRANSACTIONS OR EVENTS THAT FREQUENTLY CAUSE DIFFERENCES:

The following are the transactions and events that frequently cause a difference between the
balance as per the bank records and the organization records due to the difference in the timing of
recording these transactions.

1. Cheques issued but not presented for payment.

2. Cheques paid into the bank but not cleared.

3. Interest allowed by bank.

4. Interest and expenses charged by the bank.

5. Interest and dividends collected by the bank.

6. Direct payments by the bank.

7. Direct payment into the bank by a customer.

8. Dishonor of a bill discounted with the bank.

1FIN BY INDIGOLEARN 3.3

 9. Bills collected by the bank on behalf of the customer.

10. Errors (This is not a timing difference)

Following is the table summarizing in brief the timings of different transactions

Sr.No. Transaction Time of recording in cash Time of recording in pass

Book book
1 Issue of a cheque by the When the cheque is issued When it is presented to the
account holder bank for payment.
2 Depositing a cheque in the When deposited in the When collected from the
account Bank Account issuing party
3 Collection of bills/cheque When referring the bank When it is collected by the
directly by the bank pass book bank.
4 Direct payment to the When referring the bank When the amount is made in
account holder pass book. the account
5 Dishonor of cheque/bills When referring the bank When the cheque is
Receivable. pass book Dishonored.
6 Bank charges levied by the When referring the bank When charges are levied by
Bank pass book the bank
7 Interest and dividend When referring the bank When interest or dividend is
credited by the bank pass book collected by the bank.
8 Interest debited by the When referring the bank When interest is charged by
bank pass book the bank

Example on Reconciliation of Timing Differences:

The following is the bank passbook and bank balance as per the cash book maintained by Mr. A. for
the month of September 2018.

Bank Pass Book

1FIN BY INDIGOLEARN 3.4

As can be noted above the balance as per the bank pass book is Rs.140250/- However, as per the
Bank Column of the cash book it is Rs. 140000/-. The difference between the same is reconciled as
follow:

The reconciliation can be done by 2 ways.

i. Arriving at the pass book balance from cash book or
ii. Arriving at the cash book balance from pass book.

We will reconcile the balance by arriving at the cash book balance from the pass book balance.

Thus the balances have been reconciled.

PROCEDURE FOR RECONCILING THE CASH BOOK BALANCES WITH THE PASS BANK
BALANCE:
Understanding the following debit and credit balances presented in the cash book and bank pass
book is important in reconciling the differences:

Debit Balance as per Cash Book – Excess of Deposit over Withdrawals in Bank
Credit Balance as per Cash Book – Excess of Withdrawals over Deposit in Bank

Debit Balance as per Bank Pass Book – Excess of Withdrawals over Deposit in Bank
Credit Balance as per Bank Pass Book – Excess of Deposit over Withdrawals in Bank

The reconciliation can be done by using any of the four balances given in the question.

1FIN BY INDIGOLEARN 3.5

There can be 2 different kinds of reconciliation based on the details provided which can be
categorized as follow:
i. When the causes of differences are known
ii. When the causes of differences are not known

When causes of differences are known the reconciliation can be done by taking any of the balance
stated above and analyzing the causes and accordingly reconciling the transactions to eliminate the
effects of the various differences.

If the balance of the other book is more on account of the said causes then add the amount. If the
balance of the other book is less on account of the said causes then subtract the amount.
For example, if the reconciliation is initiated with Dr. Balance as per the cash book and there is a
cheque deposited in the bank but not cleared, then on account of non-clearance of the cheque, the
Cr. balance of the pass book would be less. In this case, the amount of cheque should be subtracted
from the cash book balance to arrive at the balance as per the pass book.

When causes of differences are not known then a comparison needs to be done of the debit entries
of cash book with the credit entries of the pass-book and vice-versa.

The entries which do not tally are the causes of difference in the balances of both the books. Once
the causes are located their effects on both the books are analyzed and then reconciliation
statement is prepared to arrive at the actual bank balance. However, one should take care that
whether opening balance of both the books tallies or not. If opening balances are not same then the
reconciliation items are divided into two categories i.e., one relating to reconciliation of opening
balance and other relating to reconciliation of closing balance.

METHODS OF RECONCILIATION:
There are 2 methods of reconciliation:

i. Without preparation of the Adjusted Cash-Book and

ii. With the preparation of the Adjusted Cash-Book

Without preparation of the Adjusted Cash-Book

The reconciliation under this method can be done by taking any of the four balances as the starting
point and reconciling the causes of differences. The following table (Extracted from the ICAI Study
Material) provides the detailed analysis of how to reconcile the difference by using the various
starting point.

Favorable Unfavorable Favorable

balance (Dr.) balance (Cr.) balance (Cr.) Unfavorable
as per cash as per cash as per pass balance (Dr.) as
Causes of differences book book book per pass book
Cheque deposited but not
cleared Subtract Add Add Subtract
Cheque issued but not
presented to bank Add Subtract Subtract Add

1FIN BY INDIGOLEARN 3.6

Cheque directly deposited in
bank by a customer Add Subtract Subtract Add
Income (e.g., interest from
UTI) directly
received by bank Add Subtract Subtract Add
Expenses (e.g., telephone bills,
Insurance charges) directly
paid by bank on standing
instructions Subtract Add Add Subtract
Bank charges levied by bank Subtract Add Add Subtract
Locker rent levied by bank Subtract Add Add Subtract
Wrong debit in the cash book Subtract Add Add Subtract
Wrong credit in the cash book Add Subtract Subtract Add
Wrong debit in the pass book Subtract Add Add Subtract
Wrong credit in pass book Add Subtract Subtract Add
Under casting of Dr. side of
bank account in the cash book Add Subtract Subtract Add
Overcastting of Dr. side of
bank account in the cash book Subtract Add Add Subtract
Under casting of Cr. side of
bank account in the cash book Subtract Add Add Subtract
Over casting of Cr. side of bank
account the cash book Add Subtract Subtract Add
Bill receivable collected
directly by bank Add Subtract Subtract Add
Interest on bank overdraft
charged Subtract Add Add Subtract
If answer is If answer is
positive then positive then If answer is
it is favorable it is positive then it
balance as per Unfavorable is Unfavorable If answer is
pass book i.e. balance as per balance as per positive then it is
Cr. Balance as pass book i.e. pass book i.e. Unfavorable
per Pass Book, Dr. Balance as Dr. Balance as balance as per
if it is per Pass Book, per Pass Book, cash book i.e. Cr.
negative then if it is if it is negative Balance as per
it is negative then then it is Cash Book, if it is
Unfavorable it is Favorable Favorable negative then it is
balance i.e.. balance i.e.. balance i.e.. Cr. Favorable balance
Dr. Balance as Cr. Balance as Balance as per i.e.. Dr. Balance as
Final Balance per Pass Book per Pass Book Pass Book per Cash Book

Note: The reconciliation statement can be presented as per the two methods:

i. Balance Presentation
ii. Plus-Minus Presentation

1FIN BY INDIGOLEARN 3.7

With preparation of the Adjusted Cash-Book:

Adjusted Cash Book:

When the balance in the cash book is first adjusted for certain adjustments before taking it to the
bank reconciliation statement, then it is known as adjusted cash book balance. Adjusting the cash-
book before preparing the bank reconciliation statement is completely optional, if reconciliation is
done during different months. But if reconciliation is done at the end of the accounting year or
financial year, the cash-book must be adjusted so as to reflect the correct bank balance in the
balance sheet.

While adjusting the cash-book the following adjustments are considered: -

1. All the errors (like wrong amount recorded in the cash-book, entry posted twice in the cash-
book, over/ under casting of the balance etc.) and omissions (like bank charges recorded in the
pass-book only, interest debited by the bank, direct receipt or payment by the bank, dishonor of
cheques/bills etc.) by the cash-book are taken into care

2. Only these transactions are considered for adjusting cash book, apart from this delay in
recording in the pass-book due to difference in timing (like cheque issued but not presented for
payment, cheque deposited but not collected) is taken to bank reconciliation statement. This
adjusted cash-book balance is taken to bank reconciliation statement.

EXAMPLE 1:
On 30th September, 2018, the bank account of Mr. A, according to the bank column of the Cash-
Book, was overdrawn to the extent of Rs 10,000. On the same date the bank statement showed a
debit balance of 15,000 in favor of A.
An examination of the Cash Book and Bank Statement reveals the following:

1. A cheque for Rs.50,000 deposited on 28th September, 2018 was credited by the bank only on 2nd
October, 2018

2. A payment by cheque for Rs.20,000 has been entered twice in the Cash Book.

3. On 29th September, 2018, the bank credited an amount of Rs.75,000 received from a customer
of A, but the advice was not received by A until 2nd October, 2018.

4. Bank charges amounting to Rs. 1500 had not been entered in the Cash Book.

5. On 6th September, 2018, the bank credited Rs.10,000 to A in error.

6. A bill of exchange for Rs.90,000 was discounted by X with his bank. This bill was dishonored on
28th September, 2018 but no entry had been made in the books of A.

7. Cheques issued up to 30th September, 2018 but not presented for payment up to that date totaled
Rs.100,000.

Prepare the following details based on the above mentioned transactions:

1FIN BY INDIGOLEARN 3.8

 1. Present appropriate rectifications in the Cash Book of Mr. A to arrive at the correct balance
as on 30th September 2018 and
2. Bank Reconciliation Statement

Cash Book (Bank Column) of Mr. A for September 30, 2018

EXAMPLE 2:
From the following information (as on 31.3.2018), prepare a bank reconciliation statement after
making necessary amendments in the cash book

Particulars Amount Bank balances as per the cash book (Dr.) 800,000

Cheques deposited, but not yet credited 45,000

Cheques issued but not yet presented for payment 35,000

Bank charges debited by bank but not recorded in the cash-book 2,500

Dividend directly collected by the bank 20,000

Insurance premium paid by bank as per standing instruction

1FIN BY INDIGOLEARN 3.9

Not intimated 18,000

Cash sales wrongly recorded in the Bank column of the cash-book 2,00,000

Customer’s cheque dishonored by bank not recorded in the cash-book 1,00,000

Wrong credit given by the bank 1,10,000

Also show the bank balance that will appear in the trial balance as on 31.3.2018.

The balance of Rs. 499,500/- will appear on the trial balance of 31st March 2018.

Questions:

From the following information (as on 31.3.2018), prepare a bank reconciliation statement after
making necessary amendments in the cash book

Particulars Amount Bank balances as per the cash book (Dr.) 600,000

1FIN BY INDIGOLEARN 3.10

Cheques deposited, but not yet credited 85,000

Cheques issued but not yet presented for payment 70,000

Bank charges debited by bank but not recorded in the cash-book 1,000

Dividend directly collected by the bank 50,000

Insurance premium paid by bank as per standing instruction

Not intimated 45,000

Cash sales wrongly recorded in the Bank column of the cash-book 1,50,000

Customer’s cheque dishonored by bank not recorded in the cash-book 3,00,000

Wrong credit given by the bank 10,000

Also show the bank balance that will appear in the trial balance as on 31.3.2018.

Illustrations
Question: 1
From the following particulars, prepare a Bank Reconciliation Statement for Jindal offset Ltd.
(1) Balance as per cash book is Rs. 2,40,000
(2) Cheques issued but not presented in the bank amounts to Rs. 1,36,000.
(3) Cheques deposited in bank but not yet cleared amounts to Rs. 90,000.
(4) Bank charges amounts to Rs. 300.
(5) Interest credited by bank amounts to Rs. 1,250.
(6) The balance as per passbook is Rs.2,86,950

Question: 2
On 31st March 2017, the Bank Pass Book of Namrata showed a balance of Rs.1,50,000 to her credit
while balance as per cash book was Rs.1,12,050. On scrutiny of the two books, she ascertained the
following causes of difference:
i.She has issued cheques amounting to Rs. 80,000 out of which only Rs. 32,000 were
presented for payment.
ii.She received a cheque of Rs.5,000 which she recorded in her cash book but forgot to
deposit in the bank.
iii.A cheque of Rs.22,000 deposited by her has not been cleared yet.
iv.Mr. Gupta deposited an amount of Rs.15,700 in her bank which has not been recorded by
her in Cash Book yet.
v.Bank has credited an interest of Rs. 1,500 while charging Rs. 250 as bank charges.
Prepare a bank reconciliation statement.

Question: 3
From the following particulars ascertain the balance that would appear in the Bank Pass Book of A
on 31st December 2017.
1. The bank overdraft as per Cash Book on 31st December 2017 Rs. 6,340.

1FIN BY INDIGOLEARN 3.11

 2. Interest on overdraft for 6 months ending 31st December 2017 Rs. 160 is entered
in Pass Book.
3. Bank charges of Rs. 400 are debited in the Pass Book only.
4. Cheques issued but not cashed prior to 31st December,2017, amounted to
Rs.11,68,000.
5. Cheques paid into bank but not cleared before 31st, December 2017 were for Rs.
22,17,000.
6. Interest on investments collected by the bank and credited in the Pass
Book Rs.12,00,000.

Question: 4
On 30th September 2017, the bank account of X, according to the bank column of the Cash- Book,
was over drawn to the extent of Rs. 4,062. On the same date the bank statement showed a debit
balance of Rs.20,758 in favour of X. An examination of the Cash Book and Bank Statement reveals
the following:
1. A cheque for Rs.13,14,000 deposited on 29th September 2017 was credited by the
bank only on 3rd October 2017
2. A payment by cheque for Rs.16,000 has been entered twice in the Cash Book.
3. On 29th September 2017, the bank credited an amount of Rs.1,17,400 received from
a customer of X, but the advice was not received by X until 1st October 2017.
4. Bank charges amounting to Rs.580 had not been entered in the Cash Book.
5. On 6th September 2017, the bank credited Rs.20,000 to X in error.
6. A bill of exchange for Rs.1,40,000 was discounted by X with his bank. This bill was
dishonoured on 28th September 2017, but no entry had been made in the books of X.
7. Cheques issued up to 30th September 2017 but not presented for payment up to
that date totalled Rs.13,26,000.
You are required:
a. to show the appropriate rectifications required in the cash Book of X, to arrive at
the correct balance on 30th September 2017. And
b. to prepare a bank reconciliation statement as on that date.

Question: 5
On 30th December 2017 the bank column of A. Philip’s cash book showed a debit balance of Rs.
4,610. On examination of the cash book and bank statement you find that:
1. Cheques amounting to Rs. 6,30,000 which were issued to trade payables and entered
in the cash book before 30th December 2017 were not presented for payment until that date.
2. Cheques amounting to Rs. 2,50,000 had been recorded in the cash book as having
been paid into the bank on 30th December 2017 but were entered in the bank statement on1st
January 2018.
3. A cheque for Rs. 73,000 had been dishonoured prior to 30th December 2017, but no
record of this fact appeared in the cash book.
4. A dividend of Rs. 3,80,000, paid direct to the bank had not been recorded in the
cash book.
5. Bank interest and charges amounting to Rs.4,200 had been charged in the bank
statement but not entered in the cash book.
6. No entry had been made in the cash book for a trade subscription of Rs. 10,000 paid
vide banker’s order in November 2017.

1FIN BY INDIGOLEARN 3.12

 7. A cheque for Rs.27,000 drawn by B. Philip had been charged to A. Philip’s bank
account by mistake in December 2017.
You are required:
a. to make appropriate adjustments in the cash book bringing down the correct balance,
and
b. to prepare a statement reconciling the adjusted balance in the cash book with the
balance shown in the bank statement.

Question: 6
From the following information, prepare a Bank reconciliation statement as at 31st December 2017
for Messrs New Steel Limited:
(1) Bank overdraft as per Cash Book on 31st December, 2017 22,45,900
th
(2) Interest debited by Bank on 26 December 2017, but no advice 2,78,700
received
(3) Cheque issued before 31st December 2017 but not yet presented to 6,60,000
Bank
(4) Transport subsidy received from the State Government directly by the
Bank but not advised to the company 14,25,000
st
(5) Draft deposited in the Bank, but not credited till 31 December, 2017 13,50,000
st
(6) Bills for collection credited by the Bank till 31 December 2017 but no
advice received by the company 8,36,000
(7) Amount wrongly debited to company account by the Bank, for which no
details are available 7,40,000

Question: 7
The Cash Book of Mr. Gadbadwala shows Rs.8,36,400 as the balance at Bank as on 31st December
2017, but you find that it does not agree with the balance as per the Bank Pass Book. On scrutiny,
you find the following discrepancies:
1. On 15th December 2017 the payment side of the Cash Book was undercast by
Rs.10,000.
2. A cheque for Rs.1,31,000 issued on 25th December 2017 was not taken in the bank
column.
3. One deposit of Rs.1,50,000 was recorded in the Cash Book as if there is no bank
column therein.
4. On 18th December 2017 the debit balance of Rs.15,260 as on the previous day, was
brought forward as credit balance.
5. Of the total cheques amounting to Rs.11,514 drawn in the last week of December
2017, cheques aggregating Rs.7,815 were encashed in December.
6. Dividends of Rs.25,000 collected by the Bank and subscription of Rs.1,000 paid by it
were not recorded in the Cash Book.
7. One out-going Cheque of Rs.3,50,000 was recorded twice in the Cash Book.
Prepare a Reconciliation Statement

Question: 8
When Nikki & Co. received a Bank Statement showing a favourable balance of Rs.10,39,200 for the
period ended on 30th June 2017, this did not agree with the balance in the cash book.
An examination of the Cash Book and Bank Statement disclosed the following:

1FIN BY INDIGOLEARN 3.13

 1. A deposit of Rs.3,09,200 paid on 29th June 2017 had not been credited by the Bank
until 1st July 2017.
2. On 30th March 2017 the company had entered into hire purchase agreement to pay
by bank order a sum of Rs.3,00,000 on the 10th of each month, commencing from April 2017.
No entries had been made in Cash Book.
3. A customer of the firm, who received a cash discount of 4% on his account of
Rs.4,00,000 paid the firm a cheque on 12th June. The cashier erroneously entered the gross
amount in the bank column of the Cash Book.
4. Bank charges amounting to Rs.3,000 had not been entered in Cash Book.
5. On 28th June, a customer of the company directly deposited the amount in the bank
Rs. 4,00,000, but no entry had been made in the Cash Book.
6. Rs.11,200 paid into the bank had been entered twice in the Cash Book.
7. A debit of Rs. 11,00,000 appeared in the Bank Statement for an unpaid cheque, which
had been returned marked ‘out of date’. The cheque had been re-dated by the customer and
paid into Bank again on 5th July 2017.
Prepare Bank Reconciliation Statement on 30 June 2017.

1FIN BY INDIGOLEARN 3.14

 Chapter 4 – Inventories
MEANING OF INVENTORY:

Inventory can be defined as an asset which is held for sale in the ordinary course of business, or in
the process of production, or for consumption in the production of goods or services for sale,
including maintenance supplies and consumables other than machinery spares, servicing equipment
and standby equipment.

Different types of businesses have different kinds of inventories. The goods which are inventory
for one business can be a fixed asset for other business.

For Example: For a business dealing in computers, the computers will form a part of inventory but
for a business providing professional consulting services computers would form a part of the Fixed
Assets.

The classification of an item as inventory also depends on how it is intended to be used.

For Example: For a business dealing in computers, the computers will form a part of inventory but
the computer which is used by the entity to maintain their accounting and other records will form a
part of the Fixed Assets and not inventory.

Every business entity needs to ascertain the closing balance of Inventory which comprise of
Inventory of raw material, work-in-progress, finished goods and other consumable items which is
reported in the financial statements by crediting the value of closing Inventory to the Trading
Account and the other effect is to report it on the asset side of the Balance Sheet.

INVENTORY VALUATION:

Inventories are reported in the balance sheet until the revenue related to them is recognized.

Most of the times inventory forms a significant component of the entities current assets especially
in case of trading and manufacturing enterprises. Proper valuation of inventory is important to
present the true and fair financial statements. The significance of inventory valuation arises due to
various reasons as explained in the following points:

1. Determination of Income:
The gross profit of the entity can be determined with the correct value of the Cost of
Goods Sold which is computed as follow:

Cost of Goods Sold = Beginning Inventory + Purchases + Direct Expenses – Ending

Inventory

The effect of overstatement or understatement on the financial Statements of the entity is as

stated below:

If closing inventory is overstated, net income for the current accounting period will be overstated
and the net income for the next accounting period will be understated.

1FIN BY INDIGOLEARN 4.1

If closing inventory is understated, net income for the current accounting period will be understated
and the net income for the next accounting period will be overstated.

2. Determination of Financial Positions:

Since inventories form a part of the current assets. They play an important role in determining
the current assets of the entity.

3. Liquidity Analysis:
Since inventories form a part of the current assets they are used in the computation of the
liquidity position of the entity.

4. Statutory Compliances:
Schedule III to the Companies Act, 2013 requires valuation of each class of goods i.e. raw
material, work-in-progress and finished goods under broad head to be disclosed in the financial
statements.

BASIS OF INVENTORY VALUATION:

As per the conservatism principle of accounting, Inventories are always valued at the “LOWER OF
COST OR NET REALIZABLE VALUE”.

Cost of Inventory comprises of the following components:

1. All cost of purchase,

2. All Costs of conversion (Converting Raw Materials to Finished Goods) and
3. All other costs incurred in bringing the inventories to their present location and condition.

Amounts Excluded from the cost of inventories:

The following expenses are not included in computing the costs of inventories:
1. Abnormal Losses or Expenses.
2. Storage costs, unless it is necessary in the production process.
3. Administrative overheads that do not contribute to bringing the inventories to their present
location and condition.
4. Selling and distribution costs

Net realizable value:

This is the price expected to be realized by selling the inventories in the ordinary course of
business less the estimated costs of completion necessary to make the sale.

INVENTORY RECORD SYSTEM:

There are 2 methods of recording inventory:

1. Periodic Inventory System

2. Perpetual Inventory System

1FIN BY INDIGOLEARN 4.2

PERIODIC INVENTORY SYSTEM:

Under the Periodic inventory system, the inventory is determined by performing an actual physical
count of the inventory items on hand at a particular date on which inventory is valued.

The system is also called physical inventory system because of the method of physically counting
the units.

The cost of goods sold is determined as shown below:

Opening inventory (known) + Purchases (known) - closing inventory (physically counted) = Cost of
goods sold.

Periodic inventory system is simple and less expensive than the perpetual system. Under this method,
inventory account is adjusted at the end of the accounting period to determine cost of goods sold.

There are some limitations in using this system which are as stated below:

i. Inventory values are needed more often and not just at the year end. Thereby making this
system more expensive.
ii. Physical count of goods can be conducted properly on by closure of normal operations of
business.
iii. It is not possible to identify loss of goods due to pilferage, damage or even fraud.
iv. Inventory control is not possible.
v. Books of accounts does not reflect inventory in hand on real time basis due to which it is
difficult to plan operations e.g. how much or when to order/manufacture.

This system is suitable for small enterprises where is easy to control physical inventory. It is not
considered suitable for medium or large enterprises.

PERPETUAL INVENTORY SYSTEM:

Under the Perpetual inventory system, the inventory balances are recorded after each transaction
involving inventory.

Under perpetual inventory system, closing inventory is determined as follows:

Beginning inventory + Purchases during the period – Cost of Goods Sold (known) = Closing Inventory
(balancing figure)

DISTINCTION BETWEEN PERIODIC AND PERPETUAL INVENTORY SYSTEM:

Periodic System Perpetual System

Based on Physical Verification Based on Book Records
Details about the cost of goods sold and Details about cost of goods sold and ending
ending inventory is available on a particular inventory is available on real time and
date. continuous basis.

1FIN BY INDIGOLEARN 4.3

Cost of Goods Sold is computed as balancing Ending Inventory is computed as balancing
figure after determining the Inventory figure after determining the Cost of Goods
balance Sold
Loss of Goods is included in Cost of Goods Loss of Goods Sold is included in Ending
Sold Inventory
Simple and Less Expensive Method Costly Method
Requires closure of business on a particular Can be carried out with the ongoing
day to count the inventories operations of the business.

FORMULA/METHODS OF DETERMINING COST OF INVENTORY:

HISTORICAL METHODS:

1. Specific Identification Method:

Allocates specific cost to each of the goods identified.
This method is generally used to determine the cost of items which are not ordinarily
interchangeable and are relatively high in value like diamonds and precious stones.

2. FIFO (First In First Out) Method:

This method assumes that the goods which came in first will be sold first. The ending
inventory comprises of the latest purchases and the Cost of Goods Sold comprises of the
earliest purchases.

Example on First In First out (FIFO):

A trader has the following details of purchases of goods in which he deals

Date Quantity (In Units) Price Per Unit

Oct 1 1000 10
Oct 5 500 12
Oct 15 200 15
Oct 25 500 13
2200 Units

The ending inventory consists of 650 units. Compute the cost of the ending inventory for October
using FIFO Method:

The Closing Inventory of 650 units would consist of 500 units purchased on Oct 25 and 150 units
purchased on Oct 15, the value of the same is as computed below:

Particulars Amount
500 units @ Rs.13 per unit 6500
150 units @ Rs.15 per unit 2250
TOTAL 8750

Thus, the value of inventory using the FIFO Method has been computed.

1FIN BY INDIGOLEARN 4.4

 3. LIFO (Last In First Out) Method:
This method assumes that the goods which came in last will be sold first i.e. the most
recent purchased goods are sold first.
The ending inventory comprises of the earliest purchases and the Cost of Goods Sold
comprises of the recent purchases.
LIFO method is based on the principle of matching current cost with current revenue as cost
of recently purchased or produced goods are charged to cost against each sale

Example on Last In First out (FIFO):

trader has the following details of purchases and issue of goods in which he deals
PURCHASES
Date Quantity (In Units) Price Per Unit
Oct 1 1000 10
Oct 5 500 12
Oct 15 200 15
Oct 25 500 13
2200 Units

ISSUES
Date Quantity (In Units)
Oct 10 900
Oct 23 700
Oct 28 200
1800 Units

The ending inventory consists of 400 units. Compute the cost of the ending inventory for October
using LIFO Method:
Under the LIFO Method the following will be the stock ledger of the entity:

1FIN BY INDIGOLEARN 4.5

Thus, as can be observed from the above computations that the value of ending inventory using the
LIFO Method for 400 units is Rs 4900/-.

4. Simple Average Method:

This method is the easiest method of computing the value of inventory.
This method is used by entities using periodic inventory system.

The simple average price per unit of the output is computed by the following formula:
Different Prices of all Purchases
Total Number of purchases

Example on Simple Average Method:

A trader has the following details of purchases and issue of goods in which he deals
PURCHASES
Date Quantity (In Units) Price Per Unit
Oct 1 1000 10
Oct 5 500 12
Oct 15 200 15
Oct 25 500 13
2200 Units

The trader has 500 units in its ending inventory. Compute the Cost of the inventory using the Simple
Average Method:

1FIN BY INDIGOLEARN 4.6

The simple average price per unit of the product is computed as below:

10+12+15+13 = Rs.12.5/- Per unit

4

The ending inventory of 500 units will be computed at Rs.12.5/- per unit. Therefore, the value of
the ending inventory is Rs.6250/-

5. Weighted Average Method:

This method is an advanced version of the simple average method.

The weighted average price per unit of the output is computed by the following formula:
Total Cost of Goods Available for Sale during the period
Total Number of units available for sale during the period

Ending Inventory = No. of units in inventory X Weighted Average price per unit
Cost of Goods Sold = No. of units in sold X Weighted Average price per unit

Example on Weighted Average Method:

A trader has the following details of purchases and issue of goods in which he deals
PURCHASES
Date Quantity (In Units) Price Per Unit
Oct 1 1000 10
Oct 5 500 12
Oct 15 200 15
Oct 25 500 13
2200 Units

ISSUES
Date Quantity (In Units)
Oct 10 900
Oct 23 700
Oct 28 200
1800 Units

The ending inventory consists of 400 units. Compute the cost of the ending inventory for October
using LIFO Method:

1FIN BY INDIGOLEARN 4.7

NON-HISTORICAL METHODS:

1. Adjusted Selling Price Method:

This method is known as retail inventory method. It is mainly used by retail business or in business
where the inventory comprises of items whose individual costs are not readily determinable.

The cost of the inventory is determined by reducing the percentage of gross margins from the
sales value of the inventory.

Example on adjusted Selling Price Method:

A trader has the following records available for the month of October 2018.
Determine the adjusted selling price of the inventory using the adjusted selling price method.

Goods purchased Rs.2,00,000/-

Packaging and transportation charges Rs.10,000/-
Sales during the year Rs.4,00,000/-
Sales price of closing inventories Rs.75,000/-

Cost of Purchases:
Goods purchased Rs.2,00,000/-

Packaging and transportation charges Rs.10,000/-

Rs.2,10,000/-

Estimated Gross Profit Margin:

Sales during the year Rs.4,00,000/-
Sales price of closing inventories Rs.75,000/-
Rs.4,75,000/-
Less: Purchases (Rs. 2,10,000/-)
Gross Profit Rs.2,65,000/-

1FIN BY INDIGOLEARN 4.8

Gross Profit Margin 55.79% (265000/475000)
Inventory Valuation:
Sales price of closing inventories Rs.75,000/-
Less: Gross Profit Margin @ 55.79% (Rs.41843)
Rs.33157

2. Standard Cost Method:

This method is used when the price of the goods which are purchased changes frequently e.g.
crude oil.

Based on the past experiences a standard cost is determined and the inventory is valued on that
price per unit.

INVENTORIES TAKING:

Ideally inventories need to be counted physically on the last day of the accounting period to
determine the correct balance of the closing inventory. However, it is not possible in most of the
cases and the same is done near the balance sheet date but not exactly on it.

For the year-end inventory valuation, physical inventory taking is done during the last week of the
financial year or during the first week of next financial year. In such a case, the actual value of the
inventory needs to be adjusted to relate it to the end of the year concerned. For doing so, the entity
needs to consider the goods that have come in either by way of purchases or sales returns and those
that have gone out either by way of sales or purchase returns during the time between the close of
the year and the date of actual inventory taking. It is important to note that all the adjustment
must be on the basis of cost. If inventory taking is finished on 5th April, whereas accounting year
ends on 31st March purchases and sales between 31st March and 5th April are then separately
adjusted.

Example on Inventories Taking:

Suppose a company that closes its books on 31st March, carried out the inventory taking on the 5 th
of April and actual inventory was of Rs. 5,00,000 on 5th April, during the period March 31 to April 5
purchases were Rs. 1,00,000 and sales were Rs. 2,00,000, the mark up being 20% on cost. The
inventory on 31st of March is computed below:

Inventories ascertained on 5th April Rs.5,00,000/-

Less: Purchases during the period 31 march to 5 April Rs.1,00,000/-

Rs.4,00,000/-

Add: Cost of Goods Sold during the period:

2,00,000 X (100/120) Rs.1,66,667/-

st
Inventory value on 31 March Rs.5,66,667/-

1FIN BY INDIGOLEARN 4.9

Questions:

Question 1:
A trader has the following details of purchases and issue of goods in which he deals
PURCHASES
Date Quantity (In Units) Price Per Unit
Oct 1 2000 25
Oct 5 1000 22
Oct 15 700 20
Oct 25 500 30
4200 Units

ISSUES
Date Quantity (In Units)
Oct 10 1500
Oct 23 1300
Oct 28 400
3200 Units

The ending inventory consists of 1000 units. Compute the cost of the ending inventory for October
using the following methods:

1. FIFO
2. LIFO
3. Simple Average
4. Weighted Average

Question 2:
A trader has the following records available for the month of October 2018.
Determine the adjusted selling price of the inventory using the adjusted selling price method.

Goods purchased Rs.5,00,000/-

Packaging and transportation charges Rs.70,000/-
Sales during the year Rs.7,00,000/-
Sales price of closing inventories Rs.1,50,000/-

Question 3:
Suppose a company that closes its books on 31st March, carried out the inventory taking on the 25th
of March and actual inventory was of Rs. 15,00,000 on 25th March, during the period March 25 to
March 31 purchases were Rs. 4,00,000 and sales were Rs. 9,00,000, the mark up being 25% on cost.
Compute the inventory on 31st of March.

Illustrations
Question: 1
A manufacturer has the following record of purchases of a condenser, which he uses while
manufacturing radio sets:

1FIN BY INDIGOLEARN 4.10

Date Quantity (units) Price Per Unit
December
4 900 50
10 400 55
11 300 55
19 200 60
28 800 47
2,600
1,600 units were issued during the month of December till 18th December

Question: 2
M/s X, Y and Z are in retail business, following information are obtained from their records for
the year ended 31st March 2016-
Particulars Amount (Rs.)
Goods received from suppliers 15,75,500
(subject to trade discount and taxes)
Trade discount 3% and sales tax 11%
Packaging and transportation charges 87,500
Sales during the year 22,45,500
Sales price of closing inventories 2,35,000
Find out the historical cost of inventories using adjusted selling price method

Question: 3
From the following information, calculate the historical cost of inventories using adjusted selling
price method:
Particulars Amount (Rs.)
Sales during the year 2,00,000
Cost of Purchases 2,00,000
Opening Inventory Nil
Closing Inventory at Selling Price 50,000

Question: 4
From the following ascertain the value of Inventories as on 31st March 2017
Particulars Amount (Rs.)
Inventory as on 01.04.2016 1,42,500
Purchases 7,62,500
Manufacturing Expenses 1,50,000
Selling Expenses 60,500
Administrative Expenses 30,000
Financial Charges 21,500
Sales 12,45,000
At the time of valuing inventory as on 31st March 2016, a sum of Rs. 17,500 was written off on an
item, which was originally purchased for Rs. 50,000 and was sold during the year for Rs. 45,000.
Barring the transaction relating to this item, the gross profit earned during the year was 20 % on
sales.

1FIN BY INDIGOLEARN 4.11

Question: 5
A trader prepared his accounts on 31st March, each year. Due to some unavoidable reasons, no
inventory taking could be possible till 15th April 2017. On which date the total cost of goods in his
go down came to Rs. 5,00,000. The following facts were established between 31st March and 15th
April 2017.
(i) Sales Rs. 4,10,000 (including cash sales Rs. 1,00,000)
(ii) Purchases Rs. 50,340 (including cash purchases Rs. 19,900)
(iii) Sales Return Rs. 10,000
Goods are sold by the trader at a profit of 20% on sales
You are required to ascertain the value of inventory as on 31st March 2017.

Question: 6
1. Inventory taking for the year ended 31st March 2016 was completed by 10th April
2016
2. The Valuation of which showed an Inventory figure of Rs. 16,75,000 at cost as on
the completion date
3. After the end of the accounting year and till the date of completion of inventory
taking
4. Sales for the next year were made for Rs. 68,750, Profit Margin being 33.33 % on
Cost
5. Purchases for the next year included in the inventory amounted to Rs. 90,000 at
cost less trade discount 10%
6. During this period, goods were added to inventory at the mark up price of Rs. 3,000
in respect of sales returns
7. After inventory taking it was found that there were certain very old slow-moving
items costing Rs. 11,250, which should be taken at Rs. 5,250 to ensure disposal to an interested
customer
8. Due to heavy flood, certain goods costing Rs. 15,500 were received from the supplier
beyond the delivery date of customer
9. As a result, the customer refused to take delivery and net realizable value of the
goods was estimated to be Rs. 12,500 on 31st March
Compute the value of inventory for inclusion in the final accounts for the year ended 30th March
2016.

1FIN BY INDIGOLEARN 4.12

 Chapter 5 – Concept and Accounting of Depreciation
OBJECTIVES

The lists of topics which will be covered in this chapter are as follows:

1. What is Depreciation and Objectives of providing depreciation?

2. Factors affecting depreciation

What is Depreciation?
Concept of Depreciation
Fixed Assets includes Property, plant and equipment that are tangible and which
are used in the production or supply of goods or services or for administrative
purposes and are expected to be used during more than a period of one accounting
year i.e. more than twelve months.

Value of such assets decreases with passage of time due to following reasons.

i. Wear and tear due to its use in business.

ii. Passage of time even when it is not being used.
iii. Obsolescence and outdating due to technological or other changes.
iv. Decrease in market value.
v. Depletion of the assets especially in case of mines and other natural reserves.

To arrive at the correct income for the current accounting period it is important
to account for value of portion of property, plant and equipment utilized for
generating revenue during that period. The portion of Property, Plant & Equipment
allocated to an accounting year is called depreciation.

As per Schedule II under the Companies Act, 2013, Depreciation is the systematic
allocation of the depreciable amount of an asset over its useful life. The
depreciable amount of an asset is the cost of an asset or other amount substituted
for cost, less its residual value. The useful life of an asset is the period over which
an asset is expected to be available for use by an entity, or the number of
production or similar units expected to be obtained from the asset by the entity.

The 3 important factors affecting the amount of depreciation are:

i. Estimated useful life of the asset

ii. Cost of the asset

iii. Residual value of the asset at the end of the of its estimated useful life

Objectives of Providing Depreciation:

1FIN BY INDIGOLEARN 5.1

 The basic objectives for providing depreciation are as follow:

i. Correct income measurement.

ii. To find True Asset value.

iii. To Ensure Sufficient Funds are available for replacement.

iv. To determine the true cost of production.

Factors affecting Measurement of Depreciation:

Following factors are taken into consideration while computing the depreciation.

i. Cost of the asset

ii. Estimated useful life of the asset.

iii. Estimated scrap value at the end of useful life of the asset.

Example on computing the depreciable amount per annum:

For example, a machinery is purchased for Rs.5,00,000. The residual value is

estimated at Rs.50,000. It is estimated that the machinery will work for 10 years.
The cost to be allocated as depreciation in the accounting periods will be
calculated as:

Acquisition Cost Rs.500000

Less: Residual Value (Rs.50000)
Depreciable Amount Rs. 450000
(÷)Estimated Useful Life 5
years

Depreciation = Depreciable Amount Rs450000 = Rs.90000/- Per Year

Estimated Useful Life 5 Years

Cost of the Fixed Asset (i.e. Property, Plant and Equipment) comprises of the following:
i. The purchase price including import duties and taxes and deducting the trade
discounts and rebates.
ii. Any cost incurred to bring the asset to its present condition to put it to its intended
usage
iii. The costs of preparing the site on which an asset is to be located.

Examples of costs directly attributable costs are:

i. Cost of labor for bringing the asset to its present condition.
ii. Cost to prepare the site.
iii. Delivery and Handling costs

1FIN BY INDIGOLEARN 5.2

iv. Installation costs
v. Cost of testing
vi. Professional fees e.g. engineers & technicians hired to install the equipment

Thus, all the expenses which are necessary for asset to bring it in condition and
location of desired used will become part of cost of the asset.

Methods of Computing Depreciation:

There are several methods of computing depreciation, in this chapter we are going
to focus on 3 methods which are as follow:

i. Straight-Line Method
ii. Diminishing Balance Method
iii. Sum of Years of Digits Method
vi. Machine Hour Method
vii. Units of Production Method
viii. Depletion Method

1. Straight-Line Method:
This method is also known as Fixed Installment Method. According to this method,
an equal amount of depreciation is written off every year so as to reduce the cost
of the asset to nil or its salvage value at the end of its useful life.

The advantage of this method is that it is the easiest methods to apply and gives
accurate results in case of leases and also in case of plant and machinery are
assumed to have a constant usage across years.

The formula to compute the depreciation and the rate of depreciation under
straight line method is as follow:

Straight Line Depreciation = Cost of Asset – Salvage Value

Useful Life of the
Asset

Straight Line Depreciation Rate = Straight Line Depreciation X 100

Cost of the Asset

2. Diminishing Balance Method:

This method is also known as Reducing Balance Method. According to this method,
a Fixed Percentage of depreciation is computed on the Asset Value every year so
as to reduce the asset value to Nil or it’s Salvage Value at the end of its useful
life.

1FIN BY INDIGOLEARN 5.3

 Under this method, the depreciation amount decreases from year to year due to
which the earlier years suffer incur a higher depreciation expense as compared
to the later years.

Under this method, the value of asset can never be completely extinguished, which
happens in the earlier explained Straight Line Method. This method assumes that
the cost of repairs will increase with the passage of time. Therefore, depreciation
is higher in earlier years and lower in the later years when the cost of the asset
is expected to be lower in the later years.

The formula to compute the depreciation under the diminishing balance method
is as follow:

Diminishing Balance Depreciation = 1 X 100

Here, n = useful life of the asset

Accounting Entries under Straight Line and Diminishing Balance Method:

There are two approaches to account for depreciation. The entity can either opt
to have a provision for depreciation account and credit the annual depreciation in
that provision account, thereby the asset account remains at the same historical
cost or else it can directly credit the depreciation amount to the asset account
and reduce the asset balance on an annual basis.

Accounting Entries under the Provision Method:

For Charging Depreciation Account Dr.
Depreciation To Provision for Depreciation Account
Transferring Profit & Loss Account Dr.
Depreciation to To Depreciation Account
Profit & Loss Account
Accounting Entries under the Direct Method:
For Charging Depreciation Account Dr.
Depreciation To Asset Account
Transferring Profit & Loss Account Dr. To
Depreciation to Profit & Depreciation Account
Loss Account

Example:

ABC Co. acquired a equipment on 1st July, 2016 at a cost of Rs.9,00,000 and spent
Rs.1,00,000 on its installation. The books are closed on 31st December every year.

Prepare the Machinery Account and Depreciation Account for 2016 & 2017 using:
i. Straight Line Method @ 10% Depreciation per annum
ii. Diminishing Balance Method @ 15% Depreciation per annum

1FIN BY INDIGOLEARN 5.4

 i. Machinery and Depreciation Account under Straight Line Method:

1FIN BY INDIGOLEARN 5.5

 Machinery and Depreciation Account under Diminishing Balance Method:

3. Sum of Years Digit Method:

Example:

ABC Co. acquired a equipment on 1st January, 2010 at a cost of Rs.20,00,000 which
had a life of 10 years and scrap value of Rs2,40,000/- . The books are closed on
31st December every year.

Prepare the Machinery Account and Depreciation Account for 2015 using
Sum of Digits method of depreciation:

1FIN BY INDIGOLEARN 5.6

 Working Notes for the above computation:

1. Computation of Depreciation for 2010-2014:

(10+9+8+7+6)X (2000000-240000) = 40/55 X 1760000 =

1280000 10(10+1)/2

2. Computation of WDV as on 1-1-2015:

2000000 – 1280000 = Rs.720000/-

3. Depreciation for 2015:

(2000000 – 240000) X 5/55 = Rs160000/-

1. Machine Hours Method:

Under this method, Depreciation is calculated on the basis of hours that the
concerned machine worked. The machine hour rate of the depreciation is
calculated after estimating the total number of hours that machine would work
during its whole life.

Example:

A machine was purchased for Rs. 20,00,000 having an estimated total working of
30,000 hours. The scrap value is expected to be Rs. 4,00,000 and anticipated
machine hours usage is as follows :
Year
1 – 2 3,000 hours per year
3 – 5 4,000 hours per year
6 – 7 6,000 hours per year

Compute the Annual Depreciation under Machine Hour Rate Method.

1FIN BY INDIGOLEARN 5.7

Statement showing the Annual Depreciation under Machine Hours Method

Year Annual Depreciation

1-2 3000/30000 X (2000000-400000) = Rs.160000/- Per Year
3-5 4000/30000 X (2000000-400000) = Rs.213333/- Per Year
6-7 6000/30000 X (2000000-400000) = Rs.320000/- Per Year

2. Production of Units Method:

Under this method depreciation of the asset is determined by comparing the
annual production with the estimated total production. The amount of depreciation
is computed by the use of following method:

Depreciation for the period = Depreciable Amount X Production during the period
Estimated total
production The method is applicable to machines producing product of uniform
specifications. Example:
A machine is purchased for Rs. 10,00,000. Its estimated useful life is 8 years.
The machine is expected to produce 10 lakh units during its life time. Expected
distribution pattern of production is as follows:

Yearly Production
1-3 100,000 units per year
4-6 150,000 units per year
7-8 125,000 units per year

Required
Determine the value of depreciation for each year using production units method.

Statement showing the Annual Depreciation under Yearly Production Method

Year Annual Depreciation

1-2 100000/1000000 X 1000000 = Rs.100000/- Per Year
3-5 150000/1000000 X 1000000 = Rs.150000/- Per Year
6-7 125000/1000000 X 1000000 = Rs.125000/- Per Year

3. Depletion Method:
This method is used in industries where only a certain quantity of product is
available. This is used in case of mines, quarries etc. The depreciation rate is
calculated by dividing the cost of the asset by the estimated quantity of product
likely to be available. Annual depreciation will be the quantity extracted multiplied
by the rate per unit.

1FIN BY INDIGOLEARN 5.8

Example:
ABC & Co. took a quarry on 1-1-2015 for Rs. 1,00,00,000. As per technical estimate
the total quantity of mineral deposit is 5,000 tonnes. Depreciation was charged
on the basis of depletion method.

Extraction pattern is as follows:

Year Quantity of Mineral extracted
2015 1,000 tonnes
2016 2,000 tonnes
2017 2,000 tonnes

Statement showing the Annual Depreciation under Depletion Method

Year Annual Depreciation

2015 1000/5000 X 10000000 = Rs.2000000/-
2016 2000/5000 X 10000000 = Rs.4000000/-
2017 2000/5000 X 10000000 = Rs.4000000/-

Profit or Loss on the sale or disposal of Property, Plant & Equipment:

Whenever any depreciable asset is sold during the year, depreciation is charged
on it for the period it has been used in the sale year. The written down value after
charging such depreciation is used for calculating the profit or loss on the sale of
that asset. The resulting profit or loss on sale of the asset is ultimately
transferred to profit and loss account.

Example:

The book value of the asset as on 1st April, 2017 is Rs.25,00,000. Depreciation is
charged on the asset @20%. On 1st October 2017, the asset is sold for
Rs.10,00,000. In such a situation, profit or loss on the sale will be calculated as
follows:

Particulars Amount
Book Value as on 1st April 2017 2500000
Less: Depreciation for 6 months @ 15% (1st April to 1st October) 187500
Written Down Value as on 1st October 2017 2312500
Less: Sales Proceeds as on 1st October 2017 1000000
Loss on Sale of the Asset 1312500

Change in the Method of Depreciation:

If there has been a significant change in the expected consumption pattern of

the asset the method should be changed to reflect the changed pattern.

1FIN BY INDIGOLEARN 5.9

 Whenever any change in depreciation method is made. Such change in method is
treated as change in accounting estimate as per Accounting Standards whose
effect needs to be quantified and disclosed. A change in an accounting estimate
may affect the current period or both the current period and future periods.

Example:

Cost of Machine:
Rs.20,00,000 Residual
Value: NIL
Useful life: 10 years.

The company charges depreciation on straight line method for the first four years
and thereafter decides to adopt written down value method by charging
depreciation @ 15%. (Calculated based on useful life).

Compute the depreciation for the 5th year. Depreciation already charged for the
first 4 years as per straight line method is Rs. 8,00,000. Therefore, WDV for 5th
year is Rs. 3,00,000 Therefore in the profit and loss account of the 5th year, the
depreciation of Rs. 3,00,000 (25% of Rs. 12,00,000) should be debited.

Revision of the Estimated Useful Life of Property, Plant & Equipment:

The residual value and the useful life of an asset needs to be reviewed every
financial year-end and, if the company expects a change in an estimated useful
life of the asset in accordance with Accounting Standards then the unamortized
depreciable amount needs to be charged over the remaining estimated useful life
of the asset.

Example:

A Machine costing Rs. 10,00,000 is depreciated on straight line basis, assuming 10

years working life and Nil residual value, for five years. The estimate of remaining
useful life after fifth year was re-evaluated for 8 years only.

Calculate depreciation for the sixth year.

Particulars Amount
Depreciation per year = Rs. 10,00,000 / 10 Rs.1000000/-
Depreciation on SLM charged for five years = Rs. 100,000 x 5 years = Rs.500000/-
Rs.500000
Book value of the asset at the end of fifth year = Rs. 10,00,000 – Rs. Rs.500000/-
5,00,000
Remaining useful life as per previous estimate 5 Years
Remaining useful life as per revised estimate 3 Years
Depreciation from the sixth year onwards = Rs.5,00,000 / 3 Rs.166667/-

1FIN BY INDIGOLEARN 5.10

Re-Evaluation of the Fixed Asset:

As a Result of Re-evaluation of the fixed asset there can either be an increase in

the value of the Fixed Asset or a Decrease in the Fixed Asset.

If there is an increase in the fixed asset, in case revaluation is done first time
then the increase is credited directly to revaluation surplus. In case of
Subsequent Reevaluation, it is recognized in the Statement of Profit and loss to
the extent it was initially reduced and it also decreases the asset previously
recognized in the Statement of profit and loss.

If there is an increase in the fixed asset, Charged to the Statement of profit

and loss and if the subsequent revaluation decreases the asset value when it was
increases during the previous revaluation then the Decrease should be debited
directly to owners' interests under the heading of Revaluation surplus to the
extent of any credit balance existing in the Revaluation surplus in respect of that
asset.

Example:

A machine of cost Rs.15,00,000 is depreciated straight-line assuming 10 year

working life and zero residual value for three years. At the end of fourth year,
the machine was revalued upwards by Rs. 200,000 the remaining useful life was
reassessed at 8 years.

Particulars Amount
Depreciation per year for the 3 years = Rs. 15,00,000 / 10 X 3 Rs.450000/-
Rs. Rs. Rs.1050000/-
Rs. Rs. Rs.1250000/-
Remaining useful life as per previous estimate 6 Years
Remaining useful life as per revised estimate 8 Years
Depreciation from the fifth year onwards = Rs.12,50,000 / 8 Rs.156250/-

Provision for Repairs and Renewals:

Expenditure incurred for repairs, renewals and maintenance on Fixed Assets

varies over the life of the asset. Therefore, to equalize the charge of repairs and
renewals, sometimes a Provision for Repairs and Renewals Account is opened.

Total of such expenses that may be incurred over the working life is estimated
beforehand and the Average amount of the expenditure is debited to Profit and
Loss Account and credited to Provision for Repairs and Renewals Account
irrespective of actual expenses incurred.

1FIN BY INDIGOLEARN 5.11

 Annually the Provision for Repairs and Renewals Account is debited and Repairs
Account is credited for actual expenses incurred. The balance in provision for
Repairs and Renewals Account is carried forward and in the end or on sale of the
asset, the account is closed by transfer to the Asset Account for any balance
left.

Example:
The following particulars are available with regard to company’s Fixed Assets:
Balance in Prov. for Repairs and Renewals Account as on 31.3.2015 Rs.
10,00,000 Actual repairs charged/incurred during the year ended
31.3.2016 Rs. 5,00,000
31.3.2017 Rs. 3,00,000

The company makes an annual provision of Rs.2,00,000 on repairs and renewals.

Prepare the Provision for Repairs and Renewals Account for the years 2015-2016
and 2016-2017.

Intangible Assets
An intangible asset is an identifiable non-monetary asset, without physical substance, held for
use in the production or supply of goods or services, for rental to others, or for administrative
purposes.
Examples of intangible assets include:
a) Streaming rights of movies/TV shows
b) Patents
c) Trademarks
d) Copyrights
e) Long-term customer contracts
f) Goodwill (Purchased)
g) Computer software
Intangible assets comprise a major portion of the balance sheet. It may be noted that it can
also be the case that intangible assets could make the entities far more valuable than the
tangible assets.

Intangible assets can be recognized in the financial statements provided they meet the
following conditions:

1FIN BY INDIGOLEARN 5.12

 i. The intangible asset is identifiable. Being identifiable means the entity could rent,
sell, exchange or distribute the specific future economic benefits attributable to the
asset without disposing of future economic benefits that flow from other assets used
in the same revenue earning activity.
ii. The enterprise can exercise control over such intangible asset. Control means the
power available with the enterprise to obtain economic benefits from the asset and
atthe same time, can restrict access of others to those benefits.
iii. It is portable that the future economic benefits attributable to the asset will flow to
the enterprise and
iv. The cost of the intangible asset can be measured reliably.

An intangible asset acquired separately usually measured at cost, as cost can be

measured reliably in such cases. The cost of the intangible asset would comprise of:

 Purchase price

 Any import duties and taxes (other than those subsequently recoverable by
the enterprise from the tax authorities)

 Any directly attributable expenditure on making the asset ready for its
intended use

Intangible assets acquired as part of acquisition, government grants, internally generated

goodwill/ intangible assets, or on exchange of assets are dealt separately at the intermediate
level

An intangible asset should be derecognised (eliminated from the balance sheet) on disposal
or when no future economic benefits are expected from its use and subsequent disposal.

Gains or losses arising from the retirement or disposal of an intangible asset should be
determined as the difference between the net disposal proceeds and the carrying amount
of the asset and should be recognised as income or expense in the statement of profit and
loss.

Difference between Tangible and Intangible assets

Tangible Assets Intangible Assets

These are assets that have a physical These are identifiable assets that do NOT
substance i.e., they can be seen and have a physical substance, held for use in
touched, held for use in the production or the production or supply of goods or
supply of goods or services, for rental to services, for rental to others, or for
others, or for administrative purposes. administrative purposes.

Tangible Assets have a finite life based on Intangible Assets have a finite life based on
expected usage. contractual terms. In some cases,
intangible assets could also have an
indefinite life e.g. purchased goodwill.

1FIN BY INDIGOLEARN 5.13

 Useful life is based on expected usage, Useful life of Intangible Assets is
with no presumption laid down for the same. presumed not to exceed 10 years unless
evidence exists to the contrary.

Tangible Assets are depreciated over the Intangible Assets are amortised over the
useful life. In other words, writing off the useful life. In other words, writing off the
value of tangible assets on an annual basis value of intangible assets on an annual basis
is known as depreciation. is known as amortisation.

Examples include Property, Machinery, Examples include software, streaming

Vehicles etc. rights, landing rights, trademarks, patents
etc.

Amortisation

The concept of amortisation in case of intangible assets is similar to the concept of

depreciation in case of tangible assets. In other words, ‘depreciation of an intangible asset’
is called AMORTISATION.

Amortisation can be defined as ‘the systematic allocation of the depreciable amount of an

intangible asset over its useful life’. Depreciable amount is the cost of an asset less its
residual value.

Useful life is either:

(a) the period of time over which an asset is expected to be used by the
enterprise; or

(b) the number of production or similar units expected to be obtained from

the asset by the enterprise.

Residual value is the amount which an enterprise expects to obtain for an asset at the
end of its useful life after deducting the expected costs of disposal.

