Lesson : 1

JOINT VENTURE
STRUCTURE 1.0 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.0 Objective Introduction Meaning of Joint Venture Feature of a Joint Venture Differences between Joint Venture, Partnership and Consignment Methods of Recording Joint Venture Transactions Summary Keywords Self Assessment Questions Suggested Readings OBJECTIVE After reading this lesson, you should be able to a) b) c) 1.1 Define a joint venture and explain its feature Differentiate between joint venture, partnership and consignment. Account for joint venture transactions under different methods. INTRODUCTION Complexities of a business as huge funds requirements, lack of technical expertise, sometimes make it difficult to undertake a business assignment individually like constructing a big building. The alternative available is that two or more persons join hand to take up that assignment. Joining hand may be 1

for finance, for technical know-how, for sharing risk etc. When two or more persons join together to carry out a specific business and share the profits on predetermined basis, it is known as a Joint Venture. Joint venture is defined as a partnership confined to a particular adventure, speculation, course of trade or voyage, and in which partners, either latent or known use no firm or social name, and incur no responsibility beyond the limits of the adventure. For example, Mr. John and Mr. Ibrahim agreed to construct a bridge for municipal corporation. They pool their resources and technical know how. After they completed this project, the profits arising thereof will be shared by them in proportion to their contribution. Whey they are undertaking this project, they are free to carry on their own business as usual unless otherwise agreed. As the project ends, the relationship between the parties i.e. co-ventures ceases. So life of joint venture depends on the duration in which a project completes. Joint venture is neither a partnership nor it is consignment. 1.2 MEANING OF JOINT VENTURE

A joint venture is usually a temporary partnership without the use of a firm name, limited to carrying out a particular business plan in which the persons concerned agree to contribute capital and to share profits or losses. The parties in a joint venture are known as co-venturers and their liability is limited to the adventure concerned for which they agree to contribute capital and share profits or losses. A joint venture may consist of a joint consignment of goods, speculation in shares, underwriting of shares or debentures, construction of a building, or any similar form of enterprise.

1.3

FEATURES OF A JOINT VENTURE

The main features of a joint venture are specifically made clear.

F Two or more person are needed. F It is an agreement to execute a particular venture or a project. F The joint venture business may not have a specific name. F It is of temporary nature. So the agreement regarding the venture

automatically stands terminated as soon as the venture is complete.

F The co-ventures share profit and loss in an agreed ratio. The profits

and losses are to be shared equally if not agreed otherwise.

F The co-ventures are free to continue with their own business unless

agreed otherwise during the life of joint venture. 1.4 DIFFERENCES BETWEEN JOINT VENTURE, PARTNERSHIP AND CONSIGNMENT In joint venture and partnership some business is carried on by two or more persons and the profits are shared by all of them. But there are some basic differences between the two which are given below: Partnership Venture -A Partnership firm always has a name -It is of a continuous nature. -Separate set of books have to be maintained. Joint Venture There is no need of firm's name. It comes to an end as soon as the work is complete. There is no need for a separate set of books, the account can be maintained even in one of the co-venturer's books only. 3

- No partner can carry on a similar business. -Though the registration of partnership is not compulsory desirable - A minor can also be admitted to the benefits of the firm.

The co-venturers are free to carry on the business of a similar nature. There no need for registration at all. A minor cannot be a co-venturer as he is incompetent to enter into a contract.

Consignment and joint venture are in the nature of an agreement between different parties but there are many points of differences between the two. Some of these are given below : Joint Venture
-Number of co-ventures is usually two but it can also be more than two. - The relationship between co-venturers is that of partnership. Co-venturers are the owners. - The relationship comes to an end as soon as the venture is completed. - All the co-venturers contribute funds to a common pool. - It may be for sale of goods or for carrying on any other activity like construction of building, investment in shares etc. - The profit is shared by all the co-venturers.

Consignment
Normally two persons are involved, the consignor and the consignee. The relationship between the consignor and the consignee is that of principal and agent. The arrangement may continue for a long time. The funds are provided by the consignor. It is generally connected with sale of movable goods.

The profit belongs to the consignor only. The consignee is entitled only to his commission. The consignor owns the goods.

- There is joint ownership

Joint venturers as mentioned earlier are beneficial under the situations where there are limitations which can not be overcome by single party. By launching joint venture two or more parties can pool their financial resources 4

to undertake a very big venture. Where experience or technical knowledge is a limitation co-ventures can also pool their expertise. Since joint ventures are normally big projects, if under unfavorable conditions there are losses then these losses are also shared thus loss to individual party is lessened. 1.5 METHODS OF RECORDING JOINT VENTURE TRANSACTIONS Joint venture accounts can be kept under any of the following three methods : A) Each co-venture records the transaction in his own books and opens "Joint Venture Account" and accounts of his fellow partners. B) One common Joint Venture Account on memorandum basis is prepared to find the profit or loss made on trading. It is not a part of the double entry system. Under this system each one of the partners open only one account which is of the nature of personal account. The account is called. "Joint venture with ...............a/c." C) Venturers agree to keep a separate set of books and a person is made incharge of recording of all transactions. Generally this method is not adopted. A) Each co-venturer records the transactions Under this system the "Joint Venture Account" is opened and debited with the value of goods bought and expenses incurred. Cash account or the party which has supplied the goods or incurred the expenses will be credited. When the sales proceeds are received, the party receiving it, will debit cash (for Debtors) account and credit the Joint Venture Account. The other parties will debit the recipient party and credit the Joint Venture Account.

Sometimes, a bill of exchange is drawn by one of the parties and is discounted. In such a case the discount on the bill should be charged to Joint Venture Account. Joint Venture Account will now show the profit or loss on trading. Under this system, each (Joint venturer) partner will open two acconts i.e. (i) Joint Venture Account (ii) The account of other parties. Journal Entries : The following journal entries will be passed 1) For Investment in Joint Venture Joint Venture A/c To Cash/Good A/c (Being the amount of goods supplied or cash put in for Joint Venture) 2) As goods are supplied by the Co-venturer or cash is invested in Joint Dr.

Venture by him Cash A/c (For cash sent) Joint Venture A/c To Co-venturer A/c (for goods sent) (Being goods supplied or cash invested by the other partner) 3). For recording sale of joint venture goods Cash A/c To Joint Venture A/c (Being Sale of goods made) 3) On sale of joint venture goods by the other party Co-Venturer A/c To Joint Venture A/c (Being Joint Venture goods sold by the other partner) 6 Dr. Dr. Dr. Dr.

5)

a)

For receipt of Bill of Exchange from the other partner Bills receivable A/c To Co-Venturer A/c (Being bill receivable received) Dr.

b)

For discounting the bill of exchange Bank A/c Joint Venture A/c To Bills Receivable A/c Dr. Dr.

(Being bill discounted and discounting charges debited to Joint Venture A/c). 6) Entries in the books of other partner Acceptor's books regarding of bills of exchange Dr. Co-venturer A/c To Bills Payable A/c (Being acceptance given) 7) On discounting the bills of exchange by other party i.e. drawer Joint venture A/c To Co-Venturer A/c 8) On commission charged under Joint Venture Joint Venture A/c To commission A/c 9) On Commission charged by other partner Joint Venture A/c To Co-Venturer A/c (Being Commission on sale effected by other partners) 7 Dr. Dr. Dr.

acceptance

10) When some products are left unsold and transferred to his own stock. Purchase A/c To Joint Venture A/c (Being the unsold goods taken) 11) If the other partner has taken the unsold goods, the entry will be:The Co-venturer A/c To Joint Venture A/c (Being the unsold goods taken by the other partner) 12) Now Joint Venture Account will be closed. If it shows profit then the profit will be divided in the agreed ratio. The entry will be Joint Venture A/c To P & L A/c (own share) To Co-venturers A/c (their share) (Being the profit on Joint Venture shared by the parties) Format of Two accounts to be maintained Joint Venture Account Dr. Particulars To Cash A/c (purchased) To Cash A/c (Expenses) To Purchase A/c (Material supplied) To Outstanding Expenses A/c To Profit transferred to: Profit & Loss A/c Co-venturers A/c 8 Cr. Amount Rs. Particulars Amount Rs. By Cash A/c By Co-venturer A/c (Goods taken over) Dr. Dr.

Co-venturer's Personal Account

Particulars To Joint Venture A/c (Good taken over) To Cash a/c ------------------------Illustration - 1 X and Y entered into Joint Venture to sell a consignment of timber sharing profits and losses equally. X provides timber from stock at mutually agreed value of Rs. 50000. He pays expenses amounting to Rs. 2500. Y incurs further expenses on cartage, storage and collieage of Rs. 6500 and receives cash for sales Rs. 30,000. He also takes over goods to the value of Rs. 10000 for his own use. At the close, X takes over the balance stock in hand which is valued at Rs. 11000. Pass Journal Entries to record the above transactions and open the necessary ledger accounts in the books of X and Y. By Joint Venture A/c ------------------------Rs. Particulars By Bills Receivables Rs.