The depreciable amount of an intangible asset should be allocated on a systematic basis

over the best estimate of its useful life. Amortisation should commence when the asset is
available for use. It is presumed that the useful life of an intangible asset will not exceed
ten years from the date when the asset is available for use unless evidence exists to the
contrary. For instance, given the rapid changes in technology, computer software and
many other intangible assets are susceptible to technological obsolescence. Therefore,
it is likely that their useful life will be short. Similarly, intangible assets with contractual
rights for a period exceeding ten years, will be amortised over such extended period rather
than the presumed period of ten years.
Given the nature of intangible assets, the residual value of an intangible asset should be
assumed to be zero unless:

(a) there is a commitment by a third party to purchase the asset at the end of its
useful life; or

1FIN BY INDIGOLEARN 5.14

 (b) there is an active market for the asset and:

(i) residual value can be determined by reference to that market; and

(ii) it is probable that such a market will exist at the end of the asset's useful
life.

The amortisation period and the amortisation method should be reviewed at least at each
financial year end. If the expected useful life of the asset is significantly different from
previous estimates, the amortisation period should be changed accordingly. If there has been
a significant change in the expected pattern of economic benefits from the asset, the
amortisation method should be changed to reflect the changed pattern.

Questions:
Question 1:
ABC Co. acquired a equipment on 1st July, 2016 at a cost of Rs.20,00,000 and
spent Rs.5,00,000 on its installation. The books are closed on 31st December
every year.

Prepare the Machinery Account and Depreciation Account for 2016 & 2017 using:
ii. Straight Line Method @ 20% Depreciation per annum
iii. Diminishing Balance Method @ 25% Depreciation per annum

Question 2:
On 1st April, 2013, ABC & Co. purchased the Equipment for Rs.10,00,000. The
life of the asset was only 3 years and would expire on 31st March, 2016.
ABC & Co. decided to set up a sinking fund.

During the three years following transactions took place:

2014 31st March: A contribution from profits of Rs. 5,00,000 was made and
this sum was invested.

2014 5th Oct.: Investments which originally costed Rs. 1,00,000 were sold for
Rs. 1,50,000 and the proceeds of sale were re-invested.

2015 31st March: A contribution from profits of Rs. 7,00,000 was made;
interest on investments of Rs. 50,000 was received and these amounts were
reinvested.

2015 15th September: Investments which originally costed Rs. 6,00,000 were
sold at a profit of Rs. 50,000 and proceeds of sale were re-invested.

2016 31st March: Interest on investments Rs. 100,000 was received which was
not invested. All existing investments were sold for Rs. 15,40,000. A contribution
from profit of an amount required to make up the sinking fund to Rs. 25,00,000
was made and this amount was not invested.

1FIN BY INDIGOLEARN 5.15

 Prepare Sinking Fund and Sinking Fund Investment Account for the years 2013-
14, 2014-15, 2015-16.

Illustrations
Question: 1
Jain Bros. acquired a machine on 1st July,2015 at a cost of Rs. 14,00,000 and spent Rs.
1,00,000 on its installation. The firm writes off depreciation at 10% p.a. of the original cost
every year. The books are closed on 31st December every year
Show the Machinery Account and Depreciation Account for the year 2015 and 2016.

Question: 2
Jain Bros. acquired a machine on 1st July,2015 at a cost of Rs. 14,00,000 and spent Rs.
1,00,000 on its installation. The firm writes off depreciation at 10% p.a. every year. The
books are closed on 31st December every year.
Show the Machinery Account on diminishing balance method for the year 2015 and 2016.

Question: 3
M/s Akash purchased a machine for Rs. 10,00,000. Estimated useful life and scrap value were
10 years and Rs. 1,20,000 respectively. The machine was put to use on 1.1.2010.
Show Machinery Account and Depreciation Account in their books for 2015 by using sum of
years digits method.

Question: 4
A machine was purchased for Rs. 30,00,000 having an estimated total working of 24,000
hours. The scrap value is expected to be Rs. 2,00,000 and anticipated pattern of distribution
of effective hours is as follows
Year Particulars
1–3 3,000 hours per year
4–6 2,600 hours per year
7 – 10 1,800 hours per year
Determine Annual Depreciation under Machine Hour Rate Method.

Question:5
A machine is purchased for Rs. 20,00,000. Its estimated useful life is 10 years with a
residual value of Rs. 2,00,000.
The machine is expected to produce 1.5 lakh units during its lifetime. Expected distribution
pattern of production is as follows:
Year Units of Production per year
1–3 20,000 units
4–7 15,000 units
8 – 10 10,000 units
Determine the value of depreciation for each year using production units method.

1FIN BY INDIGOLEARN 5.16

Question: 6
M/s Surya took lease of a quarry on 1-1-2013 for Rs. 1,00,00,000. As per technical estimate
the total quantity of mineral deposit is 2,00,000 tonnes
Depreciation was charged on the basis of depletion method. Extraction pattern is given in the
following table:
Year Quantity of Mineral extracted (in Tonnes)
2013 2,000
2014 10,000
2015 15,000
Show the Quarry Lease Account and Depreciation Account for each year from 2013 to 2015.

Question: 7
A firm purchased on 1st January,2015 certain machinery for Rs. 5,82,000 and spent Rs.
18,000 on its erection. On July 1,2015 another machinery for Rs. 2,00,000 was acquired. On
1st July,2016 the machinery purchased on 1st January,2015 having become obsolete was
auctioned for Rs. 3,86,000 and on the same date fresh machinery was purchased at a cost of
Rs. 4,00,000. Depreciation was provided for annually on 31st December at the rate of 10 per
cent p.a. on written down value
Prepare Machinery Account.

Question: 8
M/s Anshul commenced business on 1st January 2011, when they purchased plant and
equipment for Rs. 7,00,000. They adopted a policy of charging depreciation at 15% per annum
on diminishing balance basis and over the years, their purchases of plant have been:
Date Amount (Rs.)
01-01-2012 1,50,000
01-01-2015 2,00,000
On 1-1-2015 it was decided to change the method and rate of depreciation to straight line
basis. On this date remaining useful life was assessed as 6 years for all the assets purchased
before 1.1.2015 and 10 years for the asset purchased on 1.1.2015 with no scrap value.
Calculate the difference in depreciation to be adjusted in the Plant and Equipment Account
for the year ending 31st December,2015.

Question: 9
A Machine costing Rs. 6,00,000 is depreciated on straight line basis, assuming 10 years
working life and Nil residual value, for three years. The estimate of remaining useful life
after third year was reassessed at 5 years.
Calculate depreciation for the fourth year

Question: 10
The following particulars are available from the books of a public company having a large fleet
of vehicles:
Particulars Amount (Rs.)
Balance in Provision for Repairs and Renewals Account as on 31.03.2016
Actual repairs charged/incurred during the year ended 11,50,000
31.03.2016

1FIN BY INDIGOLEARN 5.17

31.03.2017 7,50,000
3,20,000
The company makes an annual provision of Rs. 4,00,000 on repairs and renewals.
Draw up the Provision for Repairs and Renewals Account for the years 2015-2016 and 2016-
2017.

Question: 11
On 1st April,2013, Z Limited purchased the lease of property for Rs. 10,00,000. The lease
would expire on 31st March,2016. Z Ltd. decided to set up a sinking fund. The Sinking Fund
was to be credited (or debited) with an annual contribution from profit, the interest on the
investments and any profits (or losses) made on the realisation of the sinking fund
investments. The sinking fund was to be represented by specific investment, and any sums
made available to the sinking fund were to be immediately invested, except at the
termination of the fund.
During the three years following transactions took place:
 31st March,2014 A contribution from profits of Rs. 3,20,000 was made and
this sum was invested
 13th Oct,2014 Investments which originally costed Rs. 1,10,000 were sold for
Rs. 1,20,000 and the proceeds of sale were re-invested
 31st March,2015 A contribution from profits of Rs. 3,20,000 was made;
interest on investments of Rs. 16,000 was received and these amounts were reinvested
 9th August,2015 Investments which originally costed Rs. 2,10,000 were sold at
a profit of Rs. 20,000 and proceeds of sale were re-invested
 31st March,2016 Interest on investments Rs. 48,000 was received which was
not invested
 All existing investments were sold for Rs. 6,60,000
 A contribution from profit of an amount required to make up the sinking fund
to Rs. 10,00,000 was made and this amount was not invested
Prepare Sinking Fund and Sinking Fund Investment Account for the years 2013-14, 2014-15,
2015-16.

Question: 12
On 1st April,2013, Z Limited purchased the lease of property for Rs. 10,00,000. The lease
would expire on 31st March,2016. Z Ltd. decided to set up a sinking fund. The Sinking Fund
was to be credited (or debited) with an annual contribution from profit, the interest on the
investments and any profits (or losses) made on the realisation of the sinking fund
investments. The sinking fund was to be represented by specific investment, and any sums
made available to the sinking fund were to be immediately invested, except at the
termination of the fund.
During the three years following transactions took place:
 31st March,2014 A contribution from profits of Rs. 3,20,000 was made and
this sum was invested
 13th Oct,2014 Investments which originally costed Rs. 1,10,000 were sold for
Rs. 1,20,000 and the proceeds of sale were re-invested
 31st March,2015 A contribution from profits of Rs. 3,20,000 was made;
interest on investments of Rs. 16,000 was received and these amounts were reinvested

1FIN BY INDIGOLEARN 5.18

  9th August,2015 Investments which originally costed Rs. 2,10,000 were sold at
a profit of Rs. 20,000 and proceeds of sale were re-invested
 31st March,2016 Interest on investments Rs. 48,000 was received which was
not invested. All existing investments were sold for Rs. 6,60,000
 A contribution from profit of an amount required to make up the sinking fund
to Rs. 10,00,000 was made and this amount was not invested
Prepare Lease A/c and Depreciation A/c for the years 2013-2014, 2014-2015, 2015-2016.

1FIN BY INDIGOLEARN 5.19

 Chapter 6 – Bills of Exchange and Promissory Note
1. BILLS OF EXCHANGE
 Definition
 Instrument in writing,
 Containing an unconditional order signed by the maker,
 Directing certain person to pay a certain sum of money
 Only to or to the order of a certain person or to the bearer of the instrument.
 When such an order is accepted in writing on the face of the order itself,
 It becomes a valid bill of exchange.

 Concept

Goods are sold or services are provided

Seller extends a credit period to buyer

 Characteristics
o It must be in writing.
o It must be dated.
o It must contain an order to pay a certain sum of money.

1FIN BY INDIGOLEARN 6.1

 o The promise to pay must be unconditional.
o The money must be payable to a definite person or to his order to the bearer.
o The draft must be accepted for payment by the party to whom the order is made.
o It should be properly stamped.
o Payment must be in legal currency of the country.
o A Bill of Exchange can be passed on to another person by endorsement.

Drawer: The party Acceptor: The party

which makes the order which accepts the order
is known as the is known as the
Drawer. acceptor.

Payee: The party to whom

the amount has to be paid is
known as the payee.

 Foreign Bill of Exchange

o A bill of exchange drawn for foreign trade operations known as Foreign Bill of Exchange.
o A foreign bill of exchange is one which is drawn in one country and is payable in another.
o It is generally drawn up in triplicate wherein each copy is sent by separate post so that at
least one copy reaches the intended party.
o Payment will be made only on one of the copies and when such payment is made the other
copies become useless.

Example
1. A bill drawn in India on a person resident outside India and made payable outside
India.
2. A bill drawn outside India on a person resident outside India.
3. A bill drawn outside India and made payable in India.
4. A bill drawn outside India and made payable outside India.

2. PROMISSORY NOTES
 Definition
 A promissory note is an instrument in writing,
 Not being a bank note or currency note
 Containing an unconditional undertaking signed by the maker to pay a certain sum of
money
 Only to or to the order of a certain person.

1FIN BY INDIGOLEARN 6.2

 Characteristics
o It must be in writing.
o It must contain a clear promise to pay. Mere acknowledgement of a debt is not a promissory
note.
o The promise to pay must be unconditional “I promise to pay 50,000 as soon as I can” is not an
unconditional promise.
o The promiser or maker must sign the promissory note.
o The maker must be a certain person.
o The payee (the person to whom the payment is promised) must also be certain.
o The sum payable must be certain. “I promise to pay 50,000 plus all fine” is not certain.
o Payment must be in legal currency of the country.
o It should not be made payable to the bearer.
o It should be properly stamped.
o It does not require any acceptance.

3. BILLS OF EXCHANGE V/S PROMISSORY NOTES

BILLS OF EXCHANGE PROMISSORY NOTE
A bill contains an unconditional order to pay. A promissory note contains only a promise to pay
certain sum of money.
There are generally 3 parties (Drawer, There are 2 parties (Maker and Payee) in
Drawee and Payee) in bill of exchange. promissory note.
A bill is paid by Acceptor. A promissory note is paid by maker.
A bill is drawn by creditor. A promissory note is made by debtor.
The drawer and payee may be same person in In promissory note maker and payee cannot be
case of bill of exchange same person.
In a bill of exchange the liability of drawer is In a promissory note the liability of a maker is
secondary and conditional. primary and absolute.
A bill of exchange can be accepted A promissory note cannot be made conditionally.
conditionally.
In a bill of exchange, notice of dishonor must Notice of dishonor is not required in case of
be given. promissory note.
In case of dishonor, a bill of exchange must Noting and protest is not required in case of
be noted and protested. dishonor of a promissory note.

4.TERM OF A BILL
1) When a bill is drawn after sight
Term of the bill: Begins from the date of ‘sighting’ i.e. when the bill is accepted.
2) When a bill is drawn after date
Term of the bill: Begins from the date of drawing the bill.

5. EXPIRY /DUE DATE OF BILL

o The date on which the term of the bill terminates is called as ‘Expiry/Due Date of the bill’.

6. DAY OF GRACE
o Every instrument payable otherwise than on demand entitled to three days of grace.

1FIN BY INDIGOLEARN 6.3

 7. DATE OF MATURITY OF BILL
o The date which comes after adding three days to the expiry/due date of a bill, is called the
date of maturity.
o The maturity of a promissory note or bill of exchange is the date at which it falls due.
o Every promissory note or bill of exchange gets matured on the third day after the day on
which it is expressed to be payable , except when it is expressed to be payable
i. on demand,
ii. at sight, or
iii. on presentment
8. BILL AT SIGHT
o Bill at Sight means the instruments in which no time for payment is mentioned.
o A promissory note or bill of exchange is payable on demand-
 when no time for payment is specified, or
 when it is expressed to be payable on demand, or at sight or on presentment.

Point to be remember
 At sight’ and ‘presentment’ means on demand.
 An instrument payable on demand may be presented for payment at any
time.
 Days of grace is not to added to calculate maturity for such types of bill.
 A cheque is always payable on demand.

9. BILL AFTER DATE

 Bill after date means the instrument in which time for payment is mentioned.
 A promissory note or bill of exchange is a time instrument when it is expressed
to be payable-
 After a specified period. Point to be remember
 on a specific day
 after sight The expression ‘after sight’ means-
 on the happening of event  In a promissory note, after presentment for
Which is certain to happen. sight.
 In a bill of exchange, after acceptance or noting
for non-acceptance or protest for non-
acceptance.

 A cheque cannot be a time instrument because the cheque is always payable on

demand.
 Though a cheque can be postdated and which can be presented on or after such
date.
 A cheque has validity of 90 days from its date after that it becomes void, normally
termed as ‘Stale Cheque’ as bank will not honour such cheque.

1FIN BY INDIGOLEARN 6.4

 9. BILL AFTER DATE
o Bill after date means the instrument in which time for payment is mentioned.
o A promissory note or bill of exchange is a time instrument when it is expressed
to be payable-
 After a specified period.
 on a specific day
 after sight
 on the happening of event
Which is certain to happen.

o A cheque cannot be a time instrument because the cheque is always payable on demand.
o Though a cheque can be postdated and which can be presented on or after such date.
o A cheque has validity of 90 days from its date after that it becomes void, normally termed
as ‘Stale Cheque’ as bank will not honour such cheque.

1FIN BY INDIGOLEARN 6.5

10. CALCULATION OF DUE DATE OF A BILL

When the bill is made payable at a

When the bill is made payable on a stated number of months(s) after date.
specific date.

That date on which the term of the bill

That specific date will be the due date shall expire will be the due date.

When the bill is made payable at a

stated number of days after date.
When the due date is a public holiday.

That date which comes after adding

stated number of days to the date of The preceding business day will be the
bill, shall be the due date. due date.
Note : the date of bill is excluded

When the due date is an

emergency/due unforeseen holiday.

The next following day will be the date.

Point to be remember
1) When the bill is made payable at a stated number of months(s) after date, the term shall
expire on that day of the month which corresponds with the day on which the bill is dated. If the
month in which the period terminates has no corresponding day, the period shall be deemed to
expire on the last day of such a month. For example, a bill signed on January 31st payable after 3
months will be due on April 30th.
2) The term of a Bill after sight commences from the date of acceptance of the bill whereas the
term of a bill after date commences from the date of drawing of bill.

11. NOTING CHARGES

o When the acceptor denies the payment of bill then it leads to dishonor of bill.
o If there is dishonour, or fear of dishonour, the bill will be given to a public official known as
“Notary Public”.

1FIN BY INDIGOLEARN 6.6

 These officials present the bill for payment
These officials present the bill for payment

If the money is If the bill is dishonoured

received, they will they will NOTE the fact
hand over the of dishonour, with the
money to the reasons and give the bill
original party. back to their client.

o For doing this activity, the officer charges a small fee known as noting charges. The amount
of noting charges is recoverable from the party which is responsible for dishonour.

12. RENEWAL OF BILL

When Acceptor is unable to pay the amount and he

himself moves that he should be given extension.

In consideration, the acceptor agrees to bear

interest for the extended tie period.
(Calculated from the date of renewal till the
date of expected settlement).

A new bill will be drawn and the old bill will

be cancelled.

The amount of the new bill may represent any of the following
1) Where the drawee pays nothing: Total of amount of original bill as well as
the interest for the extended time period.
2) Where the drawee pays the interest amount at the time of renewal: Amount of
the Original bill.
3) Where the drawee makes part payment of the original bill: that part of total of
amount of original bill remain unpaid as well as the interest for the extended
time period on unpaid amount.

1FIN BY INDIGOLEARN 6.7

 13. RETRIEMENT OF BILLS OF EXCHANGE AND REBATE

The acceptor has spare funds much before the

maturity date of the bill of exchange accepted
by him.

He approaches the payee of the bill of exchange

and asks him whether the payee is prepared to
accept cash before the maturity date.

The acceptor gets a certain rebate or interest or

discount for premature payment.

The rebate becomes the income of the acceptor

and expense of the payee.

14. ACCOMODATION BILLS

o The mechanism of bill can be used to raise finance without doing any trading activity.

For example: Sanju and Manju are two friends. Sanju needs fund for three months. . In
that case he may persuade his friend Manju to accept his draft. The bill of exchange may
then be taken by Sanju to his bank and get it discounted there. Thus, Sanju will be able to
make use of funds.

When the three months period expires Sanju will send the requisite amount to Manju
and Manju will meet the bill.
o The same mechanism can be use when both the party needs money. In that case the
proceeds divided between the drawer and drawee according to mutual concern. The discounting
charges must also be borne by the two parties in the same ratio in which the proceeds are
divided.
o It may so happen that the drawer is not able to remit the proceeds to drawee on the due
date.
In such a case, the drawee may draw a bill on the drawer, and get it discounted with the
bank to honour the first bill.

15. BILL RECEIVABLE AND BILL PAYABLE BOOKS

o Bills receivable and bills payable books are journals (Day Books) to record in a chronological
order the details of bills receivable and bills payable.

1FIN BY INDIGOLEARN 6.8

 o When large number of bill transactions take place in an organization, it is convenient to
maintain these books.
o Wherein any bill transaction takes place, the same is entered in the Day Books in the first
instance and then the posting to respective debtor or creditor and to Bills Receivable or Bills
Payable account done from the day book.
o Useful for following up the status of outstanding bills. LS

16. JOURNAL ENTRIES IN BOOKS OF DRAWER

Particular Amount
On receipt of Bill
Bills Receivable Account Dr.
To Drawee/Maker of the note

On Endorsement in favour of another Party( say Z)

Z A/c Dr.
To Bills Receivable Account

On discounting with bank

Bank Account Dr. (with the amount actually received
Discount Account Dr. (with the amount of loss or discount)
To Bills Receivable Account

On the date of maturity ( Bill is honoured)

Cash Account Dr.

To Bills Receivable Account

On the date of maturity ( Bill is dishonoured)

1. If the bill was kept till maturity then

Drawee / Maker of the note Dr.
To Bills Receivable Account
2. If the bill was endorsed in favour of a creditor, the entry is :
Drawee / Maker of the note Dr.
To Bill payables

3. If the bill was discounted with the bank :

Drawee / Maker of the note Dr.
To Bank A/c

Entry for Noting charges

1FIN BY INDIGOLEARN 6.9

 1. Suppose X received from Y a bill for 1,000. On Maturity the bill is
dishonoured and 10 is paid as noting charges. The entry in this case will
be
Y A/c Dr. 1,010
To Bills Receivable Account 1,000
To Bank A/c 10
2. Suppose X had endorsed this bill in favour of Z

Y A/c Dr. 1,010

To Z 1,010
This is because Z will claim 1,010 from X and X has the right of
recovering 1,010 from Y.

3. If the bill has been discounted with a bank, entry will be

Y Dr. 1,010
To Bank A/c 1,010

In case of Insolvency

1. When drawee become insolvent

Drawee A/c Dr.

To Bills Receivable A/c

2. When something received from estate

Cash A/c Dr.

To Drawee A/c

3. Entry for Irrecoverable Amount

Bad debt A/c Dr.

To Drawee A/c

 In case of Renewal of bill

1. Cancellation of original Bill

Entries are same as explained for dishonour of
bill.
2. Entry for New bill
Bills Receivable A/c Dr.
To Drawee A/c

1FIN BY INDIGOLEARN 6.10

 3. In case of interest charged for new period
Bills Receivable A/c Dr.
To Drawee A/c
To Interest Income A/c

In case of Retirement of Bill

Cash/ Bank A/c Dr.
Rebate on bills account Dr.
To Bills Receivable A/c

17. JOURNAL ENTRIES IN BOOKS OF DRAWEE

Particular Amount
On acceptance of Bill
Drawer A/c Dr.
To Bills Payable A/c

On the date of maturity ( Bill is honoured)

Bills Payable A/c Dr.
To Cash/Bank A/c

On the date of maturity ( Bill is dishonoured)

Bills Payable A/c Dr.
To Drawer A/c

Entry for Noting charges

Legal expense A/c Dr.
To Drawer A/c

In case of Insolvency
1. When drawee become insolvent
Bills Payable A/c Dr.
To Drawer A/c

2. When final settlement Made

Drawer A/c Dr.

To Cash/Bank A/c
3. Entry for short payment
Drawer A/c Dr.

To Deficiency A/c
In case of Renewal of bill

1FIN BY INDIGOLEARN 6.11

Cancellation of original Bill
Bills Payable A/c Dr.
To Drawer A/c

Entry for New bill

Drawer A/c Dr.

To Bills Payable A/c
In case of interest charged for new period
Drawer A/c Dr.
Interest Charged A/c Dr.
To Bills Payable
In case of Retirement of Bill
Bills Payable Dr.

To Cash / Bank
To Rebate on bill discount

18. BILLS OF COLLECTION

Particular Amount
Entries for Bills for Collection Process
Bills for Collection Account Dr.
To Bills Receivable Account

When the amount is realized the entry will be

Bank Account Dr.
To Bills for Collection Account
When the amount is not honoured, the entry will be
Party (from whom the bill was received) Dr.
To Bills for collection A/c

Question: 1
Vijay sold goods to Pritam on 1st September 2016 for Rs. 1,06,000. Pritam immediately accepted
three months bill. On due date Pritam requested that the bill be renewed for a fresh period of two
months. Vijay agrees provided interest at 9% was paid immediately in cash. To this Pritam was
agreeable. The second bill was met on due date.
Give Journal entries in the books of Vijay and Pritam.

Question: 2
On 1st January 2016, Ankita sells goods for Rs 5,00,000 to Bhavika and draws a bill at three
months for the amount. Bhavika accepts it and returns it to Ankita. On 1st March
2016, Bhavika retires her acceptance under rebate of 12% per annum.

1FIN BY INDIGOLEARN 6.12

Record these transactions in the journals of Ankita and Bhavika.

Question: 3
Journalize the following transactions in K. Katrak’s books
1 Katrak’s acceptance to Basu for Rs 2,500 discharged by a cash payment of Rs 1,000
and a new bill for the
balance plus Rs 50 for interest
2 G. Gupta’s acceptance for Rs 4,000 which was endorsed by Katrak to M. Mehta
was dishonored. Mehta paid Rs 20 noting charges. Bill withdrawn against cheque
3 D. Dalal retires a bill for Rs 2,000 drawn on him by Katrak for Rs 10 discount
4 Katrak’s acceptance to Patel for Rs 5,000 discharged by Patel. Mody’s acceptance to
Katrak for a similar amount

Question: 4
On 1st January,2016, Vilas draws a Bill of Exchange for Rs. 10,000, due for payment after 3
months on Eknath. Eknath accepts to this bill of exchange. On 4th March,2016. Eknath retires the
bill of exchange at a discount of 12% p.a.
You are asked to show the journal entries in the books of Vilas.

Question: 5
Mr. David draws two bills of exchange on 1.1.2016 for Rs 6,000 and Rs 10,000. The bills of
exchange for Rs 6,000 is for two months while the bill of exchange for Rs 10,000 is for three
months. These bills are accepted by Mr. Thomas.
On 4.3.2016, Mr. Thomas requests Mr. David to renew the first bill with interest at 18% p.a. for a
period of two months. Mr. David agrees to this proposal. On 20.3.2016, Mr. Thomas retires the
acceptance for Rs 10,000, the interest rebate i.e. discount being Rs 100. Before the due date of
the renewed bill, Mr. Thomas becomes insolvent and only 50 paisa in a rupee could be recovered
from his estate.
You are to give the journal entries in the books of Mr. David.

Question: 6
Rita owed Rs. 1,00,000 to Siriman.
 On 1st October,2016, Rita accepted a bill drawn by Siriman for the amount at 3
months
 Siriman got the bill discounted with his bank for Rs. 99,000 on 3rd October,2016
 Before the due date, Rita approached Siriman for renewal of the bill.
 Siriman agreed on the conditions that Rs. 50,000 be paid immediately together with
interest on the remaining amount at 12% per annum for 3 months and for the balance, Rita
should accept a new bill at three months
 These arrangements were carried out
 But afterwards, Rita became insolvent and 40% of the amount could be recovered
from his estate
Pass journal entries (with narration) in the books of Siriman.

Question: 7
On 1st July,2016 Gorge drew a bill for Rs. 1,80,000 for 3 months on Harry for mutual
accommodation.
 Harry accepted the bill of exchange

1FIN BY INDIGOLEARN 6.13

  Gorge had purchased goods worth Rs. 1,81,000 from Jack
 On the same date Gorge endorsed Harry’s acceptance to Jack in full settlement
 On 1st September,2016, Jack purchased goods worth Rs. 1,90,000 from Harry
 Jack endorsed the bill of exchange received from Gorge to Harry and paid Rs. 9,000
in full settlement of the amount due to Harry
 On 1st October,2016, Harry purchased goods worth Rs. 2,00,000 from Gorge
 Harry paid the amount due to Gorge by cheque
Give the necessary Journal Entries in the books of Harry and Gorge.

Question: 8
For the mutual accommodation of ‘X’ and ‘Y’ on 1st April,2016, ‘X’ drew a four month’s bill on ‘Y’ for
Rs. 4,000
 ‘Y’ returned the bill after acceptance of the same date
 ‘X’ discounts the bill from his bankers @ 6% per annum and remit 50% of the
proceeds to ‘Y’
 On due date ‘X’ is unable to send the amount due and therefore ‘Y’ draws a bill for
Rs. 7,000, which is duly accepted by ‘X’
 ‘Y’ discounts the bill for Rs. 6,600 and sends Rs. 1,300 to ‘X’
 Before the bill is due for payment ‘X’ becomes insolvent. Later 25 paise in a rupee
received from his estate
Record Journal entries in the books of ‘X’.

1FIN BY INDIGOLEARN 6.14

 Chapter 7 – Preparation of Final Accounts of Sole
Proprietors

Financial Accounts of Non-Manufacturing Entities:

What is a Non-Manufacturing Entity?

Non-manufacturing entity is the entity, which is engaged in the purchase and sale of goods at profit
without processing of those goods. Non-manufacturing entities sell the goods in its original form.

To ascertain the results of the business the entity prepares the income statement i.e. the Profit &
Loss Statement and financial position i.e. Balance Sheet at the end of the accounting year.

Important Principles to be followed in preparation of Final Accounts:

The important principles to be followed in the preparation of the Final Accounts are as follow:
i. Distinction should be made between capital and revenue receipts and payments.

ii. Only the Income earned and Expense incurred in the current accounting period should be
accounted for in the current accounting period.

iii. All the different items of income and expenditure should be accumulated under major heads
of income and expense to disclose the sources from which capital has been raised and the
liabilities, which are outstanding for payment.

iv. Distinction between Personal and Business Income should be maintained.

v. All material information needs to be disclosed which can impact the decision of the users.

Matching Principle:

As per this principle the expenses incurred to earn the revenue should be properly matched in the
same accounting period. The following point’s needs to be taken care while recording the revenue and
expense for the current period:

i. If an item of revenue or income is recorded in the Trading or Profit and Loss Account then
all the expenses relating to those revenue or income needs to be recorded in the same period
Trading and Profit & Loss Account irrespective of the fact whether or not payment has been
actually made.

ii. If some expense has been incurred but the revenue for it will be received in the next year,
the expense should be carried forward as an asset and shown in the Balance Sheet.

It will be debited to the Profit and Loss Account only when the relevant income will also be
credited. This is the same logic based on which the depreciation on assets is charged.

1FIN BY INDIGOLEARN 7.1

 iii. In the similar manner if some income has been received but the expense for the same will be
incurred in the next year, the income should be recorded as liability and shown in the Balance
Sheet.
It will be credited to the Profit and Loss Account only when the relevant expense is debited.

iv. Exception to the above rule is that costs which have been incurred or is expected to be
incurred should only be debited to Profit and Loss Account. For example, if a fire has occurred
and has damaged the firm’s property the loss must be debited to the Profit and Loss Account to
the extent it is not covered by insurance.

Trading Account:
Trading Account enables to compute the Gross Profit or Gross Loss occurred due to carrying out
the business operations during the accounting period.

Gross Profit/Gross Loss is computed as the difference between the selling price and the Cost of
Goods Sold. The Cost of Goods sold is computed using the following formula:

Opening Stock
Add: Purchases
Add: Direct Expenses
Less: Closing Stock
Cost of Goods Sold

Accounting Entries related to Trading Account:

1. Opening Inventory:
Trading A/c Dr.
To Opening Stock

2. Purchases:
Purchase A/c Dr.
To Vendor/Cash A/c

1FIN BY INDIGOLEARN 7.2

 Trading A/c Dr.
To Purchases

3. Purchase Return:
Purchase Return A/c Dr.
To Purchases

4. Carriage, Freight Inwards:

Trading A/c Dr.
To Carriage, Freight Inwards A/c

5. Wages:
Trading A/c Dr.
To Wages A/c

6. Sales:
Debtors/Cash A/c Dr.
To Trading A/c

Sales A/c Dr.

To Trading A/c

7. Sales Return:
Trading A/c Dr.
To Sales Return A/c

8. Closing Inventory:
Closing Inventory A/c Dr.
To Trading A/c

Note:
If Closing Stock appears in the Trial balance then the closing inventory is not recorded in the trading
account, it is directly presented in the balance sheet.
This is due to the fact that the entry has already been recorded to arrive at Cost of Goods Sold.
As per the valuation principle closing inventory is recorded at cost or net realisable value whichever
is less.

Profit & Loss Account:

Trading Account enables to determine the gross profit or loss derived from carrying out the trading
activities in which the organization is engaged in.

All the expenses which have not been recorded in the trading account form a part of the Profit &
Loss Account. All the income and gains except for sales form a part of the Profit & Loss Account.

Format of Profit & Loss Account:

Format of Profit & Loss Account:

1FIN BY INDIGOLEARN 7.3

Accounting Entries related to Profit & Loss Account:

1. Drawings:
Capital A/c Dr.
To Drawings

1FIN BY INDIGOLEARN 7.4

 2. Income Tax
Capital A/c Dr.
To Income Tax A/c

3. Discount received
Profit/Loss A/c Dr.
To Discount Allowed A/c

4. Discount allowed
Discount Received A/c Dr.
To Profit/Loss A/c

5. Bad Debts
Bad Debts Account Dr.
To Debtor’s Account

Profit/Loss Account Dr.

To Bad Debts A/c

In case of Provision for Bad Debts is prepared then the bad debts are first recorded against
the provision

Bad Debts Account Dr.

To Debtor’s Account

Provision for Bad Debts A/c Dr.

To Bad Debts A/c

6. Bad Debts Recovery

Bad Debts Recovered Account Dr.

To Profit/Loss Account

Closing Entries
The journal entries that are made for transferring various account to the trading and Profit & Loss
Account are known as Closing Entries.

1. For expenses to be recorded to Profit & Loss Account.

Profit and Loss Account Dr.

To Salaries Account
To Rent Account
To Interest Account
To Other Expenses Account

2. For revenues and gains to be recorded to Profit & Loss Account.

Discount Received Account Dr.

1FIN BY INDIGOLEARN 7.5

 Bad debts Recovered Account Dr.
To Profit and Loss Account

3. Net Profit or Loss transferred to Capital Account

Net Profit
Profit and Loss Account Dr.
To Capital Account
Net Loss
Capital Account Dr.
To Profit and Loss Account

Other Adjustments and their treatment:

1. Abnormal loss of Inventory by accident or fire

Loss by Fire Account Dr.

To Purchases/Trading Account

Claim received from Insurance Company

Profit & Loss A/c Dr.
To Loss by Fire A/c

2. Goods sent on Approval basis

Sales A/c Dr.

To Trade receivables A/c

Sale on approval A/c Dr.

To Trading A/c

3. Goods used other than for sale

When goods are given away as donation

` Donation A/c Dr.
To Purchases A/c

When goods are used by the proprietor for his personal use
Drawings A/c Dr.
To Purchases A/c

When goods are distributed as free samples:-

Advertisement A/c Dr.
To Purchases A/c

When goods are used in business for construction of Fixed Asset:-

Fixed Asset A/c Dr.
To Purchases A/c

1FIN BY INDIGOLEARN 7.6

 When goods are used for maintenance of Fixed Asset: -
Repair & Maintenance A/c Dr.
To Purchases A/c

4. Commission based on profit

Sometimes organizations offer the Managers and high level authorities a part of profit via
commission as a part of their compensation. The computation involved in the computation of
these commission and the journal entries to record the same are as stated below.

Commission based on Net Profit before charging such commission:

Commission = Profit before commission X Rate of Commission

100

Commission based on Net Profit after charging such commission:

Commission = Profit before commission X Rate of Commission

100 + Rate of Commission

Recording Commission in the Books of Accounts:

Commission A/c Dr.

To Commission Payable A/c

Profit/Loss Account Dr.

To Commission A/c

Example:

The following is the Trial Balance of ABC Co. on 31st Dec. 2018. Prepare the Trading and Profit &
Loss Account from the Trial Balance after passing the closing entries.

1FIN BY INDIGOLEARN 7.7

1FIN BY INDIGOLEARN 7.8
1FIN BY INDIGOLEARN 7.9
Balance Sheet:
Balance Sheet is the statement which presents an organization Assets and Liabilities position on a
particular date.

Important points with regard to Balance Sheet:

1. It is valid only for a particular date and not later. For Example, if the closing inventory for
December 31, 2018 was valued at Rs.1,00,000/- and the entity purchased inventory worth
Rs,50,000 on 1st January 2019 the Balance Sheet on 1st January 2019 would be different as
compared to 31st December 2018.

2. Balance sheet is prepared only after the preparation of the Profit and Loss Account.
Format of Balance Sheet:

CLASSIFICATION OF ASSETS AND LIABILITIES

Assets are classified into the following categories:

1FIN BY INDIGOLEARN 7.10

 1. Current Assets
These are the assets which are meant to be used or converted into cash as within the next
operating cycle or one year whichever is longer.
For Eg: Cash, Bank, Debtors, Closing stock, etc.

2. Long Term Assets: -

These are the assets which are meant for long term usage and are expected to last for more
than a year or the accounting cycle whichever is longer.
Long Term Assets are classified as Intangible Assets or Tangible Assets.

Intangible Assets are those Assets which have no physical existence i.e. which cannot be
touched, felt or seen. For Eg, Patents, Copyrights, etc.

Tangible Assets are those assets which have their physical existence and can be identified.
For Eg, Furniture, Equipments, Machinery, etc.

Liabilities can be classified into the following categories:

1. Current Liabilities:
These are the liabilities which must be settled or paid within in one year or operating cycle
whichever is higher. Current Liabilities are also known as Short Term Liabilities. For Eg,
Creditors, Bills Payable etc.

2. Long Term Liabilities:

These are the liabilities which are to be paid or settled at least after a year or the operating
cycle whichever is longer. For Eg, Long term loans, Borrowings, etc.

Example:
The following is the Trial Balance of ABC Co. on 31st Dec. 2018. Prepare the Balance Sheet.

1FIN BY INDIGOLEARN 7.11

Questions:

Question 1:
The following is the Trial Balance of ABC Co. on 31st Dec. 2018. Prepare the Trading and Profit &
Loss Account from the Trial Balance after passing the closing entries.

1FIN BY INDIGOLEARN 7.12

Question 2:
The following is the Trial Balance of ABC Co. on 31st Dec. 2018. Prepare the Balance Sheet.

Illustrations
Question: 1
Trial Balance for financial the year (FY) ended 31st March 2017 of M/s Deepakshi shows following
details:
Particulars Debit (Rs.) Credit (Rs.)
Purchases and sales 10,00,000 12,00,000
Debtors and Creditors 5,00,000 4,00,000
Opening Stock 2,00,000
Closing Stock 3,00,000
Other Expenses and Incomes 7,00,000 9,00,000
Fixed Assets and Long-term Liabilities 25,00,000 6,00,000
Capital 21,00,000
Total 52,00,000 52,00,000
Additional Information:
 Creditors balance as on 1st April 2016 is Rs. 3,00,000.
 You are required to calculate cost of goods sold and amount paid to creditors during
the year.

Question: 2
Particulars Amount (Rs.)
Opening Inventory 1,00,000
Purchases 6,72,000
Carriage Inwards 30,000
Wages 50,000
Sales 11,00,000
Returns inward 1,00,000
Returns outward 72,000
Closing Inventory 2,00,000

1FIN BY INDIGOLEARN 7.13

From the above information, prepare a Trading Account of M/s. ABC Traders for the year ended
31st March 2017 and Pass necessary closing entries in the journal proper of M/s. ABC Traders.

Question: 3
Revenue, Expenses and Gross Profit Balances of M/s ABC Traders for the year ended on 31st
March 2016 were as follows:
Particulars Amount (Rs.)
Gross Profit 4,20,000
Salaries 1,10,000
Discount (Cr.) 18,000
Discount (Dr.) 19,000
Bad Debts 17,000
Depreciation 65,000
Legal Charges 25,000
Consultancy Fees 32,000
Audit Fees 1,000
Electricity Charges 17,000
Telephone, Postage and Telegrams 12,000
Stationery 27,000
Interest paid on Loans 70,000
Prepare Profit and Loss Account of M/s ABC Traders for the year ended on 31st March.
Show necessary closing entries in the Journal Proper of M/s. ABC Traders also.

Question: 4
On 1st Jan. 2017 provision for Doubtful Debts existed at Rs. 40,000. Trade receivables on
31.12.2017 were Rs. 15,00,000. Bad debts totalled Rs. 1,00,000. It is required to write off the bad
debts and create a provision equal to 5% of the Trade receivable’s balance.

Question: 5
The following is the Trial Balance of C. Wanchoo on 31st Dec. 2017
Trial Balance on 31st December
Particulars Amount (Rs.) Amount (Rs.)
Capital Account 10,00,000
Inventory Account 2,00,000
Cash in hand 1,44,000
Machinery A/c 7,36,000
Purchases A/c 18,20,000
Wages A/c 10,00,000
Salaries A/c 10,00,000
Discount Allowed A/c 50,000
Discount Received A/c 30,000
Sundry Office Expenses A/c 6,00,000
Sales A/c 50,00,000
Sums owing by customer (Trade receivables) 8,50,000
Trade payables (sums owing to suppliers) 3,70,000
Total 64,00,000 64,00,000
Value of Closing Inventory on 31st Dec. 2017 was Rs. 2,70,000

1FIN BY INDIGOLEARN 7.14

Prepare Trading and Profit and Loss Account.

Question: 6
The balance sheet of Thapar on 1st January 2017 was as follows:
Liabilities Amount (Rs.) Assets Amount (Rs.)
Trade Payables 15,00,000 Plant and Machinery 30,00,000
Expenses Payable 1,50,000 Furniture and Fixture 3,00,000
Capital 50,00,000 Trade receivables 14,00,000
Cash at Bank 6,50,000
Inventories 13,00,000
Total 66,50,000 Total 66,50,000
During 2017, his Profit and Loss Account revealed a net profit of Rs. 15,30,000. This was after
allowing for the following:
(a) Interest on capital @ 6% p.a.
(b) Depreciation on Plant and Machinery @ 10% and on Furniture and Fixtures @ 5%
(c) A provision for Doubtful Debts @ 5% of the trade receivables as at 31st December 2017
But while preparing the Profit and Loss Account he had forgotten to provide for
(1) Outstanding expenses totalling Rs. 1,80,000
(2) Prepaid insurance to the extent of Rs. 20,000
His current assets and liabilities on 31st December 2017 were:
a. Inventories Rs. 14,50,000
b. Trade receivables Rs. 20,00,000
c. Cash at Bank Rs. 10,35,000
d. Trade payables Rs. 11,40,000
During the year he withdrew Rs. 6,00,000 for domestic use.
Draw up his Balance Sheet at the end of the year.

Question: 7
Balance Sheet as at 31st December 2017
Capital and Amount (Rs.) Assets Amount (Rs.)
Liabilities
Mahindra & Sons 5,60,000 Cash in Hand 43,000
Capital 20,00,000 Cash at Bank 2,67,500
Trade Receivables 7,49,500
Closing Inventory 9,00,000
Machinery and
Equipment 6,00,000
Total 25,60,000 Total 25,60,000
From the above given balance sheet prepare the relevant opening entry.

Question: 8
Shri Mittal gives you the following Trial Balance and some other information
Trial Balances as on 31st March 2017
Particulars Amount (Rs.) Dr. Amount (Rs.) Cr.
Capital 8,70,000
Purchases and Sales 6,05,000 12,10,000
Opening Inventory 72,000

1FIN BY INDIGOLEARN 7.15

Trade receivables and Trade payables 90,000 1,70,000
14% Bank Loan (loan taken at year end) 2,00,000
Overdrafts (overdraft taken at year end) 1,12,000
Salaries 2,70,000
Advertisements 1,10,000
Other expenses 60,000
Returns 40,000 30,000
Furniture 4,50,000
Building 8,90,000
Cash in Hand 5,000
Total 25,92,000 25,92,000
Closing Inventory on 31st March 2017 was valued at Rs. 1,00,000.
Prepare final accounts of Shri Mittal for the year ended 31st March 2017.

Question: 9
Mr. Mohan gives you the following trial balance and some other information
Particulars Amount (Rs.) Amount (Rs.)
Capital 6,50,000
Sales 9,70,000
Purchases 4,30,000
Opening Inventory 1,10,000
Freight Inward 40,000
Salaries 2,10,000
Other Administrative Expenses 1,50,000
Furniture 3,50,000
Trade receivables and Trade Payables 2,10,000 1,90,000
Returns 20,000 12,000
Discounts 19,000 9,000
Bad debts 5,000
Investments in Government Securities 1,00,000
Cash in Hand and cash at Bank 1,87,000
Total 18,31,000 18,31,000
Other Information:
(i) Closing Inventory was Rs. 1,80,000
(ii) Depreciate Furniture @ 10% p.a
1. Prepare Trading and Profit and Loss Account for the year ended on 31.3.2017.
Balance Sheet of Mr. Mohan as on that date.

Question: 10
The Balance Sheet of Mr. Popatlal, a merchant on 31st March,2017 stood as below
Capital and Amount (Rs.) Assets Amount Amount (Rs.)
Liabilities (Rs.)
Capital 2,40,000 Fixed Assets 1,25,600
Trade payables 1,64,000 Inventories 2,06,400
Bank Overdraft Trade Receivables
1,46,000 Less 1,88,000
Provision

1FIN BY INDIGOLEARN 7.16

 6,200

Cash 1,81,800
36,200
Total 5,50,000 Total 5,50,000
Show opening journal entry on 1st April,2017 in the books of Mr. Popatlal.

Question: 11
The following is the schedule of balances as on 31.3.17 extracted from the books of Shri Gavaskar,
who carries on business under the same name and style of Messrs Gavaskar Viswanath & Co., at
Bombay
Particulars Amount (Rs.) Dr. Amount (Rs.) Cr.
Cash in Hand 14,000
Cash at Bank 26,000
Sundry Debtors 8,60,000
Stock on 01.04.2016 6,20,000
Furniture & fixtures 2,14,000
Office equipment 1,60,000
Buildings 6,00,000
Motor Car 2,00,000
Sundry Creditors 4,30,000
Loan from Viswanath 3,00,000
Provision for bad debts 30,000
Purchases 14,00,000
Purchase Returns 26,000
Sales 23,00,000
Sales Returns 42,000
Salaries 1,10,000
Rent for Go down 55,000
Interest on loan from Vishwanath 27,000
Rates & Taxes 21,000
Discount allowed to Debtors 24,000
Discount Received from creditors 16,000
Freight on purchases 12,000
Carriage Outwards 20,000
Drawings 1,20,000
Printing and Stationery 18,000
Electricity Charges 22,000
Insurance Premium 55,000
General office expenses 30,000
Bad debts 20,000
Bank Charges 16,000
Motor car expenses 36,000
Capital a/c 16,20,000
Total 47,22,000 47,22,000
Prepare Trading and Profit and Loss Account for the year ended 31st March 2017 and the Balance
Sheet as at that date after making provision for the following:
I.Depreciate:

1FIN BY INDIGOLEARN 7.17

 (a) Building used for business by 5 %
(b) Furniture and fixtures by 10 %:
One steel table purchased during the year for Rs. 14,000 was sold for same price but the
sale proceeds were wrongly credited to Sales Account
(c) Office equipment by 15 %:
Purchase of a typewriter during the year for Rs. 40,000 has been wrongly debited to
purchase
(d) Motor car by 20%
II.Value of stock at the close of the year was Rs. 4,40,000
III.Two month’s rent for Go down is outstanding
IV.Interest on loan from Viswanath is payable at 12 % per annum, this loan was taken on
01.05.2016
V.Reserve for bad debts is to be maintained at 5 % of Sundry Debtors
VI.Insurance premium includes Rs. 40,000 paid towards proprietor’s life insurance policy and
the balance of the insurance charges cover the period from 01.04.2016 to 30.06.2017.

Question: 12
Crimpson Ltd.’s profit and loss account for the year ended 31st March 2016 includes the following
information
Particulars Amt (Rs.)
(i) Depreciation 57,500
(ii) Bad debts written off 21,000
(iii) Increase in provision for doubtful debts 18,000
(iv) Proposed dividend 15,000
(v) Retained profit for the year 20,000
(vi) Liability for tax 4,000
Required:
State which one of the items (i) to (vi) above are –
(a) transfer to provisions;
(b) transfer to reserves; and
(c) neither related to provisions nor reserves.

1FIN BY INDIGOLEARN 7.18

 UNIT 2: Final accounts of Manufacturing entities

Manufacturing
Business Entities

Manufacturing Profit & Loss

Trading Account Balance Sheet
Account Account

Introduction
The manufacturing entities generally prepare a separate Manufacturing Account as a part of
Final accounts in addition to Trading Account, Profit and Loss Account and Balance Sheet. The
objective of preparing Manufacturing Account is to determine manufacturing costs of
finished goods for assessing the cost effectiveness of manufacturing activities.
Manufacturing costs of finished goods are then transferred from the Manufacturing Account
to Trading Account.

Purpose
A manufacturing account serves the following functions:
1. It shows the total cost of manufacturing the finished products and sets out in
detail, with appropriate classifications, the constituent elements of such cost. It is,
therefore, debited with the cost of materials, manufacturing wages and expenses incurred
directly or indirectly on manufacture.
2. It provides details of factory cost and facilitates reconciliation of financial books with
cost records and also serves as a basis of comparison of manufacturing operations from year
to year.
3. The Manufacturing Account may also be used for various other purposes. For example,
if the output is carried to the Trading Account at market prices, it discloses the profit or
loss on manufacture. Similarly, it may also be used to fix the amount of production of profit
sharing bonus when such schemes are in force.

Manufacturing costs are classified into :

+ Raw Material Consumed .…..….
+ Direct Manufacturing Wages ………
+ Direct Manufacturing Expenses ………
+ Direct Manufacturing Cost ………
+ Indirect Manufacturing expenses or
+ Manufacturing Overhead ………
Total Manufacturing Cost

Direct Manufacturing Expenses

Direct manufacturing expenses are costs, other than material or wages, which are
incurred for a specific product or saleable service.

1FIN BY INDIGOLEARN 7.19

Examples of direct manufacturing expenses are (i) Royalties for using license or
technology if based on units produced, (ii) Hire charge of the plant and machinery used
on hire, if based on units produced, etc.
When royalty or hire charges are based on units produced, these expenses directly vary with
production.

INDIRECT MANUFACTURING EXPENSES OR OVERHEAD EXPENSES

These are also called Manufacturing overhead, Production overhead, Works overhead, etc.
Overhead is defined as total cost of indirect material, indirect wages and indirect expenses.
Overhead = Indirect Material + Indirect Wages + Indirect Expenses
Indirect material means materials which cannot be linked directly with the units produced,
for example, stores consumed for repair and maintenance work, small tools, fuel and
lubricating oil, etc.
Indirect wages are those which cannot be directly linked to the units produced, for example,
wages for maintenance works, holding pay, etc.
Indirect expenses are those which cannot be directly linked to the units produced, for
example, training expenses, depreciation of plant and machinery, depreciation of factory
shed, insurance premium for plant and machinery, factory shed, etc.
Accordingly, indirect manufacturing expenses comprise indirect material, indirect wages and
indirect expenses of the manufacturing division.

BY-PRODUCTS
In most manufacturing operations, the production of the main product is accompanied by the
production of a subsidiary product which has a value on sale. For example, the production of
hydrogenated vegetable oil is accompanied by the production of oxygen gas and the production
of steel yields scrap. The subsidiary product is termed as a by-product because its production
is not consciously undertaken but results out of the production of the main product. It is
usually very diflcult to ascertain the cost of the product. Moreover, its value usually forms a
very small percentage of the main product.
By-product is a secondary product. This is produced from the same raw materials, which are
used for producing the main product and without incurring any additional expenses from the
same production process in which the main product is produced. Some examples of by-product
are given below:
i. Molasses is the by-product in sugar manufacturing;
ii. Butter milk is the by-product of a dairy which produces butter and cheese, etc.

By-products generally have insignificant value as compared to the value of main product. They are
generally valued at net realizable value, if their costs cannot be separately identified. It is
often treated, as “Miscellaneous income” but the correct treatment would be to credit the sale
value of the by-product to Manufacturing Account so as to reduce to that extent, the cost of
manufacture of main product

Question: 1
1,00,000 units were produced in a factory Per unit material cost was Rs.10 and per unit labour cost
was Rs.5. That apart it was agreed to pay royalty @ Rs.3 per unit to the Japanese collaborator who
supplied technology.
Required: Calculate Manufacturing Cost.

1FIN BY INDIGOLEARN 7.20

Question: 2
Mr. Vimal runs a factory which produces soaps. Following details were available in respect of his
manufacturing activities for year ended on 31.03.2016.
Particulars Amt. (Rs.)
Opening Work-in-Process (10,000 units) 16,000
Closing Work-in-Process (12,000 units) 20,000
Opening inventory of Raw Materials 1,70,000
Closing inventory of Raw Materials 1,90,000
Purchases 8,20,000
Hire charges of machine @ Rs. 0.60 per unit manufactured
Hire charges of factory 2,20,000
Direct wages-Contracted @ Rs.0.80 per unit manufactured and @ Rs.0.40 per
unit of
Closing W.I.P.
Repairs and Maintenance 1,80,000
Units produced – 5,00,000 units
Prepare a Manufacturing Account of Mr. Vimal for the year ended 31.3.2016.

1FIN BY INDIGOLEARN 7.21

 Chapter 8 – Financial Statements of Not-For-Profit
Organizations

What is a Not-for-Profit Organization?

A Not-for-Profit Organization is an entity which is not being operated for the purpose of earning
profit but for the benefit for the society. It is brought into existence with a view to serve a social
cause, not to earn profits for its owners.

Following are some of the forms of Not-For-Profit Organization:

1. Public Hospitals
2. Public Educational Institutions
3. Government Clubs
4. Temples, etc.
Receipt and Payment Account:

A Receipt and Payment Account is similar to cash book except it does not include the date column.
The key features of the Receipt and Payment account are as stated below:
1. It presents the summary of cash and bank transactions.
2. All the receipts and payments irrespective of the fact whether they are capital or revenue
in nature are accounted for.
3. This account is not maintained as part of the double entry system of accounting.
4. Surplus for the period i.e. Excess of Income over expenditure or Deficit i.e. Excess of
Expenditure over income for the period cannot be determined from this account since it excludes
all non-cash transactions. This is the limitation of the Receipt and Payment Account.
Example on Receipt and Payment Account:

The receipts and payments for the ABC, NPO for the year ended March 31, 2018 were:
Particulars Amount (INR)
Entrance fees 1000
Membership Fees 5000
Donation for Club Building 1 5000
Food sales 3500
Salaries and Wages 5500
Purchase of Food 2000
Construction of Club Pavilion 13000
General Expenses 1000
Rent and Taxes 500
Bank Charges 250
Opening Cash in hand Balance 5000
Closing Cash in hand Balance 1500
Opening Cash in Bank Balance 2000
Closing Cash in Bank Balance 3500

Prepare the Receipts and Payment Account.

1FIN BY INDIGOLEARN 8.1

Income and Expenditure Account:

Income and Expenditure account can be considered as the PROFIT AND LOSS ACCOUNT for the
NPO. The key features of the Receipt and Payment account are as stated below:

1. It is the revenue account for the NPO which is prepared at the end of the accounting period
of the NPO.

2. It is prepared using the Matching Principle i.e. current year revenue and expenses are
recorded in the current accounting period only irrespective of the status of their payment.