Journal entries in the Books of X

Particulars Joint Venture A/c To Purchase A/c To Bank A/c (Being timber provided and expenses incurred) Joint Venture A/c To Y (Being expenses incurred by Y) Y To Joint Venture a/c (Being the sale proceeds by Y) Y To Joint Venture A/c (Y takes over the goods for his use) Purchase A/c To Joint Venture A/c (Being unsold goods taken) Y Profit and Loss A/c To Joint Venture A/c (Being the loss on Joint Venture shared equally) Bank A/c To Y (Being draft received from Y) 10 Dr. 37,500 37,500 Dr. Dr. 4,000 4,000 8,000 Dr. 11,000 11,000 Dr. 10,000 10,000 30,000 Dr. 30,000 Dr. 6,500 6,500 Dr. L.F. Dr. Rs. 52,500 50,000 2,500 Cr. Rs.

Ledger Account Joint Venture A/c

Particulars To Purchase To Bank (expenses) To Y (expenses) Rs. 50,000 2,500 6,500 Particulars By Y (sale proceeds) By Y (goods for his use) By Purchases (goods) By Y (loss) By Profit and Loss A/c (Ratio being 1:1) 59,000 Y's Account Particulars To Joint Venture (Sale) Rs. 30,000 Particulars By Joint Venture (Expenses) By Bank (Final Settlement) 44,000 Rs. 6,500 37,500 59,000 Rs. 30,000 10,000 11,000 4,000 4,000

To Joint Venture (goods) 10,000 To Joint Venture (goods) 4,000 44,000

Particulars

Joint Venture A/c To X (Being the goods supplied and expenses incurred) Joint Venture A/c Dr. To Bank (Being the expenses paid)

Journal Entries in the Books of Y Dr. L.F. Rs. Dr. 52,500

Cr. Rs. 52,500

6,500 6,500

11

Bank Dr. To Joint Venture A/c (Being the receipt of sale proceeds) Drawing A/c Dr. To Joint Venture A/c (Being the goods withdrawn for own use) X Dr. To Joint Venture A/c (Being the taking over the balance stock in hand by X) X Dr. Profit and Loss A/c Dr. To Joint Venture A/c (For sharing of loss in equal ratio) X Dr. To Bank (Being the draft remitted X) Ledger A/cs

30,000 30,000 10,000 10,000 11,000 11,000

4,000 4,000 8,000 37,500 37,500

Joint Venture A/c Dr. Particulars To X (goods supplied) To X (expenses) To Bank (expenses) Rs. 50,000 2,500 6,500 Particulars By Bank (by sales) By Drawing of goods By (Balance stock taken by X) By X P & LA/c (Loss) 59,000 12 4000 4000 8,000 59,000 Rs. 30,000 10,000 11,000 Cr.

X's A/c Dr. Particulars To Joint Venture A/c Rs. 11,000 Particulars By Joint Venture A/c (Good and expenses) To Joint Venture A/c (Loss) 4,000 To Bank 32,500 52,500 52,500 Rs. 52,500 Cr.

B)

Memorandum Joint Venture Account Method In the method discussed above each co-venturer records all transactions

relating to the joint venture in the Joint Venture Account opened in his books. But, under the Memorandum Joint Venture Account Method each co-venturer will record only those transactions relating to the joint venture which are directly concerned with him and not those of others. a) Under this method each co-venturer opens a Joint Venture Account including the name of the other co-venturer. The heading of the account is 'Joint Venture with (name of coventurer) Account'. The Joint Venturer with (name of co-venturer) Account is a personal account and it does not show any profit or loss. The following entries will be made in this account : i) Joint Venture with..........................Account Dr. To cash/Bank/Creditors Account (Being payments by cheque or cash or liabilities incurred on Joint Venture) 13

ii)

Cash/Debtors Accounts

Dr.

To Joint Venture............Account (Being sale Cash/Credit made on account of Joint Venture) b) A separate 'Joint Venture Memorandum Account' is prepared to ascertain profit or loss in Joint Venture. It is just like profit and loss account, all the expenses and losses are debited to it and all incomes and gains are credited to it. All the items of personal accounts will also appear on the same side of 'Joint Venture Memorandum Account'. The balance of Joint Venture Memorandum Account shows profits or loss on joint venture and each party makes an entry for his share of profits or losses. The journal entry is as under : Joint Venture with.................Account Dr. To Profit and Loss Account (Being profit earned on Joint Ventures) Or Profit and Loss Account Dr. To Joint Venture with................Account (Being loss effected on Joint Venture) Illustration - 2 A and B entered into a Joint venture involving the buying and selling of old railway material with an agreement to share profit or loss equally. (The amount is in Rs. Hundreds). The cost of the material purchased was Rs. 30,000 which was paid by A, who drew bill of Rs. 20,000 on B at three months' period. 14

The bill was discounted by A at cost of Rs. 160. The transactions relating to the ventures were: 1) A paid Rs. 200 for carriage, Rs. 600 for commission on sales and Rs.

100 for travelling expenses (ii) B paid Rs. 80 for travelling expenses and Rs. 120 for sundry expenses (iii) Sales made by A amounted to Rs. 21,400 less allowance for faulty goods Rs. 400 and (iv) Sales made by B were Rs. 15,000. The remaining goods were retained by A and B for their private use and these were charged to them as Rs. 1600 and Rs. 2400 respectively. A was credited with sum of Rs. 300 to cover the cost for warehousing and insurance. The expenses in connection with the discounting to the bill were to be treated as a charge against the venture. Prepare the ledger accounts in the books of both the parties and also the memorandum joint venture account. Solution Dr. Particulars To Materials To discount on Bill To carriage To Commission To Travelling (100+8) To Sundry expenses To Warehousing expenses To Profit A : 4220 B : 4220 8,440 40,000 15 40,000 Memorandum Joint Venture A/c Rs. 30,000 160 200 600 180 120 300 Particulars By Sales (21000 + 15000) By stock taken by A 1600 B 2400 4,000 Rs. 36,000 Cr. (Rs. In 000)

In the Books of A Joint Venture with B A/c (Rs. in 000) Dr. Particulars To Bank (material) To discount on bill To Bank Carriage Commission Warehousing 200 600 300 1,200 4,220 35,580 To Balance b/d 12,980 In the Books of B Joint Venture with A A/c Dr. Cr. (Rs. in '000) Particulars To Bank Travelling Exp. 80 Sundry Exp. To Balance c/d 120 200 4,220 12,980 17,400 By Balance b/d 17400 12980 To Profit & Loss A/c Rs. Particulars By Bank (Sales) By Stock taken Rs. 15,000 2,400 35,580 Rs. 30,000 160 Particulars By Bank (sales) By Stock taken By Balance c/d Rs. 21,000 1,600 12,980 Cr.

Travelling exp. 100 By Profit & Loss A/c

16

Sometimes the co-venturers invest money in Joint venture business and receive back the amounts on different dates. It is quite usual for them to agree to calculate interest at a certain rate. Each co-venturers is entitled to receive interest on the amounts invested by him and pay interest on the amounts received by him. Only net interest receivable from or payable to the conventurer is recorded in the joint venture account. Thus, the net amount of interest is also taken into amount before ascertaining the profit or loss on joint venture. Illustration 3 A and B enter into a joint venture sharing profits and losses equally. A purchased goods for Rs. 5,000 for cash on January 1, 1999. On the same day Bought goods for Rs. 10,000 on credit and spend Rs. 1,000 on freight etc. Further expenses were incurred as follows : On 1.2.1999 On 12.3.1999 Rs. 1,500 by B Rs. 500 by A

Sales were made by each one of them as follows : 15.1.1999 13.1.1999 15.2.1999 1.3.1999 Rs. 3,000 by A Rs. 6,000 by B Rs. 3,000 by A Rs. 4,000 by B

Creditors for goods were paid as follows 1.2.1999 1.3.1999 17 Rs. 5,000 by A Rs. 5,000 by B

On March 31, 1999 the balance of stock was taken over by B at Rs. 9,000. The accounts between the co-venturers were settled by cash payment on this date. The co-venturers are entitled to interest at 12% per annum. Prepare necessary ledger accounts in the books of venturers as per Memorandum Joint Venture Account Method. Solution Memorandum Joint Venture Account Dr. Particulars To A (cost of goods) To B (Freight etc.) To A (expenses) To B (expenses) To A (interest) Profit transferred A : 3457 B : 3458 6,915 25,050 Joint Venture with B Account Dr. Date 1999 Jan. 1 To Bank A/c (Purchase) 18 5,000 Particulars Rs. Date 1999 Jan 15 By Bank A/c (Sales) 3,000 Particulars Cr. Rs. 25050 Rs. 5,000 1,000 500 1,500 135 Particulars By A (sales) By B (sales) By B (interest) By B (stock taken) Rs. 6,000 10,000 50 9,000 Cr.

To B (Cost of goods) 10,000

Feb. 1 Mar. 1

To Bank A/c (Creditors) To Bank A/c (Expenses)

5,000 500 135 3,457 14,092

Feb. 15 By Bank A/c (Sales) Mar. 15 By Bank A/c (Final settlement)

3,000 8,902

Mar. 31 To Interest a/c Mar. 31 To Profit & Loss A/c

14,902

B's Books Joint Venture with A Account Dr. Date 1999 Jan 1 To Bank A/c (Freight) Feb. 1 Mar. 1 To Bank A/c (Exp) To Bank A/c (Crs) 1,500 5,000 Mar. 31 By Bank (sales) Mar. 31 By Goods A/c Stock taken over Mar. 31 To Profit & Loss A/c 3,458 Mar. 31 To Bank A/c (Amt. Paid in Final Statement) 19,050 19 19,050 8,092 Mar. 31 By Interest A/c 50 4,000 9,000 1,000 Particulars Rs. Date 1999 Jan 31 By Bank (Sales) 6,000 Particulars Cr. Rs.

Calculation of Interest : Payment by A Date 1.1.99 1.3.99 1.2.99 Amount Rs. 5,000 Rs. 500 Rs. 5,000 Month 3 1 2 Product (Rs.) 15,000 500 10,000 25,000 Interest = 25,500 x 12 x 1 100 12 = Rs. 255 (5,000 x 3) (500 x 1) (5,000 x 2)

Receipts by A 15.1.99 15.2.99 Rs. 3,000 Rs. 3,000 2.5 1.5 7,500 4,500 12,000 Interest = 12,000 x 12/100 x 1/12 = 120 Net Interest due = 265 - 120 = Rs. 135 Payment by B 1.1.99 1.2.99 1.3.99 Rs. 1,000 Rs. 1,500 Rs. 5,000 3 2 1 3,000 3,000 5,000 11,000 Interest = 11,000 x 12/100 x 1/12 = Rs. 110 Receipts by B 31.1.99 1.3.99 Rs. 6,000 Rs. 4,000 2 1 12,000 4,000 16,000 Interest = 16,000 x 12/100 x 1/12 = Rs. 160 Net Interest due from B = 160 - 110 = Rs. 50 20 (3,000 X 2 ) (3,000 x 1 )

C)

Separate Books Recording of transactions is done not in books of parties but in a separate

set of books. Co-venturer first contributes to a common bank account and then all payments are made through it. Accounts of parties are also opened. Profit or Loss on Joint Venture is transferred to the respective partner's accounts in due ratios. Finally, the books are closed with the close of the venture. Three main accounts opened under separate set of accounts are: 1. 2. 3. Joint Venture Account Joint Bank Account, and Personal Capital Accounts of Joint Venturers.

The following entries will be passed under this system 1) When cash is invested by Joint Venturer Joint Bank A/c Dr. To Capital Accounts of Joint Venturers. (Being cash invested by Joint Venturers and deposited into the Bank) 2) When purchases are made for joint venture out of bank A/c Joint Venture A/c Dr. To Joint Bank A/c (Being Purchase made for Joint Venture) 3) When expenses are incurred for joint venture out of Bank A/c Joint Venture A/c Dr. To Joint Bank A/c (Being expenses incurred for Joint Venture Account) 21

4)

When sales are made Joint Bank A/c Dr. To Sales (Being sales made and receipts from sales deposited into Bank)

5)

When some products are left unsold and are taken away by Joint Venturers Capital accounts of Joint Venturer A/c To Joint Venture A/c Dr.

(Being unsold stock taken by Joint Venturers) 6 (a) For Profit on Joint Venture account Joint Venture A/c Dr. To capital accounts of Joint Venturers A/c (Being profit earned on Joint Venturers) 6 (b) The reverse entry will be passed in cases of losses on Joint Venture. Illustration 4 X and Y enter into joint venture to underwrite public issue of Reliance Ltd. They agree to guarantee the subscription at par on 1,00,000 shares of Rs. 10 each of Reliance Ltd. and sharing profits and losses in the ratio of 2:3. The terms with the company are 4.5 % commission payable in cash and 6,000 fully paid shares of the company. They agreed to pay expenses in connection with the issue of shares. The expenses incurred are advertisement Rs. 5,000; Printing and stationery Rs. 2,000 and postage Rs. 600. All expenses are paid by X. The public subscribed to 88,000 shares only. The remaining shares under the agreement were duly taken by X and Y who provided the necessary cash equally. The commission is received in cash and is shared by the co-venturers in the 22

ratio of 4:5. The entire holding of the joint venture is then sold in the market through brokers as follows : 25% at a price of Rs. 9 per share, 50% at a price of Rs. 8.75 per share, 15% at a price of Rs. 8.50 per share and the remaining 10% is taken over by A and B equally at an agreed price of Rs. 8 per share. Prepare the Joint Venture Account, Joint Bank Account, Shares Account and the Accounts of X and Y showing the final statement. Solution Joint Venture Account Dr. Particulars To Advertisement Printing Postage To Shares A/c (Loss on sale) To profit transferred to X: Y: 29,600 44,400 74,000 1,05,000 Joint Bank Account Dr. Particulars To X (contribution) To Y (contribution) To Joint Venture Rs. 60,000 60,000 45,000 23 Particulars By Shares A/c By X (commission) By Y (commission) Cr. Rs. 1,20,000 20,000 25,000 1,05,000 5000 2000 600 7,600 23,400 Rs. Particulars By Joint A/c (commission) By shares a/c (commission) 60,000 Rs. 45,000 Cr.

(Commission) To Shares A/c (sale for cash) 25% 50% 15% 40,500 78,750 22,950 1,42,200 3,07,200

By X (final settlement) 70,000 By Y (final settlement) 72,000

3,07,200

Share Account Particulars To Joint Bank a/c To Joint Venture (commission) Rs. 1,20,000 60,000 Particulars By Joint Bank A/c (Sale of Shares) By Joint Bank A/c (sale of shares) By Joint Bank A/c (Sale of shares) By X (shares taken over) 7,200 By Y (shares taken over) 7,200 By Joint Venture A/c 1,80,000 X's Account Particulars To Joint Bank A/c (Commission) To Shares A/c To Joint bank A/c (Final Settlement) 97,200 24 7,200 70,000 Rs. 20,000 Particulars By Joint Venture A/c (Expenses) By Joint Bank A/c (Commission) By Joint Venture A/c (Profit) 97,200 29,600 60,000 Rs. 7,600 23,400 1,80,000 22,950 78,750 Rs. 40,500

Y's Account Particulars To Joint Bank A/c (Commission) To Shares A/c To Joint Bank A/c (Final Settlement) Working Notes 1. Distribution of commission received in cash 4.5 % of Rs. 10,00,000 = Rs. 45,000 Xs shares 4/9 x 45,000 = Rs. 20,000 Y's shares 5/9 x 45,000 = Rs. 25,000 2. Treatment of shares received Shares received by way of commission 6,000 Shares not subscribed by public 12,000 Total Number of shares received 18,000 a) Sold for cash 25% of 18,000 i.e. 4,500 shares sold @ Rs. 9 per share Rs. 40,500 50% of 18,000 i.e. 9,000 shares sold @ Rs. 8.75 per share Rs. 78,750 25 7,200 72,200 1,04,400 1,04,400 Rs. 25,000 Particulars By Joint Bank A/c (Commission) By Joint Venture A/c (Profit) 44,400 Rs. 60,000

15% of 18,000 i.e. 2,700 shares sold @ Rs. 8.50 per share Rs. 22,950. b) Dividend amongst X and Y 10 % of the remaining shares i.e. 1,800 shares are taken over equally by X and Y at an agreed price of Rs. 8 per share. X : 900 shares @ Rs. 8 per share = Rs. 7200 Y : 900 shares @ Rs. 8 per share = Rs. 7200 1.6 SUMMARY A joint venture is a contractual arrangement between two or more parties to undertake an economic activity, which is subject to joint control, i.e., agreed sharing of power to govern the financial and operating policies of an economic activity, so as to obtain benefits from it. A joint venture arises because of the limitations of a person due to constraint of available time, money expertise to execute a job etc. Despite broad similarities between joint venture and partnership, the two types of business differ considerably. A joint venture can also be distinguished from the consignment although both forms of business arise because of inherent limitations of a person to undertake a business effectively on his own. It is necessary to maintain proper accounts of all transactions of joint venture so that correct profit or loss on joint venture may be ascertained. The main methods of recording joint venture transactions are by creating an independent set of books of the joint venture which do not form part of the accounting system of an co-venturer, to record all the transactions of the joint venture, whether, entered by himself or by his co-venturer and to record only those transactions of the joint venture in which he himself features.