3. Cash as well as Non-Cash items are taken into consideration.

4. Income and Expenses which are capital in nature are excluded.

Preparing the Income and Expenditure Account from the Receipt and Payment Account:

Income and Expenditure account and the Balance Sheet for the NPO can be prepared from the
Receipt and Payment Account by making necessary adjustment with respect to the income earned
and expense incurred during the current period.
The following steps needs to be followed to prepare the income and expenditure and balance sheet
using the Receipt and Payment Account.

1. Prepare the Opening Balance Sheet to arrive at the opening balance of the accumulated
fund.

2. Prepare Ledger Accounts for the various income and expenses through which the accruals
and outstanding at the beginning and end of the period needs to be adjusted to arrive at the
income and expense for the current period.
3. Post the debit and credit of the Receipt and Payment to the Credit of the Income and
Expenditure Account for adjusting the accrual and outstanding.

4. Transfer the balance of the income and expenditure to the Accumulated/Capital Fund
Account.

1FIN BY INDIGOLEARN 8.2

 5. Transfer the amounts which are capital in nature from the Receipt and Payment to the
Balance Sheet of the NPO.

6. Prepare the Closing Balance Sheet.

Example on Computing and Preparing a particular Income Account from the Receipt and Payment
information:

During 2018, Subscription received in cash is Rs. 70000.

It includes Rs.15000 for 2017 and Rs.10000 for 2019.
Also Rs.20000 has still to be received for 2018.
Prepare the Subscription Outstanding, Subscription and Advance Subscription Account for the year
ended March 31, 2018.

The balance in Advance Subscription Account of Rs.10000/- will appear on the liabilities side and in
Outstanding subscription Account of Rs.20000/- will appear on the Asset Side.

Balance Sheet:

A Balance Sheet is the statement which presents the balance of the assets and liabilities of an
accounting period at a given date. Normally it is prepared at the end of an accounting period after
the Income and Expenditure Account has been prepared. In NPO Accounting, the excess of total

1FIN BY INDIGOLEARN 8.3

assets over total outside liabilities is known as Capital Fund which presents the amount contributed
by the Members, receipt of special donations and surplus accumulated over the years.

Example on preparing the Income and Expenditure account and Balance Sheet from the receipt
and Payment Account.

Following is the Receipt and Payment Account of Club XYZ, an NPO for the year ended March 31,
2018 along with the details of the opening and closing balance of Assets and Liabilities for the year
ended.

Prepare the Income and Expenditure and Balance Sheet for the year ended March 31, 2018.

(Miscellaneous)

Depreciation on the Computers is charged at 15% and on Equipment is charged at 10%.

The Opening Balance Sheet is as presented below:

1FIN BY INDIGOLEARN 8.4

The Income and Expenditure Account is as presented below:

The computations done in arriving at the amounts mentioned in the above income and expenditure
account are as follow:

1FIN BY INDIGOLEARN 8.5

The Balance Sheet is as presented below:

Accounting treatment of some special items

Donations: These may have been raised either for meeting some revenue or capital expenditure;
those intended for the first mentioned purpose are credited directly to the Income and
Expenditure Account but others, if the donors have declared their specific intention, then they
are credited to special fund account and in the absence thereof, to the Capital Fund Account.

If any investments are purchased out of a special fund or an asset is acquired therefrom, these
are disclosed separately. Any income received from such investments or any donations collected
for a special purpose are credited to an account indicating the purpose and correspondingly the
expenditure incurred in carrying out the purpose of the fund is debited to this account. On no
account any such expense is charged to the Income and Expenditure Account. The term "Fund" is
strictly applicable to the amounts collected for a special purpose when these are invested,
e.g. Scholarship Fund, Prize Fund etc.

Entrance and admission fees: Such fees which are payable by a member on admission to club or
society are normally considered capital receipts and credited to Capital Fund. This is because
these do not give rise to any special obligation towards the member who is entitled to the same
privileges as others who have paid only their annual subscription. Nevertheless, where the amount
is small, meant to cover expenses concerning admission, or the rules of the society provided that
such fees could be treated as income of the society, these amounts may be included in the Income
and Expenditure Account. The treatment depends upon the requirement of question. If the
question is silent then always take it to be capital receipt.

Subscription: Subscriptions being an income should be allocated over the period of their
accrual. For testing the knowledge of candidates of this important accounting principle, questions
are often set in examinations wherein figures of subscription collected by a society during the year
as well as those outstanding at the beginning of the year and at its close are given. If some
subscriptions have been received in advance, their amount is also indicated. In such cases, it is

1FIN BY INDIGOLEARN 8.6

always desirable to set up a Subscription Account for determining the amount of subscription
pertaining for the period for which accounts are being prepared

Life membership fee: Fees received for life membership is a capital receipt as it is of non-
recurring nature. It is directly added to capital fund or general fund.

For adjusting lump sum subscription collected from the life members, one of the following methods
can be adopted:

(1) The entire amount may be carried forward in a special account until the member dies,
after which the same may be transferred to the credit of the Accumulated Fund.

(2) An amount equal to the normal annual subscription may be transferred every year to the
Income and Expenditure Account and balance carried forward till it is exhausted. If,
however, the life member dies before the whole of the amount paid by him has been
transferred in this way, the balance should be transferred to the Accumulated Fund on
the date of his death.

(3) An amount, calculated according to the age and average life of the member, may annually
be transferred to the credit of Income and Expenditure Account.

Other Concepts:

1. Donation: it is gift in cash or kind from some person. It may be of two types:

(a) Specific Donation: It is received for certain specific purpose like Building
Donation, Library Books donation etc. It should be capitalized and shown on
the liabilities side of the balance sheet.

(b) General Donation: It is not received for any specific purpose and shown on the
credit side of Income and Expenditure Account.

2. Entrance Fees: It may also be known as admission fees. Entrance Fees should be
capitalized and added to the capital fund for all organization. If the question gives
any specific treatment of Entrance fees, then it should be followed accordingly.

3. Legacy: It is an amount received by an organization as per the will of the person after
the death of the person. It should be capitalised and shown on the liabilities side of
the balance sheet by adding to the Capital Fund.

4. Life Membership Fees: It should be capitalized and shown on the liabilities side
of the balance sheet. If the question gives any specific treatment of Life membership
Fees, then it should be followed accordingly.

5. Endowment Fund Donation: It is a donation received and only income from that
donation is to be used for certain specific purpose. In such cases income relating
to special funds should be added to these funds on the liabilities side of the Balance
sheet. All the expenses should be deducted from that fund on the liabilities side of the
Balance sheet.

6. Treatment of Sale of Old Newspaper and Periodicals: The amount received on such
sale is shown as Income on the credit side of income and expenditure account.

1FIN BY INDIGOLEARN 8.7

 7. Sale of old Fixed Assets: The Sale proceeds of old Fixed Assets are treated as capital
receipts. The profit or loss on sale of fixed asset is shown in the Income and
Expenditure A/c

8. Honorarium: It is paid to someone for receiving any services from person who are not
the employees of the Not for Profit Organisation.

Questions:

Question 1:
Following is the Receipt and Payment Account of Club ABC, an NPO for the year ended March 31,
2018 along with the details of the opening and closing balance of Assets and Liabilities for the year
ended.

Prepare the Income and Expenditure and Balance Sheet for the year ended March 31, 2018.

Depreciation on the Computers is charged at 25% and on Equipment is charged at 15%.

1FIN BY INDIGOLEARN 8.8

Illustrations
Question: 1
The receipts and payments for the Swaraj Club for the year ended March 31, 2016 were:
 Entrance fees Rs.300;
 Membership Fees Rs.3,000;
 Donation for Club Pavilion Rs.10,000,
 Foodstuff sales Rs.1,200;
 Salaries and Wages Rs.1,200
 Purchase of Foodstuff Rs.800;
 Construction of Club Pavilion Rs.11,000;
 General Expenses Rs.600;
 Rent and Taxes Rs.400;
 Bank Charges Rs.160.
 Cash in hand–April. 1st Rs.200, March. 31st Rs.350
 Cash in Bank–April. 1st Rs.400; March. 31st Rs.590
You are required to prepare Receipts and Payment Account.

Question: 2
During 2016, subscription received in cash is Rs.42,000. It includes Rs.1,600 for 2015 and Rs.600
for 2017. Also, Rs.3,000 has still to be received for 2016.
Calculate the amount to be credited to Income and Expenditure Account in respect of
subscription.

Question: 3
Suppose salaries paid during 2016 were Rs 23,000. The following further information is available:
Salaries unpaid on 31st March,2015 1,400
st
Salaries pre-paid on 31 March,2015 400
st
Salaries un-paid on 31 March,2016 1,800
st
Salaries pre-paid 31 March,2016 600
Required: Calculate the amount to be debited to Income and expenditure account in respect of
salaries and also, show necessary ledger accounts.

Question: 4
The following was the Receipts and Payments Account of Exe Club for the year ended March. 31,
2016 (All the figures in thousands)
Receipts Rs Payments Rs
Cash in hand 100 Groundsman’s Fee 750
Balance at Bank as per Pass Book: Moving Machine 1,500
Deposit Account 2,230 Rent of Ground 250
Current Account 600 Cost of Teas 250
Bank Interest 30 Fares 400
Donations and Subscriptions 2,600 Printing & Office Expenses 280
Receipts from teas 300 Repairs to Equipment 500
Contribution to fares 100 Honorarium to Secretary and
Sale of Equipment 80 Treasurer of 2015 400
Net proceeds of Variety Balance at Bank as per Pass Book:

1FIN BY INDIGOLEARN 8.9

Entertainment 780 Deposit Account 3,090
Donation for forth coming Current Account 150
Tournament 1,000 Cash in hand 250
7,820 7,820

You are given the following additional information:

Particulars April.1.2015 (Rs.) March.31.2016 (Rs.)
Subscription due 150 100
Amount due for printing etc. 100 80
Cheques unpresented being payment for 300 260
repairs
Estimated value of machinery and 800 1,750
equipment
Interest not yet entered in the Pass book 20
Bonus to Groundsman o/s. 300
For the year ended March. 31, 2016, the honorarium to the Secretary and Treasurer are to be
increased by a total of Rs 200.
Required: Prepare Income & Expenditure Account for period ending 31-03-2016 and the relevant
Balance Sheet.

Question: 5
The Income and Expenditure Account of the Youth Club for the Year 2016 is as follows:
Expenditure Rs. Income Rs.
To Salaries 4,750 By Subscription 7,500
To General Expenses 500 By Entrance Fees 250
To Audit Fee 250 By Contribution for annual dinner 1,000

To Secretary’s Honorarium 1,000 By Annual Sport meet receipts 750

To Stationery & Printing 450
To Annual Dinner Expenses 1,500
To Interest & Bank Charges 150
To Depreciation 300
To Surplus 600
9,500 9,500
This account had been prepared after the following adjustments:
Particulars Amount (Rs.)

Subscription outstanding at the end of 2015 600

Subscription received in Advance on 31st December,2015 450
Subscription received in advance on 31st December,2016 270
Subscription outstanding on 31st December,2016 750
Salaries Outstanding at the beginning and the end of 2016 were respectively Rs.400 and Rs.450.
General Expenses include insurance prepaid to the extent of Rs.60. Audit fee for 2016 is yet
unpaid. During 2016 audit fee for 2015 was paid amounting to Rs.200.
The Club owned a freehold lease of ground valued at Rs.10,000. The club had sports equipment on
1st January 2016 valued at Rs.2,600. At the end of the year, after depreciation, this equipment

1FIN BY INDIGOLEARN 8.10

amounted to Rs.2,700. In 2015, the Club has raised a bank loan of Rs.2,000. This was outstanding
throughout 2016. On 31st December 2016 cash in hand amounted to Rs.1,600.
Required: Prepare the Receipts and Payments Account for 2016 and Balance Sheet as at the end of
the year.

Question: 6
From the following Income and Expenditure Account and the Balance Sheet of a club, prepare its
Receipts and Payments Account and Subscription Account for the year ended 31st March 2016:
Income & Expenditure Account for the year 2015-16
Expenditure Rs. Income Rs.
Upkeep of Ground 10,000 By Subscriptions 17,320
Printing 1,000 By Sale of 260
Newspapers (Old)
Salaries 11,000 By Lectures 1,500
Depreciation on 1,000 By Entrance Fee 1,300
Furniture
Rent 600 By Misc. Income 400
By Deficit 2,820
23,600 23,600
Balance Sheet as at 31st March 2016
Liabilities Rs. Assets Rs.
Subscription in Advance Furniture 9,000
(2016-17) 100 Ground and Building 47,000
Prize Fund: Opening Balance Prize Fund
Add: Interest 25,000 Investment
1,000 Cash in Hand 20,000
Less: Prizes 26,000 Subscription 2,300
General Fund: (2,000) 24,000 (outstanding) (2015-
Opening Balance 16)
Less: Deficit 56,420 700
(2,820)
Add: Entrance Fee 53,600
1,300 54,900
79,000 79,000
The following adjustments have been made in the above accounts:
1. Upkeep of ground Rs.600 and Printing Rs. 240 relating to 2014-2015 were paid in
2015-16.
2. One-half of entrance fee has been capitalised by transfer to General Fund.
3. Subscription outstanding in 2014-15 was Rs.800 and for 2015-16 Rs.700.
4. Subscription received in advance in 2014-15 was Rs.200 and in 2015-16 for 2016-17
Rs. 100.

1FIN BY INDIGOLEARN 8.11

Question: 7
The Sportswriters Club gives the following Receipts and Payments Account for the year ended
March 31, 2016:
Receipts and Payments Account
Receipts Rs. Payments Rs.
To Balance b/d 4,820 By Salaries 12,000
To Subscriptions 28,600 By Rent and electricity 7,220
To Miscellaneous income 700 By Library books 1,000
To Interest on Fixed deposit 2,000 By Magazines and newspapers 2,172
By Sundry expenses 10,278
By Sports equipment’s 1,000
By Balance c/d 2,450
36,120 36,120
Figures of other assets and liabilities are furnished as follows:
Particulars As at March 31
Rs. Rs.
2015 2016
Salaries outstanding 710 170
Outstanding rent & electricity 864 973
Outstanding for magazines and newspapers 226 340
Fixed Deposit (10%) with bank 20,000 20,000
Interest accrued thereon 500 500
Subscription receivable 1,263 1,575
Prepaid expenses 417 620
Furniture 9,600
Sports equipment’s 7,200
Library books 5,000
The closing values of furniture and sports equipment’s are to be determined after charging
depreciation at 10% and 20% p.a. respectively inclusive of the additions, if any, during the year.
The Club's library books are revalued at the end of every year and the value at the end of March
31, 2016 was Rs. 5,250.
Required: From the above information you are required to prepare:
(a) The Club's Balance Sheet as at March 31, 2015;
(b) The Club's Income and Expenditure Account for the year ended March 31, 2016.
(c) The Club's Closing Balance Sheet as at March 31, 2016.

Question: 8
From the following balances and particulars of Republic College, prepare Income & Expenditure
Account for the year ended March 2016 and a Balance Sheet as on the date:
Rs. Rs.
Seminars & Conference Receipts 4,80,000
Consultancy Receipts 1,28,000
Security Deposit – Students 1,50,000
Capital Fund 16,06,000
Research Fund 8,00,000
Building Fund 25,00,000

1FIN BY INDIGOLEARN 8.12

Provident Fund 5,10,000
Tuition Fee Received 8,00,000
Government Grants 5,00,000
Donations 50,000
Interest & Dividends on Investments 1,85,000
Hostel Room Rent 1,75,000
Mess Receipts (Net) 2,00,000
College Stores-Sales 7,50,000
Outstanding expenses 2,25,000
Stock of-stores and Supplies (opening) 3,00,000
Purchases - Stores & Supplies 8,00,000
Salaries – Teaching 8,50,000
Research 1,20,000
Scholarships 80,000
Students Welfare expenses 38,000
Repairs & Maintenance 1,12,000
Games & Sports Expenses 50,000
Misc. Expenses 65,000
Research Fund Investments 8,00,000
Other Investments 18,50,000
Provident Fund Investment 5,10,000
Seminar & Conference Expenses 4,50,000
Consultancy Expenses 28,000
Land 1,00,000
Building 16,00,000
Plant and Machinery 8,50,000

Furniture and Fittings 6,00,000

Motor Vehicle 1,80,000
Provision for Depreciation:
Building 4,80,000
Plant & Equipment 5,10,000
Furniture & Fittings 3,36,000
Cash at Bank 6,42,000
Library 3,60,000
1,03,85,000 1,03,85,000

Adjustments:
Particulars Rs.
(1) Materials & Supplies consumed: (From college stores)
Teaching 50,000
Research 1,50,000
Students Welfare 75,000
Games or Sports 25,000
(2) Tuition fee receivable from Government for backward class Scholars 80,000

1FIN BY INDIGOLEARN 8.13

(3) Stores selling prices are fixed to give a net profit of 10% on selling price
(4) Depreciation is provided on straight line basis at the following rates:
(1) Building 5%
(2) Plant & Equipment 10%
(3) Furniture & Fixtures 10%
(4) Motor Vehicle 20%

1FIN BY INDIGOLEARN 8.14

 CHAPTER 9: ACCOUNTS FROM INCOMPLETE RECORDS

Introduction

Very often small sole proprietorship and partnership businesses do not maintain a double entry
bookkeeping system. Sometimes they keep records of the cash transactions and credit transactions
only. But at the end of the accounting period they want to know the performance and financial position
of their businesses. So, it becomes imperative to complete the accounts from available incomplete
records.

Accounts from incomplete records is also popularly known as ‘Single entry system’. Under this system
the task of the accountant is to establish linkage among the available information and to finalize the
accounts.

Types Of Single-Entry System

Types of single entry system

Pure single entry Simple single entry Quasi single entry

Personal accounts and Personal accounts, cash

Only personal accounts book and subsidiary
cash book are
are maintained books are maintained
maintained

Features Of Single-Entry System

 It is an inaccurate, unscientific and unsystematic method of recording business transactions.

 There is generally no record of real and personal accounts and, in most of the cases; a record is
kept for cash transactions and personal accounts.
 Cash books mix up business and personal transactions of the owners.

1FIN BY INDIGOLEARN 9.1

  There is no uniformity in maintaining the records and the system may differ from firm to firm
depending on the requirements and convenience of each firm.
 Profit under this system is only an estimate based on available information and therefore true
and correct profits cannot be determined. The same is the case with the financial position in the
absence of a proper balance sheet.

Financial Performance And Financial Position

ASCERTAINMENT OF PROFIT THROUGH STATEMENT OF AFFAIRS

If detailed information regarding revenue and expenses is not known, it becomes difficult to prepare a
profit and loss account. Instead by collecting information about assets and liabilities, it is easier to
prepare a balance sheet at two different points of time. So, while preparing accounts from incomplete
records, if sufficient information is not available, it is better to follow the method of capital
comparison to arrive at the profit figure.

This method is also known as Net Worth method or Statement of Affairs Method.

The above formula can also be expanded as below:

Particulars Amount
A.Capital at the end XXX
Add: drawings XXX
Less: Fresh capital introduced XXX
B. Capital at the beginning XXX
Profit (A-B) XXX

Opening and closing capital can be determined by preparing a statement of affairs at the two respective
points of time.
Statement of affairs is prepared in the following format. The opening and the closing balance is a
balancing figure.

Statement of affairs as on………….

LIABILITIES AMOUNT AMOUN ASSETS AMOUNT AMOUNT

20X0 T 20X0 20X1
20X1
capital(balancing xxx xxx Building xxx xxx
figure)
Loans, Bank overdraft xxx xxx Machinery xxx xxx
Sundry creditors xxx xxx Furniture xxx xxx

1FIN BY INDIGOLEARN 9.2

 Bills payable xxx xxx Inventory xxx xxx
Outstanding Expenses xxx xxx Sundry debtors xxx xxx
Cash at bank xxx xxx
Prepaid expenses xxx xxx
Total xxx xxx Total xxx xxx

Sources of assets and liabilities: -

Item Source of information

Cash and bank Cash book and bank pass book
Debtors and Creditors Personal ledger
Inventory Actual counting and valuation
Fixed assets The proprietor would disclose the original cost and date of purchase.
Reasonable amount of depreciation can be deducted from the same.
Loans, Bank Overdraft Corresponding bank documents

Difference Between Statement Of Affairs And Balance Sheet

Basis Statement of affairs Balance sheet

Reliability It is prepared based on transactions It is based on transactions recorded
partly recorded based on double entry strictly based on double entry book
book keeping and partly based on single keeping; Each item in the balance
entry. Most of the assets are recorded sheet can be verified from the
based on estimates, assumptions, relevant subsidiary books and ledger.
information gathered from memory Hence the balance sheet is not only
rather than records. reliable, but also dependable.
Capital In this statement, capital is merely a Capital is derived from the capital
balancing figure being excess of assets account in the ledger and therefore
over capital. Hence assets need not be the total of assets side will always be
equal to liabilities. equal to the total of liabilities side.
Omission Since this statement is prepared based There is no possibility of omission of
on incomplete records, it is very any item of asset and liability since all
difficult to locate the assets and items are properly recorded.
liabilities, if they are omitted from the Moreover, it is easy to locate the
books. missing items since the balance sheet
will not agree.
Basis of The valuation of assets is generally The valuation of assets is done on a
Valuation done in an arbitrary manner; therefore, scientific basis, that is the original
no method of valuation is disclosed. cost in the case of new assets and the

1FIN BY INDIGOLEARN 9.3

 depreciated amount based on cost
minus depreciation to date for used
assets. Any change in the method of
valuation is properly disclosed.
Objects The object of preparing this statement The object of preparing the balance
in the calculation of capital figures in sheet is to ascertain the financial
the beginning and at the end of the position on a particular date.
accounting period respectively.

Ascertainment Of Profit By Completing Books Of Accounts

 Where the accounts of a business are incomplete, it is advisable to convert them first to the double
entry system and then to draw up the Profit and Loss Account and the Balance Sheet.
 As books of accounts of different firms being incomplete in varying degrees, it is not possible to
suggest a formula which could uniformly be applied for preparing final accounts there from.
 However, the following general rule can be followed:
1. It is essential first to start the ledger accounts with the opening balances of assets, liabilities
and the capital.
2. Afterwards, each book of original entry should be separately dealt with, so as to complete the
double entry by posting into the ledger such entries as have not been posted. For example, if
only personal accounts have been posted from the Cash Book, debits and credits pertaining to
nominal accounts and real accounts that are not posted, should be posted into the ledger.
3. Afterwards, the other subsidiary books, i.e., Purchases Day Book, Sales Day Book, Return Book
and Bills Receivable and Payable, etc. should be totaled up and their totals posted into the ledger
to the debit or credit of the appropriate nominal or real accounts, the personal aspect of the
transactions having been posted already.
4. Once all the ledgers have been updated, prepare a trial balance to confirm the arithmetical
accuracy.
5. From the trial balance, prepare the financial statements.

When an Accountant is engaged in posting the unposted items from the Cash Book and other subsidiary
books, he may be confronted with a number of problems. The manner in which some of them may be
dealt with is described below:

Problems encountered by Accountants Solutions

In the Cash Book, there might be several receipts All the personal receipts should be credited to
and payments which have no connection with the his capital account. And his personal expenses
business but which belong to the proprietor, e.g., should be debited to his capital account.

1FIN BY INDIGOLEARN 9.4

interest collected on his private investment,
legacies received by him, purchase of car as gift
for his son, expenses of his pleasure trip etc.
Amounts belonging to the business after The appropriate asset or expense account
collection may have been directly utilized for should be debited and the source which had
acquiring business assets or for meeting certain provided funds credited
expenses instead of being deposited into the Cash
Book.
The proprietor may have met some of the The appropriate asset or expense account
business expenses from his private resources. should be debited, and the capital account
should be credited
Any excess or shortage in cash book for Should be adjusted with Proprietor’s capital
unidentified reasons account.
Where the benefit of an item of an expense is It should be allocated between them on some
received both by the proprietor and business equitable basis e.g. rent of premises when the
proprietor lives in the same premises, should be
allocated based on the area occupied by him for
residence.
Analysis of cash and bank receipts and payments Should be done in an extensive manner.
in detail. Prepare Cash and Bank Summary (if not available
in proper form with both sides tallied). The cash
and bank balance at the end should be reconciled
with the cash and bank books.
Having done so, the various items detailed on the
Summary Statements, should be posted into the
ledger.
The balancing figure in the summary can be the
opening balance of cash, cash sales or cash
purchases. This is based on other available
information.
Analysis of sales and purchases ledger. This should be done by considering all the
information regarding credit sales, purchases,
discount allowed/received, bad debts, return
inwards/outwards, bills received/ dishonored,
etc.
Analysis of nominal accounts This should be done by considering the
outstanding and prepaid expenses during the
period.

1FIN BY INDIGOLEARN 9.5

Analysis of Sales Ledger
It would disclose information pertaining to the opening balance of the debtors, the goods sold to them
on credit during the year, bills receivable dishonored, if any; cash received from them in the accounting
period, discount, rebate or any other concession allowed to them, receipts of bills receivable, returns
inwards, bad debts written off and transfers which can be shown in the following format.

OP Sales Bills Total Cash Discounts Bills Bad Sales Total Balance
Customer Dishonored Debits Recd. Allowed Recd. debts Returns credit (CL)
Balance

Journal entries must be made by debiting or crediting the impersonal accounts concerned with contra
credit or debit given to the total debtors account.

From the aforementioned, it will be possible to build up information about sales and other accounts
which can then be posted in totals, if so desired. It would also be possible to prepare Total Debtors.

Analysis of Purchases Ledger

A Purchases Ledger is not as commonly in existence as the Debtors Ledger for it being convenient to
make entries in respect of outstanding liabilities at the time they are paid rather than when they are
incurred.

The information is available in respect of opening balance of the creditors, goods purchased on credit,
bills payable dishonored; cash paid to the creditors during the year, discount and other concessions
obtained, returns outwards and transfers. It is made in the similar format as the sales ledger.

Journal entries must be made by debiting or crediting the respective impersonal accounts. Contra credit
or debit being given to the total creditor’s account.

If a proper record of return to creditors, discount allowed by them etc., has not been kept, it will not
be possible to write up the Total Creditors A/c.

In such a case, net credit purchase will be ascertained as follows:

Cash paid to Creditors including on account of bills payable during the period xxx
Closing balance of Creditors and Bills Payable xxx
Total xxx
Less: Opening balance of Creditors and Bills Payable xxx
Net credit purchase during the period xxx

Alternatively
Cash paid to Creditors during the period xxx
Add: Bills Payable issued to them xxx

1FIN BY INDIGOLEARN 9.6

Total xxx
Closing balance of Creditor xxx
Less: Opening balance of creditors xxx
Credit Purchases during the period xxx

Analysis of Nominal accounts

It is quite likely that the total expenditure shown by the balance of the nominal account may contain
items of expenditure which do not relate to the year for which accounts are being prepared and, also,
there may exist certain items of expenditure incurred but not paid, which have not been included
therein. On that account, each and every account should be adjusted in the following manner:

Particulars Cash Bank Outstanding Total Prepaid Expenses for the

(1) payment payment payment (4) paid/payable amount period (7) = 5 – 6
(2) (3) (5) = 2 +3 + 4 (6)
Office rent
Salaries

Only the amount entered as “expenses for the period” should be posted to the respective nominal
accounts.
A similar adjustment of nominal accounts in respect of revenue receipt should be made.
Scan the business transactions carefully to identify the nature of payment/ receipt and classify them
as drawings / fresh investments.

The following are some examples of drawings and fresh investment made by the proprietor/partner.

Drawings Fresh investment

Rent of premises commonly used for Money collected and put in the business on maturity
residential as well as business purposes of Life Insurance Policy of the proprietors

Common electricity and telephone bills Interest and dividend of personal investment of the
proprietors collected and put in the business.
Life insurance premiums of Income from non-business property collected and put
proprietor/partners paid from business in the business
cash.
Household expenses met from business cash Business expenses met by the proprietor from his
personal bank account.
Private loan paid to friends and relatives out Payment made to any creditor out of the proprietor's
of business cash personal account.
Personal gifts made to any friends and
relatives out of business cash
Goods or services taken from the business
for personal consumption
Cash withdrawals to meet family expenses

1FIN BY INDIGOLEARN 9.7

 Illustrations

Illustration – 1
Assets and Liabilities of Mr. X as on 31-12-2015 and 31-12-2016 are as follows:

Particulars 31-12-2015 31-12-2016 (Rs.)

(Rs.)
Assets
Building ?
1,00,000
Furniture ?
50,000
Inventory
1,20,000 2,70,000
Sundry debtors
40,000 90,000
Cash at bank
70,000 85,000
Cash in hand
1,200 3,200
Liabilities
Loans
1,00,000 80,000
Sundry creditors
40,000 70,000

Decided to depreciate building by 2.5% and furniture by 10%.

One Life Insurance Policy of the Proprietor was matured during the period and the amount Rs. 40,000
is retained in the business.
Proprietor took @ Rs. 2,000 p.m. for meeting family expenses.
Prepare a Statement of Affairs 31-12-2015 and 31-12-2016.
Find out profit for the year ended ended 31-12-2016

Solution

(i).Statement of affairs

Liabilities 31-12- 31-12- Assets 31-12-2015 31-12-2016

2015 2016
Rs. Rs. Rs.
Rs.
Capital 4,40, Building
2,41,200 000 1,00,000 97,500

1FIN BY INDIGOLEARN 9.8

 Loans Furniture
1,00,000 80,000 50,000 45,000
Sundry Inventory
creditors 40,000 70,000 1,20,000 2,70,000
Sundry debtors
40,000 90,000
Cash at bank
70,000 85,000
Cash in hand
1200 3200

3,81,200 5,90,000 3,81,200 5,90,000

Working notes
(i) Depreciation and closing balances
Building (Rs.) furniture(Rs.)
Balance as on 31-12-2015 1,00,000 50,000
Less : depreciation 2500 5000
Balance as on 31-12-2016 97,500 45,000
(ii) Determination of profit by applying the method of capital comparison

Particulars Amount (₹)

Capital balance as on 31-12-2016
4,40,700
Less : fresh capital introduced
(40,000)

4,00,700
Add : drawings( ₹2000 × 12)
24,000

4,24,700
Less: capital balance as on 31-12-2015
(2,41,200)
Profit 1,83,500

Note :
● Closing balance is increased due to fresh capital introduction , so its deducted
● Closing capital was reduced due to withdrawal by proprietor ;so its deducted

Alternative method
Capital account can be prepared as follows

1FIN BY INDIGOLEARN 9.9

Particulars (₹) Particulars (₹)
To drawings By balance b/d
24,000 2,41,200
To balance c/d By additional capital
4,40,700 40,000
By net profit (bal fig)
1,83,500

4,64,700 4,64,700

Illustration - 2
The Income Tax Officer, on assessing the income of Shri Moti for the financial year 1 and year 2 feels
that Shri Moti has not disclosed the full income. He gives you the following particulars of assets and
liabilities of Shri Moti as on 1st Jan Yr. 1 and 1st Jan Yr. 2.

Amount (₹)
st
1 Jan Yr. 1 Assets Cash in hand 25,500
Inventory 56,000
Sundry debtors 41,500
Land and Building 1,90,000
Wife’s Jewelry 75,000
Liabilities Owing to Moti’s Brother 40,000
Sundry creditors 35,000
1st Jan Yr. 2 Assets Cash in hand 16,000
Inventory 91,500
Sundry debtors 52,500
Land and Building 1,90,000
Motor Car 1,25,000
Wife’s Jewellery 1,25,000
Loan to Moti’s Brother 20,000
Liabilities Sundry creditors 55,000

During the two years the domestic expenditure was Rs. 4,000 p.m. The declared income of the financial
years were Rs. 1,05,000 for Yr. 1 and Rs. 1,23,000 for Yr. 2 respectively.
State whether the Income-tax Officer’s contention is correct. Explain by giving your workings.
Solution
Statement of affairs

Particulars 01.01.year 1 01.01.year 2

liabilities(₹) Assets (₹) Assets (₹)
liabilities(₹)
Assets
Cash in hand 25,500 16,000
Inventory 56,000 91,500
Sundry creditors 41,500 52,500

1FIN BY INDIGOLEARN 9.10

Land and building 1,90,000 1,90,000
Wife’s jewellery 75,000 1,25,000
Motor car _ 1,25,000
Loan to Moti’s brother _ 20,000
3,88,000 6,20,000
Liabilities
Owing to Moti’s brother ( 40,000) _
Sundry creditors ( 35,000) _ (55,000) _
Capital
3,13,000 5,60,000

Income during the 2 years

Particulars Amount (₹) Amount (₹)

Closing Capital (1st jan year 1 )
5,65,000
Add : Drawings - domestic expenses for two years (Rs.4000 × 24
months) 96,000
Less : opening capital (3,13,000) 3,48,000
Profit for the year 1 and year 2)
Profit disclosed 1,05,000
Year 1 1,23,000 (2,28,000)
Year 2
1,20,000

Income is disclosed less than Rs. 1,20,000

Hence, the contention of the Income tax Officer is correct.

Illustration – 3
A and B are in Partnership having Profit sharing ratio 2:1. The following information is available about
their assets and liabilities:

Particulars 31-3-2016 (₹) 31-3-2017 (₹)

Furniture 1,20,000 ?
Advances 70,000 50,000
Creditors 32,000 30,000
Debtors 40,000 45,000
Inventory 60,000 74,750
Loan 80,000 —
Cash at Bank 50,000 1,40,000

The partners are entitled to salary @ Rs. 2,000 p.m. They contributed proportionate capital.
Interest is paid @ 6% on capital and charged @ 10% on drawings.
Drawings of A and B

1FIN BY INDIGOLEARN 9.11

Particulars A B
April 30 —
2,000
May 31 — 2,000
June 30 4,000 —
Sept. 30 — 6,000
Dec. 31 2,000 —
Feb. 28 — 8,000

● On 30th June, they took C as 1/3rd partner who contributed Rs. 75,000.
● C is entitled to share of 9 months’ profit.
● The new profit ratio becomes 1:1:1.
● A withdrew his proportionate share.
● Depreciate furniture @ 10% p.a., new purchases Rs. 10,000 may be depreciated for 1/4th of a
year
● Current account as on 31-3-2016: A Rs. 5,000 (Cr.), B Rs. 2,000 (Dr)
Prepare Statement of Profit, Current Accounts of partners and Statement of Affairs as on 31-3-2017.

Solution
Statement of affairs as on 31-03-2016 and 31-03-2017
Liabilities 31-12- 31-12- Assets 31-12-2016 31-12-2017
2016 2017
Rs. Rs. Rs.
Rs.
Capital a/cs Furniture 1,20,000 1,17,500
A 1,50,000 75000 Advances 70,000 50,000
B 75,000 75000 Inventory 60,000 74,750
C 75000 Sundry debtors 40,000 45,000
Loan _ _ Cash at bank 50,000 1,40,000
Sundry 32000 30,000 Current a/c B 2,000 _
creditors
Current a/cs
A 5,000 74,036*
B 48,322*
C 50,142*
3,42,000 4,27,500 3,42,000 4,27,500
*refer current A/Cs

CURRENT ACCOUNTS

Particulars A B C Particulars A B C
₹ ₹ ₹ ₹ ₹ ₹
To balance b/d _ 2,000 _ By balance b./d 5,000 _ _
To drawings 8,,000 16,000 _ By salary 24,000 24,000 18,000

1FIN BY INDIGOLEARN 9.12

 To interest on drawings 533 534 - By interest on 5635 4,500 3375
capital
To balance b/d(b.f) 74,036 48,322 50,142 By share of profit 47,944 38,356 28,767

82,567 48,322 50,142 82,567 48,322 50,142

STATEMENT OF PROFIT

₹
Current account balances as on 31-3-20X2 1,72,500
Less: Salary
A Rs.2000 × 12 = 24,000
B Rs.2000 × 12 = 24,000
C Rs.2000 × 12 = 18,000 (66,000)
Less : interest on capital
A 5,625
B 4,500
C 3,375 (13,500)
Add: drawings
A 8,000
B 16,000 24,000
Add: interest on drawings
A 533
B 534 1067
1,18,067
Less: current a/c balances as on 31-3-20X1 ( 5000-2000) (3000)
Net profit for the year 1,15,067

Notes :

₹
(i) Depreciation on furniture
10 % on Rs.1,20,0000 12000
10 % on Rs. 10,000 for 1/4th year 250
12,250

(ii) furniture as on 31-3-20X1 1,20,000

Balance as on 31-3-20X1 10,000
Add: new purchase
1,30,000
(12,250)
1,17,750

1FIN BY INDIGOLEARN 9.13

 (iii) total of current accounts as on 31-3-20X2
Total of assets (1,17,750 + 50,000 + 74,750 + 45,000 + 1,40,000) 4,27,500
Less: fixed capital (75,000 + 75,000+ 75000)
(2,55,000)
1,72,500
(iv) interest on capital
A: 1,50,000 @ 6% for 3 months
2250
75,000 @ 6 % for 9 months
3375

B: 75,000 @ 6 % for 1 year 5625

C: 75,000 @ 6 % for 9 months 4500
3375
(v) interest on drawings
A: 2000 @ 10% for 11 months
4000 @ 10% for 9 months 183
6000 @ 10% for 3 months 300
50
533
B: 2000 @ 10% for 10 months 167
6000 @ 10% for 6 months 300
8000 @ 10 % for 1 month 67
534
(vi) Allocation of profit
3 months profit Rs. 1,15,067
9 months profit Rs. 28,767
A: 2/3 * 28,767 + 1/3 * 86,300
B: 1/3* 1,15,067 47,944
C: 1/3 * 86,300 38,356
28,767
1,15,067

Illustration - 4
The following information relates to the business of Mr. Shiv Kumar, who requests you to prepare a
Trading and Profit & Loss Account for the year ended 31st March, 20X2 and a Balance Sheet as on that
date:
(a)
Particulars 31-3-20X0 31-3-20X1
₹ ₹
Building 3,20,000 3,60,000
Furniture 60,000 68,000
Motorcar 80,000 80,000
Inventory ? 40,000
Bills payable
16,000
28,000

1FIN BY INDIGOLEARN 9.14

 Cash and bank balances 1,80,000 1,04,000
Sundry debtors 1,60,000 ?
Bills receivable
28,000
32,000
Sundry creditors 1,20,000 ?

(b) Cash transactions during the year included the following besides certain other items:

Amount
Particulars Particulars Amount (₹)
(₹)
Sale of old papers and 20,000 Cash purchases 48,000
miscellaneous income
Miscellaneous Trade expenses 80,000 Payment to creditors
(including salaries etc.) 1,84,000
Collection from debtors Cash sales 80,000
2,00,000

(c) Other information:

1. Bills receivable drawn during the year amount to Rs.20,000 and Bills payable accepted
Rs.16,000.
2. Some items of old furniture, whose written down value on 31st March, 20X1 was Rs.20,000 was
sold on 30th September, 20X1 for Rs.8,000. Depreciation is to be provided on Building and
Furniture @ 10% p.a. and on Motorcar @ 20% p.a. Depreciation on sale of furniture to be provided
for 6 months and for additions to Building for the whole year.
3. Of the Debtors, a sum of Rs.8,000 should be written off as Bad Debt and a reserve for doubtful
debts is to be provided @ 2%.
4. Mr. Shivkumar has been maintaining a steady gross profit rate of 30% on turnover.
5. Outstanding salary on 31st March, Year1 was Rs.8,000 and on 31st March, Year2 was Rs.10,000.
On 31st March, Year1, Profit and Loss Account had a credit balance of Rs.40,000.
6. 20% of total sales and total purchases are to be treated as for cash.
7. Additions in the Furniture Account took place in the beginning of the year and there was no
opening provision for doubtful debts.

Solution
Mr. Shiv Kumar
Trading and profit and loss account of for the year ended 31st March,20X2

Particulars Amount (₹) Amount (₹) Particulars Amount (₹) Amount (₹)
To opening inventory 80,000 By sales 4,00,000
(bal.fig) (3,20,000×100/80)
To purchases (1,92,000 × 2,40,000 By closing stock 40,000
100/80)
To gross profit c/d @ 120,000
30%on sales

1FIN BY INDIGOLEARN 9.15

 4,40,000 4,40,000
To miscellaneous expenses 82,000 By gross profit b/d 1,20,000
(w.n.10)
To depreciation By miscellaneous 20,000
receipts
building 36,000 By net loss 25,840
transferred to capital
a/c (bal.fig)
Furniture (6800 + 1000) 7800
Motor car 16000 59,800
To loss on sale of furniture 11,000
To bad debts 8,000
To provision for doubtful 5040
debts
1,65,840 1,65,840

Balance sheet as on 31st March,20X2

Liabilities Amount (₹) Amount (₹) Assets Amount (₹) Amount (₹)
Capital as on 1st 7,16,000 Building (w.n.8) 3,24,000
April,20X1
Profit and loss a/c 40,000 Furniture (w.n.5) 61,200
Less: loss for the (25,840) Motor car(w.n.9) 80,000
year
14,160 Inventory in trade 40,000
Sundry creditors 1,12,000 Sundry debtors 2,52,000
Bills payable 16,000 Less: provision for (5040) 2,46,960
doubtful debts @ 2%
Outstanding salary 10,000 Bills receivable 28,000
Cash in hand and at bank 1,04,000
8,68,160 8,68,160

Working notes:

1.Debtors account

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 1,60,000 By cash/bank a/c 2,00,000
To sales a/c 3,20,000 By bills receivable a/c 20,000
By bad debts 8,000
By balance c/d (bal.fig) 2,52,000

4,80,000 4,80,000

1FIN BY INDIGOLEARN 9.16

2.Creditors account

Particulars Amount (₹) Particulars Amount (₹)

To cash/bank a/c 1,84,000 By balance b/d 1,20,000
To bills payable a/c 16,000 By purchases a/c 1,92,000
To balance c/d (bal.fig) 1,12,000
3,12,000 3,12,000

3.Bills payable account

Particulars Amount (₹) Particulars Amount (₹)

To cash/bank a/c 28,000 By balance b/d 28,000
(bal.fig)
To balance c/d 16,000 By sundry creditors a/c 16,000

44,000 44,000

4.Bills receivable account

Particulars Amount (₹) Particulars Amount (₹)

32,000 By cash/bank a/c (b.f) 24,000
20,000 By balance c/d 28,000

52,00o 52,000

5. Furniture account

Amount
Particulars Particulars Amount (₹)
(₹)
To balance b/d 60,000 By bank/cash a/c 8,000
To bank a/c (b.f) 28,000 By depreciation 1,000
By profit and loss a/c (loss on 11,000
sale) (20,000-1000-8000)
By depreciation a/c (68,000 6,800
×10%)
61,200
88,000 88,000

1FIN BY INDIGOLEARN 9.17

6. Cash /Bank account

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 1,80,000 By miscell. Trade 80,000
expensesa/c
To miscellaneous 20,000 By purchases a/c 48,000
receipts a/c
To sundry debtors a/c 2,00,000 By furniture a/c 28,000
To sales a/c 80,000 By sundry creditors a/c 1,84,000
To furniture a/c (sale) 8000 By bills payable a/c 28,000
To bills receivable a/c 24,000 By building a/c (3,60,000- 40,000
3,20,000)
By balance c/d 1,04,000
5,12,000 5,12,000

7. Opening balance sheet as on 31.3.20X1

Liabilities Amount (₹) Assets Amount (₹)

Capital (bal.fig) 7,16,000 Building 3,20,000
Profit and loss a/c 40,000 Furniture 60,000
Sundry creditors 1,20,000 Motor car 80,000
Bills payable 28,000 Inventory in trade 80,000
Outstanding salary 8,000 Sundry debtors 1,60,000
Bills receivable 32,000
Cash in hand and at bank 1,80,000
5,12,000 5,12,000

8. Building account

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 3,20,000 By depreciation a/c 36000
To cash/bank a/c 40,000 By balance c/d 3,24,000
3,60,000 3,60,000
9. Motor car account

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 80,000 By depreciation a/c 16,000
By balance c/d 64,000
80,000 80,000

1FIN BY INDIGOLEARN 9.18

10.miscellaneous expenses

Miscellaneous expenses (including salaries) 80,000

Less:outstanding salary as on 31.3.20X1 (8000)
Add: oustanding salary as on 31.3.20X2 10,000

Illustration - 5
From the following data furyou are required to prepare a Trading and Profit and Loss Account for the
year ended 31st March, 20X2 and a Balance Sheet as at that date. All workings should form part of
your answer.

Particulars As on As on
01-04- 31-03-
x1 (Rs.) x2 (Rs.)
Creditors 15,770 12,400
Sundry expenses outstanding 600 330
Sundry Assets 11,610 12,040
Inventory in trade 8,040 11,120
Cash in hand and at bank 6,960 8,080
Trade debtors ? 17,870
Details relating to transactions in the year:
Cash and discount credited to debtors 64,000
Sales return 1,450
Bad debts 420
Sales (cash and credit) 71,810
Discount allowed by trade creditors 700
Purchase returns 400
Additional capital-paid into Bank 8,500
Realizations from debtors-paid into Bank 62,500
Cash purchases 1,030
Cash expenses 9,570
Paid by cheque for machinery purchased 430
Household expenses drawn from Bank 3,180
Cash paid into Bank 5,000
Cash drawn from Bank 9,240
Cash in hand on 31-3-x2 1,200
Cheques issued to trade creditors 60,270
Solution

Trading and profit and loss account of for the year ended 31st March,20X2

Amount
Particulars Amount (₹) Particulars Amount (₹) Amount (₹)
(₹)
To opening inventory 8,040 By sales

1FIN BY INDIGOLEARN 9.19

To purchases (58000 + 59,030 cash 4,600
1030 )
Less: returns (400) 58,630 credit 67,210
To gross profit c/d 14,810 Less: returns (1450) 70,360
By closing 11,120
inventory
81,480 81,480
To sundry expenses (w.n.5) 9300 By gross profit 14,810
b/d
To discount 1500 By discount 700
To bad debts 420
To net profit 4290
15,510 15,510

Balance sheet as on 31st March,20X2

Liabilities Amount (₹) Amount (₹) Assets Amount (₹)

Capital Sundry assets 12,040
Opening balance 26,770 Inventory in trade 11,120
Add: addition 8500 Sundry debtors 17,870
Add: net profit 4,290 Cash in hand & at bank 8,080
39,560
Less: drawings (3,180) 36,380
Sundry creditors 12,400
Outstanding expenses 330
49,110 49,110

Working notes:
1.Cash sales
Cash and bank account
Particulars Amount (₹) Particulars Amount (₹)
To balance b/d 6,960 By sundry creditors 60,270
To sundries (contra) 5000 By sundries (contra) 5,000
To sundries (contra) 9240 By sundries (contra) 9,240
To sundry debtors 62,500 By drawings 3,180
To capital a/c 8,500 By machinery 430
To sales (balancing 4,600 By sundry expenses 9,570
figure)
By purchases 1,030
By balance c/d 8,080
96,800 96,800
2. Debtors account

1FIN BY INDIGOLEARN 9.20

Particulars Amount (₹) Particulars Amount (₹)
To balance b/d 16,530 By bank 62,500
To sales (71,810-4600) 67,210 By discount (64,000- 1500
62,500)
By return inward 1450
By bad debts 420
By balance c/d 17,870
83,740 83,740

3. Total creditors account

Particulars Amount (₹) Particulars Amount (₹)

To bank 60,270 By balance b/d 15,770
To discount 700 By purchases 58,000
To return outward 400
To balance c/d 12,400

73,770 73,770

4.Balance sheet as on 1st April,20X1

Liabilities Amount (₹) Particulars Amount (₹)

Capital 26,770 Sundry assets 11,610
Sundry creditors 15,770 Inventory in trade 8,040
Outstanding expenses 600 Sundry debtors 16,530
Cash in hand and at bank 6,960

43,140 43,140

5.Calculation of sundry expenses

₹
Expenses paid in cash 9570
Add: outstanding on 31-2-20X2 330
9900
Less: outstanding on 1-4-20X1 (600)
9300

6.Due to lack of information, depreciation has not been provided on fixed assets.

Illustration – 6
Adamjee keeps his books on a single entry basis. The analysis of the cash book for the year ended on
31st December, 20X1 is given below:

1FIN BY INDIGOLEARN 9.21

Receipts Amount Payments Amount (₹)
(₹)
Bank Balance as on 1st January, Payment to Sundry Creditors 35,000
20X1 2,800
Received from Sundry Debtors Salaries 6,500
48,000
Cash Sales General Expenses 2,500
11,000
Capital brought during the year Rent and Taxes 1,500
6,000
Interest on Investments Drawings 3,600
200
Cash Purchases 12,000
Balance at Bank on 31st Dec, 6,400
20X1
Cash in hand on 31st Dec., 20X1 500

68,000 68,000

Particulars of other assets and liabilities are as follows:

Particulars 1st January 31st December
20X1 20X1 (₹)
(₹)
Sundry Debtors 14,500 17,600
Sundry Creditors 5,800 7,900
Machinery 7,500 7,500
Furniture 1,200 1,200
Inventory 3,900 5,700
Investments 5,000 5,000

Prepare final accounts for the year ending 31st December, 20X1 after providing depreciation at 10
percent on machinery and furniture and Rs. 800 against doubtful debts.

Solution

In the books of A.Adamji

Trading and profit and loss account of for the year ended 31st December,20X1

Particulars Amount (₹) Amount (₹) Particulars Amount (₹)

To opening inventory 3900 By sales 62,100
To purchases 49,100 By closing inventory 5700
To gross profit c/d (bal.fig) 14,800

67,800 67,800
To salaries 6,500 By gross profit c/d 14,800

1FIN BY INDIGOLEARN 9.22

To rent and taxes 1,500 By interest on 200
investment
To general expenses 2,500
To depreciation
Machinery @ 10 % 750
Furniture @ 10 % 120 870
To provision for doubtful debts 800
To net profit (carried to capital 2,830
a/c)
15,000 15,000

Balance sheet as on 31st December,20X1

Liabilities Amount (₹) Amount (₹) Assets Amount (₹) Amount (₹)
Capital as on 1st 29,100 Machinery 7,500
April,20X1
Add: fresh capital 6000 Less: depreciation (750) 6,750
Add: net profit 2830 furniture 12000
Less: drawings (3600) 34,330 Less: depreciation (120) 1,080
Sundry creditors 7,900 Inventory in trade 5,700
Sundry debtors 17,600
Less: provision for (800) 16,800
doubtful debts
investment 5,000
Cash at bank 6,400
Cash in hand 500
42,230 42,230

Working notes;

1. Balance sheet of Mr.Adamjee as on 1st January, 20X1

Liabilities Amount (₹) Assets Amount (₹)

Adamjee’s capital 29,100 Machinery 7500
Sundry creditors 5800 furniture 1200
inventory 3900
Sundry debtors 14,500
investments 5,000
Bank balance (from cash 2,800
statement)
34,900 34,900

1FIN BY INDIGOLEARN 9.23

 2. Ledger accounts

Adamjee’s capital account

Particulars Amount (₹) Particulars Amount (₹)

To drawings 3,600 By balance b/d 29,100
To balance c/d (b.f) 34,330 By net profit 2,830
By cash 6,000
37,930 37,930

Sales account

Particulars Amount (₹) Particulars Amount (₹)

To trading a/c (b.f) 62,100 By cash a/c 11,000
By debtors a/c 51,100

62,100 62,100

Debtors account

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 14,500 By cash 48,000
To credit sales (b.f) 51,100 By balance c/d 17,600

65,800 65,800

Purchase account

Particulars Amount (₹) Particulars Amount (₹)

To cash a/c 12,000 By trading account (b.f) 49,100
To balance b/d 37,100

49,100 49,100

Creditors account

Particulars Amount (₹) Particulars Amount (₹)

To cash 35,000 By balance b/d 5,800
To balance b/d 7,900 By credit purchases 37,100

42,900 42,900

1FIN BY INDIGOLEARN 9.24

Illustration – 7
Mr. Anup runs a wholesale business where all purchases and sales are made on credit. He furnishes the
following closing balances:
Particulars 1-1-20X1 31-12-
(₹) 20X1(₹)
Sundry Debtors
70,000 92,000
Bills Receivable 15,000
6,000
Bills Payable 12,000
14,000
Sundry Creditors
40,000 56,000
Inventory 1,10,000
1,90,000
Bank
90,000 87,000
Cash 5,200
5,300
Summary of cash transactions during the year 20X1:
i. Deposited to bank after payment of shop expenses
@ Rs. 600 p.m., wages
@ Rs. 9,200 p.m. and personal expenses
@ Rs. 1,400 p.m. Rs. 7,62,750.
ii. Withdrawals Rs. 1,21,000.
iii. Cash payment to suppliers Rs. 77,200 for supplies and Rs. 25,000 for furniture.
iv. Cheques collected from customers but dishonored Rs. 5,700.
v. Bills accepted by customers Rs. 40,000.
vi. Bills endorsed Rs. 10,000.
vii. Bills discounted Rs. 20,000, discount Rs. 750 Bills matured and duly collected Rs. 16,000.
viii.Bills accepted Rs. 24,000.
ix. Paid suppliers by cheque Rs. 3,20,000.
x. Received Rs. 20,000 on maturity of one LIC policy of the proprietor by cheque.
xi.Received Rs. 14,000 by cheque for the premises owned by the proprietor.
xii.The building was purchased on 30-11-20X1 for opening a branch for Rs. 3,50,000 and some expenses
were incurred on this building, details of which are not maintained.
xiii.and telephone bills paid by cash Rs. 18,700, due Rs. 2,200.

Other transactions:
i. Claim against the firm for damage Rs. 1,55,000 is under legal dispute. Legal expenses Rs. 17,000. The
firm anticipates defeat in the suit.
ii. Goods returned to suppliers Rs. 4,200.
iii. Goods returned by customers Rs. 1,200.
iv.Discount offered by suppliers Rs. 2,700.
v. Discount offered to the customers Rs. 2,400.