26

1.7

KEYWORDS

Joint Venture: When two or more persons joint together to carry out a specific business and share the profits or losses on predetermined basis, it is known as a joint venture. Co-venturer Account: It is a personal account and debited with sales made by the co-venturer or goods taken by him and is credited with assets given by him for the venture and expenses paid by him. Memorandum Joint Venture Account: The profit or loss of the venture is computed in an account which is not part of the double entry mechanism and is termed as Memorandum Joint Venture Account. 1.8 1. 2. 3. 4. 5. 6. SELF ASSESSMENT QUESTIONS Define a joint venture and give its various features. Name the different methods used to record joint venture transactions. Distinguish joint venture from consignment and partnership. Give the various journal entries to be passed in case where separate set of books are maintained for recording joint venture transactions. What is a Memorandum Joint Venture Account? Give the various journal entries when accounts are maintained under this method. Give the various journal entries to be passed in case where no separate set of books are maintained for recording joint venture transactions. Ramesh and Suresh entered into a joint venture to purchase and sell hosiery goods. Profit and losses were to be shared equally. Ramesh financed the venture and Suresh undertook the sales on a commission of 5% on the sales proceeds. Ramesh purchased goods to the value of Rs. 50,000 less 5% trade discount, paid freight Rs. 1,500 and advanced Rs. 1,200 to Suresh to meet expenses. Suresh expended for carriage Rs. 27

300, rent Rs. 450, advertisement Rs. 200 and sundries Rs. 150. Sales made by Suresh amounted to Rs. 67,500. It was agreed that Ramesh should receive Rs. 2,500 as interest. Remaining unsold goods costing Rs. 2,500 were retained by Suresh and those were charged to him at a price to show the same rate of gross profit (without charging any expenditure) as that made on the total sales (excluding those goods taken). Give journal entries in the books of Ramesh and Suresh and also prepare the necessary ledger accounts in their books. 7. Vikas and Vishal entered into a joint venture of underwriting 1,00,000 shares of Rs. 10 each at par issued by a joint stock company. The consideration for underwriting the shares was 2,500 other shares of Rs. 10 each fully paid to be issued to them. The public took up 90,000 shares and the remaining 10,000 shares of the guaranteed issued were taken up by Vikas and Vishal who provide cash equally for the purchase of remaining shares. The entire share holding of the joint venture was then sold through other brokers: 50% at a price of Rs. 10 less brokerage 50 paise per share; 20% at Rs. 9.50 less brokerage 50 paise per share and the balance were taken up by Vikas and Vishal equally at Rs. 9 per share. Expenses on account of joint venture were: advertisement Rs. 750 and other expenses Rs. 250. You are required to prepare; (a) Joint Venture Account; (b) Joint Bank Account; and (c) Accounts of Vikas and Vishal. 8. A and B entered into a joint venture for the purchase and sale of materials auctioned by the Government. A agreed to provide funds for the purchase of materials, and B to devote his time. The profit and loss was to be shared equally, subject to a credit of Rs. 500 to A by way of interest on 28

his capital. A purchased materials worth Rs. 50,000; and drew a bill at two months for Rs. 20,000 on B which was duly accepted by the latter. The bill was discounted at a cost of Rs. 260. The various expenses relating to the venture were: a) b) A paid Rs. 250 for carriage, Rs. 100 for brokerage, and Rs. 50 for miscellaneous expenses. B paid Rs. 300 for commission, Rs. 200 for insurance, and Rs. 100 for miscellaneous expenses. The total sales amounted to Rs. 72,000 (cash). There was, however, some stock of unsold goods which was taken over by both the parties, at Rs. 200 by A and at Rs. 300 by B. B paid the amount due to A. The expenses in connection with the discounting of the bill were to be treated as a charge against the venture. Prepare Joint Venture Account in the books of A and B separately and a Memorandum Joint Venture Account. 9. C of Calcutta and D of Delhi entered into a joint venture for the purpose of buying and selling second-hand motor cars, C to make purchases and D to effect sales. The profit or loss was to be shared as to C two-fifths and D three-fifths. A sum of Rs. 10,000 was remitted by D to C towards the venture. C purchased 10 cars for Rs. 8,000, paid Rs. 4,350 for their reconditioning and sent them to Delhi. His other expenses were -Buying Commission 2 per cent and Sundry Expenses Rs. 350. D took delivery of the cars by paying Rs. 750 for railway freight and Rs. 375 for octroi. He sold four cars at Rs. 1,600 each, two at Rs. 1,800 each and three at Rs. 2,250 each. He retained the remaining car for himself at an agreed value of Rs. 2,100. His expenses were-Insurance Rs. 150; Garage Rent Rs. 250; Brokerage Rs. 685; Sundries Rs. 450. 29

Each party's ledger contains a record of his own transactions on joint account. Prepare a statement showing the result of the venture and the account of the venture in each party's ledger as it will finally appear, assuming that the matter was finally settled between the parties. 1.9 1. 2. 3. 4. 5. 6. 7. SUGGESTED READINGS Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana.

30

Lesson : 2
CONSIGNMENT ACCOUNTS

STRUCTURE 2.0 2.1 2.3 2.4 2.5 2.6 2.7 2.8 2.9 Objective Introduction Distinction between Consignment and Sale Procedure to be followed in case of Consignment Accounting Treatment of Consignment Transactions Valuation of Stock on Consignment Accounting for Loss of Goods Invoicing goods higher than cost Summary

2.10 Keywords 2.11 Self Assessment Questions 2.12 Suggested Readings 2.0 OBJECTIVE

After reading this lesson, you should be able to a) Understand the meaning of consignment and explain the difference between consignment and sale b) c) Explain the accounting treatment of consignment transactions Account for normal and abnormal losses in consignment

2.1

INTRODUCTION Now-a-days it is quite common that manufacturers or wholesale dealers

despatch goods to their agents at home and abroad to increase their sales. The knowledge of the agent of the local conditions where he resides proves useful in increasing the sales. Moreover it is very expensive for the manufactures to sell the goods directly either in home market or in foreign market. Therefore, different agents are appointed for different places. 2.2 MEANING OF CONSIGNMENT It is common practice with practically all manufacturers or wholesalers to sell goods through agents both within the country and abroad. The goods are sent to be kept and sold on behalf of and at the risk of sender by the recipient. The person who forwards the goods for sale is consignor, the person to whom goods are forwarded for sale is consignee and goods so sent are called Goods sent on Consignment. Consignment is a means of facilitating sale but is not actually a sale. Consignment is different from sales. A consignment is returnable if goods are not sold but in case of sale, the goods are not returnable except for special reasons, such as on account of damage or if below standard goods are supplied. When goods are sold to a person the property in them passes to that person, but when goods are consigned to a person the legal ownership of the goods remains with the consignor. Hence when goods are sold the relationship between two parties is that of a creditor and debtor but when the goods are consigned relationship between the consignors and consignee is that of principal and an agent. 2.3 DISTINCTION BETWEEN CONSIGNMENT AND SALE The following points summarize clearly, the difference between a consignment and a sale.
2

Sr. Basis

Consignment

Sale Ownership passed to the buyer

1. Property in goods Ownership remains with i.e. Ownership the consignor

2. Relation

Consignee is the agent of the consignor

Buyer is debtor of seller until the account is settled.

3. Risk and damage

Consignee holds the goods at the risk of the consignor therefore subsequent damage to the goods is the loss of the consignor

Any subsequent damage to the goods is the loss of the buyer

4. Return of goods

Goods may be returned if not sold

Goods are not returnable except for special reasons e.g. wrong kind or defective goods etc.

5. Expenses after delivery

Recoverable from the consignor

To be borne by the buyer Invoice

6. Forwarding letter Proforma invoice

2.4

PROCEDURE TO BE FOLLOWED IN CASE OF CONSIGNMENT

When the goods are despatched by the consignor to the consignee, the consignor makes out a statement known as proforma invoice like a regular invoice giving details about the consignment and price which is normally at cost, but occasionally it may be at invoice price which is above the cost.

The consignee does not become liable for the payment of amount named in the invoice, but as matter of advance for goods, he usually makes payment in advance either by accepting a bill or by remitting a bank draft.

(a)

Account Sale : The consignee renders to his consignor regularly a

statement showing sales, expenses incurred, commission charged and remittance made with the resultant balance due by him. This statement is known as Accounts Sales. On receipt of Account Sales the consignor shall make entries in his books of account and complete the Consignment account and the Consignees account. (b) Advance on Consignment : It is common practice for the consignor to

ask the consignee for some deposit as a security for goods sent on consignment to the consignee. It may be paid by any mode of payment-cheque, cash or even bills of exchange. (c) Commission : The consignee usually gets a commission for selling the

goods on behalf of the consignor as a fixed percentage on sales. So more the sales more will be the commission earned by the consignor. But there are some other kinds of commission which are sometimes given to the consignee for
4

extra burden and activities i.e. Del Credre Commission and over-riding Commission. (i) Del Credre Commission : Ordinarily the consignee is not responsible

to the consignor for the payment of money by the purchasers but sometime he undertakes to guarantee payment due for all the goods he sells on credit and cash whether his customers pay him or not. In consideration of his this warranting the solvency of the buyers, he is paid an extra commission called a Del Credre Commission. The consignee will pay the consignor whether he himself receives payment from debtors or not. The commission is payable on total proceeds. (ii) Over-Riding Commission : It is an extra commission in addition to

ordinary commission. This commission is also calculated on sales like ordinary commission. This commission is generally given by the consignor to the consignee to enhance the sale or to boost up the sales of a new product. (d) Proforma Invoice : Since the goods sent on consignment can not be

treated as sales, the consignor does not prepare proper invoice. He simply prepares a Proforma invoice and sends it to the consignee, alongwith the goods despatched. This is prepared with a view to inform the consignee about price of goods, expenses incurred, mode of transportation and the minimum sale price at which the goods are to be sold. (e) Expenses : Expenses relating to consignment of goods are divided into

two categories vis. (i) Non-recurring expenses and (ii) Recurring expenses. Non-Recurring Expenses : All the expenses which are incurred for bringing goods to the godown of the consignee are non recurring in nature. Such expenses are generally goods have reached the consignees place or godown.
5