1FIN BY INDIGOLEARN 9.25

vi.The business is carried on at the rented premises for an annual rent of Rs. 20,000 which is outstanding
at the year end.
Prepare Trading and Profit & Loss Account of Mr. Anup for the year ended 31-12-20X1 and Balance
Sheet as on that date.
Solution
Trading and profit and loss account of Mr.Anup for the year ended 31st March,20X2

Amount
Particulars Amount (₹) Particulars Amount (₹) Amount (₹)
(₹)
To opening inventory 1,10,000 By sales 9,59,750
To purchases (w.n2) 4,54,100 Less : sales return (1,200) 9,58,550
Less:purchase return (4,200) 4,49,900 By closing 1,90,000
inventory
To gross profit c/d (bal.fig) 5,88,650
11,48,550 11,48,550
To salary (9200 × 12) 1,10,400 By gross profit b/d 5,88,650
To electricity & Tel. 18,700 By discount 2,700
charges received
2,200 20,900
To legal expenses 17,00
To discount allowed :
Debtors 2,400
Bills 750 3150
To shop expenses (600 × 12) 7200
To provision for claims for 1,55,000
damages
To shop rent 20,000
To net profit(b.f) 2,57,700
5,91,350 5,91,350

Balance sheet as on 31st March,20X2

Amount Amount
Liabilities Amount (₹) Assets
(₹) (₹)
Capital a/c (wn.6) 2,38,200 Building ( from cash 3,72,000
and bank a/c )
Add: fresh capital introduced Furniture 25,000
Maturity value from LIC 20,000 Inventory 1,90,000
rent 14,000 Sundry debtors 92,000
Add: net profit 2,57,700 Bills receivable 6,000
5,29,900 Cash at hand 87,000
Less : drawing (1400×12) (16,800) 5,13,100 Cash in hand 5,300
Rent outstanding 20,000
Sundry creditors 56,000

1FIN BY INDIGOLEARN 9.26

Bills payable 14,000
Outstanding expenses :
Legal expenses 17,000
Electricity & telephone charges 2,200 19,200
Provision for claims for damages 1,55,000
7,77,300 7,77,300

Working notes :

1. Sundry debtors A/C

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 70,000 By bills receivable a/c - bills accepted 40,000
by customers
To bills receivable a/c - bills 3,000 By bank a/c - cheque received 5,700
dishonoured
To bank a/c - cheque dishonoured 5,700 By cash a/c (from summary cash and 8,97,150
bank account)
To credit sales ( bal.fig.) 9,59,750 By return inward a/c 1,200
By discount a/c 2,400
By balance c/d 92,000
10,38,450 10,38,450

2. Bills receivable account

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 15,000 By sundry creditors a/c 10,000
(bills endorsed)
To sundary creditors a/c (bills 40,000 By bank a/c (20,000- 19,250
accepted) 750)
By discount a/c (bills 750
discounted)
By bank a/c (bills 16,000
collected on maturity)
By sundry debtors
Bills dishonoured 3,000
(bal.fig)
By balance c/d 6,000
55,000
55,000

1FIN BY INDIGOLEARN 9.27

 3. Sundry creditors account

Particulars Amount (₹) Particulars Amount (₹)

To bank 3,20,000 By balance c/d 40,000
To cash 77,200 By credit purchase (bal.fig.) 4,54,100
To bills payable a/c 24,000
To bills receivable a/c 10,000
To return outward a/c 4,200
To discount received a/c 2,700
To balance b/d 56,000
4,94,100 4,94,100

4. Bills payable account

Amount
Particulars Particulars Amount (₹)
(₹)
To bank a/c (bal.fig) 22,000 By balance b/d 12,000
To balance c/d 14,000 24,000
36,000 36,000

5. Summary cash and bank a/c

Particulars Cash (₹) bank(₹) Particulars Cash (₹) Bank (₹)

To balance b/d 5200 By bank 7,62,750 1,21,000
To sundry debtors (bal.fig) 8,97,150 90,000 By cash 7200
To cash By shop exp.(600 × 1,10,400
12)
To bank 121,000 7,62,750 By salary 16,800
To sundry debtors 22,000
To bills receivable 77,200 3,20,000
To bills receivable 25,000
To capital(maturity value of 20,000 5700
LIC policy )
To capital (rent received) 14,000 18,700
3,72,000
5300 87000

10,23,350 9,27,700 10,23,350 9,27,700

6. Statement of affairs as on 31st March 20X1

Liabilities Amount (₹) Assets Amount (₹)

Capital ( bal.fig.) 40,000 Inventory 1,10,000

1FIN BY INDIGOLEARN 9.28

Creditors 12,000 Debtors 70,000
Bills payable 2,38,200 Bills receivable 15,000
Cash at bank 90,000
Cash in hand 5,200
2,90,200 2,90,200

Illustration - 8
Ms. Rashmi furnishes you with the following information relating to her business:
a. Assets and liabilities as on

Particulars 1.4.20X1 31.3.20X2

Amount (Rs.) Amount (Rs.)
Furniture (w.d.v)
12,000 12,700
Inventory at cost
16,000 14,000
Sundry Debtors ?
32,000
Sundry Creditors
22,000 30,000
Prepaid expenses
1,200 1,400
Unpaid expenses
4,000 3,600
Cash in hand and at bank
2,400 1,250
b.Receipts and payments during 20X2:
● Collections from debtors, after allowing a discount of Rs. 3,000 amounted to Rs. 1,17,000.
● Collections on discounting of bills of exchange, after deduction of discount of Rs. 250 by the
bank, totaled to Rs. 12,250.
● Creditors of Rs. 80,000 were paid Rs. 78,400 in full settlement of their dues.
● Payment for freight inwards Rs. 6,000.
● Amount withdrawn for personal use Rs. 14,000.
● Payment for office furniture Rs. 2,000.
● Investments carrying annual interest of 4% were purchased at Rs. 192 (face value Rs. 200) on
1st July,2016 and payment made there for.
● Expenses including salaries paid Rs. 29,000.
● Miscellaneous receipts Rs. 1,000
c.Bills of exchange drawn on and accepted by customers during the year amounted to Rs. 20,000. Of
these, bills of exchange of Rs. 4,000 were endorsed in favor of creditors. An endorsed bill of exchange
of Rs. 800 was dishonored.
d.Goods costing Rs. 1,800 were used as advertising materials.
e. Goods are invariably sold to show a gross profit of 33-1/3% on sales.

1FIN BY INDIGOLEARN 9.29

f. Difference in cash books, if any, is to be treated as further drawing or introduction of capital by Ms.
Rashmi.
g.Provide at 2.5% for doubtful debts on closing debtors.
Prepare trading and profit and loss accounts for the year ended 31st March,20X2 and the balance sheet
as on that date.

Solution

Trading and profit and loss account of Ms.Rashmi for the year ended 31st March,20X2

Particulars Amount (₹) Amount (₹) Particulars Amount (₹)

To opening inventory 16000 By sales 1,46,100
To purchases (w.n2) 91,200 By closing inventory 14,000
Less: for advertising (1800) 89,400
To freight inwards 6,000
To gross profit c/d @ 33-⅓% 48,700
1,60,100 1,60,100
To sundry expenses (w.n.6) 28,400 By gross profit b/d 48,700
To advertisement 1800 By interest accrued on 4
investment
(200×4/100×1/2)
To discount allowed By discount received 1600
Debtors 3000 By miscellaneous 1,000
income
Bills receivable 250 3250
To depreciation on furniture 1300
(12,000+2000-12,700)
To provision for doubtful 972
debts
To net profit(b.f) 15,582
51,304 51,304

Balance sheet as on 31st March,20X2

Liabilities Amount (₹) Amount (₹) Assets Amount (₹) Amount (₹)
Capital as on 37,600 Furniture 12,000
1.4.20X1
Less: drawings (15,808) Additions during the 2,000
year
21,792 Less: depreciation (1300) 12,700
(b.f)
Add: net profit 15,582 37,374 Investments 192
Sundry creditors 30,000 Interest accrued 4
(200×4/100×1/2)

1FIN BY INDIGOLEARN 9.30

Outstanding 3,600 Closing inventory 14,000
expenses
Sundry debtors 38,900
Less: provision for 972 37,928
doubtful debts @ 2.5
%
Bills receivable 3,500
Cash in hand and at 1250
bank
Prepaid expenses 1400

70,972 70,974

Working notes:
1.Capital on 1st april, 20X1
Balance sheet as on 1.4.20X1

Liabilities Amount (₹) Assets Amount (₹)

Capital ( bal.fig.) 37,600 Furniture 12,00
Creditors 22,000 Inventory at cost 16,00
Outstanding expenses 4,000 Sundry creditors 32,00
Cash in hand and at bank 2,400
Prepaid expenses 1,200
63,600 63,600

2. Purchases made during the year

Sundry creditors
Particulars Amount (₹) Particulars Amount (₹)
To cash and bank a/c 78,400 By balance b/d 22,000
To discount received a/c 1,600 By sundry debtors a/c 800
To bills receivable a/c 4,000 By purchases a/c 91,200
(bal.fig)
To balance b/d 30,000
1,14,000 1,14,000
3. Sales made during the year

Particulars Amount (₹) Amount (₹)

Opening inventory 16,000
Purchases (w.n2) 91,200
Less: for advertising (1800) 89,400
Freight inwards 6,000
Less: closing inventory (14,000)
Cost of goods sold 97,400

1FIN BY INDIGOLEARN 9.31

Add: gross profit (@ 50 % on cost ) 48,700
1,46,100

4. Debtors on 31.3.20X2
Sundry debtors account

Amount
Particulars Particulars Amount (₹)
(₹)
To balance b/d 32000 By cash and bank a/c 1,17,000
To sales a/c (w.n.3) 1,46,100 By discount allowed a/c 3,000
To sundry creditors a/c (bills 800 By bills receivable a/c 20,000
dishonoured)
By balance c/d (bal.fig.) 38,900
1,78,900 1,78,900

5. Additional drawings by Ms.Rashmi

Cash and bank a/c

Particulars Amount (₹) Particulars Amount (₹)

To balance b/d 2,400 By freight inwards a/c 6,000
To sundry debtors a/c 1,17,000 By furniture a/c 2,000
To bills receivable a/c 12,250 By investment a/c 192
To miscellaneous income a/c 1,000 By expenses a/c 29,000
By drawings a/c 78,400
(14,000+1808(b.f)(additional drawings )]
By balance c/d 1250
1,31,650 1,31,650

6. Amount of expenses debited to profit and loss a/c

Sundry expenses a/c

Amount
Particulars Amount (₹) Particulars
(₹)
To prepaid expenses a/c (on 1200 By outstanding expenses a/c (on 4,000
1.4.20X1) 1.4.20X1)
To bank a/c 29,000 By profit and loss a/c (bal.fig) 28,400
To outstanding expenses a/c (on 3,600 By prepaid expenses a/c 1400
31.3.20X2)

33,800 33,800

1FIN BY INDIGOLEARN 9.32

7. Bills receivable on 31st March,20X2

Bills receivable account

Particulars Amount (₹) Particulars Amount (₹)

To debtors a/c 20,000 By creditors a/c 4,000
By bank a/c 12,250
By discount on bills receivable a/c 250
By balance c/d (bal.fig.) 3,500
20,000 20,000

1FIN BY INDIGOLEARN 9.33

 Chapter – 10 Partnership
Unit-1 Introduction

Business carried on by all or any one of them

acting for all. Sharing of profits and losses of the business.

If the person carrying on the business The persons concerned must agree to
acts not only for himself but for others share the profits of the business.
also so that they stand in the positions
A provision for sharing of loss is
of principals and agents, they are
not necessary.
partners.

Existence of a business. An agreement entered into by all persons

concerned.
A partnership comes into existence only when
partners begin to carry on business in A formal or written agreement is not
accordance with their agreement. necessary to create a partnership.

An association of two or more persons. Unlimited liability of all partners

Why Partnership?

Due to the financial and managerial demands of the present day business world. In Partnership,
two or more individuals may decide to pool their financial and non-financial resources to carry on
a business

2. LIMITED LIABILITY PARTNERSHIP

The Limited Liability Partnership (LLP)

1FIN BY INDIGOLEARN 10.1

Ø Viewed as an alternative corporate business proposal that provides the benefits of limited
liability.

Ø Allows its members, the flexibility of organizing their internal structure as a partnership,
which is based on a mutually arrived agreement.

Law Definition

Section 2 of the Limited Liability Partnership (LLPs) Act, 2008 defines LLP

As a partnership formed and registered under this Act

AND

“limited liability partnership agreement” means any written agreement

1) between the partners of the limited liability partnership

2) between the limited liability partnership and its partners

Which determines the mutual rights and duties of the partners and their rights and duties in
relation to that limited liability partnership.

Advantages

1.LLP is organized and operates on the basis of an agreement.

2.Enables professional/technical expertise and initiative to combine with financial risk taking
capacity in an innovative and efficient manner.

3.Limited liability of partners as in case of corporate entities along with flexibility of a

partnership without imposing detailed legal and procedural requirements.

4.Lower registration costs as compared to corporate entities.

5.Audit not mandatory

Challenges

1.Public disclosure of financial statements.

2.No opinion for Equity investments.

3.Extensive penal provisions for non-compliance.

v Features

Ø The LLP will be a separate legal entity

1FIN BY INDIGOLEARN 10.2

§ Liable to the full extent of its assets.

§ The liability of the partners being limited to their agreed contribution in the LLP which may
be of tangible or intangible nature.

§ No partner would be liable on account of the independent or un- authorized actions of other
partners or their misconduct.

The liabilities of the LLP and partners who are found to have acted with intent to defraud
Creditors or for any fraudulent purpose shall be unlimited for all or any of the debts or other
liabilities of the LLP.

Ø It is taxed as a partnership, but has the benefits of being a corporate, or more significantly,
a juristic entity with limited liability.

Ø The provisions of the Indian Partnership Act, 1932 shall not apply to LLP unless stated.

Ø Every limited liability partnership shall have at least two partners.

v Who can become a partner in LLP?

Any individual or body corporate may be a partner in a LLP.

Provided that an individual shall not be capable of becoming a partner of a limited liability
partnership if

He has been found to be of unsound mind by a

Court of competent jurisdiction .

He is an undischarged insolvent.

He has applied to be adjudicated as an insolvent

and his application is pending.

 What happen if the number of partner reduced to one and the LLP carried business for
more than 6 month.
The only partner of LLP who carries the business after 6 month and has the knowledge
of the fact he is carrying the business alone, shall be liable personally for the

1FIN BY INDIGOLEARN 10.3

 obligations of the LLP incurred during that period.

Designated Partners

Every LLP should have atleast two designated partners who are individuals and atleast one
of them should be a resident in India.

Provisions:

1. If the incorporation document-

a. Specifies who are to be designated partners, such persons should be
designated partners on incorporation
b. States that each of the partners from time to time of LLP is to be
designated partner, every such partner will be a designated partner
2. Any partner may become or cease to be a designated partner in accordance with the
LLP agreement.
3. Individual partner will not become a designated partner in any LLP unless he has
given his prior consent.
4. Every LLP should file with the registrar the particulars of every individual who has
given his consent to act as a designated partner within 30 days of his appointment.

Liabilities

a. Responsible for the doing of all acts, matters, and things as are required to be done
by the LLP in respect of compliance of the provisions of the Act
b. Liable for all penalties imposed on the LLP.

3. DISTINCTION BETWEEN ORDINARY PARTNERSHIP FIRM AND AN LLP

Key Elements Partnerships LLPs

1 Applicable Law Indian Partnership Act 1932 The Limited Liability
Partnerships Act, 2008
2 Registration Optional Compulsory with ROC
3 Creation Created by an Agreement Created by Law
4 Body No Yes
Corporate
5 Separate Legal No Yes
Entity
6 Perpetual Partnerships do not have It has perpetual succession
Succession perpetual succession and individual partners may
come and go
7 Number of Minimum 2 and Maximum 50 Minimum 2 but no maximum
Partners limit
8 Ownership of Firm cannot own any assets. The The LLP as an independent
Assets partners own the assets of the entity can own assets
firm

1FIN BY INDIGOLEARN 10.4

9 Liability of Unlimited: Partners are Limited to the extent of
Partners / severally and jointly liable for their contribution towards
Members actions of other partners and LLP except in case of
the firm and their liability intentional fraud or
extends to personal assets wrongful act of omission
or commission by a
partner.
10 Principal Agent Partners are the agents of the Partners are agents of the
Relationship firm and of each other firm only and not of other
partners
11 Mutual agency Each partner can bind the firm Each partner can bind the LLP
as well as other partners by his by his own acts but not the
own acts. other partners.
12 Designated There is no provision for such At least two designated
partners partners under the Partnership partners and atleast one of
Act 1932. them shall be a resident in
India.
13 Legal All partners are responsible for Only designated partners are
compliances all the compliances and responsible for all the
penalities under the Act compliances and penalities
under the Act.
14 Foreign Foreign nationals cannot Foreign nationals can become
partnership become a partner in a a partner in a LLP
partnership firm
15 Minor as Minor can be admitted to the Minor cannot be admitted to
partner benefits of the partnership the benefits of LLP.
with the prior consent of the
existing partners.
4. MAIN CLAUSES IN A PARTNERSHIP DEED

Name of the firm and the partners

Rate of interest to be allowed to each partner on his capital and

on his loan to the firm, and to be charged on his drawings

Commencement and duration of business

Amount of capital to be contributed by each partner

Whether a partner will be allowed to draw any salary

The ratio in which profits or losses are to be shared

Treatment of losses arising out of the insolvency of a partner

1FIN BY INDIGOLEARN 10.5

 Any variations in the mutual rights and duties of partners

Amount to be allowed to each partner as drawings and the

timings of such drawings

Method of valuing goodwill on the occasions of changes in the

constitution of the firm.
Procedure by which a partner may retire and the method of
payment of his dues
Basis of the determination of the executors of a deceased
partner and the method of payment

Procedure to be allowed for settlement of disputes among

partners

Preparation of accounts and their audit

 Special Points

Registration of a deed Non registration restricts

is not compulsory. the partners or firm from
taking any legal action.

Partnership act will

apply in case of no
partnership deed or the
deed is silent on any
point.

1FIN BY INDIGOLEARN 10.6

 Rules in the absence of Partnership Deed

No interest is to be allowed on capital

No interest is to be charged on the drawings

Profits and losses are to be shared equally

Interest at the rate of 6%.p.a is to be allowed on a partner’s loan to the firm

No partner has the right to a salary

In the absence of an agreement to the contrary, the interest and salary payable to a partner
will be paid only if there is profit.

5. MAIN CLAUSES IN A PARTNERSHIP DEED

 In case of a trading firm, the implied power of partners are the following

Receiving payments on
Engaging servants for the
Buying and selling of goods behalf of the firm and
business of the firm.
giving valid receipt.

Drawing cheques and

Borrowing money on behalf
drawing, accepting and
of the firm with or without
endorsing bills of exchange
pledging the inventories-in-
and promissory notes in the
trade.
name of the firm.

1FIN BY INDIGOLEARN 10.7

 In following cases , third parties cannot bind the firm unless all the partners have
agreed

Submitting a Compromise or
dispute relating to relinquishment of
any claim or portion
the firm arbitration
of claim by the firm
Withdrawal of a suit Opening a bank Acquisition of
or proceeding filed account on behalf immovable
on behalf of the of the firm in the property belonging
firm name of a partner to the firm
Admission of any
liability in a suit or Entering into
proceedings against partnership on
the firm behalf of the firm

6. ACCOUNTS
 Partnership Act doesn’t specify any format for preparation of accounts of Partnership Firm
 Capital Account
 May be, there are multiple capital account.
 Partner withdraw money which either can be debited to capital account or separately
debited to Drawing account.
 In a Trial Balance of a partnership firm, one may find Capital Accounts of partners as well as
Drawings Accounts.

7. PROFIT AND LOSS APPROPRIATION

Profit has to be divided between the partners in a certain profit sharing ratio after making
necessary adjustments stated in the partnership deed such as
1) Interest on capitals
2) Interest on Drawings and loans
3) Salaries or/and commission to partners

For above adjustments, there is an additional account is prepared known as Profit and Loss
Appropriation Account.

Credit Side Debit Side

1. Net profit of the 1 .Salary to the
company partners

2. Interest on Drawings 2. Interest on capital

1FIN BY INDIGOLEARN 10.8

 8. FIXED AND FLUCTUATING CAPITAL
There are two methods of accounting
1) Fixed capital method
2) Fluctuating capital method
 Fixed Capital Method
There are two accounts under this method
1) Capital account: Initial capital contributions by the partners are credited.
2) Current Account: subsequent transactions and events are dealt with through current
accounts.
Unless a decision is taken to change it, initial capital account balance is not changed.
 Fluctuating Capital method
 No current account is maintained. Only one account is maintained.
 All such transactions and events are passed through capital accounts.
 Capital account balance fluctuates all the time.
9. INTEREST ON CAPITAL

 A partner get interest on capital only if there is an agreement for it.

 Normally, interest on capital for full year on the balance of capital at the beginning of
the year.
 If any fresh capital introduced, then the interest for the relevant period of utilization
is calculated.
 If any permanent withdraw of capital then the interest for the relevant period of
utilization is calculated.
 In case of fixed capital accounts, interest is calculated on the balance of capital
accounts only and no interest is payable / chargeable on the balance of current
accounts.
 Subject to contract between the partners, interest on capitals is to be provided out of
profits only.
 In case of insufficient profits, the amount of profit is distributed in the ratio of capital
as partners get profit by way of interest on capital only.

 What is insufficient profit?

When the interest on capital is more than the net profit.

10. INTEREST ON DRAWINGS

 Interest will be charged according to the time that elapses between the taking
out of the money and the end of the year or till the time it was repaid whichever
is earlier.
 If the dates on which amounts are drawn are not given, then interest for six
months on the whole of the amount will be charged

1FIN BY INDIGOLEARN 10.9

 Withdrawals are made evenly in the Interest can be calculated on
beginning of each Month whole amount for 6.5 months
Withdrawals are made at the end Interest can be calculated on
of each month whole amount for 5.5 months
Withdrawals are mode at the Interest can be calculated on
beginning of each quarter whole amount for 7.5 months
Withdrawals are mode at the Interest can be calculated on
beginning of each quarter whole amount for 4.5 months

11. GUARANTEE OF MINIMUM PROFIT

 One partner can enjoy the right to have minimum amount of profit in a year as per the
terms of the partnership agreement.

 If share of partner (who has been guaranteed minimum profit) is more than the amount
of guarantee profit

Allocation of profit is done in a normal way

 If share of partner (who has been guaranteed minimum profit) is less than the amount of
guarantee profit

He takes minimum profit and the excess of guaranteed share of profit

over the actual share is borne by the remaining partners as per the
agreement.

 Deficiency can be share in following ways

• Excess is payable by one of the remaining partners.
• Excess is payable by at least two or all the partners in an agreed ratio.
• Excess is payable by remaining partners in their mutual profit sharing ratio.

 If question silent about the nature of guarantee

The burden of guarantee is borne by the remaining partners in their mutual profit
sharing ratio

1FIN BY INDIGOLEARN 10.10

12. CAPITAL RATIO – For sharing profits

 When capital is fixed: Profits will be shared in the ratio of given capitals
 Partners may agree to share profits and losses in the capital ratio.

When capital is fixed When capital is fluctuating

Profits will be shared in The capitals for the purpose of
the ratio of given ratio would be determined
capitals with reference to time on the
basis of weighted average
method

13. JOURNAL ENTRIES

PARTICULAR AMOUNT
1. Introduction of capital
Bank A/c Dr.

To Partner’s Capital A/c

2. Withdrawal of capital
Drawings A/c Dr.
To Bank A/c

3. Interest on Capital
Interest on capital A/c Dr.
To (Individual) Capital (or Current) Accounts
of Partners

4. Interest on Drawings
(Individual) Capital (or Current) Accounts of Partners A/c Dr.

To Interest on Drawings A/c

5. Salary to partners
Salary A/c Dr.
To (Individual) Capital (or Current) Accounts
of Partners

6. Sharing of profit

1FIN BY INDIGOLEARN 10.11

 Profit& Loss Appropriation A/c Dr.
To (Individual) Capital (or Current)
Accounts of Partners

7. In case of Loss
(Individual) Capital (or Current) Accounts of Partners Dr.
To Profit& Loss Appropriation A/c

Illustration 1 & 2
A and B start business on 1st January 2016, with capitals of Rs. 30,000 and Rs.20,000.
According to the Partnership Deed, B is entitled to salary of Rs.500 per month and interest is
to be allowed on capitals at 6% per annum. The remaining profits are to be distributed amongst
the partners in the ratio of 5:3. During 2016 the firm earned a profit, before charging salary to
B and interest on capital amounting to Rs.25,000. During the year A withdraw Rs.8,000 and B
withdrew Rs.10,000 for domestic purposes.
Give Journal entries relating to division of profit.

Illustration – 3
Ram, Rahim and Karim are partners in a firm. They have no agreement in respect of profit-
sharing ratio, interest on capital, interest on loan advanced by partners and remuneration
payable to partners. In a matter of Distribution of profits, they have put forward the following
claims:
i) Ram, who has contributed maximum capital demands interest on capital at 10% p.a.
and share of profit in the capital ratio. But Rahim and Karim do not agree
ii) Rahim has devoted full time for running the business and demands salary at the rate
of Rs.500 p.a. But Ram and Karim do not agree.
Karim demands interest on loan of Rs.2,000 advanced by him at the market rate of interest
which is 12% p.a.
How shall you settle the dispute and prepare Profit and Loss Appropriation after transferring
10% of the divisible profits to Reserve? Net profit before taking into account any of the above
claims amounted Rs.45,000 at the end of the first year of their business.

Illustration – 4
A and B start business on 1st January,2016 with capitals of Rs.30,000 and Rs.20,000. According
to the Partnership Deed, B is entitled to a salary of Rs. 500 per month and interest is to be
allowed on opening capitals at 6% per annum. The remaining profits are to be distributed
amongst the partners in the ratio of 5:3. During 2016, the firm earned a profit, before charging
salary to B and interest on capital amounting to Rs.25,000.
During the year A withdrew Rs.8,000 and B withdrew Rs.10,000 for domestic purposes. Prepare
Profit and Loss Appropriation Account.

Illustration 5
Prepare Partner’s capital account for Illustration – 4

1FIN BY INDIGOLEARN 10.12

Illustration – 6
A and B are partners sharing profits and losses in the ratio of their effective capital.
They had Rs.1,00,000 and Rs. 60,000 respectively in their Capital Accounts as on 1st January
2016. A introduced a further capital of Rs.10,000 on 1st April 2016 and another Rs.5,000on 1st
July 2016. On 30th September 2016 A withdrew Rs.40,000.
On 1st July 2016, B introduced further capital of Rs.30,000. The partners drew the following
amounts in anticipation of profit.
A drew Rs.1,000 per month at the end of each month beginning from January 2016.
B drew Rs.1,000 on 30th June and Rs.500 on 30th September 2016. 12% p.a. interest on capital is
allowed and 10% p.a. interest on drawings is chargeable.
Date of closing 31.12.2016.
Calculate:
 profit sharing ratio
 interest on capital and
 interest on drawings

Illustration 7
A and B were partners in a firm sharing profits and losses in the ratio of 3:2. They admit C for
1/6th share in profits and guaranteed that his share of profits will not be less than
Rs.2,50,00,000. Total profits of the firm for the year ended 31st March 2017 were Rs.9,00,000.
Calculate share of profits for each partner when:
1. Guarantee is given by firm
2. Guarantee is given by A
3. Guarantee is given by A and B equally

1FIN BY INDIGOLEARN 10.13

 Unit-2 Treatment of Goodwill

Necessity for Change in profit sharing ratio

valuation of
Admission of partner
goodwill
When business is dissolved or sold
Retirement or death of partner

Methods of Annuity basis

valuation of
Super profit
goodwill
Average Profit
Capitalization Basis

Goodwill

Goodwill is nothing more than the probability that old customer will resort to old
place again and again.
The capacity of a business to earn super profits in the future.

It is necessary that goodwill has some monetary or saleable vlaue

Goodwill is an intangible asset ; it cannot be seen; it cannot be felt; it cannot be

transported physically

 Why does Goodwill arise?

Due to
 Locational advantage
 Better customer service
 Possession of a unique patent right
 Personal reputation of the partner
 Quality of the goods sold.
 possession of near monopoly right
 Possession of trademarks and patents
 Presence of managerial skill.
 Cost of research and development.
 Possession of special contracts

 Recommendation of Accounting Standard

Accounting Standards require an enterprise to recognize an intangible asset, if

1FIN BY INDIGOLEARN 10.14

 • It means that it must have some value and must be
An intangible asset must have the clearly identifiable.
characteristics of an asset • It can be sold without disposing other assets or
future benefits flowing from other assets.

An intangible asset should be • Future probable economic benefits means it has a

recognized only if future probable capacity to increased revenue from sales.
economic benefits will flow to the • It means that management can make reasonable
business enterprise estimates of future benefits.

• The cost is objectively verifiable.

The cost of the intangible asset can • If the cost cannot be measured reliably, then it
be measured reliably cannot be recognized as an asset.

* Internally generated goodwill or inherent goodwill will not be recognise

Goodwill should be recorded in the books only when some consideration in money or money’ worth
has been paid for it. Only purchased goodwill should be recorded in the books of account.

In the event of reconstitution of the firm due to admission, or retirement or death of a

partner or even a change in the profit sharing ratio without reconstitution

 Goodwill of the firm is evaluated.

 The value of goodwill should not be brought into books of account because it is inherent or
self-generated goodwill since no money or money’ worth has been paid for it.
 The goodwill should be adjusted through capital accounts of the partner(s) of the firm.
 Goodwill account cannot be raised in the books of account, either on the reconstitution of
the firm or change in the profit sharing ratio.
 If goodwill account exists at the time of reconstitution of firm, It should be written off
immediately whether it is internally generated or goodwill has been bought for some
consideration.

2. METHOD FOR GOODWILL VALUATION

Three Methods
 Average profit basis,-Simple and Weighted.
 Super profit basis-Number of Year Purchase, Annuity basis, and Capitalization of Super
Profit.
 Capitalization basis- Average Profits.

1FIN BY INDIGOLEARN 10.15

 Average Profits Basis – Simple and weighted

 Average profit of past years can be calculated by using Simple average or weighted average
method.
 The no. of years for average profit and no. of years of purchase profit are decided on the
basis of judgment and negotiation.
 For averaging the past profit, either simple average or weighted average may be employed
depending upon the circumstances.

Weighted average profit : If there exists clear increasing or decreasing trend of profits.
Simple average profit : If there is no clear trend of profit.

 Super Profit Basis

 Goodwill is valued on the basis of super profits earned by the firm.

 Super profit can be calculated as follows:

Super Profit=Actual Profit-Normal Profit

Super Profit: Excess profit that can be earned by a firm over and above the normal profit
usually earned by similar firms under similar circumstances.

Actual Profit: Actual Profit is average profit

Normal Profit: Normal rate of Return (NRR) x Capital Employed

Why super profit can be use?

1) The partner who gains excess earning owing to reconstitution of firm should
compensate to partners sacrificing their share in the reconstitution.

2) The partner who gains in terms of profit sharing ratio has to contribute only for excess
profit because normal profit he can earn by joining any partnership firm.

1FIN BY INDIGOLEARN 10.16

Steps in calculation of Super profit

Identify the capital employed by the partnership

firm

Identify the average profit earned by the

partnership firm based on past few years’ figures

Determine normal rate of return prevailing in the

locality of similar firms

Apply normal rate of return on capital employed

to arrive at normal profit

Deduct normal profit from the average profit of

the firm. If the average profit of the firm is more
than the normal profit, there exists super profit
and goodwill.

How Goodwill calculate using Super Profit?

(a) Number of Years Purchase Method:

(i) Goodwill is generally valued by multiplying the amount of super profit
(ii) By certain number of years depending upon the expectation about the maintenance
of such profit in future.

(b) Annuity Method:

(i) Goodwill is valued by multiplying the amount of super profit of every year by the
discounting factor of every year and then adding them.
(ii) The major drawback of number of number of years purchase method is that time value
of money is not considered and in annuity method the time of value money considered.

(c) Capitalization Basis:

(i) Value of whole business is determined applying normal rate of return.

(ii) Value (arrived at by applying normal rate of return) is higher than the capital
employed in the business, then the difference is goodwill.

Steps :

1) Determine the normal rate of return.

2) Find out the average profit of the partnership firm for which goodwill is to be
determined.
3) Determine the capital employed by the partnership firm for which goodwill is to

1FIN BY INDIGOLEARN 10.17

 be determined.
4) Find out normal value of the business by dividing average profit by normal rate
of return.
5) Deduct average capital employed from the normal value of the business to arrive
at goodwill.

Goodwill = Normal Capital-Actual Capital

Normal capital = Average Profit/NRR

3. NEED FOR VALUATION OF GOODWILL

Whenever there is any change in the existing relationship of

the partners

Those who are sacrificing future profit should be compensated by

the others who are gaining.

Some partners have to sacrifice their future profit and some others
would gain.

The partners, who gain in terms of profit sharing ratio, have to

pay for such gain as a proportion to the value of goodwill.

The partners, who lose in terms of profit sharing ratio, receive

payments for the sacrifice as a proportion to the value of goodwill.

4. VALUATION OF GOODWILL IN CASE OF ADMISSION OF A PARTNER

When a new partner is admitted into a partnership

Certain adjustments in accounts become necessary

1FIN BY INDIGOLEARN 10.18

 Because the new partner will acquire a share in the profits of the
firm and because of this, the old partners will stand to lose.

For Example: A and B are partners sharing profits in the ratio of 3:2. C is admitted and given one
fourth share in profits.
1) If their profits are 20,000, A will get 12,000 and B will get 8,000.
2) C got 5000 and remaining 15000 will be divided between A and B.
3) A got 9000 and B got 6000.
4) Due to C’s admission, A loses 3,000 per year and B loses 2,000 per year.
5) C will have to compensate A and B for this loss.

 The above compensation is tackled through Goodwill. Compensation of goodwill is done in

profit sacrificing ratio.
 Kindly note that it is not necessary that the profit of the firm will remain 20000 after C’s
admission. Extra profits will arise and therefore, A and B will both get more than what they
previously got.
 The additional profits will be earned by the combined efforts of all the partners A, B and C
and hence no need that c compensate to A and B for extra profit in future.
As per the Accounting Standards, it is not recommended to raise goodwill account but to
show the adjustment of goodwill through partners’ capital accounts
5. ACCOUNTING TREATMENT OF GOODWILL

 Accounting Treatment of Goodwill in Case of Change in Profit Sharing Ratio

In case of change in profit sharing ratio, the value of goodwill should be determined and
preferably adjusted through capital accounts of the partners on the basis of profit
sacrificing ratio.

 Accounting Treatment of Goodwill in Case of Retirement or Death of a partner

 When a partner retired, the continuing partners will gain in terms of profit sharing ratio.
 They have to pay to retiring partner for his share of goodwill in the firm in the gaining
ratio.
 Similarly, in case of death of the partner, the continuing partners should bear the share
of goodwill due to the heirs of the deceased partner.

1FIN BY INDIGOLEARN 10.19

 Accounting treatment of Goodwill in case of Admission of a new partner

The goodwill should be recorded in the books

only when some consideration in money or
money’s worth as been paid for it.

only purchased goodwill should be recorded in

the books of the firm.

In case of admission of a partner, goodwill

cannot be raised in the books of the firm
because no consideration in money or money’s
worth is paid for it.

The adjustment of goodwill is done in Profit

Sacrificing ratio.

The profit sacrificing ratio is computed by

deducting the new profit sharing ratio from the
old profit sharing ratio. If differnece is positive
then it is a profit sacrifice and if it is negative
then it is profit gain.

Premium for The premium for goodwill shall be given in Profit sacrificing
goodwill ratio by crediting their respective partner capital or current
brought in account .
cash by new
partner
When no cash The goodwill adjusted through debiting the new partner capital
brought by account and crediting those partner's capital account who is
new partner going to sacrifice
for goodwill

When new No entry required.

partner pays
premium
privately. the amount to be paid to each partner should be calculated as
per the profit sacrificing ratio.

1FIN BY INDIGOLEARN 10.20

13. JOURNAL ENTRIES

PARTICULAR AMOUNT

Accounting treatment of Goodwill at the time of Admission

1. Premium for goodwill brought in cash by new partner

Bank A/c Dr.

To A Partner’s Capital A/c
To B Partner’s Capital A/c
(Goodwill adjustment in the profit sacrificing ratio)

2. When no cash brought by new partner for goodwill

C Partner’s Capital A/c Dr.(New partner)

To A Partner’s Capital A/c (old Partner)
To B Partner’s Capital A/c (old Partner)
(Adjustment for goodwill)

3. When new partner pays premium privately

No entry Required

Accounting treatment of Goodwill at the time of change in profit

sharing ratio
C Partner’s Capital A/c Dr. (gaining partner )
To A Partner’s Capital A/c (Sacrificing Partner)
To B Partner’s Capital A/c (Sacrificing Partner)
(Adjustment for goodwill)

Accounting Treatment of Goodwill in Case of Retirement or Death

of a partner

A Partner’s Capital A/c

B Partner’s Capital A/c
To C’s Partner Capital A/c

(C is going to retire and his share of goodwill adjusted to

existing partners’ capital accounts in profit gaining ratio)

1FIN BY INDIGOLEARN 10.21

Illustration – 1
Lee and Lawson are equal partnership. They agreed to take Hicks as one- fourth partner. For this
it was decided to find out the value of goodwill. M/s. Lee and Lawson earned profits during 2013-
2016 as follows:
Year Profits
2013 1,20,000
2014 1,25,000
2015 1,30,000
2016 1,50,000
On 31.12.2016 capital employed by M/s. Lee and Lawson was Rs.5,00,000. Rate of normal profit id
20%. Find out the value of goodwill following various methods.

Illustration – 2

The following particulars are available in respect of the business carried on by Rathore
S.No. Particulars Rs.
1) Capital invested 1,50,000
2) Trading Results
2013 profit 40,000
2014 profit 36,000
2015 loss 6,000
2016 profit 50,000
3) Market Rate of interest on investment 10%
4) Rate of risk return on capital invested in business
2%
5) Remuneration from alternative
Employment of the proprietor Rs.6,000 per annum
(if not engaged in business)

You are required to compute the value of goodwill on the basis of 5 years purchase of super profit
of the business calculated on the average profits of the last four years.

Illustration – 3

The following is the balance Sheet of Yellow and Green as at 31st December 2016:
Liabilities Rs. Assets Rs.
Trade payables 20,000 Cash at Bank 10,000
Capital: Sundry Assets 55,000
Yellow 25,000
Green

1FIN BY INDIGOLEARN 10.22

 20,000 65,000
65,000

The partners shared profits and losses in the ratio 3:2. On the above date, Black was admitted as
partner on the condition that he would pay Rs.20,000 as capital.
Goodwill was to be valued at 3 years purchase of the average of four years profits which were:
Rs. Rs.
2012 9,000 2014 12,000
2013 14,000 2105 13,000

The new profit-sharing ratio is 6:5:5.

Give journal entries and Balance Sheet if goodwill is adjusted through partner’s capital accounts.

Illustration – 4

With the information given in illustration 3, give Journal Entries assuming that goodwill is brought
in cash.

Illustration – 5

With the information given in illustration 3, assuming that goodwill is paid privately.

Illustration – 6

A, B and C are equal partners. They wanted to change the profit-sharing ratio into 4:3:2. Make the
necessary journal entries. Goodwill of the firm is valued at Rs.90,000.

Illustration – 7

A, B and C are partners sharing profits and losses in the ratio of 4:3:3.
They decided to change the profit-sharing ratio to 7:7:6. Goodwill of the firm is valued at
Rs.20,000. Calculate the sacrifice/gain by the partners and make necessary journal entry.

1FIN BY INDIGOLEARN 10.23

 Unit -3 Admission of Partner

Revaluation Account or Profit and

Loss Adjustment Account for revaluation of assets and liabilities
Adjustment of goodwill amongst the old partners in their sacrificing ratio

Reserves lying in the balance sheet transferred to the capital accounts of old partners
in their old profit sharing ratio.

Profit/loss on revaluation account is ts/f to old partners in their old profit sharing ratio

INTRODUCTION

 Reason for admitting New Partner

o For increasing the partnership capital.
o For strengthening the management of the firm.

 Effects for admitting New partner

o Desirable to bring all appreciation or reduction in the value of assets into accounts as on
the date of admission.
o Liabilities recorded, if not recorded.
o Liabilities written off, if not required to be paid.
o All profits which have accrued but not yet brought into books should be record.
o All losses which have occurred but not recorded should be recorded.
o The value of goodwill is to be assessed and proper accounting treatment is required to
bring the value of goodwill into books of accounts.

The purpose of such entries is to make an updated Balance Sheet on the date of admission.
REVLAUATION ACCOUNT OR PROFIT AND LOSS ADJUSTMENT ACCOUNT
 Revaluation Account
o Revaluation account is debited with all reduction in the value of assets and increase in
liabilities.
o Credited with increase in the value of assets and decrease in the value of liabilities.
o The difference in two sides of the account will show profit or loss.
o This is transferred to the Capital Accounts of old partners in the old profit sharing ratio.

 Why Revaluation?
When a new partner is admitted into the partnership, assets are revalued and liabilities are
reassessed.
 Memorandum Revaluation Account
Memorandum Revaluation Account prepared when all the partners including the new partner
may agree to keep the assets and liabilities at the old values even when they agree to revalue
them.
Memorandum Revaluation Account has two parts

1FIN BY INDIGOLEARN 10.24

 First Part
1. Entries for the revaluation of assets and liabilities are made in the usual
way as made in case of revaluation account.
2. No record for the revaluation of assets and liabilities is made through the
respective ledger accounts.
3. The resultant profit or loss on revaluation in the first part of this account is
transferred to the capital accounts of old partners only in the old profit and
loss sharing ratio.
Second Part
1.Entries made in the first part of Memorandum Revaluation Account are
reversed in the second part so that the values of the assets and liabilities
remain unchanged.
2.The balance of the second part is transferred to the capital accounts of all
the partners including new partner in their new profit and loss sharing ratio.

Special Points
1. If there is a profit in the first part there will be a loss of the same amount in the second
part and vice versa.

2. The result of the first part of Memorandum Revaluation Account is shared by old partners
in the old profit sharing ratio, while the result of the second part is shared by all partners
including the new one in the new profit sharing ratio.

Difference between Revaluation Account and Memorandum Revaluation Account

Basis Revaluation Account Memorandum Revaluation

Account

Asset and Liabilities Assets and liabilities appear Assets and liabilities appear
in the new balance sheet at in the new balance sheet at
the new or revalued figures. the old figures.

No. of parts Revaluation account is not Memorandum revaluation

divided into two parts. account has two parts: first
part for old partners and
second part for all partners
including the new partner.

1FIN BY INDIGOLEARN 10.25

 Sharing of Net results transferred to old partners’ The balance of the first part
capital accounts in the old is transferred to old
profit sharing ratio partner’s capital accounts in
the old profit sharing ratio
while the balance of the
second part is transferred to
all partners including the new
partner in the new profit
sharing ratio.

COMPUTATION OF NEW PROFIT SHARING RATIO

When new It is assumed that the old partner will share the remaining share in their
partner’s share is old profit sharing ratio.
given but the
question is silent
about the
sacrifice made
by the old
partners

When new The new ratio of the old partners will be calculated by deducted the
partner proportion given to the new partner from the shares of old partner.
purchases his
share from old
partner’s in a
particular ratio

When the old Determine the share surrendered by the old partners.
partners
surrender a Find the new share of the old partners by deducting share surrendered
particular from their old share.
fraction of their
share in favour Calculate share of the new partner by taking the sum of surrendered
of new partner share of old partners.
Calculate the new ratio.

When the new The sacrificing partner share is calculated by deducting his sacrifice from
partner acquires his old share.
his share entirely
from any one of
partner only

When the new The sacrifice of each partner is deducted from their old shares.
partner acquires
his share from
the old partners
in the certain
ratio

1FIN BY INDIGOLEARN 10.26

 Some Useful terms

1. Sacrificing Partner : The partners whose shares have decreased as a result of change are
known as sacrificing partners.

2. Sacrificing Ratio : Ratio in which the old partners sacrifice their share in favor of
new Partner is called sacrificing ratio.

Sacrificing ratio = Old Profit sharing ratio - New Profit sharing ratio

3. Gaining Partners : The partners whose shares have increased as a result of change are
known as gaining partners.

4. Gaining Ratio: The ratio in which the partners have agreed to gain their shares in profit
from the other partner or partners, is known as gaining ratio.
Gaining Ratio = New Profit sharing ratio - Old Profit sharing ratio

HIDDEN GOODWILL
When the value of the goodwill of the firm is not specifically given, the value of goodwill has to be
inferred

Particulars `
Incoming partner’s capital x Reciprocal of share of incoming partner xxx
Less: Total capital after taking into consideration the capital xxx
brought in by incoming partner
Value of Goodwill xxx

JOURNAL ENTRIES

PARTICULAR Amt Remarks

Accounting treatment of Revaluation of assets and

liabilities through Revaluation Account
a. Revaluation A/c Dr. With the reduction in the value
To Assets A/c of the assets

(individually which show a decrease)

b. Revaluation A/c Dr. With the increase in the

To Liabilities A/c liabilities.
(Individually which have to be
increased)

c. Assets A/c Dr. With the increase in the value

To Revaluation A/c of the of assets.

1FIN BY INDIGOLEARN 10.27

 (Individually which have to be
increased)

d. Liabilities A/c Dr. With the reduction in the

To Revaluation A/c amount liabilities.
(individually which show a decrease)

e. Revaluation A/c Dr. With the profit in the old profit

To Capital A/c of the old partners sharing ratio.

( Sharing of Revaluation Profit)

with the loss in old profit
Capital A/c of the old partners Dr. sharing ratio

To Revaluation A/c
( Sharing of Revaluation Loss)

Accounting treatment of Revaluation of assets and

liabilities through Memorandum Revaluation Account(
Part – 1)

A) Assets A/c Dr. with increase in the value of

individual assets
Liabilities A/c Dr. With decrease in the value of
individual liabilities
To Memorandum Revaluation A/c

B) Memorandum Revaluation A/c Dr.

To Assets A/c with increase in the value of
individual assets
To Liabilities A/c with decrease in the value of
individual liabilities

Memorandum Revaluation A/c Dr If there is profit on

To Old Partners’ Capital A/c revaluation.

Old Partners’ Capital A/C Dr. If there is loss on revaluation.

To Memorandum Revaluation
A/c

1FIN BY INDIGOLEARN 10.28

Accounting treatment of Revaluation of assets and
liabilities through Memorandum Revaluation Account(
Part – 2)

REVERSE ENTRIES OF PART 1 (A &B)

Memorandum Revolution A/c Dr. (New profit and loss sharing

To All Partners’ Capital A/c ratio)
(If there is Profit )

All Partners’ Capital A/c Dr. (New profit and loss sharing
To Memorandum Revaluation A/c ratio)
(If there is loss)

Reserves or Profit & Loss A/c Dr. In the old profit sharing ratio
To Old Partners’ Capital A/c
(Any reserve etc. lying in the Balance
Sheet transferred to the Capital Accounts of the
old partners)

C’s Capital A/c ( Gaining Partner) In case of Hidden Goodwill

To A’s Capital A/c ( Sacrificing
Partner)
To B’s Capital A/c ( Sacrificing
Partner)
(Being the share of C in the hidden goodwill
adjusted through capital accounts by crediting
sacrificing partners in their sacrificing ratio)

Illustration 1
The following is the Balance Sheet of Ram and Mohan, who share Profit in the ratio of 3:2 as on 1st
January 2016:
Liabilities Rs. Assets Rs.
Trade Payables 15,000 Buildings 18,000
Ram’s Capital 20,000 Plant and Machinery 15,000
Mohan’s Capital 25,000 Inventories 12,000
Trade Receivables 10,000
Bank 5,000
60,000 60,000

On this date Shyam was Admitted on the following:

1. He is to pay Rs.25,000as his capital and Rs.10,000as his share of goodwill for one fifth
share in profits.
2. The new profits sharing ratio will be 5:3:2
3. The assets are to be revalued as under:

1FIN BY INDIGOLEARN 10.29

 Rs.
Building 25,000
Machinery 12,000
Inventories 12,000
Trade receivables (Because of Doubtful debts) 9,500

4. It was found that there was a Lability for Rs.1,500 for goods received but not recorded in
books.
Give journal entries to record the above. Also, give the Balance Sheet of the partnership firm after
Shyam’s admission.

Illustration 2
A and B are partners sharing profits and losses in the ratio of 3:2. The Balance Sheet as on
31.3.2016 is given below:
Liabilities Rs. Assets Rs.
Trade Payables 50,000 Freehold premises 2,00,000
Capital A/c Plant 40,000
A 2,00,000 Furniture 20,000
B 1,00,000 Office equipment 25,000
Inventories 30,000
Trade Receivables 25,000
Bank 10,000
3,50,000 3,50,000

On 1.4.2016 they admit C on the following terms:

1. C will bring Rs.50,000 as a capital and Rs.10,000 for goodwill for 1/5 share;
2. Provision for doubtful debts is to be made on trade receivables @2%
3. Inventory to written down by 10%
4. Freehold premises are to be revalued at Rs.2,40,000, plant at Rs.35,000 furniture
Rs.25,000 and office equipment Rs.27,500.
5. Partners agreed that the values of the assets and liabilities remain the same and as such,
there should not be any change in the book values as a result of the above-mentioned
adjustments.

You are required to make necessary adjustments in the capital Accounts of the partners and show
the Balance Sheet of the New Firm.

Illustration 3
Dalal, Banerji and Mallick are partners in a firm sharing profits and losses in the ratio 2:2:1. Their
Balance Sheet as on 31st March 2016 is as below:

1FIN BY INDIGOLEARN 10.30

 Liabilities Rs. Assets Rs.
Trade payables 12,850 Land and Buildings 25,000
Outstanding Liabilities 1,500 Furniture 6,500
General Reserves 6,500 Inventory of goods 11,750
Capital Account: Trade receivables 5,500
Mr. Dalal – 12,000 Cash in Hand 140
Mr. Banerji – 12,000 Cash at Bank 960
Mr. Mallick - 5,000 29,000

49850 49850

The partners have agreed to take Mr. Mistri as a partner with effect from 1st April 2016 on the
following terms:

1. Mr. Mistri shall bring Rs.5,000 towards his capital.

2. The value of Inventory should be increased by Rs.2,500 and furniture should be
depreciated by 10%.
3. Reserves for bad and doubtful debts should be provided at 10% of the Trade receivables.
4. The value of land and buildings should be enhanced by 20% and the value of the goodwill be
fixed at Rs.15,000.
5. The value of the goodwill be fixed at Rs.15,000.
6. General Reserve will be transferred to the partner’s Capital Accounts.
7. The new profit- sharing ratio shall be: Mr. Dalal 5/15, Mr. Banerji 3/15, and Mr. Mistri
2/15.
The outstanding liabilities include Rs.1,000 due to Mr. Sen which has been paid by Mr. Dalal.
Necessary entries were not made in the books.

Prepare i) Revaluation Account, ii) The Capital Accounts of the partners, iii) Balance Sheet of the
firm after admission of Mr. Mistri

Illustration 4
A and B are in a partnership sharing profits and losses in the proportion of three- fourth
respectively. Their Balance Sheet as on 31st March 2016 was as follows:

Cash Rs.1,000: trade receivable Rs.25,000; inventory Rs.22,000; plant and machinery Rs.4,000;
trade payables Rs.12,000; bank overdraft Rs.15,000; A’s Capital Rs.15,000; B’s Capital Rs.10,000.

1. C to purchase one-third of the goodwill for Rs.20,000 and provide Rs.10,000 as capital.
Goodwill not to appear in books.
2. Further profits and losses are to share by A B and C equally.
3. Plant and machinery is to be reduced by 10% and Rs.500 is to provide for estimated bad
debts. Inventory is to be taken at a valuation of Rs.24,940.
4. By brining in or withdrawing cash and capitals of A and B are to be made proportionate to
that of C on their profit-sharing basis.

1FIN BY INDIGOLEARN 10.31

Set out entries to the above arrangement in the firm’s journal and give the partners’capital accounts
in tabular from.

Illustration 5
A and B are partners of X & Co. sharing profits and losses in 3:2 ratio between themselves. On 31st
March 2016, the Balance Sheet of the firm was as follows:

Liabilities Rs. Assets Rs.

Capital A/cs: Plant and Machinery 20,000
A:37,000 Furniture and Fittings 5,000
B:28,000 65,000 Inventories 15,000
Trade Receivables 20,000
Trade Payables 5,000 Cash in Hand 10,000

70,000 70,000
X agrees to join the business on the following conditions as and from 1.4.2016:
a. He will introduce Rs.25,000 as his capital and pay Rs.15,000 to the partners as premium for
goodwill for 1/3rd share of the future profits of the firm.
b. A revaluation of assets of the firm will be made by reducing the value of plant and
machinery to Rs.15,000, inventory by 10%, furniture and fittings by Rs.1,000 and by making a
provision of bad and doubtful debts at Rs.750 on trade receivables.
Prepare profit and losses adjustment account, capital accounts of partners including partner X
assuming that the relative ratios of the old partners will be in equal proportion after admission.

Illustration 6

A and B are in partnership sharing profits and losses equally. The Balance Sheet M/s. A and B as on
31.12.2016, was as follows:

Liabilities Rs. Assets Rs.

Capital A/cs: Sundry fixed assets 60,000
A 45,000 Inventories 30,000
B 45,000 Bank 20,000

Trade Payables 20,000

1,10,000 1,10,000

On 1.1.2017 they agreed to take C as 1/3rd partner to increase the capital base to Rs.1,35,000. C
agrees to pay Rs.60,000. Show the necessary journal entries and prepare partner’s capital accounts.

1FIN BY INDIGOLEARN 10.32

 Unit-4 Retirement of Partner

When a partner retires from a firm, the treatment of various items like revaluation of assets,
goodwill treatment, sacrifice/gain ratio, reserves etc., are similar to that of admission of a partner
into a partnership firm. The only additional treatment which is required is to settle the amount due
to outgoing partner.
Important Points:
1. The revaluation gain/loss belongs to all the partners (before retirement) and is distributed
in existing profit sharing ratio.
2. The reserves are distributed to all partners in existing profit sharing ratio.
3. The goodwill is adjusted on the basis of gain ratio or sacrifice ratio. (Can be done using
table adjustment)
4. The settlement to partner is done based on agreement between partners as discussed
below.

Settlement
1. The final amount standing to the credit of capital account may be paid in full to the retiring
partner.
Retiring Partner Capital A/c … Dr.
To Bank A/c
2. If the amount is not settled in full, the balance amount is transferred to loan account.

Retiring Partner Capital A/c … Dr.

To Bank A/c
To Retiring Partner’s Loan A/c
The loan is repaid as per the terms of retirement and entries will be passed accordingly.

Joint Life Policy

 A partnership firm may decide to take a Joint Life Insurance Policy on the lives of all
partners.
 The firm pays the premium and the amount of policy is payable to the firm on the death of
any partner or on the maturity of policy whichever is earlier.
 The objective of taking such a policy is to minimize the financial hardships to the event of
payment of a large sum to the legal representatives of a deceased partner or to the retiring
partner.