They are recurring in nature because they may be incurred repeatedly by the consignor and consignee. The examples of recurring expenses incurred by the consignor are advertising, discount of bills, commission on collection of cheques, travelling expenses of salesmen, bad debts etc. The examples of recurring expenses incurred by the consignee are godown rent; godown insurance, sales promotion etc. 2.5 (A) ACCOUNTING TREATMENT OF CONSIGNMENT TRANSACTIONS Books of the Consignor : The consignor opens three accounts in his

ledger. (1) Consignment Account : It is prepared to ascertain profit or loss on

each consignment e.g. Consignment to Bombay Acount. It is not a personal account but a special Trading and Profit and Loss account or a nominal account. (2) Consignees Account : It is prepared to show the balance due to or

from consignee at a particular date. It is a personal account; and (3) Goods sent on Consignment Account : It is prepared to show the amount

of goods sent to the consignee. This is real account. The balance is credited to Purchase or Trading Account. Journal Entries 1 price: Consignment A/c Dr. (a) When the goods are sent on consignment at cost or at invoice

To Goods sent on consignment A/c (Being goods sent on Consignment at cost)

(b)

If goods are sent at invoice price then one more entry is needed for making the adjustments. The amount of this entry is the difference between the invoice price and the cost price. The entry will be: Goods sent on consignment A/c To Consignment A/c Dr.

2.

When expenses are incurred by the Consignor: Consignment A/c To Bank A/c (Being expenses incurred) Dr.

3.

When the Account Sales is received from the Consignee : (i) Consignee A/c To Consignment A/c (Being the total sales by consignee) (ii) Consignment A/c To Consignee A/c (Being the expenses incurred by consignee and with his Commission) Dr. Dr.

4.

When the consignee remits the cash or bills: Bank A/c/ Cash A/c/Bills receivable A/c To Consignee A/c (Being Cash/B/R received) Dr.

5.

When bills is discounted with Bank: Cash A/c/ Bank A/c Discount A/c To Bills receivable A/c (Being B/R discounted with the Bank) Dr.

6.

For Stock remaining unsold: Consignment stock A/c To Consignment A/c (Being the value of stock plus proportionate expenses) Dr.

7.

For Abnormal Loss of stock: General Profit & Loss Account A/c (with unrecoverable loss) Insurance company A/c (with total recoverable loss) To Consignment A/c (with total loss) (For the abnormal loss of stock, amount recoverable and amount not recoverable) Dr. Dr.

8.

For Profit or loss on Consignment: (i) If there is profit on Consignment Consignment A/c To general Profit and Loss A/c (Being the Profit on consignment transferred to Profit and Loss A/c) (ii) If there is loss on Consignment General Profit and loss Account To Consignment A/c (Being the loss on Consignment transferred to Profit & Loss Account)
8

Dr.

Dr.

9.

For settlement of account with consignee: Bank/Bills recoverable To Consignee A/c (Being amount sent for final settlement) The Goods sent on Consignment Account which shows credit balance Dr.

will now be transferred to the Trading Account. Then the entry is : Goods sent on consignment Account To Trading A/c (Being the goods sent on consignment account transferred to trading account). Ledgers a) Consignment Account : Consignor prepares this account in his ledger. In it all transactions of a consignment are shown. This account discloses profit or loss incurred by each consignment. Debit side shows goods sent on consignment expenses incurred by consignor and consignee, consignees commission, bad debts etc. Credit side shows total sales (cash and credit), goods returned, and unsold stock etc. The difference between the debit and credit totals of Consignment Account is regarded as profit or loss which is transferred to the Profit and Loss Account and the Consignment Account stands closed. It is infact a nominal account and is just like Trading and Profit and Loss Account about which you must have studied earlier in final accounts. Therefore the principles applied to Trading and Profit and Loss Account hold good for this account also. Like Trading and Profit and loss Account all expenses and purchases are debited to this account and all sales and incomes are credited.
9

Dr.

b)

Goods sent on consignment Account : This account shows the goods transferred from the consignor to the consignee and goods returned by the consignee to the consignor. All the goods consigned by the consignor will be credited to this account and the goods returned by the consignee are debited to this account. The balance represents the cost of goods with consignee for sale, and is transferred to the Trading Account.

c)

Consignees Account : This account discloses what amount is due from the consignee. The consignees account is debited with all cash and is credited by sales effected by the consignee. The various expenses incurred by the consignee, the commission charged by him as well as the advance remitted by him are credited to this account. This account usually shows a debit balance indicating the amount due from the consignee. At times it may show credit balance, if the advance given by the consignee is more than the sale affected by him. The balance revealed by this account is shown in the balance sheet of the consignor.

Illustration 1 : Vimal Mills Ltd. sent 100 pieces of suiting to Lal Garments House of Delhi on consignment basis. The consignees are entitled to receive 5 per cent commission plus expenses. The cost of Vimal Mills Ltd. is Rs. 200 per suiting. Lal Garments House pays following expenses : Railway Freight Godown Rent & Insurance Rs. 500 Rs. 1,000

Vimal Mills Ltd. draw on the consignees a bill for Rs. 10,000 which is duly accepted. Subsequently it is discounted for Rs. 9,500. The consignees informed the consignor of the sale of the entire consignment for

10

Rs. 28,500. Show journal entries and ledger accounts in the book of the consignor. Solution Journal entries in the Book of Vimal Mills Ltd. (Consignor) Date Particulars Consignment A/c To goods sent on consignment A/c (100 pieces of suiting consigned to Lal Garments House at cost Rs. 200 per suiting) Bill receivable A/c Dr. 10,000 10,000 20,000 Dr. Dr. 20,000 Cr.

To Lal Garment House (Being of the bills of exchange received from consignee) Cash Account Discount Account To bill receivable A/c (being bill discounted with the bank) Lal Garment House To Consignment A/c (Being gross proceeds of the goods sold) Consignment A/c Dr. 1,500 Dr. 28,500 Dr. Dr. 9,500 500

10,000

28,500

To Lal Garment House (being the expenses incurred by Lal Garment house)

15,00

11

Consignment A/c

Dr.

1,425 1,425

To Lal Garment House (Being Commission @ 5% on sales) Consignment A/c To Profit & Loss A/c (Being profit on consignment transferred) Goods sent on Consignment A/c To Trading A/c (Being goods sent on consignment A/c transferred to trading A/c Ledger Accounts Consignment Account Dr. Particulars To goods sent on consignment A/c To Lal Garments To Lal Garment House (commission) To Profit & Loss A/c (Profit on consignment) 28,500 5,575 1,500 1,425 Rs. 20,000 Particulars By Lal Garment House (Sales) Dr. 30,000 Dr. 5,575

5,575

30,000

Cr. Rs. 28,500

28,500

12

Lal Garments House Dr. Particulars To consignment A/c Rs. 28,500 Particulars By bills receivable By Consignment A/c (Expenditure) By Consignment A/c (Commission) By Balance c/d 28,500 15,575 28,500 1,425 Cr. Rs. 10,000 1,500

Goods Sent on Consignment Account Particulars To Trading A/c (transferred) 20,000 20,000 Rs. 20,000 Particulars By Consignment A/c Rs. 20,000

B. Books of the Consignee Consignee need not pass any entry in his books on the receipt of goods by him or for expenses incurred by the consignor. He should, in principle, open the Consignors Account in his books and route all the transactions through it in the following manner: 1. When cash is remitted or bill is accepted Consignor A/c To Cash A/c/Bills payable A/c (Being cash remitted or bills accepted).
13

Dr.

2.

When expenses are incurred Consignor A/c To Cash A/c (Being expenses incurred on consignment) Dr.

3.

When sale is made on Consignment (i) For cash sales Cash a/c To Consignors A/c (ii) For credit sales Debtors A/c To Consignor A/c (Being goods sold on credit) Dr. Dr.

4.

On remitting balance to consignor after commission Consignors A/c To Cash A/c/Bank A/c To Commission A/c (Being cash remitted after commission) Note : (A) For unsold stock lying with consignee, no entry is to be passed in his book of account. (B) Consignee does not pass any entry for profit or loss in his books. The consignee also prepares ledger accounts after passing all the journal Dr.

entries. The Consignors Account and Commission Account are the two important account prepared by the consignee in his books. Of course he will also do the postings to the other accounts such as Consignment Debtors Account, Consignment Expenses Account and Bills Payable Account etc.
14

(a)

Consignors Personal Account : It is the main account of Consignees

books which is prepared for working out the amount due to the consignor. Whatever amount he receives from sales of goods is credited to this account. All expenses incurred by the consignor in relation to consignment the commission due to him and the advance given by him to the consignor will be debited to this account. Further, if the consignee does not get del credre commission, the bad debts on account of credit sales are also debited to the Consignors Account. The balance of this account indicates the amount payable to the consignor. This account is just the opposite of the Consignees Account in the books of the consignor. (b) Commission Account : It is nominal account. It shows the income

earned by the consignee for the services rendered by him. All types of commission whether ordinary or special, due to the consignee is credited to this account. The commission account will be debited with bad debts if the consignee is to bear such loss because of del credre commission. To continue with the same illustration No. 1, the consignee will have the following journal entries and ledger accounts:

Journal Entries
Date Particulars Vimal Mills Ltd. To Bills payable A/c (Being bill accepted) Vimal Mills Ltd. To Cash A/c (Being expenses (incurred)
15

L.F. Dr.

Dr. 10,000

Cr.

10,000

Dr.

1,500 1,500

Cash A/c To Vimal Mills (Being Sales proceeds received on consignment) Vimal Mills Ltd. To Commission A/c

Dr.

28,500 28,500

Dr.

1,425 1,425

(Being 5% commission on total sales) B/P A/c To Cash A/c (Being bill met on maturity) Ledger Account Vimal Mills Ltd. (Consignor) Dr. Particulars To Bill payable A/c To Cash A/c (expenses) To Commission A/c To Balance c/d Rs. 10,000 1,500 1,425 15,575 28,500 28,500 Particulars By Cash (sale proceeds) Rs. 28,500 Cr. Dr. 10,000 10,000

Illustration 2. :- B. Ghosh of Bombay sent on consignment to Alok of Calcutta 300 cases @ Rs. 125 on 1st July 2006 to be sold on his account and at his risk for 10% commission B. Ghosh incurred Rs. 3,000 expenses on dispatching the goods to Alok. On July 10, 2006 B. Ghosh received a bill for Rs. 20,000 at 2 months from Alok. On September 30, 2006 Alok sent on account sales disclosing that 200 cases have been sold for Rs. 160/- each and the remaining

16

cases @ Rs. 150/- each. The account sales also discloses that Alok has incurred unloading expenses Rs. 600 and selling expenses Rs. 900. He sends a draft for the net amount due. You are required to : (a) (b) Prepare the account sales; and Enter the transactions in the books of both the parties.

Solution Account sales of 300 cases received from B. Ghosh to be sold on his account and risk. 200 cases @ Rs. 160 100 cases @ Rs. 150 Less : Expenses Unloading expenses Selling expenses Commission @ 10% on sales RS. 47,000 (Rs. 32,000 + Rs. 15,000) 40,800 Less Bill given as an advance on 10.7.1999 Balance (draft enclosed herewith) 20,800 20,000 600 900 1,500 4,700 6,200 32,000 15,000 47,000

E & O. E.

Alok Calcutta 30th Sept., 2006

17

Journal Entries in the Books of B. Ghosh (Consignor) Journal Date 2006 July1 Particulars Consignment A/c To goods sent on consignment A/c (Being 300 cases @ Rs. 125 sent on consignment to Alok) July 1 Consignment A/c To Bank A/c (Being expenses incurred on account of goods sent on consignment) Sep 10 Bills receivable A/c To Alok (Being an acceptance for 2 months bill from Alok as an Advance) Sep 13 Bank Account (Being the acceptance of Alok on the due date) Sep 30 Consignment A/c To Alok (Being unloading expenses Rs. 600 and selling expenses Rs. 900/- incurred by Alok) Dr. 1,500 1,500 Dr. 20,000 20,000 To Bills Receivable A/c Dr. 20,000 20,000 Dr. 3,000 3,000 37,500 Dr. L.F. Dr. 37,500 Cr.

18

Sep 30 Alok To Consignment A/c (Being goods sent on consignment sold by

Dr.

47,000 47,000

Alok-200 cases @ Rs. 160 and 100 case @ Rs. 150) Sep. 30 Consignment A/c To Alok (Being commission payable to Alok @ 10% on Rs. 47,000) Sep 30 Bank A/c To Alok (Being amount due from Alok received) Sep 30 Consignment A/c Dr. 300 300 Dr. 20,800 20,800 Dr. 4,700 4,700

To Profit & Loss A/c (Being profit on consignment transferred to Profit and Loss A/c) Sep.30 Goods sent on consignment A/c To Trading A/c (Being goods sent on consignment transferred to Trading A/c)
19

37,500 Dr. 37,500

Ledger Consignment Account Dr. Date 2006

July1 To good sent on consignment A/c 37,500 Sep 30 By Alok (Sales) 200 cases @ 160 32,000 100 case @ Rs. 150 15,000 47,000 July 1 Sep 30 Sep 30 Sep 30 To Bank A/c (Exp) To Alok (Expenses) To Alok (Commission) To Profit transferred to profit & loss a/c 47,000 47,000 3,000 1,500 4,700 300

Cr. Particulars Rs. Date Particulars Rs.

Goods sent on Consignment Account

Dr. Date Particulars Rs. Date Particulars Rs. Cr.

2006
Sept30 To Trading A/c Sept30 To Trading A/c 37,500 37,500 July1 July1 By Consignment to By Consignment to Calcutta a/c 37,500 37,500 37,500 37,500

20

Bills Receivable Account

Dr. Date 2006 Jul10 To Alok 20,000 20,000 Alok Dr. Date 2006 Sept 30 To Consignment a/c (Sales) 47,000 Particulars Rs. Date 2006 Jul 10 By bills receivable 20,000 1,500 Particulars Rs. Cr. Particulars Rs. Date 2006 Sep.13 By Bank A/c 20,000 20,000 Particulars Rs. Cr.

Sep 30 By consignment to Calcutta C/c (Exp) Sep 30 By Consignment A/c (Commission) Sep 30 By Bank a/c 47,000

4,700

20,800 47,000

Bank Account
Dr. Date Particulars Rs. Date Particulars Rs. Cr.

2006 July 1 To balance b/c

2006 July 1 By consignment a/c 3,000

Sep 13 To Bills receivable 20,000 Sep. 30 To Alok 20,800 Sep.30 By Bal. c/d

21

Profit and Loss Account 2006 Sep 30 By Consignment to Calcutta a/c Entries in the Books of Alok (Consignee) Journal Date Jul 10 Particulars B. Ghosh To Bills payable A/c (Being acceptance of bill for 2 months given) Ghosh To Bank A/c (Being unloading expenses Rs. 600 and selling expenses Rs. 900 incurred on account of B. Ghosh) Sep 13 Bills payable A/c To Bank A/c (Being bill met on the due date) Bank A/c To B. Ghosh (Being goods sold on behalf of B. Ghosh) Sep 30 B. Ghosh To Commission A/c (Being 10% commission on sales charged to B. Ghosh). Dr. 4,700 4,700 Dr. 47,000 47,000 Dr. 20,000 20,000 Dr. 1,500 1,500 Dr. Dr. 20,000 20,000 Cr. 300

22

Sep 30 B. Ghosh To Bank A/c

Dr.

20,800 20,800

(Being bank draft sent to B. Ghosh for the amount due) B. Ghosh 2006 Jul 10 To Bills payable A/c To Bank A/c (expenses) Sep 30 To commission A/c Sep 30 To Bank A/c 4,700 20,800 47,000 Bills Payable Account 2006 Sep 13 To Bank Account 20,000 July 10 Commission Account 2006 Sep 13 Bank Account 2006 July 1 To Balance b/d To B. Ghosh ? ? 47,000 Sep 13 Sep 30 ? By B. Ghosh By Bills payable By B. Ghosh 1,500 20,000 20,800 B. Ghosh 4,700 B. Ghosh 20,000 47,000 20,000 1,500 By bank A/c (sales) 47,000

23

Illustration 3 Suresh and Co. of Bombay sent on consignment to Mahesh & Co. of Delhi 60 cases cutlery goods costing Rs. 175 per case. Expenses incurred by the consignor at Bombay were : Freight Rs. 275, insurance Rs. 55 and loading charges Rs. 20. Suresh & Co. draw on Mahesh & Co. 2 months bills at sight for Rs. 7,000 which the latter accepts. The charges paid by Mahesh & Co. at Delhi were unloading Rs. 30, Storage Rs. 85, insurance Rs. 15, Commission is payable to Mahesh & Co. at 2% on all sales in addition to 1% del credere commission. The consignee sells for prompt cash 30 cases @ Rs. 225 per case; 25 cases @ Rs. 250 per case and the balance @ Rs. 280 per case. The account was settled immediately by means of a bank draft. Write up the transactions and ledger acconts in the books of both the parties. Solution Consignors Books Journal Consignment to Delhi Account To Goods sent on consignment Account (60 cases consigned @ Rs. 175 per case) Dr. 10,500 10,500

Consignment to Delhi Account To Bank (expenses on consignment paid)

Dr.