Accounting
Treatment

Expense Asset Reserve

1FIN BY INDIGOLEARN 10.33

 1. When JLP is treated as expense
Payment of JLP premium JLP Premium A/c Dr.
To Bank A/c
Transfer of JLP to P&L Profit & Loss A/c Dr.
To JLP Premium A/c
On Maturity of Policy Bank A/c Dr.
To Partners Capital A/c (in PSR)

2. When JLP is treated as Asset

Payment of JLP premium Joint Life Policy A/c Dr.
To Bank A/c
Year End – Check with Surrender Value Profit & Loss A/c Dr.
Loss = JLP Balance – Surrender Value To Joint Life Policy A/c
On Maturity of Policy Bank A/c Dr.
To Joint Life Policy A/c
To Partner’s Capital A/c (In case of gain)

3. Creation of JLP Reserve

Payment of JLP premium Joint Life Policy A/c Dr.
To Bank A/c
Year End Profit & Loss Appropriation A/c Dr.
Creation of Reserve To JLP Reserve A/c
Year End – Check with Surrender Value JLP Reserve Dr.
Loss = JLP Balance – Surrender Value To Joint Life Policy A/c
On Maturity of Policy JLP Reserve A/c
To Joint Life Policy A/c
Balance in JLP A/c Transferred to Partners

Joint Life Policy – Individual

 All the partners may take individual life policies for each of them by paying the premium
from the firm.
 In the event of retirement, the retired partner is entitled for the surrender value of the
life policies of all the partners.

1FIN BY INDIGOLEARN 10.34

 Right in subsequent profits

If account of retiring
partner is not settled

Business is continued by
remaining partners

Share in profits
Interest @6% per annum
attributable to his
on his share
property in partnership

Retirement of Partner
Illustration 1
F, G and K were partners sharing profits and losses at the 2:2:1. K wants to retire on 31.12.2015.
given below is the Balance Sheet of the Partnership as well as other information:
Balance Sheet as on 31.12.2015
Liabilities Rs. Assets Rs.
Capital A/cs: Sundry Fixed Assets 1,50,000
F 1,20,000 Inventories 50,000
K 80,000 Trade Receivables 70,000
G 60,000 (including Bills
Receivables Rs.20,000)
Reserves 10,000 Bank 50,000
Trade Payables 50,000

3,20,000 3,20,000

F and G agrees to share profits and losses at the ratio of 3:2 in future. Value of Goodwill is taken
to be Rs.50,000. Sundry fixed Assets are revalued upward by Rs.30,000 and inventories by
Rs.10,000. Bills Receivable dishonoured Rs.5,000 on 31.12.2015 but not recorded in the books.
Dishonour of bill was due to insolvency of the customer. F and G agree to bring sufficient cash to
discharge claim of K and to make their capital proportionate. Also, they wanted to maintain Rs.
75,000 bank balance for working capital.
Required:
Pass necessary journal entries and draft the balance Sheet of M/s F & G. Also prepare capital
accounts of partners and the Balance Sheet of M/s F& G after K’s retirement.

1FIN BY INDIGOLEARN 10.35

 Illustration 2
K, L & M are partners- sharing profits and losses in the ratio 5:3:2. Due to illness, L wanted to
retire from the firm on 31.12.2015 and admit his son N in his place.

Balance Sheet of K, L and M as on 31.3.2015

Liabilities Rs. Assets Rs.
Capital A/cs: Goodwill 30,000
F: 40,000 Furniture 20,000
K: 60,000 Trade receivables 50,000
G: 30,000 1,30,000 Inventory in trade 50,000
Cash and bank balance 50,000
Reserves 50,000
Trade Payables 20,000

2,00,000 2,00,000

On the retirement of L assets were revalued: Goodwill Rs.50,000, furniture Rs.10,000 and
inventory in trade Rs.30,000. 50% of the amount due to L was paid off in cash and the balance was
retained in the firm as capital of N. On admission of the new partner, goodwill has been written
off. M is paid off his extra balance to make capital proportionate.

You are required to give:

i. Necessary journal entries
ii. Balance Sheet of M/s K, M and N
Capital Accounts of partners

Illustration 3
Dowell & Co. is a partnership firm with partners Mr. A, Mr. B and Mr. C, sharing profits and losses
in the ratio of 10:6:4. The Balance Sheet of the firm as at 31st March 2015 is as under:

Liabilities Rs. Assets Rs.

Capital A/cs: Land 10,000
Mr. A:80,000 Buildings 2,00,000
Mr. B:20,000 Plant and Machinery 1,30,000
Mr. C: 30,000 1,30,000 Furniture 43,000
Reserves Investment 12,000
(inappropriate profit) 50,000 Inventories 1,30,000
Long term Debt 3,00,000 Trade Receivables 1,39,000
Bank O/D 44,000
Trade Payables 1,70,000

6,64,000 6,64,000

1FIN BY INDIGOLEARN 10.36

It was mutually agreed that Mr. B will retire from the partnership and in his place Mr. D will be
admitted as a partner with effect from 1st April 2015. For this purpose, the following adjustments
are to be made:
a. Goodwill is to be valued at 1 lakh but the same will not appear as an asset in the books of
the reconstituted firm.
b. Building and plant and machinery are to be depreciated by 5% and 20% respectively.
Investments are to be taken over by the retiring partner at Rs.15,000. Provision of 20% is to
be made on trade receivables to cover doubtful debts.
c. In the reconstituted firm, the total capital will be Rs.2 lakhs which will be contributed by
Mr. A, Mr.C and Mr. D in their new profit- sharing ratio, which is 2:2:1.
1. The surplus funds, if any will be used for repaying bank O/D.
2. The amount due to retiring partner shall be transferred to his loan account.
Required:
Prepare i) Revaluation account
ii) Partners capital accounts:
iii)Bank account and
iv)Balance Sheet of the reconstituted firm as on 1st April 2015.
Illustration 4
Red, White and Black shared profits and losses in the ratio of 5:3:2. They took out a joint life
policy in 2011 for Rs.50,000, a premium of Rs.3,000 being paid annually on the 10th June.
The surrender value of the policy on 31st December of various years was as follows: 2011 nil;
2012 Rs.900;
2013 Rs.2,000;
2014 Rs.3,600.
Black retires on 15th April 2015.
Required
Prepare ledger accounts assuming no Joint Life Policy Account is Maintained.

Illustration 5

A, B and C are in partnership sharing profits and losses at the ratio of 5:3:2. The balance sheet of
the firm on 31.12.2015 was as follows:
Balance Sheet
Liabilities Rs. Assets Rs.
Capital A/cs : Sundry Fixed Assets 80,000
A 50,000 Inventories 50,000
B 40,000 Trade receivables 30,000
C 30,000 Joint Life Policy 20,000
Bank loan 40,000 Bank 10,000
Trade payables 30,000
1,90,000 1,90,000
On 1.1.2016 A wants to retire B and C agreed to continue at 2:1. Joint Life Policy was taken on
1.1.2010 for Rs.1,00,000 and its surrender value as on 31.12.2015 was Rs.25,000.
For the purpose of A’s retirement goodwill was raised for Rs.1,00,000.
Sundry Fixed Assets was revalued for Rs.1,10,000. But B and C did not prefer to show such
increase in assets in the Balance Sheet.
Also, they agreed to bring necessary cash to discharge 50% of the A’s claim, to make the bank
balance Rs25,000and to make their capital proportionate.

1FIN BY INDIGOLEARN 10.37

Required:
Prepare necessary journal entries.

Illustration 6

A, B & C were in partnership sharing profits in the proportions of 5:4:3. The balance sheet of the
firm as on 31st March 2015 was as under:
Liabilities Amount Assets Amount
(Rs) (Rs)
Capital accounts: Goodwill 40,000
A 1,35,930 Fixtures 8,200
B 95,120 Inventories 1,57,300
C 61,170 Trade receivables 93,500
Trade payables 41,690 Cash 34,910
3,33,910 3,33,910
A had been suffering from ill-health and gave notice that he wished to retire. An agreement was,
therefore, entered as on 31st March 2015, the terms of which were as follows:
1. The profit and loss account for the year ended 31st March 2015 which showed a net profit
of Rs 48,000 was to be re-opened. B was to be credited with Rs 4,000 as bonus, in
consideration of the extra work which had devolved upon him during the year. The profit
sharing was to be revised as from 1st April 2014 as 3:4:4
2. Goodwill was to be valued at two years’ purchase of the average profits of the preceding
five years. The fixtures were to be valued by an independent valuer. A provision of 2% was to
be made for doubtful debts and the remaining assets were to be taken at their book values.
The valuations arising out of the above agreement were goodwill Rs 56,800 and fixtures Rs
10,980.
B and C agreed, as between themselves, to continue the business, sharing profits in the ratio of
3:2 and decided to eliminate goodwill from the balance sheet, to retain the fixtures on the books
at the revised value, and to increase the provision for doubtful debts to 6%.
You are required to submit the journal entries necessary to give effect to the above arrangements
and to draw up the capital account of the partners after carrying out all adjusting entries as
stated above.

Illustration 7
K, L & M are partners sharing profits and losses in the ratio 5:3:2
 Due to illness, L wanted to retire from the firm on 31.03.2015 and admit his son N in his
place

Balance Sheet of K, L and M as on 31.3.2015

Liabilities Amount Amount Assets Amount (Rs.)
(Rs.) (Rs.)
Capital Goodwill 30,000
K 40,000 Furniture 20,000
L 60,000
M 30,000 Trade Receivables 50,000
1,30,000

1FIN BY INDIGOLEARN 10.38

Reserve 50,000 Inventory in Trade 50,000
Trade Payable 20,000
Cash and Bank 50,000
Balances

2,00,000 2,00,000

On Retirement of L assets were revalued –

 Goodwill Rs. 50,000
 Furniture Rs. 10,000
 Inventory in Trade Rs. 30,000
 50% of the amount due to L was paid off in cash and the balance was retained in the firm as
capital of N
On admission of the new partner, goodwill has been written off
M is paid off his extra balance to make capital proportionate
Required
i. Necessary journal entries
ii. Balance sheet of M/s K, M and N as on 01.04.2015
Capital accounts of partners.

1FIN BY INDIGOLEARN 10.39

 Unit-5 Death of a Partner

The problems arising on the death of a partner are similar to those arising on retirement
Important Points:
 The revaluation gain/loss belongs to all the partners and is distributed in existing profit
sharing ratio.
 The reserves are distributed to all partners in existing profit sharing ratio.
 The goodwill is adjusted on the basis of gain ratio or sacrifice ratio. (Can be done using
table adjustment)
 The treatment of Joint Life Policy would be different as the firm would receive the sum
assured on the policy.
 The amount due to the deceased partner would be paid to the legal heirs.
 Business may be continued by other partners (also known as reconstitution of partnership)
Right in subsequent profits

If account of deceased
partner is not settled

Business is continued
by remaining partners

Share in profits
attributable to his Interest @6% per
property in annum on his share
partnership

Amount payable to legal representatives

1. The amount standing to the credit to the capital account of the deceased partner
2. Interest on capital, if provided in the partnership deed up to the date of death
3. Share of goodwill of the firm;
4. Share of undistributed profit or reserves;
5. Share of profit on the revaluation of assets and liabilities;
6. Share of profit up to the date of death;
7. Share of Joint Life Policy.
8. Share in profits after death if account is not settled

The following amounts will be deducted

1. Drawings
2. Interest on drawings

1FIN BY INDIGOLEARN 10.40

 3. Share of loss on revaluation of assets and liabilities
4. Share of loss up to the date of death
Settlement
3. The final amount standing to the credit of capital account may be paid in full to the retiring
partner.
Retiring Partner Capital A/c … Dr.
To Bank A/c
4. If the amount is not settled in full, the balance amount is transferred to loan account.
Retiring Partner Capital A/c … Dr.
To Bank A/c
To Retiring Partner’s Loan A/c
The loan is repaid as per the terms of retirement and entries will be passed accordingly.
Calculation of profits up to the death of a partner
 Profit is calculated through P&L Suspense account.
 Amount due to the deceased partner, it should be credited to his Executor’s Account.
 The representatives of the deceased partner are entitled to his/her share of profits
earned till the date of his/her death

Ascertainment of
Profits

Time Basis Turnover/Sales Basis

Profit is assumed to
Assumed that profit is have been earned on
earned evenly the basis of
throughout the year profitability of previous
year

Joint Life Policy

 The firm will receive the sum assured on joint life policy
 The gain on joint life policy will be credited to the partners in profit sharing ratio
 The joint life policy reserve will be credited to the partners in profit sharing ratio

Entry at time of receipt of amount from Joint Life Policy

Bank A/c Dr.
To Joint Life Policy A/c

Entry to transfer gain on Joint Life Policy (balance in JLP)

1FIN BY INDIGOLEARN 10.41

 Joint Life Policy A/c Dr. (Balance Figure)
To Partner’s capital A/c (PSR)

Entry to transfer Joint Life Policy (JLP) reserve

Joint Life Policy Reserve A/c

To Partner’s Capital A/c (PSR)
Joint Life Policy – Separate Policy
If the firm has taken separate policy for each partner, then at the time of death of partner,
 The firm will receive sum assured on the policy of deceased partner
 The policy of other partners will be valued at surrender value.
Any gain on account of above will be credited to the continuing partners and executor (legal
representative)
Bank A/c Dr.
To Separate Life Policy of Deceased partner A/c

(Policy value received on death of a partner)

Separate Life Policy of Deceased Partner A/c Dr. (Sum Assured)

Separate Life Policy of Remaining Partners A/c Dr. (Surrender Value)
To Executor’s A/c
To Remaining partners A/c
(Distribution of balances)

Illustration 1
The following was the Balance Sheet of Om & Co. in which X, Y, Z were partners sharing profits
and losses in the ratio of 1:2:2 as on 31.3.2016. Mr. Z died on 31st December 2016. His account has
to be settled under the following terms.
Balance Sheet of Om & Co. as on 31.3.2016
Liabilities Rs. Assets Rs.
Trade payables 20,000 Goodwill 30,000
Bank Loan 50,000 Building 1,20,000
General reserve 30,000 Computers 80,000
Capital accounts: Inventories 20,000
X: 40,000 Trade receivables 20,000
Y: 80,000 Cash at bank 20,000
Z:80,000 2,00,000 Investments 10,000

3,00,000 3,00,000
Goodwill is to be calculated at the rate of two years purchase on the basis of average of three
years profits and losses. The profits and losses for three years were detailed as below:
Year ending on Profits/loss
31.3.2016 30,000
31.3.2015 20,000
31.3.2014 (10,000) loss
Profit for the period from 1.4.2016 to 31.12.2016 shall be ascertained proportionately on the basis
of average profits and losses of the preceding three years. During the year ending on 31.3.2016 a

1FIN BY INDIGOLEARN 10.42

car costing Rs.40,000 was purchased on 1.4.2015 and debited to traveling expenses account on
which depreciation is to be calculated at 20% p.a. this asset is to be brought into account at the
depreciated value.
Other values of assets were agreed as follows:
Inventory at Rs.16,000, Building at Rs.1,40,000, Computers at Rs. 50,00; investments at Rs.6,000.
Trade receivables were considered good.
Required
i. Calculate goodwill and Z’s share in the profits of the firm for the period 1.4.2016 to
31.12.2016
ii. Prepare revaluation account assuming that other items of assets and liabilities remained the
same
Prepare partners’ capital accounts and balance sheet of the firm Om & Co. as on 31.12.2016.

Illustration 2

The partnership agreement of a firm consisting of three partners- A, B and C (who share profits in
proportion of ½ ¼ and ¼ and whose fixed capitals are Rs.10,000; Rs.6,000 and Rs.4,000
respectively) provides as follows:
a. That partners be allowed interest at 10 per cent per annum on their fixed capitals, but no
interest be allowed on undrawn profits or charged drawings.
b. That upon the death of a partner, the goodwill of the firm be valued at two years’ purchase
of the average net profits (after charging interest on capital) for the three years to 31st
December preceding the death of a partner.
That an insurance policy of Rs.10,000 each to be taken in individual names of each partner, the
premium is to be charged against the profit of the firm.
a. Upon the death of a partner, he is to be credited with his share of the profits, interest on
capitals etc. calculated upon 31st December following his death.
b. That the share of the partnership policy and goodwill be credited to a deceased partner as
on 31st December following his death.
c. That the partnership books be closed annually on 31st December.
A died-on 30th September 2016, the amount standing to the credit of his current account on 31st
December 2015 was Rs.450 and from that date to the date of death he had withdrawn Rs.3,000
from the business.
An unrecorded liability of Rs.2,000 was discovered on 30th September 2016. It was decided to
record it and be immediately paid off.
The trading result of the firm (before charging interest on capital) had been as follows: 2013
profit Rs.9,640; 2014 profit Rs.6,720; Loss Rs.640; 2016 Profit Rs.3,670
Assuming the surrender value of the policy to be 20 percent of the sum assured.
Required
Prepare an account showing the amount due to A’s legal representative as on 31st December 2016.

1FIN BY INDIGOLEARN 10.43

 DISSOLUTION OF PARTNERSHIP FIRMS

1. Introduction

One of the important aspects of partnership accounts is to close books of accounts in case of
dissolution.
Dissolution of partnership means the ending of the relationship between partners as in the case of
admission of a partner.
Dissolution of a Partnership firm means when the business ceases to exist, and also includes
dissolution of the partnership as the relation between the partners also comes to an end.
This chapter deals with the accounting for Dissolution.

2. Circumstances of Dissolution

 All partners agree to dissolve the firm

 All partners except one become insolvent
 The business becomes illegal
 Partner gives notice of dissolution in partnership
at will.
Dissolution  The court orders dissolution.
occurs when  The expiry of the term for which it was formed
 The completion of the venture for which it was
entered into
 Death of a partner/Insolvency of a partner.

 A partner has become of unsound mind

 A partner suffers from permanent incapacity
 A partner is guilty of misconduct in the business
 A partner persistently disregards the partnership
Court orders
agreement
dissolution of
firm when  A partner transfers his interest or shares to a third
party
 the business cannot be carried on except at a loss;
and where it appears to be just and equitable.

1FIN BY INDIGOLEAEN 10.44

3. Dissolution of Partnership Vs Partnership Firm

Basis Dissolution Of Partnership Dissolution Of Firm

Meaning Discontinue the relationship The entire firm and the relation
between partners or between partners cease.
reconstitution of partnership. Eg: Business becomes illegal
Eg: Change in profit sharing
ratio, admission of partner etc.
Continuation of Partnership is reconstituted and Business comes to an end
Business business continues.
Power of Court No intervention by the court Court has the power to order
the dissolution of a firm.
Economic Economic relationship among Economic relationship among
Relationship partners may change or remain partners comes to an end.
the same.
Revaluation v/s Assets and liabilities are Assets and liabilities are
Realization revalued after the winding up of realized and settled on winding
the existing partnership. up.

Revaluation account is prepared

Realization account is prepared.
Books of Books of accounts are not closed Books of accounts are closed
Accounts

4. Consequences of Dissolution

4.1 Section 48 of the Partnership Act

 The assets of the firm including the goodwill are realized initially.
 The assets realized are utilized in the following manner:
 to pay the debts of third parties
 to settle loans and advances from partners
 To repay partners’ capital
 Surplus if any, to be divided in the profit sharing ratio

 Losses including deficiencies of capital are paid;

 First out of profits
 Next out of capital
 If necessary, by partners in their profit sharing ratio

4.2 Dissolution Before the Expiry of a Fixed Period

 Some partners enter the partnership on the condition that the firm will not be dissolved before
the expiry of a certain period and pays a premium. This premium or its part is refundable if
the firm dissolves earlier. This is borne by other partners in their profit sharing ratio.

1FIN BY INDIGOLEAEN 10.45

  Exceptions:
 Dissolution due to the death of a partner
 Dissolution due to the misconduct of the partner claiming the refund
 In pursuing an agreement with no provision of refund of premium

5. Closing of Books of the Partnership Firm

Accounts To Be Created

 Realisation A/c ;
 Partner’s Loan A/c;
 Partner’s capital A/c;
 Cash A/c

Realization a/c

 All assets except cash in hand or at bank are transferred to this account at book values.
 Sundry Debtors and Provisions for Bad Debts Accounts are two separate accounts and the
gross amount of debtors should be separately transferred.
 Outsider’s liabilities and Reserves or Provisions against Assets are also transferred to
Realization A/c, which will also include Partner’s spouse loan account.

 If the question is silent about the realization of an asset, it is assumed that the asset has not
realized any amount. All liabilities have to be settled in full whether or not mentioned in the
question
 If goodwill is already appearing in the balance sheet, it is treated like any other asset and is
transferred to the realization account.

JOURNAL ENTRIES
Date Particulars Debit (₹) Credit (₹)
1 Realization A/c

Transfer of assets
Realization A/c Dr.
To Asset A/c

Transfer of outside liabilities

Liabilities A/c Dr.
To Realization A/c

Amount realized from sale of an asset

Cash A/c Dr.
To Realization A/c

1FIN BY INDIGOLEAEN 10.46

 Payment of outside liabilities
Realization A/c Dr.
To Cash A/c

Asset taken over by the partner at agreed value

Partner’s Capital A/c
Dr.
To Realization A/c

Liability taken over by the partner at agreed value

Realization A/c Dr.
To Partner’s Capital A/c

Payment of Dissolution Expenses or Realization

expenses
Realization A/c Dr.
To Cash A/c

Dissolution Expenses borne by Partner

Realization A/c Dr.
To Partner’s Capital A/c

In case of profit, Closing Realization A/c and

transferring profit
Realization A/c Dr.
To Partner’s Capital A/c

In case of loss, Closing Realization A/c and

transferring loss
Partner’s Capital A/c Dr.
To Realization A/c

 Investment fluctuation fund is transferred to the credit side of the realization account only
if investments are appearing on the asset side. Otherwise, it is credited to the partner’s capital
account.

 Bank Overdraft is not transferred to Realization A/c, since it should be shown as a negative
balance in Bank A/C.

Partner’s loan a/c

 Loan taken from a partner will be passed through cash or bank account.

 Loan given to a partner will be transferred (debited) to his capital account.

1FIN BY INDIGOLEAEN 10.47

  If the current account of the partner from whom loan has been taken by the firm, shows a
debit balance after all adjustments, his loan account will be transferred to the credit of his
capital account to the extent of the debit balance of the capital account.

JOURNAL ENTRIES
Date Particulars Debit (₹) Credit (₹)
2 Partner’s loan A/c

Payment of Partner’s Loan Account

Partner’s Loan A/c Dr.
To Cash A/c

In case of debit balance of partner’s current

accounts
Partner’s Loan A/c Dr.
To Partner’s Current Account

Partner’s Capital A/c

 Apart from the realization profit or loss, undistributed profits such as General reserve, P&L
account etc are transferred to the partners’ capital account.

 Fictitious assets like Debit balance of the P&L account, deferred revenue expenditure etc.
should not be transferred to the realization account. Such accounts are transferred to the
partner’s capital account
JOURNAL ENTRIES
Date Particulars Debit (₹) Credit (₹)
Transfer of reserves, undistributed profits or
fictitious assets

Distribution of Undistributed Profits/ Reserves

Reserves A/c Dr.
Profit and Loss A/c (Credit Balance)
Dr.
To Partner’s Capital A/c

Transfer of fictitious assets

Partner’s Capital A/c
Dr.
To Profit and Loss A/c (Debit Balance)
To Deferred Expenditure

1FIN BY INDIGOLEAEN 10.48

Cash A/c

 The balance of the cash account at the end will be exactly equal to the balance of the capital
accounts, provided they are in credit; credit cash and debit the partners’ capital account with
the amount payable to them to close their accounts.

JOURNAL ENTRIES
Date Particulars Debit Credit(₹)
(₹)
4 BALANCE

In case of surplus cash balance, paid toward capital

Partner’s Capital A/c
Dr.
To Cash A/c

In case of deficit cash balance, brought in by

partners
Cash A/c Dr.
To Partner’s Capital A/c

6. Insolvency of a Partner
Any partner who is unable to pay its debts in the usual course of business and has been declared to
be insolvent by the appropriate court is an insolvent. The following are the consequences of the
insolvency of a partner;

 The partner adjudicated as insolvent ceases to be a partner on the date on which the order
of adjudication is made.
 The firm is dissolved on the date of the order of adjudication unless there is a contract to
the contrary.
 The estate of the insolvent partner is not liable for any act of the firm after the date of the
order of adjudication and,
 The firm cannot be held liable for any acts of the insolvent partner after the date of the
order of adjudication.
6.1 Loss arising from Insolvency of a Partner

The share of loss of an insolvent partner is to be borne by other solvent partners following the
decision in the English case of Garner vs. Murray.

1FIN BY INDIGOLEAEN 10.49

 Garner v/s murray

 normal loss on realization of assets to be borne by all partners (including insolvent partner)
in the profit-sharing ratio.

 loss due to insolvency of a partner must be borne by the solvent partners in the capital ratio.

Calculation of capital ratio in different scenarios

Scenarios Consequence
When Capitals are fixed Loss on insolvency is borne by the solvent partners in the
(Fixed Capital Method) ratio of their fixed capitals.

All other adjustments are done through their current

accounts, which may have a debit or credit balance
When Capitals are not fixed The Capital ratio will be determined after adjusting
(Fluctuating Capital  all the reserves and accumulated profits to the
Method) date of dissolution,
 all drawings to the date of dissolution,
 all interest on capitals and on drawings to the date
of dissolution
 but before adjusting profit or loss on Realization
Account.
A partner has a Debit Although he is not insolvent, he cannot be called up to
Balance in his Capital bear the loss on insolvency.
Account
(Partner other than the
insolvent partner)
When outside liabilities  It is advised not to transfer creditors to
cannot be paid in full Realization A/c
 out of firm’s assets  Creditors may be paid the amount available
 out of partners’ including the amount contributed by the partners.
personal assets  The remaining portion of the creditor account is
transferred to the Capital Accounts of the
partners in the profit sharing ratio, then Capital
Accounts are closed.
 In doing so first close the Partners’ Capital
Account which is having the worst position. The
last account will be automatically closed.

1FIN BY INDIGOLEAEN 10.50

7. Piecemeal payment
Generally, the assets sold upon dissolution of the partnership are realized only in small instalments
over a period of time. In such cases, liabilities are settled gradually as cash is received rather than
waiting to collect the entire sum. This is the system of Piecemeal Payments. In this system,

 Outside liabilities are settled initially, which includes creditors and thereafter loan from
spouse of the partner
 In the next stage, inside liabilities which includes loans from partners are settled.
 Finally, Partners’ Capitals are settled by;
1) Maximum Loss Method OR
2) Highest Relative Capital Method

Highest Relative Capital Method

(OR)
Maximum Loss Method
Proportionate capital method
Each instalment realized is considered to be
The partner who has the higher
the final payment i.e., outstanding assets and
relative capital, that is, whose
claims are considered worthless, and partners'
capital is greater in proportion to his
accounts are adjusted on that basis each time
profit-sharing ratio, is first paid off.
when a distribution is made, following either
Garner vs. Murray Rule or the profit-sharing
ratio rule.

Methods - Stepwise

Steps Maximum possible loss method Highest relative capital method

Step 1 Adjust the money available with the Ascertain capital per profit sharing
total amount due to the partners unit for each partner
(capital balance/ profit sharing ratio)

Step 2 Determine the maximum possible Determine the capital balance to be

loss assuming there is no more maintained by each partner
money going to be realized considering the lowest per unit capital
as base

Step 3 Distribute the maximum possible Determine partners with capital

loss amongst the partners in their greater in proportion to their profit-
profit-sharing ratio sharing ratio and ascertain excess for
each such partner

1FIN BY INDIGOLEAEN 10.51

 Step 4 If any partner has deficiency Compare the excess per unit of profit
(negative balance), distribute the for all such partners. Ascertain the
deficiency to the other partners in partner with the largest excess
their capital ratio by applying capital following the above procedure
Garner vs Murray Rule

Step 5 The amount left is the value of Pay the partner with the largest
money to be distributed to the excess capital the value of money
partners from the installment equivalent to excess capital

Step 6 Subtract the amount from the Pay other partners who have excess
opening balance and arrive at the capital (amounting to excess capital)
revised capital balances. Repeat until the capital of partners is
the above procedure reduced to their profit-sharing ratio.

Distribute the balance money amongst

all the partners in profit sharing ratio

NOTE: Total payment made to each partner will be the same under both methods.

8. Limited Liability Partnerships

A limited liability partnership is a body corporate formed and incorporated under the Limited
Liability Partnership Act, 2008. It has a separate legal entity with perpetual succession and the
change in the partners of a limited liability partnership does not affect the existence, rights, or
liabilities of the limited liability partnership.

8.1 Incorporation of LLP

 Two or more persons associated

 to carry on a lawful business to earn profits may
 subscribe their names to an incorporation document and
 file the same with the Registrar of the state in which the Registered Office of the LLP is
to be situated,
 in such manner with such fees as may be prescribed
 along with a statement in the prescribed form made
 either by an advocate, a company secretary or a chartered accountant, or a cost
accountant,
 who is engaged in the formation of LLP
 and by anyone who subscribed his name to the incorporation document,
 that all the requirements of the LLP Act 2008 and the rules made thereunder have been
complied with.

1FIN BY INDIGOLEAEN 10.52

8.2 Important Sections

Section Title Law

Section 5 Members any individual or body corporate may be a partner in an

LLP provided he is not;
 of unsound mind
 undischarged insolvent
 applied to be adjudicated insolvent

Section 6 Number every LLP should have at least 2 partners

Of Members
if at any time the number of partners is reduced below
2 and the LLP carries on business for more than six
months,
 the person, who is the only partner during such
six months and has the knowledge of the fact
 will be liable personally for the obligations of the
LLP incurred during that period.

Section 7 Designated every LLP should have at least two designated partners
Partners who are ;
 individuals and
 at least one should be a resident of India

"resident in India" means a person who has stayed in

India for not less than 182 days during the immediately
preceding year.

where all the partners are bodies corporate or in which

one or more partners are individuals and bodies
corporate,
at least two individuals who are partners of such LLP
or nominees of such body corporate will act as
designated partners.

Section 8 Liabilities of responsible for the doing of all acts, matters, and things
Designated as are required to be done by the LLP, complying with
Partners the provisions of the act
Eg: filing of any document, return etc.

liable to all penalties imposed on the LLP for any

contravention of those provisions.

1FIN BY INDIGOLEAEN 10.53

Section 27 Limitation of 27 (1) A LLP is not bound by anything done by a partner
liability of an in dealing with a person, if:
LLP and its  The partner does not have the authority to act
Partners on behalf of the LLP in doing a particular act; and
 The other person knows that the partner has no
authority or does not know or believe him to be a
partner in the LLP

27(2) The LLP is liable if a partner of the LLP is liable

to any person due to wrongful or omission on his part in
the course of business of the LLP or with his authority.

27(3) An obligation of an LLP arising out of a contract or

otherwise, will be solely the obligation of the LLP and
liabilities met out of the properties of the LLP

Section 28 A partner is not personally liable, directly or indirectly,

for an obligation referred to in Section 27 (3) above

Section 30 The liability of the LLP and the partners from fraud will
be unlimited for all or any of the debts or other
liabilities of the LLP.

Section 34 Financial 34(1) Every LLP should maintain such proper books of
disclosures accounts as may be prescribed relating to its affairs
and Returns  for each year of its existence
 on cash basis or accrual basis and
 according to the double entry system of accounting
and
 maintain at its registered office for the
prescribed period

34(2) within six months of the end of each financial year

prepare a Statement of Account and Solvency as of the
last day of the said financial year, in the prescribed
form and should be signed by the designated partners
of the LLP

34(3) should file within the prescribed time, the

Statement of Account and Solvency with the Registrar
every year in such form and manner and with such fee
as may be prescribed

34(4) accounts of an LLP must be audited in following

such rules.

1FIN BY INDIGOLEAEN 10.54

 Section 35 Every LLP is required to file an Annual Return which is
 duly authenticated with the registrar
 within sixty days of the closure of its financial
year
 in such form and manner and with such fees as may
be prescribed.

Section 55 Conversion of A firm may convert into an LLP in accordance with the
Firm into provisions of the Act and the Second Schedule to the
Limited Act.
Liability
Partnership

Section 56 A private limited company may convert into an LLP in

accordance with the provisions of the Act and the Third
Schedule to the Act.

Section 57 An unlisted public limited company may convert into an

LLP in accordance with the provisions of the Act and the
Fourth Schedule to the Act.

Section 63 Winding up an LLP may be wound up

and  voluntarily or
Dissolution  by the Tribunal
 and such LLP so wound up may be dissolved

Section 64 LLP may be wound up by the Tribunal if

 the LLP decides
 number of partners remain less than two for
more than six months
 unable to pay its debts;
 acted against the interests of the integrity and
sovereignty of India, the security of the state or
public order;
 defaulted in the filing of the Statement of
Account and Solvency with the Registrar for five
consecutive financial years;
 the Tribunal believes that it is just and equitable
that the LLP be wound up.

9. Summary

 Dissolution of partnership occurs when the relationship between the partners comes to an end
 Dissolution of partnership firm occurs when the business ceases to exist.

1FIN BY INDIGOLEAEN 10.55

 Realization account is prepared and profit or loss is transferred to the Partners’ Capitals.
 In case of Insolvency of a partner Garner vs Murray rule is followed.

Garner v/s murray

 normal loss on realization of assets to be borne by all partners (including insolvent partner)
in the profit sharing ratio

 loss due to insolvency of a partner has to be borne by the solvent partners in the capital
ratio.

10. Illustrations

1. Illustration
X, Y and Z are partners of the firm XYZ and Co., sharing Profits and Losses in the ratio of 4 : 3 :
2. Following is the Balance Sheet of the firm as at 31st March, 20X1:
Balance Sheet as at 31st March, 20X1
Liabilities Rs. Assets Rs.
Partners’ Capitals: Fixed Assets 5,00,000
X 4,00,000 Stock in trade 3,00,000
Y 3,00,000 Sundry debtors 5,00,000
Z 2,00,000 Cash in hand 10,000
General Reserve 90,000
Sundry Creditors 3,20,000
13,10,000 13,10,000

1. Partners of the firm decided to dissolve the firm on the above said date.
2. Fixed assets realised Rs. 5,20,000 and book debts Rs. 4,40,000.
3. Stocks were valued at Rs. 2,50,000 and it was taken over by partner Y.
4. Creditors allowed discount of 5% and the expenses of realisation amounted to Rs. 6,000.
You are required to prepare:
(i) Realisation account;
(ii) Partners capital account; and
(iii) Cash account

1FIN BY INDIGOLEAEN 10.56

Solution 1
Realisation A/c

Particulars ₹ Particulars ₹

To Fixed Assets 5,00,000 By Creditors 3,20,000

To Stock in trade 3,00,000 By Cash 5,20,000
To Sundry debtors 5,00,000 By cash 4,40,000
To Cash A/c 3,04,000 By Partner’s capital A/c 2,50,000
To Cash A/c 60,000 By loss (transferred to 80,000
Partner’s capital A/c in
4:3:2)
16,10,000 16,10,000

Particulars X Y Z Particulars X Y Z

To 25,000 By Balance 4,00,000 3,00,000 2,00,000

Realisation 35,555 26,667 17,778 B/d 40,000 30,000 20,000
A/c By General
To reserve
Realisation 4,04,445 53,333 2,02,222 [90,000 in
A/c 4:3:2]
[ 80,000 4,40,000 3,30,000 2,20,000 4,40,000 3,30,000 2,20,000
loss in 4:3:2]
To Cash A/c
Partners Capital Account

Cash A/c
Particulars ₹ Particulars ₹

To Balance B/d 10,000 By Realisation A/c 3,04,000

To Realisation A/c 5,20,000 [95% of
To Realisation A/c 4,40,000 3,20,000] 6,000
By Realisation A/c 4,04,445
By X’s Capital A/c 53,333
By Y’s Capital A/c 2,02,222
By Z’s Capital A/c
9,70,000 9,70,000

1FIN BY INDIGOLEAEN 10.57

2. Illustration
P, Q and R were partners sharing profits and losses in the ratio of 3 : 2 : 1, no partnership salary
or interest on capital
being allowed. Their balance sheet on 30th June, 20X1 is as follows:
Liabilities Rs. Assets Rs.
Fixed Capital Fixed assets:
P 20,000 Goodwill 40,000
Q 20,000 FreeholdProperty 8,000

R 10,000 50,000 Plant and Equipment 12,800

Current Accounts: Motor Vehicle 700

P 500 Current Assets
Q 9,000 9,500 Stock 3,900
Loan from P 8,000 TradeDebtors 2,000

Trade Creditors 12,400 Less: Provision (100) 1,900

Cash at Bank 200

Miscellaneouslosses

R's CurrentAccount 400

Profit and LossAccount 12,000

79,900 79,900

On 1st July, 20X1 the partnership was dissolved. Motor Vehicle was taken over by Q at a value of
Rs. 500 but no cash passed specifically in respect of this transaction.
Sale of other assets realised the following amounts:

Rs.
Goodwill nil
Freehold Property 7,000
Plant and Equipment 5,000
Stock 3,000
Trade Debtors 1,600

Trade Creditors were paid Rs. 11,700 in full settlement of their debts. The costs of dissolution
amounted to Rs. 1,500.
The loan from P was repaid, P and Q were both fully solvent and able to bring in any cash required
but R was forced into bankruptcy and was only able to bring 1/3 of the amount due.
You are required to show:
(a) Cash and Bank Account,
(b) Realisation Account, and
(c) Partners Fixed Capital Accounts (after transferring Current Accounts’
balances).

1FIN BY INDIGOLEAEN 10.58

Solution 2

Realisation A/c

Particulars ₹ Particulars ₹

To Goodwill 40,000 By Loan from P 8,000

To Freehold property 8,000 By Trade Creditors 12,400
To Plant & Equipment 12,800 By Provisions 100
To Motor vehicle 700 By Q’s Capital A/c 500
To Stock 3,900 By Cash/Bank A/c (Asset sale) 16,600
To Trade Debtors 2,000 By Loss (B.F) 51,000
To Cash/Bank A/c (Creditors) 11,700 ( Transferred to Partner’s
To Cash/Bank A/c ( Expenses) 1,500 Capitals)
To Cash/Bank A/c ( P’s Loan) 8,000
88,600 88,600

Garner vs Murray Rule

 Realisation Loss: Divide in Profit sharing ratio as given in the Deed. Solvent
Partners to get their share in cash.
 Deficiency: Divide amongst other partners in ratio of Capitals after few
adjustments.

Cash A/c

Particulars ₹ Particulars ₹

To Balance B/d 200 By Realisation A/c 11,700

To Realisation A/c 16,600 (Creditors Paid)
(Asset sale) By Realisation A/c (Expenses) 1,500
[7,000 + 5,000 + 3,000 + By Realisation A/c ( P’s Loan) 8,000
1,600] 25,500 By P’s Capital A/c 14,200
To P’s Capital A/c 17,000 By Q’s Capital A/c 24,200
To Q’s Capital A/c 300
To R’s Capital A/c
9,70,000 9,70,000

1FIN BY INDIGOLEAEN 10.59

 Partner’s Capital Account
Particulars P Q R Particulars P Q R

To Current A/c 400 By Balance B/d 20,000 20,000 10,000

To Profit and loss 6,000 4,000 2,000 By Current A/c 500 9,000
A/c By Cash/Bank 25,500 17,000
[ 12,000 in 500 A/c 300
3:2:1] 25,500 17,000 8,500 By Cash/Bank 300
To Realisation A/c A/c
To Realisation Loss 300 300 By P’s Capital 300
[3:2:1] 14,200 24,200 A/c (W.N:1)
To R’s Capital A/c 46,000 46,000 10,900 By Q’s Capital 46,000 46,000 10,900
To Cash A/c (B.F) A/c (W.N:1)

Working Note: 1
Bal. Fig in R’s Capital −> 900
1/3 2/3
Cash = 300 Deficiency = 600
In the Ratio of Fixed Capital
A/c
(20,000:20,000) = (1:1)
P Q
₹300 ₹300

3. Illustration
Amal and Bimal are in equal partnership. Their Balance Sheet stood as under on 31st March, 20X1
when the firm was dissolved:
Liabilities Rs. Assets Rs.
Creditors A/c 4,800 Plant & Machinery 2,500
Amal's Capital A/c 750 Furniture 500
Debtors 1,000
Stock 800
Cash 200
Bimal's drawings 550
5,550 5,550
The assets realised as under:

1FIN BY INDIGOLEAEN 10.60

 Asset Rs.
Plant & Machinery 1,250
Furniture 150
Debtors 400
Stock 500

The expenses of realisation amounted to Rs. 175. Amal's private estate is not sufficient even to
pay his private debts, whereas Bimal's private estate has a surplus of Rs. 200 only.
Show necessary ledger accounts to close the books of the firm.

Solution 3

Realisation A/c

Particulars ₹ Particulars ₹

To Plant & Machinery 2,500 By Cash (1,250+150+400+500) 2,300

To Furniture 500 By Partner’s Capital (Bal.Fig) 2,675
To Debtors 1,000 [Realisation loss]
To Stock 800
To Cash (Expenses) 175

4,975 4,975

Cash A/c

Particulars ₹ Particulars ₹

To Balance B/d 200 By Realisation A/c 175

To Realisation A/c 2,300 By Creditors A/c (Bal.Fig) 2,525
To Bimal’s Capital A/c 200

2,700 2,700

1FIN BY INDIGOLEAEN 10.61

 Partner’s Capital Account

Particulars Amal Bimal Particulars Amal Bimal

To Balance B/d 550 By Balance B/d 750

To Realisation A/c 1,337 1,338 By cash A/c 200
[2,675 in 1:1] By Deficiency A/c 587 1.688
(Bal.Fig)

1,337 1,888 1,337 1,888

Sundry Creditors A/c
Particulars ₹ Particulars ₹

To Cash A/c 2,525 By Balance B/d 4,800

To Deficiency A/c (Bal.Fig) 2,275
4,800 4,800

Deficiency A/c
Particulars ₹ Particulars ₹

To Amal’s Capital A/c 587 By Sundry creditors A/c 2,275

TO Bimal’s Capital A/c 1,688

2,275 2,275

4. Illustration

M/s X, Y and Z who were in partnership sharing profits and losses in the ratio of 2:2:1 respectively,
had the following Balance Sheet as at December 31, 20X1:
Liabilities Rs. Rs. Assets Rs. Rs.
Capital :X 29,200 Fixed Assets 40,000
Y 10,800 Stock 25,000
Z 10,000 50,000 Book Debts 25,000
Z’s Loan 5,000 Less : Provision (5,000) 20,000
Loan from Mrs. X 10,000 Cash 1,000
Sundry Trade 25,000 Advance to Y 4,000
Creditors
90,000 90,000

The firm was dissolved on the date mentioned above due to continued losses

1FIN BY INDIGOLEAEN 10.62

• After drawing up the balance sheet given above, it was discovered that goods amounting to
Rs. 4,000 have been purchased in November, 20X1 and had been received but the purchase was not
recorded in books.
• Fixed assets realised Rs. 20,000; Stock Rs. 21,000 and Book Debt Rs. 20,500.
• Similarly, the creditors allowed a discount of 2% on the average.
• The expenses of realisation come to Rs. 1,080.
• X agreed to take over the loan of Mrs. X.
• Y is insolvent, and his estate is unable to contribute anything.
Give accounts to close the books; work according to the decision in Garnervs. Murray.

Solution 4
Realisation A/c

Particulars ₹ Particulars ₹

To Fixed Assets 40,000 By Z’s Loan 5,000

To Stock 25,000 By Sundry Creditors 25,000
To Book Debts 25,000 By Provision 5,000
To Cash 28,420 By Sundry Creditors – 4,000
To Cash 1,080 (Unrecorded liability)
To Cash (Z’s Loan) 5,000 By Cash (20,000 + 21,000 + 61,500
20,500
By Loss – Transferred to 24,000
1,24,500 Partners Capital (Bal. Fig) 1,24,500

Cash A/c

Particulars ₹ Particulars ₹

To Balance B/d 1,000 By Realisation A/c 28,420

To Realisation A/c 61,500 By Realisation A/c 1,080
To X’s Capital A/c [Cash 9,600 By Realisation A/c 5,000
for loss] 4,800 By X’s Capital A/c 34,300
To Y’s Capital A/c [ Cash BY Z’s Capital A/c 8,100
for loss] 76,900 76,900

1FIN BY INDIGOLEAEN 10.63

 Partner’s Capital Account
Particulars X Y Z Particulars X Y Z

-
To Y’s Advance - 4,000 By balance 29,200 10,800 10,000
To Creditors 1,600 1,600 800 B/d 10,000 -
Unrecorded By Mrs X’s 9,600 - 4,800
[4,000 in 2 : 2 : 1] 9,600 9,600 4,800 loan 3,300
To Realisation Loss 3,300 - 1,100 By Cash 1,100
{2:2:1) 34,300 8,100 By X’s
To Y’s Capital Capital
To Cash 48,800 15,200 14,800 BY Z’s 48,800 15,200 14,800
Capital

Working Note: 1
Purchases – Unrecorded
Trading ,Profit and loss A/c Dr 4,000
To Creditors A/c 4,000

 ₹ 4,000 will reduce profits, it should be debited to Partner’s Capital A/c => 4,000
(in 2 : 2 :1 ratio).
 Creditors increased by ₹ 4,000.

Working Note: 2
Creditors
Creditors 25,000
(+) Unrecorded Creditors 4,000
29,000
(98% of 29,000) – Cash paid 28,420

Working note: 3

 Y’s Deficiency => 16,000 + 4,000 + 9,600 = ₹4,400

[after all adjustment]

1FIN BY INDIGOLEAEN 10.64

 Rs. 4,400

In the ratio of Capital before

dissolution
[Fluctuating capital method]
X = 3,300 X : Z = 29,200-1,600 : Z = 1,100
10,000-800
= 27,600 : 9,200
= 3: 1

5. Illustration (5&6)
The following is the Balance Sheet of A, B, C on 31st December, 20X1 when they decided to dissolve
the partnership:
Liabilities Rs. Assets Rs.
Creditors 2,000 Sundry Assets 48,500
A’s Loan 5,000 Cash 500
Capital Accounts:
A 15,000
B 18,000
49,000 49,000

The assets realised the following sums in instalments:

I 1,000
II 3,000
III 3,900
IV 6,000
V 20,100
34,000

The expenses of realisation were expected to be Rs.500 but ultimately amounted to Rs.400 only.
Show how at each stage the cash received should be distributed between partners. They share
profits in the ratio of 2:2:

Solution 5
Maximum Loss Method

 Statement showing Realisation and Distribution

Particulars Amount Creditors Partner’s Partner’s

Realised (A’s) Capital
Loan
Balance payable (Due) - 2,000 5,000 42,000

1FIN BY INDIGOLEAEN 10.65

 1st Instalment 1,000 (1,000) - -

1,000 5,000 42,000

2nd Instalment 3,000 (1,000) (2,000) -

0 3,000 42,000

3rd Instalment 3,900 - (3,000) (900)

- 0 41,100

4th Instalment 6,000 - - (6,000)

- - 35,100

5th Instalment 20,100 - - (20,100)

Deficiency / Loss - - - 15,000

* Includes savings in expenses i.e. Rs.100 (Rs.500-Rs.400 )

 Statements showing Realisation and Distribution of cash to Partners

 Distribution of ₹900 (3rd Instalment)

Particulars Amount A B C

Balance payable (Due) 42,000 15,000 18,000 9,000

Balance from 3rd instalment (900)

Maximum possible loss 41,100 (16,440) (16,440) (8,220)

(Divided into 2 :2 :1 )
(1,440) + 1,560 +780

A’s Deficiency split between B&C in

their capital ratio of 18 : 9 as per + 1,440 (960) (480)
Garner vs Murray
Actual pay out
(Balance available and to be 0 600 300
distributed)
Closing Capital after 3rd Instalment 41,100 15,000 [18,000- [9,000-
600] 300]
17,400 8,700

 Distribution of ₹6,000 (4th Instalment)

Particulars Amount A B C

Capital balance 41,100 15,000 17,400 8,700

1FIN BY INDIGOLEAEN 10.66

 4th instalment (6,000)

Maximum possible loss 35,100 (14,040) (14,040) (7,020)

(Divided into 2 :2 :1 )
Actual pay out 960 3,360 1,680
(Balance available and to be
distributed)
=15,000- =17,400- =8,700-
th
Closing Capital after 4 35,100 900 3,360 1,680
Instalment =14,040 =14,040 =7,020

 Distribution of ₹20,000 (5th Instalment)

Particulars Amount A B C

Capital balance 35,100 14,040 14.040 7,020

5th instalment (20,100)

Maximum possible loss 15,000 (6,000) (6,000) (3,000)

(Divided into 2 :2 :1 )
Actual pay out 8,040 8,040 4,020
(Balance available and to be
distributed)
Closing Capital after 4th 15,000 =14,040- =14,040- =7,020-
Instalment 8,040 8,040 4,020
=6,000 =6,000 =3,000

Summary

Particulars Amount Creditors Partner’s A B C

Realised (A’s)
Loan
Opening balance - 2,000 5,000 15,000 18,000 9,000

 1st 1,000 (1,000) - - - -

Instalment
 2nd 3,000 (1,000) (2,000) - - -
Instalment
 3rd 3,900 - (3,000) (600) (300)
Instalment
 4th 6,000 - - (960) (3,360) (1,680)
Instalment
 5th 20,100 - - (8,040) (8,040) (4,020)
Instalment

1FIN BY INDIGOLEAEN 10.67

Deficiency / Loss - - - 6,000 6,000 3,000

6. Illustration (Same as 5th )

Solution 6
Highest Relative Capital Mthod

Statement showing Realisation and Distribution

Particulars Amount Creditors Partner’s Partner’s

Realised (A’s) Capital
Loan
Balance payable (Due) - 2,000 5,000 42,000

1st Instalment 1,000 (1,000) - -

1,000 5,000 42,000

2nd Instalment 3,000 (1,000) (2,000) -

0 3,000 42,000

3rd Instalment 3,900 - (3,000) (900)

- 0 41,100

4th Instalment 6,000 - - (6,000)

- - 35,100

5th Instalment 20,100 - - (20,100)

Deficiency / Loss - - - 15,000

Statement showing basis for calculation of distribution of cash

Particulars A B C

a) Capital 15,000 18,000 9,000

b) PSR 2 2 1

c) Capital per unit of profit (a) ÷ 7,500* 9,000 9,000

(b)
d) Taking A’s Capital as base [7,500 15,000 15,000 7,500
x (b)]
(i.e. Lowest capital)*
e) Excess (a) – (d) 0 3,000 1,500

f) PSR 2 2 1

1FIN BY INDIGOLEAEN 10.68

 g) Excess per unit of profit (e) ÷ - 1,500 1,500
(f)

Conclusion

1) 3,000 + 1,500 = 4,500. => 1st 4,500 towards Partner’s capital will be divided among B:C in 2:1
ratio.
2) Subsequent amount will be divided among A : B : C in 2 : 2 : 1 ratio.

Statement showing distribution of cash to partners

Particulars Amount A B C

3rd Instalment 900 - 600 300

B : C => 2 : 1
4th Instalment 6,000
 4,500 - 900 = 3,600 - 2,400 1,200
(B:C=>2:1)
 6,000 - 3,600 = 2,400 (2 960 960 480
:2 :1)
5th instalment (2 : 2 : 1) 20,100 8,040 8,040 4,020

Total Pay out 27,000 9,000 12,000 6,000

7. Illustration
Ajay Enterprises, a Partnership firm in which A,B and C are three partners sharing profits and losses
in the ratio of 4 : 3 : 3. the balance sheet of the firm as on 31st December, 20X1 is as below:
Liabilities Rs. Assets Rs.
A’ s Capital 15,000 Factory Building 24,160
B’ s Capital 7,500 Plant & 16,275
Machinery

C’ s Capital 15,000 Debtors 5,400

B’ s Loan 4,500 Stock 12,390

Sundry Creditors 16,500 Cash at Bank 275

58,500 58,500

1FIN BY INDIGOLEAEN 10.69

On balance sheet date all the three partners have decided to dissolve their partnership. Since the
realisation of assets was protracted, they decided to distribute amounts as and when feasible and
for this purpose they appoint C who was to get as his remunerations 1% of the value of the assets
realised other than cash at Bank and 10% of the amount distributed to the partners.
Assets were realised piecemeal as under:
First instalment Rs. 18,650
Second instalment Rs. 17,320
Third instalment Rs. 10,000
Last instilment Rs. 7,000
Dissolution expenses were provided for estimatedamount Rs. 3,000
of
The creditors were settled finally for Rs. 15,900
Prepare a statement showing distribution of cash amongst the partners by ‘Higher Relative Capital
Method’

Solution 7
 Statement showing Distribution of Cash

Particulars Amount Expenses Commission on Creditors

Realised sale of assets

Balance payable (Due) - N/A N/A 16,500

1st Instalment (WN: 1) 18,925 3,000 187 (15,738)

2nd Instalment (WN: 2 & 17,320 - 173 (162)

5)
3rd Instalment (WN : 3 10,000 - 100 -
& 6)
4th Instalment (WN: 4) 7,000 - 70 -
Closing balance - N/A N/A 600*

 *600 is a gain transferred to P & L A/c

Partner’s Commission A B C
Loan from
Payment to
Partners
4,500 N/A 15,000 7,500 15,000

- - - - -
(4,500) 1,135 (4,343) - (7,007)

1FIN BY INDIGOLEAEN 10.70

 [3,750 +
3,257]
- 900 (3,797) (2355) (2,848)
[657 + 3,140] [493 + 2,355]
- 630 (2,520) (1,890) (1,890)
0 N/A 4,340 3,255 3,255

 Loss suffered by Partners : A = 4,340

B = 3,255
C = 3,255

Highest Relative Capital method

Statement showing basis for calculation of distribution of cash to Partners

Particulars A B C

a) Capital 15,000 7,500 15,000

b) PSR 4 3 3

c) Capital per unit of profit (a) – (b) 3,750 2,500 5,000

d) Revised capital taking B’s capital as 10,000 7,500 7,500

base [ 2,500 x (b) ]
e) Excess (a) – (d) 5,000 - 7,500

f) Excess per unit of profit (e) ÷ (b) 1,250 - 2,500

g) Excess consideration taking A’s 1,250 x 4 - 1,250 x 3

excess as base = 5,000 =3,750
h) C’s excess over A (e) – (g) - - 3,750

Conclusions:
1) 1st 3,750 to C only
2) Next 5,000 + (7,500 – 3,750) = 8,750 to A & C in 4 : 3
3) Balance will be paid to A : B : C in 4 : 3 : 3

1FIN BY INDIGOLEAEN 10.71

Working note: 1
1st installment
Sale amount = 18,650
(+) cash balance = 275
= 18,925

3,000 expenses 18,650 x 1% = 187 Balance = 18,925 - 3,000 - 187

[Remuneration or = 15,738
Commision on sale of (-) Creditors = ( 15,738) = 0
asset]
Balance payable to Creditors (15,900 -
15,738) is Rs. 162

Working note: 2

2nd Instalment : 17,320

17,320 x 1% = 173 Sundry Balance = 17,320 - 173 - 162

[Remuneration or Creditors
= 16,985
Commision on sale of = 162 (WN:
1) (-) Partners Loan = (4,500)
asset]
=12,485

a) 12,485 x (10/110) = 1,135 (commission)

b) 12,485 x (100/110) = 11,350 (Partners payment)

Working note: 3

3rd installment = 10,000

Balance = 10,000 - 100 = 9,900

10,000 x 1% = 100
a) 9,900 x (10/110) = 900 (commission)
[Remuneration or Commision
on sale of asset] b) 9,900 x (100/110) = 9,000 (Partners
payment)

1FIN BY INDIGOLEAEN 10.72

Working note: 4

4th installment = 7,000

7,000 x 1% = 70 Balance = 7,000 - 70 = 6,930

[Remuneration or Commision on a) 6,930 x (10/110) = 630 (commission)
sale of asset] b) 6,930 x (100/110) = 6,300 (Partners
payment)

Working Note: 5

Particulars ₹

Total 2nd Instalment 17,320

Less : Commission and B’s Loan (5,970)
Balance after Commission and B’s 11,350
loan
Less : First payment from balance (3,750)
to C
( as per conclusion 1 )
Balance available after payment to 7,600
C
 This 7,600 will be split in 4 : 3 ration
to A & C as per conclusion (2)
 A = 7,600 x 4/7 = 4,343
 C = 7,600 x 3/7 = 3,257

Working Note: 6
Particulars ₹

3rd Instalment 10,000

Less: Remuneration (1,000)
Balance available 9,000
Less: Balance of ₹1,150 [(8,750 – (1,150)
7,600)
as per conclusion (2)] split among
A & C in 4 : 3
Balance available 7,850
 The balance ₹7,850 will be split
among A & B & C on 4 : 3 : 3 [ 3,140 : 2,355 : 2,355 ]

1FIN BY INDIGOLEAEN 10.73

8. Illustration
The partners A, B and C have called you to assist them in winding up the affairs of their partnership
on 30th June 20X1. Their Balance Sheet as on that date is given below:
Liabilities Amount (₹) Assets Amount (₹)
Sundry Creditors 17,000 Cash at Bank 6,000
Capital Accounts Sundry Debtors 22,000
A 67,000 Stock in trade 14,000
B 45,000 Plant and Equipment 99,000
C 31,500 Loan-A 12,000
Loan-B 7,500
1,60,500 1,60,500

(1) The partners share profit and losses in the ratio of 5:3:2
(2) Cash is distributed to the partners at the end of each month
(3) A summary of liquidation transactions are as follows:
 July 20X1
o ₹ 16,500 collected from Debtors, balance is uncollectable.
o ₹ 10,000 received from sale of entire stock.
o ₹ 1,000 liquidation expenses paid.
o ₹ 8,000 cash retained in the business at the end of the month.

 August 20X1

o ₹ 1,500 liquidation expenses paid.

o As part payment of his Capital, C accepted a piece of equipment for ₹ 10,000 (book
value ₹ 4,000).

o ₹ 2,500 cash retained in the business at the end of the month.

 September 20X1

o ₹ 75,000 received on sale of remaining plant and equipment.

o ₹ 1,000 liquidation expenses paid. No cash retained in the business.

Required : Prepare a schedule of cash payments as of September 30, showing how the cash
was distributed under 'Highest Relative Capital Method'

Solution 8
Statement of Distribution of Cash

Partner’s Capital
Particulars Creditors
A B C
Balance Due 17,000 67,000 45,000 31,500

(-) Loan to Partners (12,000) (7,500) -

1FIN BY INDIGOLEAEN 10.74

 17,000 55,000 37,500 31,500

Opening Cash 6,000

+ Sale of Stock 10,000
+ Debtors Collection 16,500
(-) Liquidation (1,000)
expenses (8,000)
(-) Closing cash
Distribution (WN:1) 23,500 (17,000) - - (6,500)
Revised balance 0 55,000 37,500 25,000
August
Opening Cash 8,000
(-) Liquidation (1,500)
expenses (2,500)
(-) Closing Cash - - (4,000) (10,000)
assets
Cash 4,000
Revised balance 0 55,000 33,500 15,000
September
Opening Cash 2,500
(+) Inflows 75,000
(-)Liquidation expenses (1,000)
Distribution (WN: 2) 76,500
 1st 500 to B - (500) -
 Next 28,000 => A:B in (17,500) (10,500) -
5:3
 Next 48,000 => A:B:C in (24,000) (14.400) (9,600)
5:3:2
Loss 13,500 8,100 5,400

Total Payment 41,500 25,400 9,600

Working note: 1

Particulars A B C

1) Bal. Net of Loan 55,000 37,500 31,500

2) PSR 5 3 2

3) Capital / Unit of Profit (1) 11,000 12,500 15,750

÷ (2) (Lowest)
4) Revised Capitals - taking ‘A’ 55,000 33,000 22,000
as Base [11,000* x (2)]
5) Excess (1) – (4) 0 4,500 9,500

1FIN BY INDIGOLEAEN 10.75

 6) PSR - 3 2

7) Excess / Unit of Profit - 1,500 4,750

(5) ÷ (6)
8) Revised Excess –taking B’s - 4,500 3,000
excess as base (1,500 x (1,500 x
3) 2)
9) Excess of C’s capital over B - - 6,500
[ (5) –(9) ]

Conclusions:

1) Till ₹6,500*, only ‘C’ will take

2) Combining excess of B & C = 4,500 + 9,500
= 14,000
14,000 – 6,500* = 7,500 will be split between B & C in 3 : 2
3) Thereafter, A : B : C in 5 : 3 : 2

Working Note: 2
Revised Calculation for September

Particulars A B C

1) Opening Capitals 55,000 33,500 15,000

2) PSR 5 3 2

3) Capital / Share of Profit 11,000 11,167 7,500*

(1)÷(2) (Lowest)
4) Revised Capitals - taking ‘C’ 37,500 22,500 15,000
as Base [7,500* x (2)]
5) Excess (1) – (4) 17,500 11,000 -

6) PSR 5 3 -

7) Excess / Share of Profit 3,500 3,667 -

(5)÷(6)
8) Revised Excess –taking A’s 17,500 10,500 -
excess as base (3,500 x
3)
9) Excess of B’s capital over - 500 -
A [ (5) –(9) ]

Conclusions
1) 500 => only B
2) Next (17,500 + 11,000 – 500) = 22,000 => A : B in 5 : 3
3) Thereafter, A : B : C in 5 : 3 : 2

1FIN BY INDIGOLEAEN 10.76

 Chapter – 11 Company Accounts
Unit-1 INTRODUCTION
TYPES OF COMPANIES

Prepraration Balance Sheet

of Financial
Statements Statement of Profit & Loss

Cash Flow Statement

Notes to Accounts

1FIN BY INDIGOLEARN 11.1

Unit-1 INTRODUCTION

COMPANY

A Company is a separate legal entity registered under Companies Act, 2013

Company consists of individuals, called shareholders by virtue of holding the

shares of a company,
Shareholders are authorised by law to elect a board of directors

Through Board of Directors , the Companyt performs its activities as an

artificial person.

2. SALIENT FEATURES

A company can contract, sue

and be sued in its incorporated
name and capacity.

The liability of every shareholder is limited

to the amount he has agreed to pay (fully Ownership – Shareholders;
paid up value of shares) to the company on
the shares allotted to him. Management: Board of Directors, appointed
 by the shareholders

1FIN BY INDIGOLEARN 11.2

 Why ‘Company’ form of organisation?

Large amount of money, modern technology, large human contribution etc. is required to increase
the scale of operations so as to provide goods and services to the ever-increasing needs of the
growing population of consumers, which is not possible to arrange under partnership or
proprietorship. This led to the inception of the concept of ‘Company’ or ‘Corporation’.
3. TYPES OF COMPANIES

1. Government Company - Section 2(45) of the Companies Act, 2013

 Any Company in which not less than fifty-one per cent of the paid-up share capital is held
by
o the Central Government, or
o any State Government or Governments, or
o partly by the Central Government and partly by one or more State Governments,
 and includes a company which is a subsidiary company of such a Government company.

2. Foreign Company - Section 2 (42) of the Companies Act, 2013,

Any company or body corporate incorporated outside India which –
 Has a place of business in India whether by itself or through an agent physically or
through electronic mode; and
 Conducts any business activity in India in any other manner.

3. Private Company - Section 2(68) of the Companies Act, 2013

A company which by its articles,
 restricts the right to transfer its shares;
 Prohibits any invitation to the public to subscribe for any securities of the
company.
 Shares of a Private Company are not listed on Stock Exchange.
 Exception
 One Person Company limits the number of its members to two hundred. Joint
membership will be considered as single member
 Employees – Present & past holding shares are not considered as members

4. Public Company - Section 2(71) of the Companies Act, 2013

 A company which is not a private company;
 Subsidiary of company which is not a private company shall also be considered as public
company even where such subsidiary company continues to be a private company in its
articles.
 A unlisted public company.
 No Minimum Paid-up Share Capital

Note:The minimum paid-up share capital requirement of INR 1,00,000 (in case of a
private company) and INR 5,00,000 (in case of a public company) has been done away
with under Companies Act, 2013.

1FIN BY INDIGOLEARN 11.3

5. One Person Company - Section 2 (62) of the Companies Act, 2013
A company which has only one person as a member.

6. Small Company - Section 2(85) of the Companies Act, 2013

 A company, other than a public company
o paid-up share capital
 does not exceed Rs.50 lakhs or
 such higher amount as may be prescribed which shall not be more than Rs.5
Crores; or
o turnover (as per its last profit and loss account)
 does not exceed Rs.2 Crores or
 such higher amount as may be prescribed which shall not be more than Rs.20
crores
Note: The status of a company as a Small Company may change from year to year.

7. Listed Company - Section 2 (52) of the Companies Act, 2013

A company which has any of its securities listed on any recognised stock exchange.

8. Unlisted Company
The company, whose shares are not listed on any recognised stock exchange. An
unlisted company can be a public company or a private company.
9. Company limited by Shares - Section 2(22) of the Companies Act, 2013
Liability of its members is limited by the memorandum to the amount, if any, unpaid
on the shares respectively held by them.
10. Company limited by Guarantee - Section 2(21) of the Companies Act, 2013
Liability of its members limited by the memorandum to such amount as the members
may respectively undertake to contribute to the assets of the company in the event of
its being wound up.
11. Unlimited Company - Section 2 (92) of the Companies Act, 2013
A company not having any limit on the liability of its members.

12. Holding Company - Section 2 (46) of the Companies Act, 2103

A company of which one or more other companies companies are subsidiary companies.

13. Subsidiary Company - Section 2(87) of the Companies Act, 2013

o A company in which the holding company:
 Controls the composition of the Board of Directors (i.e. power to appoint or
remove all or a majority of the directors); or
 Exercises or controls > ½ of the total share capital either on its
 own or
 together with one or more of its subsidiary companies.
o Deemed Subsidiary Company - indirect control through the subsidiary company (ies).

4. MAINTENANCE OF BOOKS OF ACCOUNTS – Section 128

 Who should maintan : Every company

1FIN BY INDIGOLEARN 11.4

  Where to maintain : Registered office
o What to maintain : Books of accounts and other relevant books and papers and
financial statement for every financial year which give a true and fair view of the state
of the affairs of the company
 Whose books : Company’s, Branch office’s or Company’s other offices, explaining the
transactions effected both at the registered office and its branches
 How to maintain :
o Method of Accounting- Accrual basis and according to the double entry system of
accounting
o Mode – Physical or electronic

5. PREPARATION OF FINANCIAL STATEMENTS

Requisites of Financial Statements (Section 129)

 Give a true and fair view of the state of affairs of the company or companies
 Comply with the notified accounting standards
 Format
i. If specific Act is applicable (Eg: Insurance Company, Banking company, etc.) –
as given in the respective statute
ii. Schedule III of the Companies Act, 2013
o Part I: Balance Sheet
o Part II: Profit & Loss Account
 Board of Directors of the company shall lay financial statements at every annual
general meeting of a company
 What are Financial Statements? (Section 2(40) of the Companies Act, 2013)

i.Balance Sheet as at the end of the financial year;

Profit and Loss Account, or an Income and

Expenditure Account for the financial year
Financial
Statements i.Cash Flow Statement for the financial year;
include

Statement of Changes in Equity

Explanatory Note Annexed to, or forming part of, any

document referred above
3 .

Part I – Form of Balance Sheet

Name of the Company…………………….

1FIN BY INDIGOLEARN 11.5

 Balance Sheet as at………………………
(Rs. in…)
Particulars Not Current Previous
es Year Year
No.

EQUITY AND LIABILITIES

1. Shareholders’ funds
a. Share capital (A)
b. Reserves and Surplus (B)
c. Money received against share warrants
2. Share application money pending allotment
3. Non-current liabilities
a. Long-term borrowings (C)
b. Deferred tax liabilities (Net)
c. Other long-term liabilities
d. Long-term provisions (D)
4.
Current liabilities
a. Short-term borrowings (E)
b. Trade Payables
 Total outstanding dues to micro enterprises
and small enterprises
 Total outstanding dues to creditors other than
micro enterprises and small enterprises
c. Other current liabilities (F)
d. Short-term provisions
Total
1
ASSESTS
Non-current assets
a. Property, Plant and Equipment
i. Tangible assets (G)
ii. Intangible assets (H)
iii. Capital Work-in-progress
iv. Intangible assets under development
b. Non-current investments (I)
c. Deferred tax assets (Net)
d. Long-term loans and advances (J)
e. Other non-current assets
2 Current assets
a. Current investments (K)
b. Inventories (L)
c. Trade receivables
d. Cash and cash equivalents (M)
e. Short-term loans and advances
f. Other current assets
Total

1FIN BY INDIGOLEARN 11.6

Balance Sheet items to be explained in the Explanatory Note:
A. SHARE CAPITAL – for each class
 Authorised share capital - Number and amount.
 Issued; Subscribed & Fully paid; and Issued subscribed but not fully paid.
 The par value per share.
 Reconciliation of Shares outstanding
o at the beginning &
o at the end of the reporting period
 Calls unpaid
 Forfeited shares
B. RESERVES AND SURPLUS – subheads (Additions and deductions since last balance sheet
to be shown under each of the specified heads)
 Capital Reserves
 Capital Redemption Reserve (CRR)
 Securities Premium
 Debenture Redemption Reserve.
 Revaluation Reserve
 Surplus (the balance as per Profit and Loss statement)
 Other Reserves (specify the nature and purpose)

C. LONG TERM BORROWINGS - subheads

 Bonds/Debentures
 Term loans
o From Banks
o From Other parties
 Deferred payment liabilities
 Deposits
 Long term maturities of finance lease obligations
 Loans and advances from related parties
 Other loans and advances (specify nature)

D. OTHER LONG-TERM LIABILITIES

(a) Trade payables;
(b) Others.

E. LONG TERM PROVISIONS

 Provision for Employee Benefits (eg: gratuity, provident fund etc.)
 Other provisions (specify the nature)
F. SHORT TERM BORROWINGS
o Loans repayable on demand
 From banks
 From other parties
o Loans and advances from related parties
o Deposits
o Other loans and advances (specify the nature)

1FIN BY INDIGOLEARN 11.7

FA. TRADE PAYABLES - Outstanding dues to Micro, Small and Medium Enterprises
o Principal amount and interest due thereon remaining
o Amount of interest paid
o Amount of interest due and payable for period of delay
o Amount of interest accrued and remaining unpaid

G. OTHER CURRENT LIABILITIES

o Current maturities of long-term debt
o Current maturities of finance lease obligations
o Interest accrued but not/and due on borrowings
o Income received in advance
o Unpaid dividends
o Application money received for allotment of securities and due for refund and
interest accrued thereon
o Unpaid matured deposits and interest accrued thereon
o Unpaid matured debentures and interest accrued thereon
o Other current liabilities (specify the nature)

H. SHORT TERM PROVISIONS

 Provision for Employee Benefits
 Other provisions (specify the nature)


I TANGIBLE ASSETS - Classification

 Land
 Buildings
 Plant and Equipment
 Furniture and Fixtures
 Vehicles
 Office equipment
 Others (specify nature)

J. INTANGIBLE ASSETS
 Goodwill
 Brands /trademarks
 Computer software
 Mastheads and publishing titles
 Mining rights
 Copyrights, and patents and other intellectual property rights, services and
operating rights
 Recipes, formulae, models, designs and prototypes
 Licenses and franchise
 Others (specify nature)

K. NON-CURRENT INVESTMENTS (Classify as Trade & Other Investments)

o Investment property;
o Investments in Equity Instruments;

1FIN BY INDIGOLEARN 11.8

 o Investments in preference shares;
o Investments in Government or trust securities;
o Investments in debentures or bonds;
o Investments in Mutual Funds;
o Investments in partnership firms;
o Other non-current investments (specify nature)

L. LONG TERM LOANS AND ADVANCES

 Long-term loans and advances shall be classified as:
o Capital Advances;
o Security Deposits;
o Loans and advances to related parties (giving details thereof);
o Other loans and advances (specify nature).
 The above shall also be separately sub-classified as:
o Secured, considered good;
o Unsecured, considered good;
o Doubtful.

M. OTHER NON-CURRENT ASSETS

 Long-term Trade Receivables (including trade receivables on deferred credit
terms);
 Others (specify nature);

Long term Trade Receivables, shall be sub-classified as:

o Secured, considered good;
o Unsecured, considered good;
o Doubtful.
N. CURRENT INVESTMENTS
o Investments in Equity Instruments
o Investment in Preference Shares
o Investments in Government or Trust Securities
o Investments in Debentures or Bonds
o Investments in Mutual Funds
o Investments in Partnership Firms
o Other investments (specify nature)

O. INVENTORIES
 Raw materials
 Work-in-progress
 Finished goods
 Stock-in-trade (in respect of goods acquired for trading)
 Stores and spares
 Loose tools
 Goods in transit
 Others (specify nature)

P. TRADE RECEIVABLES

1FIN BY INDIGOLEARN 11.9

  Secured, considered good
 Unsecured, considered good
 Doubtful

Aggregate amount of Trade Receivables outstanding for a period exceeding six months
from the date they are due for payment should be separately stated.

Q. CASH AND CASH EQUIVALENTS

 Balances with banks
 Cheques, drafts on hand
 Cash on hand
 Others (specify nature)

R. SHORT TERM LOANS AND ADVANCES

 Loans and advances to related parties (giving details thereof);
 Others (specify nature).

The above shall also be sub-classified as:

(a) Secured, considered good;
(b) Unsecured, considered good;
(c) Doubtful.
S. OTHER CURRENT ASSETS – Specify nature

T. CONTINGENT LIABILITIES AND COMMITMENTS

 Contingent liabilities
o Claims against the company not acknowledged as debt;
o Guarantees;
o Other money for which the company is contingently liable.
 Commitments
o Estimated amounts of contracts remaining to be executed on capital
account and not provided for;
o Uncalled liability on shares and other investments partly paid;
o Other commitments (specify nature).

PART II – Form of STATEMENT OF PROFIT AND LOSS

Name of the Company…………………….
Profit and Loss Statement for the year ended ………………………

(Rs.in……….)
Particulars Note Figures Figures for
No. for the the previous
current reporting
reporting period
period

1FIN BY INDIGOLEARN 11.10

 I. Revenue from operations xxx xxx
II. Other income xxx xxx
III. Total Revenue (I + II) xxx xxx
IV. Expenses: xxx xxx
Cost of materials consumed xxx xxx
Purchases of Stock-in-Trade xxx xxx
Changes in inventories of finished goods Work- xxx xxx
in- Progress and Stock-in-Trade
Employee benefits expense xxx xxx

Finance costs xxx xxx

Depreciation and amortization expense xxx xxx
Other expenses xxx xxx
Total expenses xxx xxx
V. Profit before exceptional and extraordinary items xxx xxx
and tax (III-IV)
VI. Exceptional items xxx xxx
VII. Profit before extraordinary items and tax (V-VI) xxx xxx
VIII. Extraordinary Items xxx xxx
IX. Profit before tax (VII-VIII) xxx xxx
X. Tax expense:
(1) Current tax xxx xxx
(2) Deferred tax xxx xxx xxx xxx
XI. Profit (Loss) for the period from continuing xxx xxx
operations (VII-VIII)
XII. Profit/(Loss) from discontinuing operations xxx xxx
XIII. Tax expense of discontinuing operations xxx Xxx

XIV. Profit/(Loss) from discontinuing operations xxx xxx

(after tax) (XII-XIII)
XV. Profit (Loss) for the period (XI + XIV) xxx xxx
XVI. Earnings per equity share:
(1) Basic xxx xxx
(2) Diluted xxx xxx

1FIN BY INDIGOLEARN 11.11

 Unit-2 Issue, Forfeiture and Re-issue of Shares

Procedure for raising funds through equity

COMPANY

(1) PROSPECTUS

APPLICATION &
CALL MONEY

(4)

(3)

SHARE SHARE
APPLICATION HOLDER
S
(2)
(5) Shares Allotted

1FIN BY INDIGOLEARN 11.12

 Issue of prospectus
inviting applications for
shares from the public

Applications
received & Share
application
money received

Under subscription
Full subscription Over subscription
(Issued >
(Issued = Subscribed) (Issued < Subscribed)
Subscribed)

Minimum Minimum
subscription subscription NOT
received received

Directors make Pro-rata

All application
allotment for allotment made
money returned
shares applied by Directors

Allotment money
received

Further calls
made and call
money received

Note: Section 53 of Companies Act,

2013 a company cannot issue
Shares issued
shares at discount except for in
for cash
case of sweat equity shares and
therefore any issue on discount by
the company will be void with
company being punishable with At face value At Premium
fine.

“Securities Premium
Account” is credited
with the entry for
“Share Capital
Account”

1FIN BY INDIGOLEARN 11.13

INTRODUCTION

Capital
Funds provided by the owners.
Business Organization Ownership Type of Capital Liability of Owners
Sole - Proprietorship Proprietor Capital Unlimited

Partnership Partners Partners' Capital Unlimited

Company Shareholders Share Capital Limited to issue price of
shares held

SHARE CAPITAL
 Share
Total capital of the company is divided into a number of small indivisible units of a fixed amount
called shares. The capital of the company is called ‘Share Capital’

 Face / Nominal Value of Share

The fixed value of a share printed on the share certificate.
 Share Price
Issue price – The value at which the share is issued [Face (+) Premium, if any
(–) Discount, if any]
Book building - Process through which company determines it's share prices. Under this
method company determines a price band of its shares and on the basis of bids received from
potential investors at various prices within the price band finally fixes its issue price
Market Price – The value at which the share is traded on the stock exchange

1FIN BY INDIGOLEARN 11.14

SHARE CAPITAL - Categories

Authorised Share Subscribed Share

Capital or Nominal Issued Share Capital Capital
Capital

•It is the maximum limit of •It is the portion of the •It is part of Issued Share
capital which a company is authorised capital issued Capital
authorised to raise during by the company •subscribed by the public
its lifetime •allotted by the company
•It includes the nominal
•It is mentioned in 'Capital value of shares issued for •It also includes face value
Clause' of the •Cash of shares issued by
"Memorandum of •Consideration other than company for consideration
Association" Cash to other than cash.
• Promoters
•It is disclosed on the face • Others
of the Balance Sheet at
face value
•The remaining portion of
the Authorised Share
capital which is not issued
either in cash or
consideration may be
termed as ‘Un-issued
Capital’

1FIN BY INDIGOLEARN 11.15

SHARE CAPITAL - Categories

Called-up Paid-up Share Subscribed Reserve Share

Share Capital Capital Share Capital capital

•It is the portion of •It is the portion of •It is part of Issued •It is the portion of
the issue price of called up capital Share Capital the uncalled
shares which a which is paid by •subscribed by the capital which a
company has the shareholders. public company has
demanded or •allotted by the decided to call
called from • A particular company only in case of
shareholders amount called by liquidation of the
the company and company
•It also includes
•The balance, not paid by the face value of
which the company shareholder(s), shares issued by •As per Section 65
has decided to fully or partially, is company for of the Companies
demand in future known as ‘unpaid consideration other Act, 2013, a
may be referred to calls’ or than cash. Company may
as Uncalled ‘installments (or decide by passing a
Capital." Calls) in Arrears’ resolution

• Paid up Capital =
Called up Capital –
Installments in
Arrears

•In balance sheet,

Called -up and
Paid-up share
capital are showin
together

1. Authorised Capital = Issued Capital + Unissued Capital.

2. Subscribed Capital differs based on subscription type
• Fully Subscribed: Subscribed Capital = Issued Capital
• Over Subscribed: Subscribed Capital > Issued Capital
• Under Subscribed: Subscribed Capital < Issued Capital
3. Called up Capital = Paid up Capital + Calls in arrears if any – Calls in advance if any
 Calls in advance
4. Uncalled capital = Issued Share Capital – Called up Share Capital

 Calls in advance
been paid by shareholder. It is shown separately, in the Balance Sheet as liability of the
company under the heading ‘Current Liabilities’ until the calls are made and the amount actually
becomes payable by the shareholder.

1FIN BY INDIGOLEARN 11.16

Types of Shares

SHARES
Preference
Equity

 Preference Shares
As per Section 43 of the Companies Act, 2013, Preference shareholders
 are assured of a preferential dividend at a fixed rate during the life of the
company.
 carry a preferential right over other shareholders to be paid first in case of
winding up of the company.

 Type of Preference Shares

Based on "Right to • Cumulative

accumulate dividends" • Non-Cumulative

Based on "Right to • Participating

participate in surplus • Non-Participating

• Redeembable
Based on Redemption
• Non-Redeemable

Based on Conversion • Convertible

into equity • Non-Convertible

a. Cumulative Preference Shares

 It carries the right to a fixed amount of dividend or dividend at a fixed rate.
 Dividend on these shares accumulates unless it is paid in full
 The arrears of dividend are then shown in the balance sheet as a contingent
liability.
 In India, a preference share is considered cumulative unless otherwise stated.
 If arrears of dividend are outstanding for a period more than two years,
holders of such shares can vote on every resolution on every matter in the general
body meeting of the shareholders.

b. Non-cumulative Preference Shares:

 It carries with it the right to a fixed amount of dividend.

1FIN BY INDIGOLEARN 11.17

  Dividend on these shares does not accumulate in the year with no profits
 The right to dividend expires every year.

c. Participating Preference Shares

 These shares give the right to participate in the surplus profits, if any, after
the equity shareholders
o Every year for dividend at a stipulated rate
o At the time of winding up for distribution of profits (a pre-determined
proportion)

d. Non-participating Preference Shares

 No additional rights in profits and in the surplus on winding-up,
 Unless otherwise specified, the preference shares are generally non-
participating.

e. Redeemable Preference Shares

 The company will repay after the fixed period or even earlier at company’s
discretion.
 The repayment on these shares is called redemption and is governed by Section
55 of the Companies Act, 2013.

f. Non-redeemable Preference Shares

 No redemption arrangement agreed upon.
 According to Section 55, no company limited by shares shall issue irredeemable
preference shares or preference shares redeemable after the expiry of 20 years
from the date of issue.
 A Company may issue preference shares redeemable after 20 years for such
infrastructure projects as may be specified, under the Companies Act, 2013.

g. Convertible Preference Shares

 These shares give the right to get converted into equity shares at the
shareholder’s option.

h. Non-convertible Preference Shares

 No right to get his holding converted into equity share
 Preference shares are non-convertible unless otherwise stated.
Special Points related to Preference Shares:
 They enjoy preferential rights in the matter of :
o Payment of dividend, and
o Repayment of capital
 Generally, holders of these shares do not get voting rights
 The cost of raising preference share capital is cheaper than raising debt
 The Companies Act, 2013 prohibits the issue of any preference share which is
irredeemable.
 Preference shares are cumulative and non-participating unless expressly stated
otherwise.
 Unless mentioned otherwise Preference Shares are Non-Cumulative, Non
Participating, Non- Convertible and Redeemable in nature.

1FIN BY INDIGOLEARN 11.18

  Dividend is generally cumulative.

 Equity Shares

Those shares, which are not preference shares are called Equity Shares.

Special Points for Equity Shares

 These shares carry voting rights.
 No preferential rights in the matter of payment of dividend or repayment of
capital
 Dividend on equity shares is recommended by the Board of Directors and may vary
from year to year.
 Rate of dividend depends upon the dividend policy and the availability of profits
after satisfying the rights of preference shareholders.
 Companies Act, 2013 permits issue of equity share capital with differential rights
as to dividend.

Types of Equity Shares

Equity Equity
Shares Shares
Issued for
Issued for Cash consideration
other than Cash

1FIN BY INDIGOLEARN 11.19

ISSUE OF SHARES FOR CASH

Private Companies

• Private Placement

Public Companies

• Issue Prospectus
• Invite General Public to subscribe for Shares
• Receive Share applications and Application money (Section 39 Application
money ≥ 5% of nominal value)
• Allot Shares to subscribers as per SEBI guidelines (A company cannot
proceed to allot shares unless minimum subscription is received by the
company

 Minimum Subscription
A public limited company cannot make any allotment of shares unless
 minimum subscription stated in the prospectus has been subscribed and
 application money for such shares has been paid to and received by the company.

The amount of minimum subscription to be disclosed in prospectus by the Board of

Directors should consider the following
(a) Preliminary expenses,
(b) Commission payable on issue of shares,
(c) Cost of fixed assets purchased or to be purchased,
(d) Working capital requirements, and
(e) Any other expenditure for the day to day operation of the business.
Guidelines of the Securities Exchange Board of India (SEBI)
 Minimum subscription to be received in an issue shall not be less than 90% of the offer
through offer document.
 Non receipt of the minimum subscription of 90% of the issue, all application moneys
received shall be refunded:
o Non-underwritten Issue – within 15 days of the closure of the issue; and
o Underwritten Issue – within 7 days of the closure of the issue
o Underwritten issue where minimum subscription including devolvement obligations
paid by the underwriters is not received – within 60 days of the closure of the issue.
 The company has the right to reject or accept an application fully or partially.
o Accepted applications – Shareholders have to pay “Allotment Money”
o Rejected applications – Application money is refunded by the Company (delayed

1FIN BY INDIGOLEARN 11.20

 refunds shall be paid with interest)
 ‘Calls’ (subsequent instalments of the issue price) made by company as given in prospectus.

Note: The issue price of shares is generally received by the company in instalments:
First instalment Application Money
Second Instalment Allotment Money
Third Instalment First Call Money
Fourth Instalment Second Call Money and so on.
Last Instalment Final Call Money

Application money

Companies Act,
SEBI Regulations
2013 - Section 39

≥ 5% of Face ≥ 25% of Issue

Value Price

Section 24 of the Companies Act, 2013 - Matters related to issue and transfer of securities
will be administered by the SEBI and not by the Company Law Board. Thus the application
money has to be minimum of 25% of Issue price.

SUBSCRIPTION OF SHARES

 Full Subscription
Number of shares offered for subscription = Number of shares actually subscribed by the
public

 Under Subscription
Number of shares offered for subscription > Number of shares actually subscribed by the
public.
Important Note: shares can be allotted, in this case, only when the minimum subscription
is received.
 Minimum subscription received è Proceed for allotment
 Minimum subscription not received è Refund the amount received on application, as
per guidelines

 Over Subscription
Number of shares offered (Public issue) < Number of shares actually subscribed by the public.
 Applications rejected è application money refunded
 Applications accepted
o All shares applied are allotted è No refund
o Part of the shares applied are allotted è excess amount received can be used
for allotment or call money

1FIN BY INDIGOLEARN 11.21

JOURNAL ENTRIES – ISSUE OF SHARES

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1) Receipt of Bank A/c Dr. xxxx Actual amount
Application received.
Money To Share Application Money A/c xxxxx Actual amount
received.
(Being application money received)
(1a) Refund of Share Application A/c Dr. xx Actual amount
Application money To Bank A/c xx refunded
to applicants) (Being application money refunded)
(2) Allotment Share Allotment A/c Dr. xxxx Amount due on
of Share allotment
Share Application A/c Dr. xxxx Application amount
received on allotted
shares
To Share Capital A/c xxxxxx Amount due on
allotment and
application
(Being the sum due on allotment and
application money transferred to
capital account)
(2a) A part of Share Application A/c Dr. xxxx
shares applied for
are allotted To Share Allotment A/c ** xxxx Application money
accepted for
allotment
To Shares Calls in advance A/c xxx Amount from
application money
adjusted for future
calls
To Bank A/c xx Excess amount to be
refunded
(Being application money adjusted)
** Credited to Share Capital A/c
subsequently
(3) Receipt of Bank A/c Dr. xxxx Amount actually
allotment received on allotment.
money To Share Allotment A/c xxxx
(Being money received on allotment)
(4) Call being Share Call A/c Dr. xxx Amount due on the
made call
To Share Capital A/c xxx
(Being share call made due at Rs……)
(5) Receipt of Bank A/c Dr. xxxx Amount called
Call Money actually received

1FIN BY INDIGOLEARN 11.22

 To Share Call A/c xxxx
(Being share call money received)

Note: Sometimes separate Application and Allotment Accounts are not prepared and entries
relating to application and allotment monies are passed through a combined account “Share
Application & Allotment Account”.

SHARES ISSUED AT DISCOUNT

Shares are issued at DISCOUNT, if Issue Price < Nominal or Par Value
Discount = Nominal Value – Issue Price

Example:
Nominal Value Issue Price Discount (Rs.) Discount %
(a) (b) (c) = (a-b) (d)= [(c) ÷ (a) ]100
100 100 0 N.A
100 98 2 2%
100 110 N.A N.A
250 200 50 20%

Important Note: As per Section 53 of the Companies Act, 2013, a Company cannot issue shares
at a discount except in the case of issue of sweat equity shares (issued to employees and
directors). Thus, any issue of shares at discount shall be void (if issued to general public).

SHARES ISSUED AT PREMIUM

Shares are issued at PREMIUM, if Issue Price > Nominal or Par Value
Premium = Issue Price -Nominal Value

Example:
Nominal Value Issue Price Premium (Rs.) Premium %
(a) (b) (c) = (b-a) (d)= [(c) ÷ (a) ]100
100 100 0 N.A
100 120 20 20%
100 90 N.A N.A
250 350 100 40%

Premium is generally called with the amount due on allotment, sometimes with the application of
money and rarely with the call money

 Securities Premium Account

 Premium amount is credited to a separate account called Securities Premium Account.
 It is not a part of share capital. Rather, it represents a gain of a capital nature to the
company.
 It is shown under the heading, “Reserves and Surplus”, which is further shown as
“Shareholders’ Funds” in the Balance Sheet as per Schedule III.

1FIN BY INDIGOLEARN 11.23

  Utilisation of Securities Premium Account
It may be used by the company as given under Section 52 of the Companies Act, 2013:
(a) Towards issue of un-issued shares of the company to be issued to members of the
company as fully paid bonus securities.
(b) To write off preliminary expenses of the company.
(c) To write off the expenses of, or commission paid, or discount allowed on any of the
securities or debentures of the company.
(d) To provide for premium on the redemption of redeemable preference shares or
debentures of the company.
(e) For the purchase of own shares or other securities i.e. Buy back of shares.
Note Companies whose financial statements comply with the accounting standards prescribed
for them under Section 133 of the Companies Act, 2013.

JOURNAL ENTRIES – ISSUE OF SHARES AT PREMIUM

(1) Premium amount called with Application Money
Event Entry Debit Credit Remarks
(Rs.) (Rs.)
(1) Receipt of Bank A/c Dr. xxxx Total application
Application money + Premium
Money amount
To Share Application Money A/c xxxxx Actual amount
received.
(Being application money received for
_____ shares @ Rs._____ per share
including premium)
(2) Allotment Share Application A/c Dr. xxxx No. of shares x
of Share Application money per
share
To Share Premium A/c Dr. xxxx No. of shares
allotted x Premium
per share
To Share Capital A/c xxxxxx No. of shares
allotted x Nominal
Value per share
(Being the application money
transferred to capital account)

(2) Premium amount called with Allotment Money

Event Entry Debit Credit Remarks
(Rs.) (Rs.)
(1) Receipt of Bank A/c Dr. xxxx Total application
Application money + Premium
Money amount
To Share Application A/c xxxxx Actual amount
received.

1FIN BY INDIGOLEARN 11.24

 (Being application money received for
_____ shares @ Rs._____ per share
including premium)
(2) Allotment Share Application A/c Dr. xxxx No. of shares x
of Share Application money per
share
Share Allotment A/c Dr. xxxx No. of shares
allotted x Allotment
& Premium amount
per share
To Share Capital A/c xxxxxx No. of shares
allotted x Application
& allotment amount
per share
To Share Premium A/c Dr. xxxx No. of shares
allotted x Premium
per share
(Being Amount due on allotment of
shares @ Rs.____per share including
premium )
(3) Allotment Bank A/c Dr. xxxx Actual amt received
money To Share Allotment Money A/c xxxxx Total allotment money
received + Premium amount
(Being money received including
premium consequent upon allotment)

OVER SUBSCRIPTION AND PRO-RATA ALLOTMENT

Number of shares offered (Public Issue) < Number of shares actually subscribed by the
public.

Reasons for oversubscription

 investors’ confidence in the company,
 previous performance of the company
 general economic conditions,
 pricing of the issue etc

Allotment for oversubscription

 Shares can be allotted to the applicants by a company in any manner it thinks proper.
 Some Applicants rejected in full and remaining accepted in fullè application money
refunded to such applicants
 Multiple applications by the same person not considered è application money refunded
for applications
 All Applications accepted è allotment done on pro-rata basis i.e. ‘Pro-rata allotment’
means allotment in proportion of shares applied for.

1FIN BY INDIGOLEARN 11.25

 Example
Shares offered to public 10,000
Applications received 12,000
Ratio 12,000:10,000 i.e. 6:5
For every 6 shares applied, 5 shares are allotted

 Excess amount received is treated as an advance against allotment and calls and
thereby adjusted against the amount due on allotment or calls.
 Surplus money after making adjustment against future calls is returned to the
applicants.
 The applicants are informed about the allotment procedure through an advertisement
in leading newspapers.

JOURNAL ENTRIES – OVER SUBSCRIPTION (PRO-RATA ALLOTMENT)

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1) Rejected Share Application A/c Dr. xxxx Application money x no.
applications of shares rejected
To Bank A/c xxxxx Actual amount received.

(Being application money refunded

for rejected applications as per
Board’s Resolution No….dated….)
(2) Pro-rata Share Application A/c Dr. xxxx Total money received –
Allotment (No. of shares allotted x
Application money per
share)
To Share Allotment A/c xxxxxx No. of shares allotted x
Allotment money per
share
(Being excess application money
adjusted against allotment money as
per Board’s Resolution No….dated….)

1FIN BY INDIGOLEARN 11.26

CALLS IN ADVANCE & CALLS IN ARREARS

Calls made

Scenario I Scenario II Scenario III

Calls paid = Calls paid < Calls paid >

Calls made Calls made Calls made

Calls in
All Dues paid Calls in Arrears
Advance

 Calls in Arrears
 The total unpaid amount on one or more instalments called but shareholder failed to pay is
known as Calls-in-Arrears or Unpaid Calls.
 It is the uncollected amount of capital from the shareholders;
 It is shown by way of deduction from ‘called-up capital’ to arrive at paid-up value of the share
capital.
 Calls in Advance
 Amount not yet called up but paid by shareholders is known as Calls-in-advance.
 Interest at a rate not exceeding 12 % p.a. is to be paid on such advance call money.
 This amount is credited in Calls-in-Advance Account and shown separately under Current
Liabilities
 Interest on Calls in Arrears & Calls in Advance

Interest on Calls in Arrears Interest on Calls in Advance

Receivable by the Compay Payable by the Company to
from the Shareholders Shareholders
Maximum Rate (Table F Maximum Rate (Table F
prescribed) is 10% prescribed) is 12%
Interest period = Call due date Inerest period = Actual money
to actual money receipt date receipt date to Call due date
Directors have right to waive Shareholders are not entitled
off such interest on their to dividend on calls in advance
discretion Expense - debited to P&L A/c
Income - credited to P&L A/c
as a nominal account

1FIN BY INDIGOLEARN 11.27

 JOURNAL ENTRIES – CALLS IN ADVANCE & CALLS IN ARREARS

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1a) Calls in Calls in arrears A/c Dr. xx Amount of Unpaid Calls
Arrears after call Bank A/c Dr. xxxx Amount received
made To Share Allotment A/c xxx Total allotment money
due
To Share Calls A/c xxxx Total allotment money
due
( Being call money/ allotment money
received on .... shares at ` per
share.)
(1b) Calls in Bank A/c Dr. xx Amount of Unpaid calls
Arrears received To Calls in Arrears A/c xx received
(Being unpaid calls received)
(2a) Calls in Bank A/c Dr. xxx Call amount received in
Advance received To Calls in Advance A/c xxx advance
(Being excess application money
received)
(2b) Call made Calls in Advance A/c Dr. xxx Call amount received in
advance
Bank A/c Dr. xx Remaining call money
received, if any
To Particulars Call A/c xxxx Call money due
(Being call in advance adjusted and
call money due received)
(3a)For interest Shareholder’s A/c Dr. xxx
receivable on Calls- To Interest on Calls in arrears A/c xxx
in-Arrears (Being interest on calls in arrears at
the rate of _____% due)
(3b) For receipt of Bank A/c Dr. xxx
interest To Shareholder’s A/c Xxx
(Being interest money received)
(4a) For interest Interest on Calls-in-AdvanceA/c Dr. xxx Amount of interest due
payable on Calls- To Shareholder’s A/c xxx for payment
in-Advance due (Being interest on calls in advance
due)
(4b) For payment Shareholder’s A/c Dr. xxx Amount of interest paid
of interest To Bank A/c xxx
(Being interest money received)

FORFEITURE OF SHARES

 Forfeiture of shares is the action taken by a company to cancel the shares, WHEN
shareholders fail to pay their allotment and/or calls on the due dates

1FIN BY INDIGOLEARN 11.28

  The directors are usually empowered by the Articles of Association to forfeit those
shares by strictly following the rules and regulations in the Articles of Association
 Proper notice to the defaulting shareholder(s) should be served.
 Directors also have the right to cancel such forfeiture before the forfeited shares
are re-allotted.
 When shares are forfeited, the title of such shareholder is extinguished but the
amount paid to date is not refunded to him.
 The shareholder then has no further claim on the company.

Forfeiture of Shares

Scenario I Scenario II
Scenario III***
Shares issued at Par Shares issued at
Fully paid Shares
Premium

*** Forfeiture for non-payment of calls, premium, or the unpaid portion of the face value of the
shares is one of the many causes for which a share may be forfeited. But fully paid-up shares may
be forfeited for realization of debts of the shareholder if the Articles specifically provide it.

JOURNAL ENTRIES – FORFEITURE OF SHARES

Important Amounts to consider:
(i) Amount called-up (i.e., amount credited to capital) in respect of forfeited shares.
(ii) Amount already received in respect of those shares.
(iii) Amount due but has not been received in respect of those shares.

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1a) Forfeiture of Share Capital A/c Dr. xxxx No. of forfeited shares
shares issued at x called-up value per
Par – No Calls-in- share
Arrears To Forfeited Shares A/c xxx Amount already received
on forfeited shares
To Share Allotment A/c xxx IF amount due but not
paid
To Share Call A/c xx IF amount due but not
paid

(1b) Forfeiture of Share Capital A/c Dr. xxxx No. of forfeited shares x
shares issued at called-up value per share
Par – With Calls-in- To Calls in Arrears A/c xx Total Amount due but not
Arrears paid
To Forfeited Shares A/c xxx Amount already received
on forfeited shares

1FIN BY INDIGOLEARN 11.29

(2a) Forfeiture of Share Capital A/c Dr. xxx Call amount received in
shares issued at advance
Premium – IF Securities Premium A/c Dr. Amount of Security
Premium NOT premium not received
received To Forfeited Shares A/c xxx Amount already received
on forfeited shares
To Share Allotment A/c xxx IF amount due but not
paid
To Share Call A/c xx IF amount due but not
paid
(2a) Forfeiture of Share Capital A/c Dr. xxx Call amount received in
shares issued at advance
Premium – IF To Forfeited Shares A/c xxx Amount already received
Premium received on forfeited shares
To Share Allotment A/c xxx IF amount due but not
paid
To Share Call A/c xx IF amount due but not
paid
Note: If the premium has already received by the company, it cannot be cancelled even if the shares are
forfeited in the future:

RE-ISSUE OF FORFEITURE OF SHARES

 A forfeited share is merely a share available to the company for sale and remains vested in
the company as an obligation to dispose it off.
 Reissue of forfeited shares is not allotment of shares but only a sale. In practice, forfeited
shares are disposed off, by auction.
 These shares can be re-issued at any price so long as the total amount received (from the
original allottee and the second purchaser) for those shares is not less than the amount in
“Calls-in-arrears” on those shares.

Re-issue of Shares

Scenario I Scenario II
Loss on Re-issue Profit on Re-issue

 Important Points
 Loss on re-issue should not exceed the forfeited amount.
 When the shares are re-issued at a loss, such loss is to be debited to “Forfeited Shares
Account”.
 If the loss on re-issue is less than the total amount forfeited, the surplus should be
transferred to Capital Reserve.

1FIN BY INDIGOLEARN 11.30

  When only a portion of the forfeited shares are re-issued, then the profit made on re-issue
of such portion of shares only must be transferred to Capital Reserve.
 If the shares are re-issued at a price which is more than the face value of the shares, the
excess amount will be credited to Securities Premium Account.
 The forfeited amount on shares (amount originally paid-up) not yet reissued should be shown
under the heading ‘share capital.’
 If the re-issued amount and forfeited amount (taken together) exceeds the face value of
the shares re-issued, it is not necessary to transfer such amount to Securities Premium
Account.
 The credit balance of forfeited shares account cannot be considered a surplus until the
shares forfeited have been re-issued, because the company may, on re-issue, allow the
discount to the new purchaser equivalent to the amount held in credit in this regard in the
forfeited shares Account
 Calculation of Profit on Re-issue of Forfeited Shares
Example
No.of shares forfeited 120
Nominal value of each share Rs.10
Paid up amount on each forfeited share Rs.5

First Re-Issue 50 shares (Rs.6 per share collected to make it fully paid up)
Amount received [50x 6] Rs.300

Amount transferred from No. of shares x (Nominal Value – Amount Rs.200

Shares forfeited A/c to received on re-issue) i.e. [50 (10 – 6)]
Share Capital A/c

Surplus on Re-issue: Amount Amount in Shares Forfeited A/c for shares Rs.50
transferred to Capital re-issued – Amount transferred to Share
Reserve Capital A/c i.e.
[(50x5)-Rs.200]
Amount carried forward in Total Value of Shares Forfeited – Amount Rs.350
Shares Forfeited A/c transferred to Share Capital on re-issue –
Surplus transferred to Capital Reserve
[(120x5) – Rs.200 – Rs.50]

JOURNAL ENTRIES – FORFEITURE OF SHARES

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1) Re-issue of Bank A/c Dr. xx Actual amount received
shares Forfeited Shares A/c Dr. xxx Profit on re-issue
To Share Capital A/c xxx

1FIN BY INDIGOLEARN 11.31

 (Being the re-issue of….shares @
Rs.…. each as per Board’s Resolution
No…. dated.)
(2) Surplus Forfeited Shares A/c Dr. xxxx
transferred to To Capital Reserve A/c xx
Capital Reserve (Being the profit on re-issue,
A/c transferred to capital reserve).

ISSUE OF SHARES FOR CONSIDERATION OTHER THAN CASH

 A public limited company generally, issue their shares for cash but it may issue shares
o in a direct exchange for land, buildings or other assets.
o in payment for services rendered by promoters, lawyers in the formation of
the company.
 These shares should be shown separately under ‘Share Capital’.
 Within specified time of allotment, the company must produce before the Registrar
a written contract of sale of service in respect of which shares have been allotted.

When assets are purchased in exchange of shares

Assets Account Dr.

To Share Capital Account

1FIN BY INDIGOLEARN 11.32

Illustrations

Question: 1
JHP Limited is a company with an authorised share capital of Rs.10,00,000 in equity shares of
Rs.10 each, of which 6,00,000 shares had been issued and fully paid on 30th June 2016. The
company proposed to make a further issue of 1,00,000 of these Rs.10 shares at a price of Rs.14
each, the arrangements for payment being:
a. Rs.2 per share payable on application, to be received by 1st July 2016;
b. Allotment to be made on 10th July 2016 and a further Rs.5 per share (including the
premium) to be payable;
c. The final call for the balance to be made, and the money received by 30th April 2017.
Applications were received for 3,55,000 shares and were dealt with as follows:
i. Applicants for 5,000 shares received allotment in full;
ii. Applicants for 30,000 shares received an allotment of one share for every two applied for;
no money was returned to these applicants, the surplus on application being used to reduce the
amount due on allotment;
iii. Applicants for 3,20,000 shares received an allotment of one share for every four applied
for; the money due on allotment was retained by the company, the excess being returned to the
applicants; and
iv. the money due on final call was received on the due date.
You are required these transaction (including cash items) in the Journal of JHP Ltd.

Question: 2
A company had an authorised capital of Rs.10,00,000 divided into 1,00,000 equity shares of Rs.10
each. It decided to issue 60,000 shares for subscription and received applications for 70,000
shares. It allotted 60,000 shares and rejected remaining applications. Up to 31-3 -2017, it has
demanded or called Rs.9 per share. All shareholders have duly paid the amount called, except one
shareholder, holding 5,000 shares who has paid only Rs.7 per share.
Prepare a balance sheet assuming there are no other details.

Question: 3
A company invited applications for 10,000 equity shares of Rs.50 each payable on:
1. Application Rs.15;
2. Allotment Rs.20,
3. on first and final call Rs.15.
Applications are received for 10,000 shares and all the applicants are allotted the number of
shares they have applied for and instalment money was duly received by the company.
Show Journal entries in the books of the company.

Question: 4
On 1st April 2017, A Ltd. issued 43,000 shares of Rs. 100 each payable as follows:
 Rs.20 on application;
 Rs.30 on allotment;
 Rs.25 on 1st October 2017; and
 Rs. 25 on 1st February 2018

1FIN BY INDIGOLEARN 11.33

By 20th May, 40,000 shares were applied for and all applications were accepted. Allotment was
made on 1st June. All sums due on allotment were received on 15th July; those on 1st call was
received on 20th October.
Journalise the transactions when accounts were closed on 31st March 2018.

Question: 5
Pant Ltd. invited applications for 50,000 equity shares at Rs.50 each, which are payable as on
application Rs.20, on allotment Rs.10 and on first and final call Rs.20. The company received
applications for 60,000 shares. The directors accepted application for 50,000 shares and rejected
the rest.
Show Journal entries if company refunded the application money to rejected applicants and
allotment money was received for 45,000 shares.

Question: 6
The Delhi Artware Ltd. issued 50,000 equity shares of Rs 100 each and 1,00,000 preference
shares of Rs.100 each. The Share Capital was to be collected as under:
Particulars Equity Shares Preference
Rs. Shares Rs.
On Application 25 20
On Allotment 20 30
First Call 30 20
Final Call 25 30
All these shares were subscribed. Final call was received on 42,000 equity shares and 88,000
preference shares.
Prepare the cash book and journalise the remaining transactions in the books of the company.

Question: 7
On 1st October 2017 Pioneer Equipment Limited received applications for 2,50,000 Equity Shares
of Rs. 100 each to be issued at a premium of 25 per cent payable as:
On Application Rs.25
On Allotment Rs.75 (including premium)
Balance Amount on Shares As and when required
The shares were allotted by the Company on October 20, 2017 and the allotment money was duly
received on October 31, 2017.
Record journal entries in the books of the company to record the transactions in connection with
the issue of shares

Question: 8
JHP Limited is a company with an authorised share capital of Rs.10,00,000 in equity shares of
Rs.10 each, of which 6,00,000 shares had been issued and fully paid on 30thJune, 2016. The
company proposed to make a further issue of 1,00,000 of these Rs.10 shares at a price of Rs.14
each, the arrangements for payment being:
 Rs.2 per share payable on application, to be received by 1st July 2016.
 Allotment to be made on 10th July 2016 and a further Rs.5 per share (including the
premium) to be payable.
 The final call for the balance to be made, and the money received by 30th April 2017.
Applications were received for 3,55,000 shares and were dealt with as follows:

1FIN BY INDIGOLEARN 11.34

 i. Applicants for 5,000 shares received allotment in full
ii. Applicants for 30,000 shares received an allotment of one share for every two applied for,
no money was returned to these applicants, the surplus on application being used to reduce the
amount due on allotment.
iii. Applicants for 3,20,000 shares received an allotment of one share for every four applied
for, the money due on allotment was retained by the company, the excess being returned to the
applicants.
iv. the money due on final call was received on the due date.
You are required to record these transactions (including cash items) in the Journal of JHP
Limited.

Question: 9
Shreyas Ltd. did not receive the first call on 10,000 equity shares @ Rs. 3 per share which was due
on 1.7.2016. This amount was received on 1.4.2017.
Open Calls in arrears account and journalise the entries in the books of the company on 1.7.2016
and 1.4.2017. Also show an extract of Balance Sheet on 31.3.2017.

Question: 10
Rashmi Limited issued at par 1,00,000 Equity shares of Rs.10 each payable:
 Rs.2.50 on application;
 Rs.3 on allotment;
 Rs. 2 on first call and balance on the final call.
All the shares were fully subscribed. Mr. Nair who held 10,000 shares paid full remaining amount
on first call itself. The final call which was made after 3 months from first call was fully paid
except a shareholder having 1000 shares who paid his dues amount after 2 months along with
interest on calls in arrears. Company also paid interest on calls in advance to Mr. Nair.
Give journal entries to record these transactions

Question: 11
A Ltd forfeited 30,000 equity shares of Rs.10 fully called-up, held by Mr. X for non-payment of
final call @ Rs.4 each. However, he paid application money @ Rs.2 per share and allotment money @
Rs.4 per share. These shares were originally issued at par.
Give Journal Entry for the forfeiture

Question: 12
X Ltd forfeited 20,000 equity shares of Rs.10 each, Rs. 8 called-up, for non-payment of first call
money @ Rs. 2 each. Application money @ Rs. 2 per share and allotment money @ Rs.4 per share
have already been received by the company.
Give Journal Entry for the forfeiture (assume that all money due is transferred to Calls-in-
Arrears Account).