350 350

24

Bills receivable Acount To Mahesh & Co.

Dr.

7,000 7,000

(Being Expenses incurred by consignee)

Consignment to Delhi Account To Mahesh & Co.

Dr.

130 130

(Being Expenses incurred by consignee)

Mahesh & Co.

Dr.

14,400 14,400

To Consignment to Delhi Account (Sales affected by consignee)

Consignment to Delhi Account To Mahesh & Co. (Being Commission due to the consignee including del credre commission on sales i.e. 2% and 1% of Rs. 14,400)

Dr.

504 504

Bank Account To Mahesh & Co. (Being Received bank draft in settlement of the accounts)

Dr.

6,766 6,766

25

Consignment to Delhi Account To General Profit & Loss a/c (Being Goods sent on consignment account closed)

Dr.

2,916 2,916

Ledger Account Consignment to Delhi Account Dr. July 1 To goods sent ton consignment a/c 10,500 By Mahesh & Co. (sales) Cr. 14,400

To Bank (expenses)

350

To Mahesh & Co. 130 (Expenses) To Mahesh & Co. 504 (Commission) 634

To General Profit & Loss A/c 2,916

14,400

14,400

26

M/s Mahesh & Cos Account To consignment to Delhi A/c (sales) By Consignment to Delhi Account Expenses Commission 130 504 634 14,400 By B/R A/c 7000

By Bank a/c

6,766

14,400

14,400

GOODS SENT ON CONSIGNMENT ACCOUNT To Trading A/c (transfer) 10,500 By consignment to Delhi A/c Consignees Books Journal Suresh & Co. To Bills payable accepted (Suresh & Cos bill accepted) Dr. 7,000 7,000 10,500

Suresh & Co. To cash A/c (Being cash sent on expenses)

Dr.

130 130

27

Cash account To Suresh & Co. (Sales effected on consignors behalf)

Dr.

14,400 14,400

Suresh & Co. To Commission A/c (Commission @ 2% and del credre commission @ 1.5% on Rs. 14,400)

Dr.

504 504

Suresh & Co. To Bank A/c (Balance remitted vide draft No._________ dt. _______ )

Dr.

6,766 6,766

Ledger Accounts M/s Suresh & Cos Account To bills payable A/c To cash (expenses) To Commission A/c To Bank A/c (draft) 7,000 130 504 6,766 14,400 14,400 By cash (sales) 14,400

Till now we have presumed that all the gods consigned are sold. But in practice we find that at the time of submitting the account sale, a part of goods consigned may still be unsold and may be lying with the consignee. In

28

order to calculate the true profit or loss on consignment, the unsold stock should be valued and accounted for. 2.6 VALUATION OF STOCK ON CONSIGNMENT Valuations of unsold stock is usually done at cost. Cost, in case of consignment stock, would include the cost at which the goods are consigned plus, the proportionate non-recurring expenses. All the non-recurring expenses, whether incurred by the consignor or by the consignees, are to be taken into account. In the absence of details of expenditure incurred by the consignee, all expenses incurred by him are to be taken as recurring expenses and thus are not to be considered in the calculation of closing stock. In other words, while valuing the closing stock we add such proportionate expenses to the cost price that have been incurred upto the time the goods are brought to the place of the consignee. Any other expenses paid by the consignor or the consignee after this point will not be considered as these expenses do not add to the value of the goods. Such expenses are godown rent, selling expenses, carriage outwards, godown insurance, discount etc. Usually following expenses are added for calculation of closing stock : Carriage and Freight, Loading Charges, Custom Duty, Clearing Charges, Dock Dues, Carriage paid upto the Godown, and Unloading charges. Following are the expenses which are not considered for calculation of closing stock : Godown rent, Discount, Bad Debts, Insurance of the goods in the Godown, and Selling and Distribution expenses. One can notice that all expenses incurred by the consignor are considered for valuation of the closing stock. The problem arises only selecting recurring expenses in case of consignee.

29

The value of unsold stock affects the profit or loss on any consignment so its valuation and recording in the books of consignor is very important. It is shown on the credit side of Consignment Account for which the journal entry passed would be as :

Stock on Consignment A/c To Consignment A/c (Being the values of sold stock)

Dr.

On the other hand the Consignee, will not pass any entry for the closing stock. It is because he is not the owner of the goods and does not pass any entry even when the goods are received or he returns the goods. 2.7 ACCOUNTING FOR LOSS OF GOODS Goods sent on consignment may be lost or damaged in transit. The loss of goods may be either (i) normal or (ii) abnormal Treatment in the books of accounts will depend upon the nature of loss. Normal Loss : Loss of goods is sold to be normal when it is natural, unavoidable and is due to inherent characteristic of the goods despatched like evaporation, sublimation etc. The amount of stock to be carried down is the proportion of the total cost that the number of units on hand bears to be the total number units as diminished by loss. Deficiency of Stock : When there is deficiency of stock at the time of stocktaking and the consignee is under a liability to account for the missing stock, the entry will be:

30

Consignee To Consignment a/c

Dr.

(Being the deficiency of stock charged to the consignee). If, on the other hand, he is not liable, the stock of the consignment will be shown at the gross figure and the consignment account will be debited with the loss in stock. Abnormal Loss : There are the losses which are accidental and not natural like theft. Abnormal loss may occur in the godown of the consignee or in transit. Let us see the effect of abnormal loss on the closing stock under both situations. When the abnormal loss occurs in the godown of the consignee the valuation of closing stock is not effected because the expenses incurred after they reach the godown of the consignee are not to be taken into account for the purpose. Hence, the normal formula will be followed for the valuation of closing stock. Look at illustration 4 and see how the abnormal loss and the value of closing stock is calculated when the abnormal loss occurs in the godown of the consignee. The treatment in accounts will depend upon whether the unforeseen loss has been insured against or not. In case of insurance the consignment account will be credited but the insurance companies or underwriters account will be debited with the amount of loss (which shall be calculated like valuation of stock on consignment i.e. including proportionate non-recurring expenses of both the consignor and the consignee). If the goods are not insured, instead of Insurance Companys or Underwriters Accounts being debited, Profit and Loss Account will be debited and consignment account will be credited. In this way the final net profit on consignment is not adversely affected.

31

Illustration 4 : X of Calcutta sent on 15th January, 2006, a consignment of 500 toys bicycles costing Rs. 100 each. Expenses of Rs. 700 met by the consignor. Y of Bombay spent Rs. 1,500 for clearance and the selling expenses were Rs. 10 per bicycle. Y sold, on 4th April 2006, 300 pieces @ Rs. 160 per piece and again on 20th June 1999, 150 pieces @ Rs. 172. Y was entitled to a commission of Rs. 25 per piece sold plus one fourth of the amount by which the gross proceeds less total commission thereon exceeded a sum calculated at the rate of Rs. 125 per piece sold. Y sent the amount due to X on 30th June 2006. You are required to show the Consignment Account and Ys Account in the books of X. Solution Consignment Account 2006 Jan 15 To goods sent on consignment a/c 500 @ Rs. 100 Jan 15 To Bank A/c - Exp. To Y-Clearing Exp Apr 4 Jun 20 Jun 30 To Y-selling Exp To Y- selling Exp 700 1,500 3,000 1,500 June 20 By Y-sale of 150 25,800 Pieces @ 172 June 30 By consignment stock A/c 5,220 Rs. 2006 pieces @ Rs. 160 Rs. By Y-sale of 300 48,000 50,000 Apr 4

To Commission A/c 12,510

June 30 To Profit & Loss A/c 9,810 Profit on Consignment 79,020

32

79,020

Y Account 2006 Apr 4 Rs. 2006 Rs. By consignment A/c 1,500 (clearing exp.) Jun 20 To Consignment A/c 25,800 Apr 4 By consignment A/c 3,000 (selling exp.) June 20 By consignment A/c 1500 (selling exp.) Jun 30 By consignment A/c 12,510 commission (2) By Bank A/c 73,800 73,800 55290

To Consignment A/c 48,000 ?

Working Note (1) Valuation of Closing stock 50 pieces @ Rs. 100 each Plus : Proportionate Expenses Expenses incurred by X on 500 pieces = Rs. 700 Clearing expenses incurred by Y Total Expenses = Rs. 1500 Rs. 2,200 Rs. 5,000

Therefore, expenses on 50 pieces 2200x50/500

Rs. 220 Rs. 5,220

33

(2)

Calculation of Commission Let Total Commission of Y be a a = No. of pieces sold x Rs. 25 + [Gross sale proceeds - (Rs. 125x No. of pieces sold] - (a) a = 450 x Rs. 25 + [R. 73,800 - (Rs. 125 x 450] -a) a = Rs. 45,000 + Rs. 17,500 -a 5a = Rs. 62, 550 Therefore : a = 62,550/5 = Rs. 12,510

2.8

INVOICING GOODS HIGHER THAN COST Sometimes the goods sent on consignment are priced not at cost but

above cost i.e. at selling or near selling price. The purpose is to hide the real profit on the consignment from the competitive eye of the consignee. It does not affect the profits of the consignor. Here a few adjusting entries in respect of goods sent on consignment and stock are to be made at the end of the financial year. The entries are as follows : To bring down the invoice of the goods sent on consignment to cost, debit goods sent on consignment account and credit consignment account with the difference in the invoice and the cost price. (i) Goods sent on consignment A/c To consignment A/c (Being the excess of Invoice price written back) To adjust the value of the stock lying unsold with the consignee, debit the consignment account and credit Stock Reserve Account with the difference in prices. Dr.