Question: 13
X Ltd. forfeited 5,000 equity shares of Rs.100 each fully called-up which were issued at a premium
of 20%.
Amount payable on shares were:- on application Rs.20; on allotment Rs.50 (including premium); on
First and Final call Rs.50. Only application money was paid by the shareholders in respect of these
shares.
Pass Journal Entries for the forfeiture.

1FIN BY INDIGOLEARN 11.35

Question: 14
Mr. Shami has applied for 1,000 shares of Company XYZ Ltd. paying application money @ Rs. 2 per
share but has been allotted only 600 shares. The shares have a face value of Rs.10 and a premium
of Rs. 2 per share, which are payable as: on Allotment- Rs.5 (including premium) and on final call Rs.
5. Now in case Mr. Shami doesn't pay allotment money and final call and his shares are forfeited,
then following entry will be passed on forfeiture:

Question: 15
Mr. Long who was the holder of 2,000 preference shares of Rs.100 each, on which Rs. 75 per share
has been called up could not pay his dues on Allotment and First call each at Rs.25 per share. The
Directors forfeited the above shares and reissued 1500 of such shares to Mr. Short at Rs. 65 per
share paid-up as Rs.75 per share.
Give Journal Entries to record the above forfeiture and re-issue in the books of the company.

Question: 16
Beautiful Co. Ltd issued 30,000 equity shares of Rs.10 each payable as
 Rs.3 per share on Application,
 Rs.5 per share (including Rs.2 as premium) on Allotment and
 Rs.4 per share on Call.
All the shares were subscribed. Money due on all shares was fully received except from Ram,
holding 500 shares, who failed to pay the Allotment and Call money and Shyam, holding 1,000
shares, who failed to pay the Call Money. All those 1,500 shares were forfeited. Of the shares
forfeited, 1,250 shares (including whole of Ram’s shares) were subsequently re-issued to Jadu as
fully paid up at a discount of Rs.2 per share.
Pass the necessary entries in the Journal of the company to record the forfeiture and re-issue of
the share. Also prepare the Balance Sheet of the company.

Question: 17
X Co. Ltd. was incorporated with an authorized share capital of 90,000 equity shares of Rs.10 each.
The company purchased land and buildings from Y Co. Ltd for Rs.4,00,000 payable in fully paid-up
shares of the company. The balance of the shares was issued to the public, which were fully
subscribed and paid for.
You are required to pass Journal Entries and to prepare the Balance Sheet.

1FIN BY INDIGOLEARN 11.36

 Unit-3 Issue of Debentures

Debentures
(Types)

Convertibility Permanence Negotiability

Security basis Priority
basis basis basis

First
Secured Convertible Redeemable Registered
Mortgage

Second
Non- Mortgage
Unsecured Irredeemable Bearer
Convertible

Introduction

Sources of
Finance for
Companies

Borrowed
Own Funds Funds /
Debt

Loans from
Share
Profits Debentures Banks &
Capital
Institutions

Equity Preference

 Debenture
It is one of the most commonly used debt instrument issued by the company to raise funds for
the business. Reason for opting Debentures: Benefits of Debt financing
 reduces the cost of the capital
 helps in designing appropriate capital structure of the company. REVLAUATION

1FIN BY INDIGOLEARN 11.37

 Debenture
A Bond
Company issues under its
seal
Acknowledges a Debt
Provides repayment of
principal and interest
Section 2 (30) of the Companies Act, 2013 - “Debenture” includes debenture stock, bonds or
any other instrument of a company evidencing a debt, whether constituting a charge on the assets
of the company or not.

Thus, debenture may be Secured Debenture or Unsecured Debenture. Those debentures that
have charge on the assets of the company are called “Secured Debentures”

 Charge on Assets
 It is a right of a lender (debenture holder, in this case) to be paid from a
borrower's (Company’s) assets if the debt is not paid on time as promised.
 The nature of the charge and the assets charged are described in the Bond.
 The charge is not valid unless registered with the Registrar, and the certificate
registering the charge is printed on the bond.
 It is also customary to create a trusteeship in favour of one or more persons in
the case of mortgage debentures.
 The trustees of debenture holders have all powers of a mortgage of a property
and can act in whatever way they think necessary to safeguard the interest of
debenture holders.
Note: No company shall issue any debentures carrying any voting rights.

 Features of Debentures

 It is a fixed interest-bearing security where interest falls due on specific dates.

 Interest is payable at a predetermined fixed rate, regardless of the level of profit.
 The original sum is
o repaid at a specified future date or
o converted into
• shares or
• other debentures.
 It may or may not create a charge on the assets of a company as security.
 It is a document which evidences a loan made to a company.
 It can generally, be bought or sold through the stock exchange at a price above or
below its face value.

1FIN BY INDIGOLEARN 11.38

DISTINCTION BETWEEN DEBENTURES AND SHARES

Difference Debentures Shares

Holders - Creditors of the company. Owners of the company.

status
Voting Rights No voting rights Holders have voting rights and thus
Thus, no threat to the existing issue will dilute the existing control
control of the company.
Return on Interest is paid at a pre- determined Dividend is paid at
Investment fixed rate. (i) a variable rate for equity
for the shares
holder (ii) fixed rate for preference
shares

Payment of Payable whether there is any profit or Payable only if profits are there.
Interest not. Interest on debentures has to be
paid

Deductible Interest is charge against profits and Dividends are appropriation of profits
expense they are deductible as an expense in and these are not deductible.
determining taxable profit of the
company.
Types Secured/Unsecured; Equity Shares;
Redeemable/ Irredeemable; Preference Shares.
Registered/Bearer;
Convertible / Non-convertible, etc.

Presentation “Long Term Borrowings” in the “Shareholder’s Fund” in the Company’s

in financial Company’s Balance Sheet Balance Sheet.
statements Shares are shown under detailed in
‘Share Capital’ of Notes to Accounts.

Convertibility Debentures can be converted into Shares cannot be converted into other
other debentures or shares as per the shares in any circumstances.
terms of issue of debentures.

Forfeiture Debentures cannot be forfeited for Shares can be forfeited for non-
non-payment of call moneys. payment of allotment and call moneys.

Redemption At maturity, debenture holders get (i) Equity shareholders: cannot

back their money as per the terms and get back their money before
conditions of redemption. the liquidation of the
company
(ii) Preference shareholders: can
get back their money before
liquidation .

Winding up At the time of liquidation, debenture At the time of liquidation shareholders

holders are paid-out before the are paid at last, after paying debenture
shareholders. holders, Trade payable, etc.

1FIN BY INDIGOLEARN 11.39

TYPES OF DEBENTURES

Debentures

Convertibility Permanence Negotiability

Security basis Priority
basis basis basis

Secured Convertible Redeemable Registered First Mortgage

Second
Non- Mortgage
Unsecured Irredeemable Bearer
Convertible

1. Based on Security
(a) Secured Debentures: These are secured by a charge upon some or all assets of the
company. There are two types of charges:
(i) Fixed charge: It is a mortgage on specific assets. These assets cannot be sold
without the consent of the debenture holders. The sale proceeds of these assets
are utilized first for repaying debenture holders; and
(ii) Floating charge: It generally covers all the assets of the company including
future one.
(b) Unsecured or “Naked” Debentures: These are not secured by any charge upon
any assets. A company merely promises to pay interest on due dates and to repay
the amount due on maturity date.
2. Based on Convertibility
(a) Convertible Debentures: These will be converted into equity shares (either at
par or premium or discount) after a certain period of time from the date of its
issue. These debentures may be fully or partly convertible.
(b) Non-Convertible Debentures: These cannot be converted into shares in future.
As per the terms of issue, these debentures are repaid.
3. Based on Permanence
(a) Redeemable Debentures: These are repayable as per the terms of issue.
(b) Irredeemable Debentures: These are not repayable during the lifetime of the
company i.e. they are repaid at the time of liquidation. These are also called
perpetual debentures.
4. Based on Negotiability
(a) Registered Debentures: These are payable to a registered holder whose name,
address and particulars of holding is recorded in the Register of Debenture
holders. They are not easily transferable. Debenture interest is paid either to the

1FIN BY INDIGOLEARN 11.40

 order of registered holder as expressed in the warrant issued by the company or
the bearer of the interest coupons.
(b) Bearer Debentures: These are transferable by delivery. These are negotiable
instruments payable to the bearer. No kind of record is kept by the company in
respect of the holders of such debentures. Therefore, the interest on it is paid to
the holder irrespective of any identity. No transfer deed is required for transfer
of such debentures.
5. Based on Priority
(a) First Mortgage Debentures: These are payable first, out of the property charged.
(b) Second Mortgage Debentures: These are payable after satisfying the first
mortgage debentures.

ISSUE OF DEBENTURES

Debentures

Issued at Issued at Issued at

Par Discount Premium

ISSUE OF DEBENTURES – JOURNAL ENTRIES

Debentures issued at Par

The debentures which are issued at par are issued at the same price as their nominal value

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1) Cash Bank A/c Dr. xxxx
received on To Debentures Application A/c xxxx
application (Being money received on __%
debentures @ Rs.___ each)
(2) Excess Debenture Application A/c Dr. xxx
money To Bank A/c xx Amount refunded
refunded or To Debenture Allotment A/c xxx Amount adjusted for
adjusted allotment
for future (Being excess money adjusted as per
calls Board’s resolution No…… dated……
(3) Debentures Debenture Application A/c Dr. xxxx
Allotted To …… % Debenture A/c xxxx
(Being the allotment of ….%
Debentures of Rs….. each as per
Board’s resolution No….. dated……)

Debenture Allotment A/c Dr. xxxx

1FIN BY INDIGOLEARN 11.41

 (4) Allotment To ….% Debentures A/c xxxx
money being (Being allotment money being called)
called
(5) Allotment Bank A/c Dr. xxxx
money being To Debenture Allotment A/c xxxx
received (Being allotment money received)
(6) Debenture Debenture Calls A/c Dr. xxxx
Call money To ….. % Debentures A/c xxxx
being called (Being call money made due)
(7) Call money Bank A/c Dr. xxxx
received To Debenture Calls A/c xxxx
(Being call money received)

Debentures issued at Premium

 The debentures, which are issued at a premium, are issued at a higher price than their
nominal value.
 Debentures are issued at a premium by a company when the market rate of interest is lower
than the debentures interest rate.
 The premium on debentures is credited to ‘Securities Premium Account’ as ‘Debentures’
are covered in the definition of ‘securities’ u/s 2(h) of the Securities Contracts
(Regulation) Act.
 Utilisation of such Debenture Premium is restricted as it is governed by Section 52 of
the Companies Act, 2013.

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1) Cash Bank A/c Dr. xxxx
received on To Debentures Application A/c xxxx
application (Being money received on __%
debentures @ Rs.___ each)
(2) Excess Debenture Application A/c Dr. xxx
money To Bank A/c xx Amount refunded
refunded or To Debenture Allotment A/c xxx Amount adjusted for
adjusted allotment
for future (Being excess money adjusted as per
calls Board’s resolution No…… dated……
(3) Debentures Debenture Application A/c Dr. xxxx
Allotted To …… % Debenture A/c xxxx
To Securities Premium A/c xx Difference between
issue and nominal value
(Being the allotment of ….%
Debentures of Rs….. each and Premium
amount transferred to Securities
Premium A/c as per Board’s resolution
No….. dated……)

1FIN BY INDIGOLEARN 11.42

 (4) Allotment Debenture Allotment A/c Dr. xxxx
money being To ….% Debentures A/c xxxx
called (Being allotment money being called)
(5) Allotment Bank A/c Dr. xxxx
money being To Debenture Allotment A/c xxxx
received (Being allotment money received)
(6) Debenture Debenture Calls A/c Dr. xxxx
Call money To ….. % Debentures A/c xxxx
being called (Being call money made due)
(7) Call money Bank A/c Dr. xxxx
received To Debenture Calls A/c xxxx
(Being call money received)

Debentures issued at Discount

 The debentures which are issued at a discount are issued at a lower price than nominal value
 The Companies Act does not impose any restriction on the price at which debentures can be
issued. Unlike shares, there is no limit for discount on issue of debentures.
 The company issues debentures at a discount when the market rate of interest is higher
than the debenture interest rate.
 The difference between the nominal value of debentures and cash received is transferred
to “Discount on Issue of Debentures Account”.
 Such “Discount on Issue of Debentures” is written-off proportionately in subsequent
years by charging to the Statement of Profit and Loss. It is considered a normal practice
to amortize discount on issue of debentures over the period of benefit, i.e., normally 3 to
5 years.
 The Discount on issue of debentures is considered as incremental interest expense. The
true expense (net borrowing cost) for a particular accounting period is, therefore, the
total interest payment plus the discount written off.

Event Entry Debit Credit Remarks

(Rs.) (Rs.)
(1) Cash Bank A/c Dr. xxxx
received on To Debentures Application A/c xxxx
application (Being money received on __% debentures @
Rs.___ each)
(2) Excess Debenture Application A/c Dr. xxx
money To Bank A/c xx Amount refunded
refunded To Debenture Allotment A/c xxx Amount adjusted
or adjusted for allotment
for future (Being excess money adjusted as per Board’s
calls resolution No…… dated……
(3) Debentures Debenture Application A/c Dr. xxxx
Allotted Discount on Issue of Debentures A/c Dr. xx Difference
between issue

1FIN BY INDIGOLEARN 11.43

 price and nominal
value
To …… % Debenture A/c xxxx
(Being the allotment of ….% Debentures of
Rs….. each and Discount amount transferred
to Discount on Issue of Debentures A/c as
per Board’s resolution No….. dated……)
(4) Allotment Debenture Allotment A/c Dr. xxxx
money To ….% Debentures A/c xxxx
being called (Being allotment money being called)
(5) Allotment Bank A/c Dr. xxxx
money To Debenture Allotment A/c xxxx
being (Being allotment money received)
received
(6) Debenture Debenture Calls A/c Dr. xxxx
Call money To ….. % Debentures A/c xxxx
being called (Being call money made due)
(7) Call money Bank A/c Dr. xxxx
received To Debenture Calls A/c xxxx
(Being call money received)

ISSUE OF REDEEMABLE DEBENTURES – JOURNAL ENTRIES

Redeemable
Debentures

Scenario (1) Scenario (2) Scenario (3)

Issued at Par Issued at Discount Issued at Premium

(1.1) (2.1) (3.1)

Redeemable at Par Redeemable at Par Redeemable at Par

(1.2) (2.2) (3.2)

Redeemable at Redeemable at Redeemable at
Discount Discount Discount

(1.3) (2.3) (3.3)

Redeemable at Redeemable at Redeemable at
Premium Premium Premium

1FIN BY INDIGOLEARN 11.44

 Scenario Entry Debit Credit Remarks
(Rs.) (Rs.)
(1.1) Bank A/c Dr. xxxxx
Issued at Par To Debenture Application A/c xxxxx Application
Redeemed at money
Par (Being application money received)
Debenture Application A/c Dr. xxxxx Application
To ____% Debenture A/c Xxxxx money
(Being application money transferred to Debenture A/c)
(2.1 & 2.2) Bank A/c Dr. xxxxx The difference
Issued @ To Debenture Application A/c xxxxx between the
Discount (Being application money received) amount received
Redeemed @ Debenture Application A/c Dr. xxxxx and amount
Par/ Discount Discount on issue of debentures A/c Dr. xx payable in future
To ____% Debenture A/c xxxxx is considered as
(Being application money transferred to Debenture A/c on loss on issue on
allotment) debentures and
is to be written-
off over the life
of debentures.
(3.1 & 3.2) Bank A/c Dr. xxxxx The gain on
Issued @ To Debenture Application A/c xxxxx paying less
Premium (Being application money received) than what is
Redeemed @ Debenture Application A/c Dr. xxxxx received in this
Par/Discount To ____% Debenture A/c xxxxx scenario will
not be
To Securities Premium A/c xx
recognised in
(Being application money transferred to Debenture A/c on
the books at
allotment)
the time of
issue of
debentures as
per the
conservatism
concept.

(1.3) Bank A/c Dr. xxxxx The redemption

Issued @ Par To Debenture Application A/c xxxxx premium is
Redeemed @ (Being application money received) recorded as a
premium Debenture Application A/c Dr. xxxxx loss on issue of
To ____% Debenture A/c xxxxx debentures
(Being application money transferred to Debenture A/c) allotment time.
Bank A/c Dr. xxxx Debenture
Loss on issue of debenture A/c Dr. xxxx Redemption
(Amount equal to redemption premium) Premium A/c is a
To __% Debenture A/c xxxxx personal account

1FIN BY INDIGOLEARN 11.45

 To __% Debenture Redemption Premium A/c xxxxx representing
(Being call made subsequent to allotment) company’s
liability.
(2.3) Bank A/c Dr. xxxxx The difference
Issued @ To Debenture Application A/c xxxxx between the
Discount (Being application money received) redemption price
Redeemed @ Debenture Application A/c Dr. xxxxx and par value plus
premium To ____% Debenture A/c xxxxx difference
(Being application money transferred to Debenture A/c) between the
Bank A/c Dr. xxxx issue price and
Discount/Loss on issue of debenture A/c Dr. xxxx par value is
(Amount equal to discount on issue + premium on treated as
redemption) discount/loss on
To __% Debenture A/c xxxxx issue of
To _% Debenture Redemption Premium A/c xxxxx debentures
(Amount equal to premium payable on
redemption)
(Being call made subsequent to allotment)
(3.3) Bank A/c Dr. xxxxx The premium
Issued @ To Debenture Application A/c xxxxx received at the
premium (Being application money received) time of issue of
Redeemed @ Debenture Application A/c Dr. xxxxx debentures is
premium To ____% Debenture A/c xxxxx credited to
(Being application money transferred to Debenture A/c) Securities
Bank A/c Dr. xxxx premium account
Discount/Loss on issue of debenture A/c Dr. xx and premium paid
(Amount equal to premium on redemption) at the time of
To __% Debenture A/c xxxxx redemption is a
To Securities Premium A/c xx loss to be
(Amount equal to premium on issue) provided at the
To _% Debenture Redemption Premium A/c xx time of issue of
(Amount equal to premium payable on debentures
redemption)
(Being call made subsequent to allotment)

DEBENTURES AS COLLATERAL SOCIETY

Collateral security = Secondary or Supporting security for a loan

 Under this arrangement, the borrower agrees that a particular asset or a group of assets
of the company, will be realized and the proceeds there from will be applied to repay the
loan in the event that the amount due, cannot be paid.
 Sometimes companies issue their own debentures as collateral security for a loan or a
fluctuating overdraft.
o When the loan is repaid on the due date, these debentures are at once released with
the main security.

1FIN BY INDIGOLEARN 11.46

 In case, the company cannot repay its loan and the interest thereon on the due date,
o
the lender becomes the debenture holder who can exercise all the rights of a
debenture holder.
 The holder of such debentures is entitled to interest only on the amount of loan,
but not on the debentures.
Accounting Entries
There are two methods of showing these types of debentures in the accounts of a company.
 Method 1
No entry is made in the books of account of the company at the time of making issue of
such debentures.
In the ‘Notes to Accounts’ of Balance Sheet, the fact of the debentures being issued and
outstanding is shown by a note under the liability secured.
 Method 2
Under this method, the following accounting entry is made to record the issue of such
debentures:

Debentures Suspense A/c Dr.

To …..% Debentures A/c
(Being the issue

of…debentures collaterally

as per Board’s Resolution

No…..dated)

The Debentures Suspense Account will appear on the assets side of the Balance Sheet
under Other Non- Current Assets and Debentures on the liabilities side of the Balance
Sheet. When the loan is repaid, the entry is reversed in order to cancel it.

Students should note that the Method 1 is much more logical from the accounting point of view.
Therefore, it is advised to follow Method 1.

DEBENTURES IN CONSIDERATION OTHER THAN FOR CASH

Debentures, just like shares, can also be issued for consideration other than for cash, such as for
purchase of land, machinery, etc.
In this case, the following entries are passed:

(a) Sundry Assets A/c Dr. [Assets taken over]

To Sundry Liabilities A/c [Liabilities assumed]
To Vendors Account [Purchase
consideration]
(Being the assets and liabilities taken over)
(b) Vendors A/c Dr.
To Debentures A/c
(Being the issue of….% debentures to satisfy purchase consideration)
Further it should be noted that these debentures can be issued at par, premium and at
discount. In each case the second entry for issue of debentures would be done accordingly

1FIN BY INDIGOLEARN 11.47

 i.e. “Securities Premium A/c” will be created in case of ‘issued at premium’ or “Discount
on Issue of Debentures A/c” will be created in case of ‘issued at discount’.

Number of debentures to be issued is calculated as follows:-

1. When debentures are issued at par

No. of Debentures = Purchase Consideration
Par Value

2. When debentures are issued at premium

No. of Debentures = Purchase Consideration
Par Value + Premium

3. When debentures are issued at discount

Purchase Consideration
No. of Debentures =
Par Value - Discount

TREATMENT OF DISCOUNT / LOSS ON ISSUE OF DEBENTURES

The discount on issue of debentures is amortised over a period between the issuance date and
redemption date.
It should be written-off in the following manner depending upon the terms of redemption:
(a) If the debentures are redeemable after a certain period of time, the total amount of
discount should be written-off equally throughout the life of the debentures (applying
the straight-line method). The main advantage of this method is that it spreads the
burden of discount equally over the years.
(b) If the debentures are redeemable at different dates, the total amount of discount
should be written-off in the ratio of benefit derived from debenture loan in any
particular year (applying the sum of the year’s digit method). This method is suitable
when debentures are redeemed by unequal instalments.

The accounting entries would be as follows :

Profit and Loss A/c Dr.

To Discount on Issue of Debentures A/c
(Being the amount of discount on issue of debentures written-off)

Loss on issue of debentures is also a capital loss and should be written off in a similar
manner as discount on debentures issued.
In the balance sheet both the items (Discount and Loss) are shown as Non-current/ current
assets depending upon the period for which it has to be written off.
INTEREST ON DEBENTURES

 Interest payable on Debentures is treated as a charge against the profits of the

company.

1FIN BY INDIGOLEARN 11.48

  Interest on debenture is paid periodically and is calculated at coupon rate on the
nominal value of debentures.
 The company will pay interest net of tax to the debenture holders because the
company is under obligation to deduct tax at source at the rates applicable under
tax rules from time to time.
 The companies will deposit the tax so deducted with income tax authorities.

Following accounting entries are to be recorded in this regard:

Event Entry Debit Credit Remarks
(Rs.) (Rs.)
(1) For making Interest A/c Dr. xxx
interest To ….% Debentures holders’ A/c xxx
due (Being interest due on debentures)
(2) Payment …% Debentures holders’ A/c Dr. xxx
of To TDS Payable A/c xxx
interest To Bank A/c x
and (Being interest paid to the debenture
deduction holders after deducting tax at source)
of tax at
source
(TDS)
(3) Payment of TDS Payable A/c Dr. x
TDS To Bank A/c x
(Being TDS deducted from interest on
debentures paid)
(4) Interest Profit & Loss A/c Dr. xxx
charged to To Interest A/c xxx
P&L A/c (Being interest charged as expense to
P&LA/c)

Illustrations
Question: 1
Amol Ltd. issued 40,00,000, 9% debentures of Rs.50 each, payable on application as per term
mentioned in the prospectus and redeemable at par any time after 3 years from the date of
issue.
Record necessary entries for issue of debentures in the books of Amol Ltd.

Question: 2
Atul Ltd. issued 1,00,00,000, 8% debenture of Rs.100 each at a discount of 10% redeemable at par
at the end of 10th year.
Money was payable as follows:
 Rs.30 on application
 Rs. 60 on allotment
Record necessary journal entries regarding issue of debenture.

1FIN BY INDIGOLEARN 11.49

Question: 3
Koinal Chemicals Ltd. issued 15,00,000, 10% debenture of Rs.50 each at premium of 10%, payable
as Rs.20 on application and balance on allotment. Debentures are redeemable at par after 6 years.
All the money due on allotment was called up and received.
Record necessary entries when premium money is included in application money.

Question: 4
Modern Equipment’s Ltd. issued 4,00,000, 12% debentures of Rs. 100 payables as follows:
 On application Rs.30
 On allotment Rs. 70
The debenture was fully subscribed, and all the money was duly received. As per the terms of
issue, debentures are redeemable at Rs.110 per debenture. Record necessary entries regarding
issue of debentures.
Record necessary entries regarding issue of debentures.

Question: 5
Agrotech Ltd. issued 150 lakh 9% debentures of Rs.100 each at a discount of 6%, redeemable at a
premium of 5% after 3 years payable as:
 Rs.50 on application and
 Rs. 44 on allotment.
Record necessary journal entries for issue of debentures.

Question: 6
Simmons Ltd. issued 1,00,000, 12% Debentures of Rs.100 each at par payable in full on application
by 1st April, Application were received for 1,10,000 Debentures. Debentures were allotted on 7th
April. Excess money refunded on the same date.
You are required to pass necessary Journal Entries (including cash transactions) in the books of
the company.

Question: 7
X Ltd. issued 1,00,000 12% Debentures of Rs.100 each at a discount of 10% payable in full on
application by 31st May 2017. Applications were received for 1,20,000 debentures. Debentures
were allotted on 9th June 2017. Excess monies were refunded on the same date.
Pass necessary Journal Entries. Also show necessary ledger accounts

Question: 8
X Ltd. obtains a loan from IDBI of Rs.1,00,00,000, giving as collateral security of Rs.1,50,00,000
(of Rs.10 each), 14%, First Mortgage Debentures.

Question: 9
X Company Limited issued 10,000 14% Debentures of the nominal value of Rs.50,00,000 as follows:
(a) To sundry persons for cash at 90% of nominal value of Rs.25,00,000.
(b) To a vendor for purchase of fixed assets worth Rs.10,00,000 – Rs.12,50,000 nominal value.
(c) To the banker as collateral security for a loan of Rs.10,00,000 – Rs.12,50,000 nominal value.
Pass necessary Journal Entries.

1FIN BY INDIGOLEARN 11.50

Question: 10
HDC Ltd issues 1,00,000, 12% Debentures of Rs.100 each at Rs.94 on 1st January 2017. Under the
terms of issue, the debentures are redeemable at the end of 5 years from the date of the issue.
Calculate the amount of discount to be written-off in each of the 5 years.

Question: 11
A company issued 12% debentures of the face value of Rs.10,00,000 at 10% discount on 1-1-2017.
Debenture interest after deducting tax at source @ 10% was payable on 30th June and 31st of
December every year. All the debentures were to be redeemed after the expiry of five-year
period at 5% premium.
Pass journal entries for the accounting year 2017.

1FIN BY INDIGOLEARN 11.51

 ACCOUNTING FOR BONUS ISSUE AND RIGHT ISSUE

1.BONUS ISSUE
1.1 Introduction
● Issue of additional shares to existing shareholders, free of cost in proportion to existing
holding
● It is also known as ‘capitalization of profit’ or ‘ scrip issue’ or ‘ capitalization of profits’.

EXAMPLE:

Alpha company announced bonus issue to its shareholders in the ratio of 2:3 (2 shares
for 3 shares held)

Shareholder X has 6000 shares before announcement.

He will be entitled to 4000 bonus shares (6000 shares *2/3)

1.2 Provisions of Companies Act 2013

As per section 63 (1) a company can issue fully paid up bonus issue to members, in any manner
out of
● Free reserves
● Securities premium account
● Capital redemption reserve account
Provided that no issue shall be made out of
● Capital reserve
● Revaluation reserve

1.2.1 Conditions for bonus issue – Sec 63(2)

a) authorised by articles of association

b) on the recommendation of the board, must be authorised in the general meeting
c) not defaulted in the payment of interest or principal in respect of fixed assets, deposits
or debt securities
d) not defaulted in the payment of statutory dues of employees (gratuity, provident fund,
bonus)
e) outstanding partly paid-up shares made fully paid-up

SEBI Regulation 293

Includes above points +

Any of its promoters or directors is not an economic fugitive offender

Note: While converting partly paid up shares into fully paid up,

1FIN BY INDIGOLEARN 11.52

 Free reserve Can be used
Securities premium a/c Cannot be used
Capital redemption reserve a/c Cannot be used

1.3. Journal entries

s. n Particulars Debit Credit

(A) 1. Sanction of an issue of bonus shares

Capital redemption reserve a/c Dr
General reserve a/c Dr
Profit and loss a/c Dr
To bonus to shareholders a/c

2. Issue of bonus shares

Bonus to shareholders a/c Dr
To share capital a/c

(B) 1. Sanction of bonus by converting partly paid up

shares into fully paid up shares
General reserve a/c Dr
Profit and loss a/c Dr
To bonus to shareholders a/c

2. On making final call due

Share final call a/c Dr
To share capital a/c

3. On adjustment of final call

Bonus to shareholders a/c Dr

To share final call a/c

Note: Balance in the securities premium for issue of bonus shares, utilized in the following manner

listed company cannot be utilized

not realized in cash

securities premium unlisted company can be utilized

a/c

realized in cash can be utilized

1FIN BY INDIGOLEARN 11.53

Regulation 295 – Completion of a bonus issue

Shareholders Approval

NOT required Required

within 15 days from the date of Within 2 months from the date of
approval of BOD approval of shareholders

1.5. EFFECTS OF BONUS ISSUE

Bonus issue has following major effects:
● Increase in share capital
● Reduction in earnings per share (EPS) and other per share values
● Favourable act considered by the market
● Adjustment in market price
● Reduction in accumulated profit

2.RIGHT ISSUE
2.1 Introduction
The companies act, 2013 provides existing shareholders a right to subscribe to any fresh issue
of shares by the company in proportion to their existing holding for shares.
If the shareholders are not willing to exercise the rights, they are given right to renounce it
in favour of someone else (unless the Articles of the company prohibits)

2.2. Conditions for Rights Issue of Shares

As per section 62(1)(a) of Companies Act 2013, the shares to existing equity shareholders through
a letter of offer subject to the following conditions, namely:
A. The offer made by notice,
● Specifying the number of shares offered,
● Limiting a time not being less than 15 days and not exceeding 30 days from the date of
offer

B. The offer shall include a right exercisable by the person concerned to renounce his shares
offered; and the notice shall contain a statement of this right

1FIN BY INDIGOLEARN 11.54

 C. Board of directors shall dispose the notice, after the expiry of specified time

2.3. Exceptions to the rights of existing equity shareholders

As per section 62, rights shares can be offered, without being offered to existing shareholders
under following situations, provided company has passed special resolution.
To employees under employees stock option

To any persons, either for cash or consideration, (Price of the shares is determined by
registered valuer)

To creditors or debenture holders, as an option to buy equity shares

To government for converting the debentures or loan into equity shares

2.4. Right of renunciation

It refers to the right of the shareholder to surrender his right to buy the securities and
transfer such rights to any other person
The monetized value available to equity shareholders due to right issue is known as ‘value of
right’
Cum−right value of existing shares + (Rights shares ∗ Issue price)
Ex right value of shares =
Existing number of shares + number of rights shares

Value of right = cum right value of share - ex right value of the shares

2.5. Journal Entries

S.N PARTICULARS DEBIT CREDI
T

1 Issue of right shares at par

Bank a/c
Dr
To equity share capital a/c
(Being issue of right shares at par)

2 Issue of right shares at premium

In case rights shares are being offered at a premium,
the premium amount credited to securities premium a/c
Bank a/c
Dr

1FIN BY INDIGOLEARN 11.55

 To equity share capital a/c
To securities premium a/c
(being issue of right shares at premium)
2.6. EFFECTS OF RIGHT ISSUE
● Maintenance of existing shareholders’ proportional holding in company and retain their
financial governance rights
● Dilution in the value of share
● Image enhancement
● Convenience in handling issue.

Summary
● Bonus issue means an issue of additional shares free of cost to existing shareholders
● Bonus shares can be issued from following:
1. Free Reserves
2. Securities Premium
3. Capital Redemption Reserve
● Bonus issue cannot be made out of revaluation reserve created by revaluation of assets
● A Right issue is an offer of equity shares in a further issue of shares by a company to its
existing shareholders, for maintaining their financial and governance interest in the company.
● The right shares are offered at a price less than cum - right value of shares, causing dilution
in its post - right issue.
● The value of share offered after right is termed as ex- right value of shares (average price)
● The right issue is cost effectiveness as compared to a full-blown public issue.
● However, the dilution in the value of the share is a dampener and a major limitation in case
of right issue.

Illustrations

Illustration – 1

Following items appear in the trial balance of Bharat Ltd. (listed company ) as on 31st March,
20X1:
Particulars Amount (Rs.)
40,000 Equity shares of Rs. 10 each 4,00,000
Capital Redemption Reserve 55,000
Securities Premium (collected in cash) 30,000
General Reserve 1,05,000
Surplus i.e. credit balance of Profit and Loss Account 50,000

The company decided to issue to equity shareholders bonus shares at the rate of 1 share for
every 4 shares held and for this purpose, it decided that there should be the minimum reduction
in free reserves. Pass necessary journal entries.

1FIN BY INDIGOLEARN 11.56

Solution: Illustration 1

Journal Entries

Particulars Dr. (₹) Cr. (₹)

Capital Redemption Reserve A/c Dr. 55,000
Securities Premium A/c Dr. 30,000
General Reserve A/c (b.f.) Dr. 15,000
To Bonus to Shareholders A/c 1,00,000
(Being Bonus issue of one share for every
four shares held)
Bonus to Shareholders A/c Dr. 1,00,000
To Equity Share Capital A/c 1,00,000
(Being Bonus shares allotted or
Capitalisation of profit)

Working Note:

Number of Bonus shares to be issued- (40,000 shares / 4) X 1 = 10,000 shares

Value of Bonus shares = 10,000 shares of ₹10 each = ₹1,00,000

Illustration – 2
Following is the extract of the Balance Sheet of Solid Ltd. as at 31st March, 20X1:
Particulars Amount
(Rs.)
Authorised capital:
10,000 12% Preference shares of Rs. 10 each 1,00,000
1,00,000 Equity shares of Rs. 10 each 10,00,000
11,00,000
Issued and Subscribed capital:
8,000 12% Preference shares of Rs. 10 each fully paid 80,000
90,000 Equity shares of Rs. 10 each, Rs. 8 paid up 7,20,000
Reserves and Surplus:
General reserve 1,60,000
Revaluation reserve 35,000
Securities premium (collected in cash) 20,000
Profit and Loss Account 2,05,000
Secured Loan:
12% Debentures @ Rs. 100 each 5,00,000

On 1st April, 20X1 the Company has made final call @ Rs. 2 each on 90,000 equity shares.
The call money was received by 20th April, 20X1.
Thereafter the company decided to capitalize its reserves by way of bonus at the rate of one
share for every four shares held. Show necessary entries in the books of the company and

1FIN BY INDIGOLEARN 11.57

prepare the extract of the Balance Sheet immediately after bonus issue if the company has
passed necessary resolution at its general body meeting for increasing the authorized capital.

Solution: Illustration 2

Journal Entries in books of Solid Ltd.

Particulars Dr. (₹) Cr. (₹)

20X1
April 1 Equity Share Final Call A/c Dr. 1,80,000
To Equity Share Capital A/c 1,80,000
(Final call of ₹2 per share on
90,000 equity shares due as per
Board’s Resolution dated ... )
April Bank A/c Dr. 1,80,000
20
To Equity Share Final Call A/c 1,80,000
(Being Final Call Amount Received)
April Securities Premium A/c Dr. 20,000
20
General Reserve A/c Dr. 1,60,000
Profit and Loss A/c (b.f.) Dr. 45,000
To Bonus to Shareholders A/c 2,25,000
(Bonus issue @ 1 share for every 4
shares held by utilising various
reserves as per Board’s Resolution
dated...)
April Bonus to Shareholders A/c Dr. 2,25,000
20
To Equity Share Capital A/c 2,25,000
(Capitalisation of profit)

Balance Sheet (Extract) as at 30th April, 20X1 (after bonus issue)

Particulars Notes Amount (₹)

I. Equity and Liabilities
(1) Shareholders’ funds
(a) Share capital 1 12,05,000
(b) Reserves and Surplus 2 1,95,000
(2) Non-current liabilities
(a) Long-term borrowings 3 5,00,000
19,00,000
Notes to Accounts

No ₹ ₹
1 Share Capital
Authorised share capital

1FIN BY INDIGOLEARN 11.58

 1,12,500 Equity shares of ₹10 each 11,25,000
10,000 12% Preference shares of ₹10 each 1,00,000 12,25,000
Issued, subscribed and fully paid share capital
1,12,500 Equity shares of ₹10 each, fully paid 11,25,000
(Out of above, 22,500 equity shares @ ₹10 each were
issued by way of bonus)
8,000 12% Preference shares of ₹10 each 80,000 12,05,000
2 Reserves and Surplus
General Reserve 1,60,000
Less : Used for Bonus (1,60,000) Nil
Revaluation Reserve 35,000
Securities Premium 20,000
Less: Utilised for bonus (20,000) Nil
Profit & Loss Account 2,05,000
Less: Utilised for bonus issue (45,000) 1,60,000
Total 1,95,000
3 Long-term borrowings
Secured
12% Debentures @ ₹100 each 5,00,000

Illustration – 3
A company offers new shares of Rs. 100 each at 25% premium to existing shareholders on one
for four bases. The cum-right market price of a share is Rs. 150. Calculate the value of a
right. What should be the ex-right market price of a share?

Solution: Illustration 3

Cum Right (Market) Price =₹150

Issue Price = 100 + 25% of 100

= 100 + 25 = ₹125

Ratio = 1:4
4×₹150+1×₹125
Theoretical Ex – Right Price = 4+1

₹725
= = ₹145
5

Value of Right = Market Price - Theoretical Ex – Right Price

= ₹150 – ₹145 = ₹5

*This Method is Recommended for Exams

OR
Theoretical Ex – Right Price−Issue Price
Value of Right = No.of Shares Held

1FIN BY INDIGOLEARN 11.59

 ₹145−₹125
= 4
= ₹5

OR
Market Price−Issue Price
Value of Right = No.of Shares Held (After Rights)

₹150−₹125
= 5
= ₹5

Illustration 4
Following is the extract of the Balance Sheet of Manoj Ltd. as at 31st March, 20X1
Rs.
Authorised capital:
30,000 12% Preference shares of Rs. 10 each 3,00,000
4,00,000 Equity shares of Rs. 10 each 40,00,000
43,00,000
Issued and Subscribed capital:
24,000 12% Preference shares of Rs. 10 each fully 2,40,000
paid
2,70,000 Equity shares of Rs. 10 each, Rs. 8 paid up 21,60,000
Reserves and surplus:
General Reserve 3,60,000
Capital Redemption Reserve 1,20,000
Securities premium (collected in cash) 75,000
Profit and Loss Account 6,00,000

On 1st April, 20X1, the Company has made final call @ Rs. 2 each on 2,70,000 equity shares. The call
money was received by 20th April, 20X1. Thereafter, the company decided to capitalize its reserves
by way of bonus at the rate of one share for every four shares held.
Show necessary journal entries in the books of the company and prepare the relevant extract of the
balance sheet as on 30th April, 20X1 after bonus issue.

Solution: Illustration 4

Journal Entries in the books of Manoj Ltd.

Particulars Dr. (₹) Cr. (₹)

20X1
April 1 Equity Share Final Call A/c Dr. 5,40,000
To Equity Share Capital A/c 5,40,000
(Final call of ₹2 per share on
2,70,000 equity shares due as per
Board’s Resolution dated ... )
April Bank A/c Dr. 1,80,000
20
To Equity Share Final Call A/c 1,80,000
(Being Final Call Amount Received)

1FIN BY INDIGOLEARN 11.60

 April Securities Premium A/c Dr. 75,000
20
Capital Redemption Reserve A/c Dr. 1,20,000
General Reserve A/c Dr. 3,60,000
Profit and Loss A/c (b.f.) Dr. 1,20,000
To Bonus to Shareholders A/c 6,75,000
(Bonus issue @ 1 share for every 4
shares held by utilising various
reserves as per Board’s Resolution
dated...)
April Bonus to Shareholders A/c Dr. 6,75,000
20
To Equity Share Capital A/c 6,75,000
(Capitalisation of profit)
Extract of Balance Sheet as at 30th April, 20X1 (after bonus issue)

Particulars Amount (₹)

Authorized Capital
30,000 12% Preference shares of ₹10 each 3,00,000
4,00,000 Equity shares of ₹10 each 40,00,000
Issued and subscribed capital
24,000 12% Preference shares of ₹10 each, fully 2,40,000
paid
3,37,500 Equity shares of ₹10 each, fully paid 33,75,000
(Out of the above, 67,500 equity shares @ ₹10
each were issued by way of bonus shares)
Reserves and surplus
Profit and Loss Account 4,80,000
Value of right share = Cum-right value of the share – Ex-right value of the share (working Note)

= ₹190 – ₹176 = ₹14 per share

Working Note:

= (Cum-right value of the existing shares + Rights shares x Issue Price) / (Existing No. of shares +
No. of right shares) = (₹190 X 4 Shares + ₹120 X 1 Share) / (4 + 1) Shares

= ₹880 / 5 shares = ₹176 per share

1FIN BY INDIGOLEARN 11.61

 REDEMPTION OF PREFERENCE SHARES

Introduction

● Redemption is the process of repaying an obligation, at prearranged amounts and timings.

● These shares are issued on the terms that shareholders will be repaid the invested amount at a
future date

Purpose Of Issuing Redeemable Preference Shares

● Raising finance in a dull primary market

● Encouraging potential investors to make investment , inorder to raise share capital of the
company whose shares are traded on the stock exchange
● Utilizing surplus funds in redeeming capital when it cannot be used in the business for profitable
purpose.

Provisions Of The Companies Act ( Section 55)

1) Issue of Preference Shares should be authorized by Articles

2) Shares should be redeemable within a period not exceeding 20 years from the date of issue (
30 years for the company undertaking infrastructure projects)
3) Only fully paid up shares can be redeemed.
4) Shares can be redeemed out of the profits of the
company which would otherwise available for dividend
or out proceeds of fresh issue of shares made for
Note -
the purpose of redemption In case of companies ,which are prescribed
5) A sum equal to the nominal amount of the shares and whose financial statements comply
with section 133,
redeemed should be transferred to Capital
the premium, payable on redemption shall
Redemption Reserve account . be provided for out of profits of the
6) If the premium payable on redemption , the same company ,
before redemption .
shall be provided for out of the profits of the
company or out of securities premium account.
Section 52 of the Companies Act,2013 provides that the securities premium account may be

1FIN BY INDIGOLEARN 11.62

 applied by the company;

(a) Towards issue of bonus shares

Note -
(b) To write off preliminary expenses Companies whose financial statements
(c) To write off the expenses of, commission paid, or comply with Accounting Standards as
prescribed under Section 133 of
discount allowed on securities the Companies Act, 2013, can’t apply the
(d) To provide for premium on the redemption of securities premium account for the
purposes (b) and (d) mentioned above.
redeemable preference shares or debentures
(e) For purchase of its own shares or other securities

Methods Of Redemption Of Fully Paid Up Shares

The preference shares can be redeemed under any of these following methods

● By fresh issue of Equity shares

● By capitalization of undistributed divisible profits
● By combination of A and B

Redemption Of Preference Shares By Fresh Issue Of Equity Shares

Reasons :
● For having permanent capital, it makes sense to issue to equity shares in place of preference
shares
● When the balance of profit , which would otherwise be available for dividend,is insufficient.
● When the liquidity position of the company is not good enough

Advantages Disadvantages

No cash outflow of money There will be dilution of future

earnings

Shares may be valued at a premium Share - holding in the company is

changed

Shareholders can retain their equity interest

Accounting Entries

S.N PARTICULARS DEBIT CREDIT

1. When shares are issued at par

1FIN BY INDIGOLEARN 11.63

 Bank a/c
Dr.

To Share capital a/c

(being issue of…… shares of….each for purpose of redemption)

2. When shares are issued at a premium

Bank a/c
Dr.

To Share capital a/c

To Securities Premium a/c

( being the issue of ……shares of ….each at a premium of…..each for the

purpose of redemption)

3. When preference shares are redeemed at par

Redeemable Preference Share Capital a/c

Dr.

To Preference Shareholders a/c

(being amount payable on redemption of preference shares)

4. When preference shares are redeemed at a premium

Redeemable Preference Share Capital a/c

Dr.

Premium on Redemption of Preference Shares a/c Dr.

To Preference Shareholders a/c

( being amount payable on redemption of preference shares at premium)

5. When payment is made to preference shareholders

Preference Shareholders a/c

1FIN BY INDIGOLEARN 11.64

 Dr.

To Bank a/c

( being the amount paid on redemption on preference shares )

6. For adjustment of premium on redemption

Profit and loss a/c

Dr.

To Premium on redemption of preference shareholders a/c

( being premium on redemption written off out of profits)

Calculating of Minimum Fresh Issue of Shares

The minimum number of shares should be issued to ensure that provisions of Section 55 of the
Companies Act,2013,are not violated. This is done in following four steps.

(1) The maximum amount of reserves and surplus available for redemption is ascertained taking into
account the balances appearing in the balance sheet before redemption and the additional
information given in problem.

(2) Minimum proceeds of fresh issue of shares:

Nominal value of Maximum amount minimum

preference of reserves and proceeds of
shares to be surplus available fresh issue of
redeemed for redemption shares

(3) Minimum number of shares to be issued :

Minimum proceeds to comply with Sec 55

Minimum number of shares =
Face value of one share

1FIN BY INDIGOLEARN 11.65

 (4) Shares cannot be issued in fractions , it must be approximated to the next highest figure to
ensure that provisions of Section 55 are not violated, number of shares should be multiple of 10
or 50 or 100.

Redemption Of Preference Shares By Capitalisation Of Undistributed Divisible Profits

● The profit or a portion that can be otherwise legally

distributed as dividend to shareholders is known as
Divisible or distributable profit. (profit and loss a/c , Note :
General Reserve and other free reserves)
Securities Premium and Capital
● When shares are redeemed by utilizing distributable
Reserve cannot be utilised for or
profit, an amount equal to the face value is transferred transfer to Capital Redemption
to Capital Redemption Reserve account. Reserve

ADVANTAGES DISADVANTAGES

● No change in the percentage of equity ● Reduction in liquidity

shareholding pattern

● Surplus funds can be used

Accounting entries

S.n Particulars Debit Credit

1. For transferring nominal amount of shares redeemed

General reserve a/c

Dr.

Profit and loss a/c

Dr.

Or any divisible profits a/c

Dr.

To Capital Redemption Reserve a/c

( being the amount transferred to Capital Redemption

Reserve a/c)

1FIN BY INDIGOLEARN 11.66

 2. When shares are redeemed at par

Redeemable preference share capital a/c

Dr.

To preference shareholders a/c

( being the amount payable on redemption of preference

shares)

3. When shares are redeemed at a premium

Redeemable preference share capital a/c

Dr.

Premium on Redemption of Preference Shares a/c

Dr.

To Preference Shareholders a/c

( being amount payable on redemption of preference shares

at premium)

4. When payment is made to preference shareholders

Preference Shareholders a/c

Dr.

To Bank a/c

( being the amount paid on redemption on preference shares

)

5. For adjustment of premium on redemption

Profit and loss a/c

Dr.

To Premium on redemption of preference shareholders

a/c

( being premium on redemption written off out of profits)

1FIN BY INDIGOLEARN 11.67

Redemption Of Preference Shares By Combination Of Fresh Issue And Capitalization Of
Undistributed Divisible Profits

A company can redeem the preference shares partly from the proceeds from issue and partly out of
profits. In order to fill the ‘ gap’ between the face value of shares redeemed and the proceeds of new
issue, a transfer should be made from distributable profits to Capital Redemption Reserve a/c.
Formula
1) Amount to be transferred to Capital Redeption Reserve

Amount
Face value of shares redeemed ******
Less : Proceeds from new issue ******
—--------
******
—---------
2) Proceeds to be collected from New Issue

Amount
Face value of shares redeemed ******
Less: Profits available for distribution of dividend ******
—----------
*******
—----------

The term proceeds from fresh/new issue shall be interpreted as:

a) Amount credited to share capital, in case of issue at par.
b) Amount credited to share capital, in case of issue at premium. Premium is received which is
credited to the Securities Premium A/c, the same shall not be regarded as ‘proceeds’, because
if it were treated as such, the transfer of distributable profits to the Capital Redemption
Reserve would be lower by the amount of the premium received.
c) Amount received,in case of issue at discount.

Sale Of Investments To Provide Sufficient Funds For Redemption

Companies sell investments in the market to arrange funds for redemption of preference shares

Accounting entry: DEBIT CREDIT

Bank a/c Dr. *****

1FIN BY INDIGOLEARN 11.68

Profit and loss a/c (loss on sale ) Dr. *****
To Investments a/c *****
To profit and loss a/c ( profit on sale) *****

Redemption Of Partly Called- Up Preference Shares

● The final call on shares are demanded and received before proceeding with redemption of
preference share
● Only fully paid up shares are redeemed and partly paid up shares are left are intact.
● The company can forfeit the shares, if the call money is not received by the company in spite
of giving opportunity to pay via reminders.

Redemption Of Fully Called But Partly Paid-Up Preference Shares

When The Amount Of Calls -In-Arrears Is Received By The Company

If the amount of unpaid calls is received by the company before redemption,

Bank a/c Dr. ****
To calls in arrears a/c ****

The company can proceed with redemption, as the shares become fully paid up.

In Case Of Forfeited Shares

When the amount of calls in arrears not received by the company, inspite of receiving proper
notice by the shareholder, Board may decide to forfeit the shares instead of re-issuing, as redemption
is due immediated or near future.

Following entry is passed

Preference Share Capital a/c Dr. ****
To calls in arrears a/c ****
To Shares Forfeited a/c ****

In this case, the number of shares to be redeemed will be reduced by the number of share forfeited.

1FIN BY INDIGOLEARN 11.69

Summary

● A company limited by shares , authorized by its Articles , may issue redeemable preference
shares.
● Only fully paid up shares can be redeemed
● These are redeemed out of divisible profits.
● Methods of redemption of fully paidup shares;
(a) By Fresh issue of equity
(b) By Capitalization of undistributed profits
(c) By Combination of both

Illustrations
Illustration – 1
Hinduja Company Ltd. had 5,000, 8% Redeemable Preference Shares of Rs. 100 each, fully paid up. The
company decided to redeem these preference shares at par by the issue of sufficient number of equity
shares of Rs. 10 each fully paid up at par.

You are required to pass necessary Journal Entries including cash transactions in the books of the
company.

Solution: Illustration 1
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c Dr. 5,00,000
To Equity Share Capital A/c 5,00,000
(Being the issue of 50,000 Equity
Shares of ₹10 each)
8% Redeemable Preference Share Dr. 5,00,000
Capital A/c
To Preference Shareholders A/c 5,00,000
(Being the amount payable on
redemption of Preference shares)
Preference Shareholders A/c Dr. 5,00,000
To Bank A/c 5,00,000
(Being amount paid to preference
Shareholders)
Workings:
No. of Preference Shares = 5,000
Face Value = 100
Premium on Redemption = 0
Total amount Payable = 5,000 × ₹100
= ₹5,00,000 (Towards Face Value)

1FIN BY INDIGOLEARN 11.70

Face Value of Equity Shares = ₹10
No. of equity shares to be issued = 5,00,000/10 = 50,000

Illustration – 2
C Ltd. had 10,000, 10% Redeemable Preference Shares of Rs. 100 each, fully paid up. The company
decided to redeem these preference shares at par, by issue of sufficient number of equity shares of
Rs. 10 each at a premium of Rs. 2 per share as fully paid up.

You are required to pass necessary Journal Entries including cash transactions in the books of the
company.

Solution: Illustration 2
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c Dr. 12,00,000
To Equity Share Capital A/c 10,00,000
To securities premium A/c
(Being the issue of 1,00,000 Equity 2,00,000
Shares of ₹10 each at a premium of
₹2)
10% Redeemable Preference Share Dr. 10,00,000
Capital A/c
To Preference Shareholders A/c 10,00,000
(Being the amount payable on
redemption of Preference shares)
Preference Shareholders A/c Dr. 10,00,000
To Bank A/c 10,00,000
(Being amount paid to preference
Shareholders)

Working Notes:
1. Amount payable to Preference shareholders:
= 10,000 × ₹100
= ₹10,000
No premium on redemption.
2. Number of equity shares to be issued:
(Face value of Redemption of Preference Shares)
=
(Face value of Equity Shares)
(₹10,00,000)
= (₹10)
= 1,00,000
- 1Lakh equity shares to be issued with a face value of ₹10 at a premium of ₹2

Illustration – 3

1FIN BY INDIGOLEARN 11.71

The Board of Directors of a Company decide to issue minimum number of equity shares of Rs. 9 to
redeem Rs. 5,00,000 preference shares. The maximum amount of divisible profits available for
redemption is Rs. 3,00,000. Calculate the number of shares to be issued by the company to ensure that
provisions of Section 55 are not violated. Also determine the number of shares if the company decides
to issue shares in multiples of Rs. 50 only.

Solution: Illustration 3
Nominal value of preference shares = ₹ 5,00,000
Maximum possible redemption out of profits = ₹3,00,000
Minimum proceeds of fresh issue = ₹5,00,000 – ₹3,00,000
Proceed of one share = ₹9
Minimum number of shares = ₹2,00,000/9 = 22,222.22shares
As fractional shares are not permitted, the minimum number of shares to be issued is 22,223 shares.
If shares are to be issued in multiples of 50, then the next higher figure which is a multiple of 50 is
22,250. Hence, minimum number of shares to be issued in such a case is 22,250 shares.

Illustration 4
The Balance Sheet of X Ltd. as on 31st March, 20X3 is as follows:
Particulars Amount (Rs.)
EQUITY AND LIABILITIES
1. Shareholders’ funds
a Share capital 2,90,000
b Reserves and Surplus 48,000
2. Current liabilities
Trade Payables 56,500
Total 3,94,500
ASSETS
1. Fixed Assets
Tangible asset 3,45,000
Non-current investments 18,500
2. Current Assets
Cash and cash equivalents (bank) 31,000
Total 3,94,500
The share capital of the company consists of Rs. 50 each equity shares of Rs. 2,25,000 and Rs. 100 each
Preference shares of Rs. 65,000 (issued on 1.4.20X1

The necessary Journal Entries to record the above transactions and prepare the balance sheet as on
completion of the above transactions.

1FIN BY INDIGOLEARN 11.72

Solution: Illustration 4
Journal Entries
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c (625 × ₹60) Dr. 37,500
To Equity Share Capital A/c 31,250
To Securities Premium 6,250
[Being 625 equity shares issued at
₹60 (50 towards Face Value + ₹10
Premium)]
Bank A/c Dr. 15,000
Profit and Loss A/c (loss on sale) A/c Dr. 3,500
To Investments 18,500
(Being Investment sold )
Profit and Loss A/c Dr. 3,500
To Loss on sale of Investment 3,500
(Being loss on Sale of Investment
Transferred to P/L)
Profit and Loss A/c Dr. 6,500
To Premium on Redemption of
Preference Shares A/c 6,500
(Being Premium on Redemption
transferred to P/L)
Profit and Loss A/c Dr. 33,750
To Capital Redemption Reserve A/c 33,750
(65,000 – 31,250)[Being Creation of
CRR to the extent of excess of
nominal value of Preference share
over fresh issue]
Preference Shareholders A/c Dr. 71,500
To Bank A/c 71,500
(Being amount paid to preference
Shareholders)
Balance Sheet (after redemption)
Particulars Note Amount
I. EQUITY AND LIABILITIES
(1) Shareholder’s Funds
(a) Share capital 1 2,56,250
(b) Reserves and Surplus 2 44,250
(2) Current liabilities
(a) Trade Payables 56,500
Total 3,57,000
II. Assets
(1) PPE

1FIN BY INDIGOLEARN 11.73

 (a) Tangible asset 3,45,000
(b) Current Assets 3 12,000
Total 3,57,000
Notes to accounts
₹ ₹
1 Share Capital
Authorised, Issued, and Paid - up Shares of 2,56,250 2,56,250
₹50
2 Reserves and Surplus
Capital Redemption Reserve 33,750
Profit and Loss Account (48,000 – 6,500 – 4,250
3,500 – 33,750)
Securities Premium 6,250 44,250
3 Cash and cash equivalents
Balances with banks (31,000 + 37,500 12,000
+15,000 – 71,500)

Working Notes:
1. Amount Payable to Preference Share holders
Nominal value of Preference Shares = ₹65,000
Add: Premium (10%) = ₹6,500
= ₹71,500
2. No. of Equity shares to be issued
Current Bank Balance = ₹31,000
Add: Amount Realised on sale = ₹15,000
Total Available = ₹46,000
Less: Minimum Balance of = ₹12,000
Amount available for redemption = ₹71,500 – ₹34,000
= 37,500
Issue Price of equity shares = ₹50 (Issue Price) + ₹10 (Premium)
= ₹60
₹37,500
No. of Shares to be issued = ₹60
= 625 Shares
Equity Share Capital = 625 × ₹50 = 31,250
Securities Premium = 625 × ₹10 = 6,250

Illustration 5
The following are the extracts from the Balance Sheet of ABC Ltd. as on 31st December, 20X1.
Particulars Amount (Rs.)
Share capital:

1FIN BY INDIGOLEARN 11.74

40,000 Equity shares of Rs. 10 each fully paid Rs. 4,00,000
1,000,10% Redeemable preference share s of Rs. 100 each fully paid Rs. 1,00,00
Reserve & Surplus:
Capital reserve Rs. 50,000
Securities premium Rs. 50,000
General reserve Rs. 75,000
Profit and Loss Account Rs. 35,000
On 1st January 20X2, the Board of Directors decided to redeem the preference shares at par by
utilization of reserve.
You are required to pass necessary Journal Entries including cash transactions in the books of the
company.

Solution: Illustration 5
Date Particulars Dr. (₹) Cr. (₹)
20X2 10% Redeemable Preference Share Capital Dr. 1,00,000
Jan 1 A/c 1,00,000
To Preference Shareholders A/c
(Being the amount payable on redemption
transferred to Preference Shareholders
Account)
Preference Shareholders A/c Dr. 1,00,000
To Bank A/c 1,00,000
(Being the amount paid on redemption of
preference shares)
General Reserve A/c Dr. 75,000
Profit & Loss A/c Dr. 25,000
To Capital Redemption Reserve A/c 1,00,000
(Being the amount transferred to Capital
Redemption Reserve Account as per the
requirement of the Act)

Illustration 6
C Limited had:
3,000, 12% Redeemable Preference Shares of Rs. 100 each, fully paid up
The company had to redeem these shares at a premium of 10%
It was decided by the company to issue the following:
 25,000 Equity Shares of Rs. 10 each at par
 1,000 14% Debentures of Rs. 100 each
The issue was fully subscribed, and all amounts were received in full. The payment was duly made. The
company had sufficient profits.

1FIN BY INDIGOLEARN 11.75

Show Journal Entries in the books of the company.

Solution: Illustration 6
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c Dr. 2,50,000
To Equity Share Capital A/c 2,50,000
(Being the issue of 25,000 equity shares
of ₹10 each at par as per Board’s
resolution No……dated…..)
Bank A/c Dr. 1,00,000
To 14% Debenture A/c 1,00,000
(Being the issue of 1,000 Debentures of
₹100 each at par)
12% Redeemable Preference Share Capital Dr. 3,00,000
Premium on Redemption of Preference Dr. 30,000
Shares A/c
To Preference Shareholders A/c 3,30,000
(Being the amount payable on redemption
to Preference Shareholders at 10%
premium)
Preference Shareholders A/c Dr. 3,30,000
To Bank A/c 3,30,000
(Being the amount paid on redemption of
preference shares)
Profit & Loss A/c Dr. 30,000
To Premium on Redemption of 30,000
Preference Shares/c (Being Premium on
redemption transferred to P/L)
Profit & Loss A/c Dr. 50,000
To Capital Redemption Reserve A/c 50,000
(Being the amount transferred to Capital
Redemption Reserve Account on
redemption to the extent not covered by
fresh issue)
Working Note:
Amount to be transferred to Capital Redemption Reserve Account
Face value of shares to be redeemed (3,000 × ₹100) 3,00,000
Add: 10% Premium 30,000
Amount Payable to Preference Share Holders 3,30,000
Proceeds from fresh issue (25,000 shares @ ₹10) 2,50,000
Amount of CRR requirement (3,00,000 – 2,50,000) 50,000

1FIN BY INDIGOLEARN 11.76

Illustration 7
The capital structure of a company consists of:
Particulars Amount (Rs.)
20,000 Equity Shares of Rs. 10 each fully paid up
1,000 8% Redeemable Preference Shares of Rs. 100 each fully paid up
(issued on 1.4.20X1).
Undistributed reserve and surplus stood as:
General Reserve Rs. 80,000
Profit and Loss Account Rs. 20,000
Investment Allowance Reserve (out of which Rs. 5,000, not free for Rs. 10,000
distribution as dividend)
Securities Premium Rs. 2,000
Cash at bank Rs. 98,000

Preference shares are to be redeemed at a Premium of 10% and for the purpose of redemption, the
directors are empowered to make fresh issue of Equity Shares at par after utilizing the undistributed
reserve and surplus, subjected to the conditions that a sum of Rs. 20,000 shall be retained in general
reserve and which should not be utilized.
Pass Journal Entries to give effect to the above arrangements and show how the relevant items will
appear in the Balance Sheet of the company after the redemption carried out.

Solution: Illustration 7
Working Note:
1
₹
Face Value of Preference Shares (1,000 × 100) 1,00,000
Premium on Redemption (10% of 1,00,000) 10,000
Amount Payable to Preference Share Holders 1,10,000
2. Maximum CRR Possible
Total Restricted Available
General Reserve 80,000 20,000 60,000
Profit & Loss 20,000 10,000 (Premium) 10,000
Investment 10,000 5,000 5,000
Allowance
Reserve
Securities -- -- --
Premium*
Maximum CRR 25,000
Face Value of Preference Shares Redeemed 1,00,000
Shortfall (Required to Fresh issue) 75,000

1FIN BY INDIGOLEARN 11.77

*Securities Premium not considered as a free reserve for the purpose of Redemption of Preference
shares
Journal Entries
Date Particulars Dr. (₹) Cr. (₹)
Bank A/c Dr. 25,000
To Equity Share Capital A/c 25,000
(Being the issue of 2,500 equity shares of
₹10)
8% Redeemable Preference Share Capital Dr. 1,00,000
A/c Dr. 10,000
Premium on Redemption of Preference
Shares A/c 1,10,000
To Preference Shareholders A/c
(Being amount payable to Preference
Share Holders)
Preference Shareholders A/c Dr. 1,10,000
To Bank A/c 1,10,000
(Being the amount paid to Preference
Share Holders)
Profit & Loss A/c Dr. 10,000
To Premium on Redemption of 10,000
Preference Shares a/c (Being Premium
Transferred to P/L)
General Reserve A/c Dr. 60,000
Profit & Loss A/c Dr. 10,000
Investment Allowance Reserve A/c Dr. 5,000
To Capital Redemption Reserve A/c 75,000
(Being CRR created to the extent not
covered by Fresh issue)
Balance Sheet as on ………[Extracts]
Particulars Note Amount
I. EQUITY AND LIABILITIES
(1) Shareholder’s Funds
(a) Share capital 1 2,25,000
(b) Reserves and Surplus 2 1,02,000
Total
II. Assets
(1) PPE
(a) Current Assets 3 13,000
Total
Notes to accounts
₹ ₹
1 Share Capital

1FIN BY INDIGOLEARN 11.78

 Authorised, Issued, and Paid - up 2,25,000 2,25,000
22,500 equity Shares of ₹10
2 Reserves and Surplus
General Reserve (80,000 – 60,000) 20,000
Investment Allowance Reserve 5,000
Capital Redemption Reserve 75,000
Securities Premium 2,000 1,02,000
3 Cash and cash equivalents
Balances with banks (98,000 + 25,000 – 13,000 13,000
1,10,000)

Illustration 8
The Balance Sheet of XYZ as at 31st December, 20X1 inter alia includes the following:
Particulars Amount (Rs.)
50,000, 8% Preference Shares of Rs. 100 35,00,000
each, Rs. 70 paid up
1,00,000 Equity Shares of Rs. 100 each fully 1,00,00,000
paid up
Securities Premium 5,00,000
Capital Redemption Reserve 20,00,000
General Reserve 50,00,000
Under the terms of their issue, the preference shares are redeemable on 31st March, 20X2 at 5%
premium.
In order to finance the redemption, the company makes,Rights issue of 50,000 equity shares of Rs.
100 each at Rs. 110 per share
Rs. 20 being payable on application
Rs. 35 (including premium) on allotment
Balance on 1st January, 20X3
1. The issue was fully subscribed, and allotment made on 1st March, 20X2. The money due on
allotment were received by 31st March, 20X2.
2. The preference shares were redeemed after fulfilling the necessary conditions of Section 55
of the Companies Act, 2013.
You are asked to pass the necessary Journal Entries and show the relevant extracts from the balance
sheet as on 31st March, 20X2 with the corresponding figures as on 31st December, 20X1

Solution: Illustration 8
Journal Entries
Date Particulars Dr. (₹) Cr. (₹)

1FIN BY INDIGOLEARN 11.79

 8% Preference Share Final Call A/c Dr. 15,00,000
To 8% Preference Share Capital A/c 15,00,000
(For final call made on preference shares @
₹30 each to make them fully paid up)
Bank A/c Dr. 15,00,000
To 8% Preference Share Final Call A/c 15,00,000
(Being amount received from preference
shareholders for final call)
Bank A/c Dr. 10,00,000
To Equity Share Application A/c 10,00,000
(Being application money on 50,000 equity
shares @₹20 per share)
Equity Share Allotment A/c Dr. 17,50,000
To Equity Share Capital A/c 12,50,000
To Securities Premium A/c 5,00,000
(Being amount due on 50,000 equity shares @
₹35 per share including a premium)
Bank A/c Dr. 17,50,000
To Equity Share Allotment A/c 17,50,000
(Being amount received from equity
shareholders towards allotment)
8% Preference Share Capital A/c Dr. 50,00,000
Premium on Redemption of Preference Dr. 2,50,000
Shares A/c
To Preference Shareholders A/c 52,50,000
(Being amount payable to preference
shareholders on redemption at 5% premium)
Preference Shareholders A/c Dr. 52,50,000
To Bank A/c 52,50,000
(Being amount paid to preference
shareholders)
General Reserve A/c Dr. 2,50,000
To Premium on Redemption 2,50,000
(Being premium on redemption of preference
shares transferred to General Reserve)
General Reserve A/c Dr. 27,50,000
To Capital Redemption Reserve A/c 27,50,000
(Being CRR created as per the requirement
of companies Act i.e, 50,00,000 – 10,00,000 -
12,50,000)
Balance Sheet (extracts)
Particulars Note As at As at
31.3.20X2 31.12.20X1(₹)
(₹)

1FIN BY INDIGOLEARN 11.80

 EQUITY AND LIABILITIES
I. Shareholders’ funds
(a) Share capital 1 1,22,50,000 1,35,00,000
(b) Reserves and Surplus 2 77,60,000 75,00,000

Notes to accounts
As at As at
31.3.20X2 31.12.20X1(₹)
(₹)
1 Share Capital
Authorised
1,00,000 equity Shares of ₹100 1,00,00,000
1,50,000 equity Shares of ₹100 1,50,00,000
50,000 preference shares of ₹100 50,00,000 50,00,000
200,00,000 1,50,00,000
Issued, and Paid–up:
1,00,000 Equity shares of ₹100 each fully 1,00,00,000 1,00,00,000
paid up 22,50,000 -
50,000 Equity shares of ₹100 each ₹45 paid
up
50,000, 8% Preference shares of ₹100 each, - 35,00,000
₹70 paid up
1,22,50,000 1,35,00,000
2 Reserves and Surplus
Securities Premium 10,00,000 5,00,000
Capital Redemption Reserve 47,50,000 20,00,000
General Reserve (50 – 2.5 -27.5) 20,00,000 50,00,000
77,50,000 75,00,000
Note: Amount collected towards face value on issue of Equity Shares can be used for
redemption of preference shares.
Workings:
Amount payable to preference shareholders:
= ₹50,00,000 + ₹2,50,000
= ₹52,50,000

Illustration 9
The following are the extracts from the Balance Sheet of ABC Ltd. as on 31st December, 20X1:
Share capital:
 50,000 Equity shares of Rs.10 each fully paid – Rs.5,00,000;
 2,000 10% Redeemable preference shares of Rs.100 each fully paid – Rs. 2,00,000.
Reserve & Surplus:
 Capital reserve – Rs.2,00,000;

1FIN BY INDIGOLEARN 11.81

  General reserve –Rs. 2,00,000;
 Profit and Loss Account – Rs.75,000.
On 1st January 20X2, the Board of Directors decided to redeem the preference shares at premium of
5% by utilization of reserves.
You are required to prepare necessary Journal Entries including cash transactions in the books of the
company.

Solution: Illustration 9
Journal Entries
Date Particulars Dr. (₹) Cr. (₹)
20X2 10% Redeemable Preference Share Capital Dr. 2,00,000
Jan 1 A/c 10,000
Premium on Redemption of Preference 2,10,000
Shares
To Preference Shareholders A/c
(Being the amount payable on redemption
transferred to Preference Shareholders
Account)
Preference Shareholders A/c Dr. 2,10,000
To Bank A/c 2,10,000
(Being the amount paid on redemption of
preference shares)
General Reserve A/c Dr. 2,00,000
To Capital Redemption Reserve A/c 2,00,000
(Being the amount transferred to Capital
Redemption Reserve Account)
Profit & Loss A/c Dr. 10,000
To Premium on Redemption of Preference 10,000
Shares A/c
(Being premium on redemption charged to
Profit and Loss A/c)
Note: Capital reserve cannot be utilized for transfer to Capital Redemption Reserve.

Illustration 10
The Balance Sheet of XYZ Ltd. as at 31st December, 20X1 inter alia includes the following
information:
Particulars Rs.
50,000, 8% Preference Shares of Rs.100 each, Rs.70 paid up 35,00,000
1,00,000 Equity Shares of Rs.100 each fully paid up 1,00,00,000
Securities Premium 5,00,000
Capital Redemption Reserve 20,00,000

1FIN BY INDIGOLEARN 11.82

General Reserve 50,00,000
Bank 15,00,000

Under the terms of their issue, the preference shares are redeemable on 31st March, 20X2 at 5%
premium. In order to finance the redemption, the company makes a rights issue of 50,000 equity shares
of Rs. 100 each at Rs. 110 per share, Rs. 20 being payable on application, Rs. 35 (including premium) on
allotment and the balance on 1st January, 20X3.
The issue was fully subscribed and allotment made on 1st March, 20X2. The money due on allotment
were duly received by 31st March, 20X2. The preference shares were redeemed after fulfilling the
necessary conditions of Section 55 of the Companies Act, 2013.
Assume that the Preference Shareholders holding 2,000 shares fail to make the payment for the Final
Call made under Section 55,
You are asked to pass the necessary Journal Entries and show the relevant extracts from the balance
sheet as on 31st March, 20X2 with the corresponding figures as on 31st December, 20X1 assuming that
the shares in default are forfeited after giving proper notices.

Solution: Illustration 10
Journal Entries
Date Particulars Dr. (₹) Cr. (₹)
8% Preference Share Final Call A/c Dr. 15,00,000
To 8% Preference Share Capital A/c 15,00,000
(Being Final call of ₹30 made on 50,000 pref.
shares)
Bank A/c Dr. 14,40,000
Calls – in – arrear A/c Dr. 60,000
To 8% Preference Share Final Call A/c 15,00,000
8% Preference Share Capital A/c Dr. 2,00,000
To Calls – in – arrear A/c 60,000
To Shares Forfeited A/c 1,40,000
(Being Forfeiture of 2000 pref. shares ₹70
paid up)
Bank A/c Dr. 10,00,000
To Equity Share Application A/c 10,00,000
(Being receipt of share application money on
50,000 equity shares @ 20 each)
Equity Share Application A/c Dr. 10,00,000
To Equity Share Capital A/c 10,00,000
(Being Capitalization of share application
money)

1FIN BY INDIGOLEARN 11.83

 Equity Share Allotment A/c Dr. 17,50,000
To Equity Share Capital A/c (50,000 × 12,50,000
₹25) 5,00,000
To Securities Premium A/c (50,000 ×₹10)
Bank A/c Dr. 17,50,000
To Equity Share Allotment A/c 17,50,000
(Amount received on allotment)
8% Preference Share Capital A/c Dr. 48,00,000
Premium on Redemption of Preference Dr. 2,40,000
Shares A/c (48,00,000 × 5%)
To Preference Shareholders A/c 50,40,000
(Being amount payable on redemption of
48,000 preference shares at a premium of
5%)
Preference Shareholders A/c Dr. 50,40,000
To Bank A/c 50,40,000
(For amount paid to preference
shareholders)
General Reserve A/c Dr. 25,50,000
To Capital Redemption Reserve A/c 25,50,000
[48,00,000 – 10,00,000 – 12,50,000]
(Being creation of CRR not covered by the
proceeds of fresh issue)
General Reserve A/c Dr. 2,40,000
To Premium on Redemption A/c 2,40,000
(Being Premium on Redemption Written – off)
Balance Sheet (extracts)
Particulars Note As at As at
31.3.20X2 31.12.20X1(₹)
(₹)
EQUITY AND LIABILITIES
I. Shareholders’ funds
(a) Share capital 1 1,23,90,000 1,35,00,000
(b) Reserves and Surplus 2 77,60,000 75,00,000
ASSETS
2. Current Assets
Cash and cash equivalents 3 6,50,000 15,00,000
Notes to accounts
As at As at
31.3.20X2 31.12.20X1(₹)
(₹)
1 Share Capital
Issued, and Paid–up:
1,00,00,000 1,00,00,000

1FIN BY INDIGOLEARN 11.84

 1,00,000 Equity shares of ₹100 each fully 22,50,000 -
paid up
50,000 Equity shares of ₹100 each ₹45 paid
up
50,000, 8% Preference shares of ₹100 each, - 35,00,000
₹70 paid up
Shares Forfeited 1,40,000
1,23,90,000 1,35,00,000
2 Reserves and Surplus
Securities Premium 10,00,000 5,00,000
Capital Redemption Reserve 45,50,000 20,00,000
General Reserve (50 – 25.5 -2.4) 22,10,000 50,00,000
77,60,000 75,00,000
3 Cash and Cash Equivalents
Bank 6,50,000 15,00,000
Working Note:
Bank Balance
Opening Balance 15,00,000
Add: Preference share final call 14,40,000
Add: Equity Share Application 10,00,000
Add: Equity Share Allotment 10,00,000
56,90,000
Less: Preference Shares Redeemed 50,40,000
Closing Balance 6,50,000

1FIN BY INDIGOLEARN 11.85

 REDEMPTION OF DEBENTURES
1. Introduction
 A debenture is an instrument issued by a company under its seal, acknowledging a debt and containing
provisions as regards repayment of the principal and interest
 It’s a long-term debt for the company. They are commonly secured by charge. Thus, they appear under
“Secured Liabilities”.
 If a charge has been created on any or the entire asset of the company, the nature of the charge and
the asset charged therein are described in the bond. The certificate registering the charge with the
registrar is also printed on the bond.
 A trusteeship in favor of one or more persons in the case of mortgage debentures is created. The
trustees of debenture holders can take any action necessary to safeguard the interest of debenture
holders.
 It earns a fixed income in form of interest. Interest is payable by the company whether it earns profit
or not.
 The procedure for issue of debentures is similar to that of issue of shares. Thus, the amount can be
collected in lumpsum along with application or in instalments.
 In case of oversubscription, the excess applications must be rejected, and the amount should be
refunded. The excess money cannot be adjusted as in case of shares.
 They can be issued for

 Cash
 Consideration other than cash.
 As collateral security.
 They can be issued at

 Par
 Premium
 At discount
 The terms of redemption should also be accounted at the time of issue. Redemption of debentures at
a premium is a known loss at the time of issue of debentures as the terms of issue generally contain
such provisions for redemption.

2. Provision Of Companies Act 2013

 Sec.71(1) - A company may issue debentures with an option to convert such debentures into shares,
either wholly or partly at the time of redemption. Provided the issue of convertible debentures is
approved by a special resolution passed at a duly convened general meeting.

 Sec.71 (2) -No company can issue any debentures which carry any voting rights.

 Sec.71(4)-The company should create a debenture redemption reserve account (DRR) out of free
reserves and the amount credited to such account should not be utilized by the company for any
purpose other than the redemption of debentures.

1FIN BY INDIGOLEARN 11.86

3. Types Of Debentures
Secured debentures
Security
Unsecured debentures

Convertible
Convertibility
Non-Convertible

Reedemable
Types of debentures Permanence
Irreedemable

Registered
Negotiability
Unregistered

First mortgage
Priority
second mortgage

Redeemable debentures - Debentures, which can be redeemed or for which payment is made after a specified
time are called Redeemable debentures.

These are redeemable-

(i) At the expiry of a specified period either at par or at a premium;
(ii) By purchasing in the open market at any time at the price prevailing in the market; and
(iii) By annual drawings.

Irredeemable debentures - When the issuing company does not fix any date by which debentures can be
redeemed, and the holders of such debentures cannot demand payment from the company so long as it is a
going concern it is called irredeemable debentures. Usually such debentures are repayable after a long period
of time or when the company decides to wind up.

First debentures: - Those debentures, which are repaid before other debentures are paid out, are called First
debentures.

Second debentures: - Those debentures, which are paid after the payment towards the First debenture, are
called Second debentures.

Convertible debentures: - Those debentures, which are given the option to convert the debentures fully or
partly into equity shares after a specified time, are called Convertible Debentures. If the debentures are fully
converted, then it is called as ‘Fully Convertible debentures. those which are partly convertible are called ‘Partly
Convertible debentures.

Non-convertible Debentures: - The debentures that cannot be converted into equity shares such are non-
convertible debentures.

Mortgage Debentures: - Debentures, which are secured either on a particular asset [called fixed charge], or
on the general assets of the company [called floating charge], are called Mortgage debentures.

1FIN BY INDIGOLEARN 11.87

Unsecured / Naked Debentures: - Those debentures which are not secured, are called naked debentures.
Companies with very good standing can issue such debentures.

Registered Debentures – Those which are registered with the Registrar

Unregistered Debentures – Those which are not registered with the registrar.

4. Debenture Redemption Reserve – Sec 71 Of Companies Act 2013

(1) Where a company issues debenture under this section, it should create a Debenture Redemption
Reserve (DRR) account out of its profits which are available for distribution of dividend every year
until such debentures are redeemed.

(2) If Debentures are redeemed at a premium, DRR is created for an amount including redemption
amount.

(3) The amounts credited to the debenture redemption reserve should not be utilized by the company
except for the purpose aforesaid.

(4) The company should pay interest and redeem the debentures in accordance with the terms and
conditions of their issue.

(5) In case of failure by the company, the Tribunal may, on the application of any or all the holders of
debentures or debenture trustee and, after hearing the parties concerned, direct, by order, the
company to redeem the debentures forthwith by the payment of principal and interest due thereon.

(6) The company can create an investment out of the amount set aside for the reserve. It will be called
Debenture Redemption Reserve Investment.

(7) Interest earned on DRR investments will be credited to profit and loss account.

(8) In last year, the Debenture Redemption Reserve Investments are encashed and the amount so
obtained is used for the redemption of debentures.

(9) Any profit or loss made on the encashment of Debenture Redemption investments is also transferred
to Profit & Loss account.

(10) The balance of Debenture Redemption Reserve is subsequently transferred to General Reserve.

5. Investment Of Debenture Redemption Reserve (Drr) Amount

Rule 18(7) of Companies (Share Capital and Debentures) Rules, 2014 prescribes the following
conditions:

 Every company required to create DRR should before the 30th day of April of each year, deposit or
invest, as the case may be, a sum which should not be less than 15% of the amount of its debentures
maturing during the year ending on the 31st day of March next following in any one or more of the
following methods, namely:

 in deposits with any scheduled bank, free from charge or lien;

 in unencumbered securities of the Central Government or of any State Government;

 in unencumbered securities mentioned in clauses (a) to (d) and (ee) of Section 20 of the Indian
Trusts Act, 1882;

1FIN BY INDIGOLEARN 11.88

  in unencumbered bonds issued by any other company which is notified under clause (f) of
Section 20 of the Indian Trusts Act, 1882;

 The amount deposited or invested, as the case may be, above should not be utilized for any purpose
other than for the repayment of debentures maturing during the year referred to above, provided that
the amount remaining deposited or invested, as the case may be, should not at any time fall below
15% of the amount of debentures maturing during the 31st day of March of that year.

 Ministry of Corporate Affairs has made the following clarification on adequacy of Debenture
Redemption Reserve (DRR):

Pre August 16, 2019 Post August 16, 2019

1 For debentures issued by All No DRR is required No DRR is required

India Financial Institutions
(AIFIs) regulated by Reserve
Bank of India and Banking
Companies for both public
as well as privately placed
debentures

2 For other Financial 25% of the value of No DRR is required

Institutions (FIs) and NBFCs outstanding debentures
registered with RBI and for issued through public issue.
housing finance companies No DRR is required in the
registered with National case of privately placed
Housing Bank debentures.

3 For debentures issued by 25% of the value of No DRR is required

listed companies including outstanding debentures (irrespective of public or
manufacturing and issued through public issue. Private Issue)
infrastructure companies. Also 25% DRR is required in
the case of privately placed
debentures by listed
companies

4 For unlisted companies DRR will be 25% of the value DRR will be 10% of the
issuing debentures on of outstanding debentures. value of outstanding
private placement basis, debentures

6. Methods Of Redemption

Method of
redemption of
debentures

By payment in By payment in By purchase in By conversion

lumsum installments open market into shares

1FIN BY INDIGOLEARN 11.89

By payment in lumpsum

Under payment in lumpsum method, at maturity or at the expiry of a specified period of debenture the payment
of entire debenture is made in one lot or even before the expiry of the specified period

By payment in Instalments

Under payment in installments method, the payment of specified portion of debenture is made in installments
at specified intervals

ACCOUNTING FOR DEBENTURE REDEMPTION FUND AND INVESTMENT

Journal entries
1. At the end of First Year
For setting aside the fixed amount of profit for redemption
Profit and Loss A/c Dr.
To Debenture Redemption Reserve A/c
(Being transfer of profits to Debenture redemption reserve A/c)

For investing the amount set aside for redemption

Debenture Redemption Reserve Investment A/c Dr.
To Bank A/c
(Being amount invested in DRR investment A/c)

2. At the end of second year and subsequent years other than last year

For receipt of interest on Debenture Redemption Reserve Investments

Bank A/c Dr.
To Interest on Debenture Redemption Reserve Investment A/c
(Being interest on investment received)
For transfer of Interest on Debenture Redemption Reserve Investment (DRRI) to profit
and loss account.
Interest on Debenture Redemption Reserve Investment A/c Dr.
To Profit & Loss A/c
(Being interest on investment transferred to P&L A/c)
For setting aside the fixed amount of profit for redemption

Profit and Loss A/c Dr.

To Debenture Redemption Reserve A/c
(Being transfer of profits to Debenture redemption reserve A/c)
For investments of the amount set aside for redemption and the interest earned on
DRRI
Debenture Redemption Reserve Investment A/c Dr.
To Bank A/c
(Being amount invested in DRR investment A/c)

3. At the end of last year

For receipt of interest
Bank A/c Dr.
To Interest on Debenture Redemption Reserve Investment A/c
(Being interest on investment received)

1FIN BY INDIGOLEARN 11.90

 For transfer of interest on Debenture Redemption Reserve Investment to
Profit and loss account.
Interest on Debenture Redemption Reserve Investment A/c Dr.
To Profit and loss A/c

For setting aside the fixed amount of profit for redemption

Profit and Loss A/c Dr.
To Debenture Redemption Reserve A/c

For encashment of Debenture Redemption Reserve Investments

Bank A/c Dr.
To Debenture Redemption Reserve Investment, A/c

For the transfer of profit/loss on realization of Debenture Redemption

Reserve Investments
(i) In case of Profit
Debenture Redemption Reserve Investment A/c Dr.
To profit and loss A/c
Or

(ii) In case of Loss

Profit and loss A/c Dr
To Debenture Redemption Reserve Investment, A/c

For amount due to debenture holders on redemption

Debenture A/c Dr
To Debenture holder’s A/c

For payment to debenture holders

Debenture holder’s A/c Dr
To Bank A/c
For transfer of balance in DRR to General Reserve
Debenture Redemption Reserve A/c Dr.
To General reserve A/c

ACCOUNTING FOR PURCHASE OF DEBENTURES IN THE OPEN MARKET

A company, if authorized by its Articles of Association, can buy its own debentures in the open market.

This can be categorized as follows:

For immediate cancellation

When the company cancels the debentures so purchased, it amounts to redemption of debentures. It means
after cancellation; redemption is automatic, and these debentures cannot be reissued.

For investment in the form of own debentures

If the company purchases its debentures from open market and holds them for some time before cancellation,
such debentures are known as own debentures. Own debentures are held by company as investment and may
be resold till cancellation. After cancellation, the debentures are said to be redeemed and cannot be resold.

Accounting treatment for purchase of own debentures for immediate cancellation.

1FIN BY INDIGOLEARN 11.91

 Journal entries
On purchase and cancellation of debentures
Debentures A/c (with the amount paid) Dr.
To Bank A/c
(Being debentures purchased in the open market and cancelled immediately)

If there is any difference between the nominal value of the debentures cancelled and the
price paid for them,
In case of profit
Debenture A/c Dr.
To Bank A/c
To Profit on redemption of debentures A/c
(Being debentures purchased in the open market for immediate cancellation and
profit made on the same)

Transferring the above profit to Capital reserve A/c

Profit on redemption of debentures A/c Dr.
To Capital Reserve A/c
In case of loss

Debenture A/c Dr.

Loss on redemption A/c Dr.
To Bank A/c
(Being debentures purchased in the open market for immediate cancellation and
Incurred loss on the same)
Transferring the above loss to Capital reserve A/c or P&L A/c or Securities premium A/c
Profit and Loss A/c Or
Securities Premium A/c Or Dr.
Capital Reserve A/c Dr.
To Loss on redemption A/c Dr.

ACCOUNTING FOR REDEMPTION BY CONVERSION

Journal entries
When shares are issued at Par
Debentures A/c Dr.
To Share Capital A/c
(Being debentures converted in ………… (no. of) Equity shares of Rs…. each)

When shares are issued at premium

Debenture A/c Dr.
To Share capital A/c
To Securities premium A/c
(Being debentures converted in ………… (no. of) Equity shares of Rs…. Each
issued at a premium of Rs……each)

1FIN BY INDIGOLEARN 11.92

 Illustrations

Illustration – 1

X Ltd. issued 1,00,000; 9% Debentures of Rs.50 each at a premium of 10% on 30 thJune, 2019 redeemable on
31st March 2021.The issue was fully subscribed. The Company decided to create DRR on 31 st March,2020 and
invest in Fixed Deposit Earnings interest @ 10% p.a. on 1st April 2020 to meet the legal requirement. Tax was
deducted at source (TDS) by bank @ 10%.

Pass journal entries for issue and redemption of debentures along with interest on investment.

Solution: Illustration 1

Date Particulars Dr. (₹) Cr. (₹)

30-6-x1 Bank A/c Dr. 55,00,000
To Debenture Application A/c 55,00,000
30-6-20x1 Debenture Application A/c Dr. 55,00,000
To 9% Debenture A/c 50,00,000
To Securities Premium A/c 5,00,000
(Being Allotment of Debentures)
31-3-x2 Profit & Loss A/c Dr. 5,00,000
To Debenture Redemption Reserve A/c 5,00,000
(Being Creation of DRR as per the statute)
31-3-x2 Interest on Debenture A/c Dr. 3,37,500
To Bank A/c (1,00,000 × 50% × 9% × 3,37,500
9/12)
(Being Interest on Debentures paid)
31-3-x2 Profit & Loss A/c Dr. 3,37,500
To Interest on Debenture A/c 3,37,500
1-4-x2 DRR Investment A/c Dr. 7,50,000
To Bank 7,50,000
(Being Creation of DRR Investment)
31-3-x3 Bank A/c Dr. 8,25,000
To DRR Investment A/c 7,50,000
To Interest on DRR investment A/c 75,000
(Being Redemption of DRR investment)
31-3-x3 Interest on DRR Investment A/c Dr. 75,000
To Profit & Loss A/c 75,000
(Interest Received on DRR Investment
Transferred to P&L)
31-3-x3 9% Debentures A/c Dr. 50,00,000
To Debenture Holder A/c 50,00,000
31-3-x3 Debenture Holder A/c Dr. 50,00,000
To Bank 50,00,000
31-3-x3 DRR A/c Dr. 5,00,000
To General Reserve 5,00,000
(Being Balance on DRR transferred to
General Reserve)

1FIN BY INDIGOLEARN 11.93

Illustration – 2

On January 1, Rama Ltd., had 500 Debentures of Rs.100 each outstanding in its books carrying interest at 6%
per annum. DRR balance is standing in books at

12,500/-. In accordance with the powers in the deed, the directors acquired debentures from the open market
for immediate cancellation as follows:

March 1 Rs.5,000 at 98.00/- (cum interest)

Aug. 1 Rs. 10,000 at 100.25/- (cum interest)

Dec. 15 Rs. 2,500 at 98.50/- (ex-interest)

Debenture interest is payable half-yearly, on 30th June and 31st Dec.

Show ledger accounts of Debenture and Debenture interest for the first year, ignoring income-tax.

Solution: Illustration 2

Working Note:

Date Face Value Purchase Price Amount Paid Interest Ex-Interest

(₹) (₹)
Mar -1 5,000 98 4,900 (Cum) 50 4,850
(5,000 × 6% ×
2/12)
Aug - 1 10,000 100.25 10,025 (Cum) 50 9,975
(10,000 × 6% ×
1/12)
Dec - 15 2,500 98.5 2531.25 68.75 2,462.5
(2,500 × 6% ×
5.5/12)
6% Debentures (1st Half)

Date Particulars Debit ₹ Date Particulars Credit ₹

1st
To Bank 4,850 Jan. 1 By Balance b/d 50,000
March
1st To Profit on Cancellation 150
March
30th To Balance c/d 45,000
June
50,000 50,000
Interest on Debentures (1 Half) st

Date Particulars Debit ₹ Date Particulars Credit ₹

1st
To Bank 50 30 June By Profit and Loss
th
1,400
March
30 June To Bank A/c 1,350
1,400 1,400
6% Debentures (2 nd
Half)

Date Particulars Debit ₹ Date Particulars Credit ₹

1 Aug
st
To Bank 9,975 Aug. 1 By Balance b/d 45,000

1FIN BY INDIGOLEARN 11.94

1st Aug To Profit on Cancellation 25
15 th
To Bank 2,462.5
Dec
15th To Profit on Cancellation 37.5
Dec
31st Dec To Balance c/d 32,500
45,000 45,000
Interest on Debentures (2 nd
Half)

Date Particulars Debit ₹ Date Particulars Credit ₹

1 Aug
st
To Bank A/c 50 30 June By Profit and Loss
th
1093.75
15 th
To Bank A/c 68.75
Dec
31st Dec To Bank A/c 975
1093.75 1093.75

Illustration – 3

The following balances appeared in the books of Paradise Ltd as on 1-4-20X1:

1.
12 % Debentures Rs. 7,50,000
2.
Balance of DRR Rs. 1,00,000
3.
DRR Investment 1,12,500 represented by 10% 1,125 Secured Bonds of the Government of India of Rs.
100 each.
Annual contribution to the DRR was made on 31st March every year. On 31-3-20X2, balance at bank was Rs.
7,50,000 before receipt of interest. The investment was realised at par for redemption of debentures at a
premium of 10% on the above date.

You are required to prepare the following accounts for the year ended 31st March, 20X2:

1. Debentures Account
2. DRR Account
3. DRR Investment Account
4. Bank Account
Debenture Holders Account.

Solution: Illustration 3

12% Debenture Account

Date Particulars ₹ Date Particulars ₹

31-03- To Debenture Holders A/c 7,50,000 1-4-X1 By Balance b/d 7,50,000

X2

7,50,000 7,50,000

DRR Account

Date Particulars ₹ Date Particulars ₹

1-4-X1 By Balance b/d 25,000

1FIN BY INDIGOLEARN 11.95

31-03- To General 75,000 1-4-X1 By Profit & Loss A/c 50,000
X2
reserve A/c (75,000 -25,000) WN1

75,000 75,000

DRR Investment Account (10% GOI Bonds)

Date Particulars ₹ Date Particulars ₹

1-4-X1 To Balance b/d 1,12,500 31-03- By Bank 1,12,500

X2

1,12,500 1,12,500

Bank Account

Date Particulars ₹ Date Particulars ₹

31-03- To Balance b/d 7,50,000 31-03- By Debenture holders A/c 8,25,000

X2 X2

31-03- To Interest on DRR 11,250 By Interest on Debentures 90,000

X2 Investment

(10% × ₹100 × 1,125)

To DRR Investment A/c 1,12,500

31-03- To balance c/d 41,250

X2

9,15,000 9,15,000

Debenture Holders Account

Date Particulars ₹ Date Particulars ₹

31-03- By 12% Debentures 7,50,000

X2

31-03- To Bank A/c 8,25,000 By Premium on redemption of 75,000

X2 debentures (7,50,000 × 10%)

8,25,000 8,25,000

Working Note:

1. Closing balance required in DRR (10% of 7,50,000) = 75,000

Illustration – 4

Sencom Limited issued Rs.1,50,000 5% Debentures on 30 th September Year 0 on which interest is payable half
yearly on 31st March and 30th September. The Company has power to purchase debentures in open market for
cancellation thereof.

1FIN BY INDIGOLEARN 11.96

 The following purchases were made during the year ended 31 st December Year 2 and the cancellation were
made on the same date. On 31st December Year 1, balance in the DRR of the Company was Rs.25,000 and
investments made for the purpose of redemption were Rs.20,000.

The purchase details are:

 1st March Year 2 – Rs.25,000 nominal value purchased for Rs.24,725 ex-interest.
 1st September Year 2– Rs.20,000 nominal value purchased for Rs.20,125 cum-interest.
You are required to draw up the following accounts up to the date of cancellation:

(i) Debentures Account and

(ii) Own Debenture (Investment) Account.
Ignore Taxation.

Solution: Illustration 4

5% Debentures A/c (20X2)

Date Particulars Amount Date Particulars Amount

Mar 1 To Own Debenture Investment 24,725 Jan 1 By Balance b/d 1,50,000
To Gain on Cancellation 275
(25,000 – 24,725)
Sep 1 To Own Debenture Investment 19,708
To Gain on Cancellation (WN) 292
Sep 1 To Balance c/d 1,05,000
1,50,000 1,50,000
Own Debenture Investment A/c (20X2)

Date Particulars Face Interest Cost Date Particulars Face Interest Cost
Value Value
1/3 To Bank 25,000 521 24,725 1/3 By 5% 25,000 - 24,725
Debentures
A/c
1/9 To Bank (WN) 20,000 417 19,708 1/9 By 5% 20,000 - 19,708
Debenture
A/c
1/9 By P&L 938
45,000 938 44,433 45,000 938 44,433
Working Note

Date Face Value (Nominal Amount Interest Ex- Interest

Value) Paid
1/03/21 25,000 25,246 521 24,725
(25,000 × 5% × 5/12)
Gain on Cancellation 275
1/9/X2 20,000 20,125 417 19,708
(20,000 × 5% × 5/12)
Gain on Cancellation 292

Illustration – 5 : Deleted

Illustration – 6

1FIN BY INDIGOLEARN 11.97

The Summarized Balance Sheet of BEE Co. Ltd. as on 31st March, 20X1 is as under:

Liabilities Amount (Rs.) Assets Amount (Rs.)

Share Capital: Freehold property 1,15,000
Authorized:
30,000 Equity Shares of Rs. 10 each 3,00,000
Stock 1,35,000
Trade receivables 75,000
Issued and Subscribed: Cash 30,000
20,000 Equity Shares of Rs. 10 each
fully paid 2,00,000
Balance at Bank 2,00,000

Profit and Loss Account 1,20,000

12% Debentures 1,20,000
Trade payables 1,15,000 ________
5,55,000 5,55,000
At the Annual General Meeting, it was resolved:

1. To give existing shareholders the option to purchase one Rs. 10 shares at Rs. 15 for every four shares
(held prior to the bonus distribution), this option being taken up by all shareholders.
2. To issue one bonus share for every five shares held.
3. To repay the debentures at a premium of 3%.
Give the necessary journal entries and the company’s Balance Sheet after these transactions are completed.

Solution: Illustration 6

Working Notes:

1) Rights Issue

Number of Rights shares to be issued- (20,000 shares / 4) X 1 = 5,000 shares @ ₹15 (Face Value @₹10 + ₹5
towards premium)

2) No. of Bonus Shares

Number of Bonus shares to be issued- (25,000 shares / 5) X 1 = 5,000 bonus shares

Journal of BEE Co. Ltd

Particulars Dr. (₹) Cr. (₹)

Bank A/c Dr. 75,000
To Equity Shareholders A/c 75,000
(Being amount collected from equity shareholders @₹15
per share for 5,000 right shares)
Equity Shareholders A/c Dr. 75,000
To Equity Share Capital A/c 50,000
To Securities Premium A/c 25,000
(Being right shares issued to the shareholders @₹15. ₹10
accounted as Share Capital and ₹5 accounted as
securities Premium)
Securities Premium A/c Dr. 25,000
Profit & Loss A/c Dr. 25,000
To Bonus to Shareholder’s A/c 50,000

1FIN BY INDIGOLEARN 11.98

(Being amount transferred for issue of Bonus Share)

Bonus to Shareholders A/c Dr. 50,000

To Equity Share Capital A/c 50,000
(Being 5000 Bonus Shares issued @1 share for every 5
shares held)
Profit and Loss A/c Dr. 12,000
To Debenture Redemption Reserve 12,000
(Being DRR created at 10% of debentures redeemed)
Debenture Redemption Reserve Investment A/c Dr. 18,000
To Bank A/c
(Being DRR Investment created 15% x 1,20,000 as per the 18,000
provisions)
12% Debentures A/c Dr. 1,20,000
Premium on Redemption of Debentures A/c Dr. 3,600
To Debenture Holders a/c
(Being amount payable to Debenture holders) 1,23,600
Debenture holders a/c Dr. 1,23,600
To Bank A/c 1,23,600
(Being Amount repaid to debenture holders)
DRR A/c Dr. 12,000
To General Reserve A/c 12,000
(Being DRR balance transferred to General Reserve after
redemption of debentures)
Bank A/c Dr. 18,000
To DRR Investment 18,000
(Being DRR investment Realised at par)
Balance Sheet of BEE Co. Ltd. As on ......... (after completion of transactions)

Particulars Note No ₹
I. Equity and liabilities
(1) Shareholder's Funds
(a) Share Capital 1 3,00,000
(b) Reserves and Surplus 2 91,400
(2) Current Liabilities
(a) Trade payables 1,15,000
Total 5,06,400
II. Assets
(1) Non-current assets
(a) Property, Plant and Equipment
(i) Tangible Assets 3 1,15,000
(2) Current assets
(a) Inventories 1,35,000
(b) Trade receivables 75,000
(c) Cash and bank balances 4 1,81,400
Total 5,06,400
Notes to Accounts

1 Share Capital 3,00,000

1FIN BY INDIGOLEARN 11.99

 30,000 shares of ₹10 each fully paid (5,000 shares of ₹10 each, fully
paid issued as bonus shares out of securities premium and P&L
Account)
2 Reserve and Surplus
Profit & Loss Account 1,20,000
Less: Utilisation for issue of bonus shares (25,000)
Less: DRR created (12,000)
Less: Premium on Redemption (3,600)
79,400
General Reserve 12,000 91,400
3 Tangible assets
Freehold property 1,15,000
4 Cash and bank balances
Cash at bank (2,00,000 + 75,000 – 1,23,600) 1,51,400
Cash in hand 30,000 1,81,400
Notes:

Closing Balances after Transaction

Account Opening Additions Deletions Closing Balance

Cash& Bank 2,00,000 75,000 18,000 1,51,400
18,000 1,23,600
Equity Share Capital 1,20,000 50,000 + 3,00,000
50,000
Securities Premium 0 25,000 25,000 0
Profit & Loss 1,20,000 25,000 79,400
12,000
3,600
DRR 30,000 12,000 12,000 0
DRR Investment 18,000 18,000 0
12% Debentures 1,20,000 1,20,000 0
General Reserve - 12,000 - 12,000

Illustration – 7

The summarised Balance Sheet of Convertible Limited, as on 30th June, 20X1, stood as follows:

Particulars Amount (Rs.)

Liabilities:
Share Capital: 5,00,000 equity shares of Rs. 10 each fully paid 50,00,000
General Reserve 75,00,000
Profit And loss A/c 10,00,000
Debenture Redemption Reserve 25,00,000
13.5% Convertible Debentures, 1,00,000 Debentures of Rs. 100 each 1,00,00,000
Other loans 65,00,000
Current Liabilities and Provisions 1,25,00,000
4,50,00,000

1FIN BY INDIGOLEARN 11.100

The Debentures are due for redemption on 1st July, 20X1. The terms of issue of debentures provided that they
were redeemable at a premium of 5% and conferred option to the debenture holders to convert 20% of their
holdings into equity shares at a predetermined price of Rs.15.75 per share and the payment in cash.

Assuming that:

1. except for 100 debenture holders holding totally 25,000 debentures, the rest of them exercised the
option for maximum conversion.
2. the investments were realised at par on sale; and
3. all the transactions are put through, without any lag, on 1st July, 20X1.
Redraft the balance sheet of the company as on 1st July, 20X1 after giving effect to the redemption. Show your
calculations in respect of the number of equity shares to be allotted and the necessary cash payment.

Solution: Illustration 7
Working Notes :
1) Calculation of number of shares to be allotted:
Total number of debentures 1,00,000
Less: Number of debentures for which debenture holders did not opt for (25,000)
conversion
75,000
20% of 75,000 opt for conversion as in the form equity shares (Redemption) 15,000
Redemption value of 15,000 debentures (15,000x105) ₹15,75,000
Therefore No. of equity shares to be issued (15,75,000/15.75) 1,00,000
equity
shares
2) Computation of cash to be Paid
Total number of debentures 1,00,000
Less: Converted to Equity 15,000
To be Paid (Cash/Bank) in Number of Deb. holders 85,000
Total amount to be Paid (85,000 × 105) ₹89,25,000
Convertible Limited Balance Sheet as on July 1,20X1
Particulars Note No ₹ in Lakhs
I. Equity and liabilities
(1) Shareholder's Funds
(a) Share Capital 1 60
(b) Reserves and Surplus 2 110.75
(2) Non - Current Liabilities
(a) Long-term borrowings 3 65
(3) Current Liabilities
(a) Short-term provisions 125
Total 360.75
II. Assets
(1) Non-current assets
(a) Property, Plant and Equipment
(i) Tangible Assets 160
(2) Current assets
(a) Cash and bank balances 4 0.75
(b) Other current assets 200
Total 360.75
[Text Wrapping Break]Notes to Accounts

1FIN BY INDIGOLEARN 11.101

(In Lakhs)
1 Share Capital 60
Authorised, issued and Subscribed (5,00,000 +
1,00,000)
6,00,000 @₹10 (Refer WN (1))
2 Reserve and Surplus
General Reserve 75
Add: Transfer from DRR 25 100
Profit & Loss 10
Less: Premium on Redemption (5) 5
Securities Premium 5.75
110.75
3 Long Term Borrowings
Secured Loans 65
4 Cash and bank balances 75
Add: DRR Investment 15
90
Less: Debenture Holder Payment (89.25) 0.75

Illustration 8

The following balances appeared in the books of a company, which is an unlisted company other than All India
Financial Institution , Banking Company, NBFC and HFC, as on 31st December of Year 1:
 6% Mortgage 10,000 debentures of Rs.100 each;
 Debenture Redemption Reserve (for redemption of debentures) Rs.2,00,000;
 Investments in deposits with a scheduled bank free from any charge or lien Rs.1,50,000 at interest of
4% p.a. receivable on 31st December every year.
 Bank Balance with the company is Rs.9,00,000.
 The Interest on debentures has been paid up to 31st December of Year 1.

On 28th February of Year 2, the investments were realised at par and the debentures were paid off at Rs.101,
together with accrued interest.
Write up the concerned ledger accounts (excluding bank transactions). Ignore taxation.
Solution: Illustration 8
6% Debentures Account
Particulars Debit ₹ Particulars Credit ₹
To Debenture Holders 10,00,000 By Balance b/d 10,00,000
10,00,000 10,00,000
Debenture Investment Account
Particulars Debit ₹ Particulars Credit ₹
To Balance b/d 1,50,000 By Bank 1,50,00
1,50,000 1,50,000
Bank A/c
Particulars Debit ₹ Particulars Credit ₹
To Balance b/d 9,00,000 By Deb. Interest A/c 10,000
To Interest on Debentures 1,50,000 By Debenture holders 10,10,000
Redemption Investment (10,000 x 101)
To interest on DRR 1,000 By Balance c/d 31,000
Investment

1FIN BY INDIGOLEARN 11.102

 10,51,000 10,51,000
Debenture Redemption Reserve A/c
Particulars Debit ₹ Particulars Credit ₹
To General Reserve 1,00,000 By Balance b/d 50,000
By P&L 50,000
1,00,000 1,00,000
Debenture Holders A/c
Particulars Debit ₹ Particulars Credit ₹
To Bank A/c 10,10,000 By 6% Debentures A/c 10,00,000
By Premium on Redemption of 10,000
Debentures
10,10,000 10,10,000

Illustration 9

A Company has issued 20,000 13% debentures of Rs.100 each on 1st April 20X1. The debentures are due for
redemption on 1st July 20X2.

The terms of issue of debentures provided that they were redeemable at a premium of 5% and also conferred
option to debenture holders to convert 20% of their holding into equity shares (Nominal value Rs.10) at a price
of Rs.15 per share. Debenture holders holding 2,500 debentures did not exercise the option.

Calculate the number of equity shares to be allotted to the debenture holders exercising the option to the
maximum

Solution: Illustration 9
Calculation of number of equity shares to be allotted
Number
Total number of debentures 20,000
Less: Debenture holders not opted for conversion (2,500)
Balance eligible for conversion 17,500
Conversion Ratio (Maximum – 20%) 20%
Number of debentures to be converted (20% of 17,500) 3,500
Redemption value (105% of ₹100) 105
Number of debentures to be converted (20% of 17,500) ₹3,67,500
Agreed price of each share 15
No. of shares to be issued (₹ 3,67,500/ ₹ 15) 24,500 shares

Illustration 10

Libra Limited (a listed company) recently made a public issue in respect of which the following information is
available:

(a) No. of partly convertible debentures issued- 2,00,000; face value and issue price - Rs. 100 per
debenture.
(b) Convertible portion per debenture- 60%, date of conversion- on expiry of 6 months from the date of
closing of issue.

1FIN BY INDIGOLEARN 11.103

(c) Date of closure of subscription lists- 1.5.20X1, date of allotment- 1.6.20X1, rate of interest on
debenture- 15% payable from the date of allotment, value of equity share for the purpose of conversion- Rs.
60 (Face Value Rs. 10).
(d) Underwriting Commission- 2%.
(e) No. of debentures applied for- 1,50,000.
(f) Interest payable on debentures half-yearly on 30th September and 31st March.
Write relevant journal entries for all transactions arising out of the above during the year ended 31st March,
20X2 (including cash and bank entries).

Solution: Illustration 10
Journal Entries in the books of Libra Ltd.
Date Particulars Dr. (₹) Cr. (₹)
01/05/X1 Bank A/c Dr. 1,50,00,000
To Debenture Application A/c 1,50,00,000
(Being 1,50,000 Application received for ₹100 each)
1/6/20X1 Debenture Application A/c Dr. 1,50,00,000
Underwriters A/c Dr. Dr. 50,00,000
To 15% Debentures A/c 2,00,00,000
(Being 2,00,000 Debentures allotted and shortfall
undertaken)
Underwriting Commission Dr. 4,00,000
To Underwriters A/c 4,00,000
(Commission payable to underwriters @ 2% on ₹
2,00,00,000)
Bank A/c Dr. 46,00,000
To Underwriters A/c 46,00,000
(Amount receivable from underwriter received)
01/06/20X1 Debenture Redemption Investment A/c 12,00,000
To Bank A/c 12,00,000
(200,000 X 100 x 15% X 40%)
(Being Investment in specified securities made for
redeemable value as per Rule 18)
30/09/20X1 Debenture Interest A/c Dr. 10,00,000
To Bank A/c 10,00,000
(Being interest due 15% debenture paid on due date)
31/10/20X1 15% Debentures A/c Dr. 1,20,00,000
To Equity Share Capital 20,00,000
To Securities equity premium 1,00,00,000
(Being 60% of 15% debentures converted into
2,00,000 equity shares of ₹60 each)
Working Note:
Calculation of Debenture Interest for the half year ended 31st March, 20X2
On ₹ 80,00,000 for 6 months @ 15% ₹6,00,000
On ₹ 1,20,00,000 for 1 months @ 15% ₹ 1,50,000
₹7,50,000

1FIN BY INDIGOLEARN 11.104