34

(ii)

Consignment A/c

Dr.

To Consignment Stock Reserve A/c (Being the excess of invoice price or value over cost Price of unsold stock adjusted). The balance of the goods sent on consignment account will be transferred to the Trading Account as indicated earlier. The stock on consignment and Stock Reserve Account will be closed and the balance will be shown in Balance sheet. Next year the stock on consignment account will be transferred to the debit of the Consignment Account and Stock Reserve Account will be transferred to the Consignment Account (of course at the end of the next year.) Illustration 5 B. Ltd. of Delhi consigned 1,000 cases of milk powder to S. of Bombay. The goods were charged at proforma invoice value of Rs 10,000 including a profit of 25% on invoice price. The consignors paid Rs. 600 for freight and insurance. Consignee paid import duty Rs. 1,000, Dock Dues Rs. 200 and sent to the Consignors a bank draft of Rs. 4,000 as advance. They sold 80 cases for Rs. 10,500 and sent for the balance due to the consignors after deducting commission of 5% on gross sale proceeds. Show ledger accounts in the books of the consignor.

35

Dr. 2006 To goods sent on

consignment A/c 25%

Consignment Rs. 2006

Cr. Rs. 10,500

10,000 By S of Bombay (consignee)

over cost To Bank Expenses 600 By Goods sent on consignment To S of Bombay (Exp) 1,200 To consignment stock 500 reserve A/c (25% of stock Rs. 200 To Profit transferred To P & L A/c 15,360 Dr. 2006 S of Bombay (Consignee) Rs. To Consignment A/c 10,500 2006 By Bank 15,360 Cr. Rs. 4,000 2,535 By Consignment stock 2,360 2,500

By Consignment A/c Expenses 1200

Commission 525 1725 By Bank 10,500 4,775 10,500

36

Dr. 2006 To consignment a/c To Trading a/c

Goods sent on Consignment Rs. 2,500 7,500 10,000 2006 By Consignment a/c

Cr. Rs. 10,000

10,000 Cr. Rs. 2,360 2,360 Cr. Rs. 500 500 To balance b/d 500

Dr. 2006

Consignment Stock A/c Rs To Consignment A/c 2,360 2,360 2006 By balance c/d

Dr. 2006 To balance c/d

Consignment Stock Reserves A/c Rs. 500 500 2006 By consignment A/c

Working Notes Valuation of Stock 20 cases of Milk Rs. 100 = Rs. 2,000 Proportionate Expenses = Consignor expenses + Consignee Expenses = Rs. 600 (freight and insurance + Rs. 1000 (Import duty) + Rs. 200 (Dock Dues) = Rs. 1800 Expenses on unsold Stock 1800 x 20/100 = 360 Total value = Rs. 2000 + 360 = Rs. 2360

37

Adjustment Entries Excess of invoice price over cost price in case of goods sent on consignment = 10,000 x 25/100 = Rs. 2500. 2.9 SUMMARY Consignment is a specialised kind of transaction between consignor and consignee, whereby consignor sends goods to consignee to be sold by the latter on behalf of the former for a mutually agreed commission. The goods consigned to the agent cannot be treated as sales at the time of the consignment, they are treated as sales only when those are sold by the consignee. In a consignment transaction, the consignor sends goods to the consignee and makes a bill called Proforma Invoice. The value recorded in the proforma invoice may be the actual cost to the consignor or actual cost to the consignor plus mark-up. The objective of consignor in making accounts relating to consignment are to ascertain the results of consignment and to make final settlement with the consignee. To achieve this, he prepares consignment account and consignee account. The consignee makes accounts relating to consignment relating to consignment to effect the settlement with the consignor and to recognise his commission entitlement as consignee. 2.10 KEYWORDS Consignment: A shipment of goods by a manufacturer or wholesale dealer to an agent to be sold by him on commission basis, on the risk and account of the former, is known as consignment.

38

Consignor: The person who sends the goods to the agent to be sold by him as commission basis is called the consignor. Del Credere Commission: It is a commission which is paid by the consignor to the consignee for taking additional risk of recovery of debts on account of sales made on credit by the consignee on behalf of the consignor. Account Sales: It is a statement which contains the details of sales, expenses incurred and commission entitlement and balance due to the consignor. Normal Loss: The normal loss is one which cannot be avoided because of the basic nature of the goods/processes involved. 2.11 SELF ASSESSMENT QUESTIONS 1. Define 'Consignment'. What is the difference between a consignment and a sale of goods? 2. Why goods are sent to consignee at invoice price? What adjustment entries are recorded in the books of the consignor to find profit on consignment when goods are invoiced at proforma prices? 3. Give journal entries in respect of consignment transactions in the books of consignor and consignee. 4. Write short notes on: a) b) Del Credere Commission Treatment of normal and Abnormal Losses in Consignment Account c) Valuation of Unsold Stock in Consignment
39

5.

On 1st July, 2006 Radio House of Delhi consigned 200 Radios to Banerjee Bros. of the Calcutta. The cost of each radio was Rs. 400. Radio House paid Rs. 5,000 for freight and insurance. On 7 July, 2006 Banerjee Bros. accepted a 3 months bill drawn upon them by Radio House for Rs. 50,000, Banerjee Bros. paid Rs. 2,200 as rent and Rs. 1,300 for advertisement and upto 31st December, 2006 (on which date Radio House close their books) they sold 180 radios at Rs. 500 each. Banerjee Bros. were entitled to a commission of 5% on sales. Give Journal entries and prepare necessary accounts to record the above transactions in the books of the parties.

6.

Arun sends goods on consignment to Seemu. The terms are that Seemu will receive 10% commission on the price (which is cost plus 25%) and 20% of any price realised above the invoice price. Seemu will meet his expenses himself, goods to be sent freight paid. Arun sent goods whose cost was Rs. 16,000 and spent Rs. 1,500 on freight, forwarding, etc. Seemu accepted a bill for Rs. 16,000 immediately on receiving the consignment. His expenses were Rs. 200 as rent and Rs. 100 as insurance. Seemu sold of the goods for Rs. 19,500. Part of the sales were on credit and one customer failed to pay Rs. 400. Give Consignment Account and Seemu's Account in the books of Arun and Arun's Account in the books of Seemu.

7.

Dutt of Delhi makes sewing machines at a cost of Rs. 120. On 1st January, 1994 he consigned 200 of them, invoice price Rs. 150 to Khan at Madras to be sold on behalf of Dutt, Khan receiving a commission of 8% on
40

sales plus 2% del credere and 10% of any profit that may remain on the basis of invoice price. Khan was to bear all expenses after the machines reach his godown. Dutt incurred Rs. 500 as forwarding expenses and insurance. 10 machines were damaged during transit for which Dutt received Rs. 1,050 from insurers. Khan took delivery of remaining machines paying Rs. 1,140 as freight, octroi duty, cartage, etc. (Subsequently he also paid Rs. 500 as storage and other charges). Khan sold 160 machines @ Rs. 180; 100 of them on credit out of which the proceeds of 5 machines could not be received because of the disappearance of the customer. Khan remitted the amount due to Dutt. You are required to prepare the Consignment to Madras A/c and Khan's A/c in Dutt's Books. 2.12 SUGGESTED READINGS 1. Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. 2. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. 3. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. 4. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi.
41

Lesson : 3
BRANCH ACCOUNTS
STRUCTURE 3.0 3.1 3.2 Objective Introduction Types of Branches 3.3.1 Branch not keeping full system of accounting 3.3.2 Branch keeping full system of accounting 3.3.3 Foreign Branches 3.4 3.5 3.6 3.7 3.0 Summary Keywords Self Assessment Questions Suggested Readings OBJECTIVE

After reading this lesson, you should be able to a) b) Explain the different types of branches Calculate branch profit in head office books on cast basis by using debtor system, final account systems and stock and debtor system c) 3.1 Convert into home currency the results of foreign branches INTRODUCTION As the business of a firm grows in size it open branches in order to sell its product over a large territories. The main object of keeping branch accounts is dependent on the nature of the business and specific need of a particular branch. 1

The object of keeping the branch accounts acceptable to all business are to evaluate the progress and performance of each branch and to know the profit and loss of each branch separately. By keeping branch accounts we can ascertain the financial position of each branch on a particular date and know the cash and goods requirements of various branches. It may be possible to give concrete suggestions for the improvement in the working of various branches. 3.2 OBJECT OF BRANCH ACCOUNTING The main object of keeping branch accounts is dependent on the nature of the business and specific need of a particular branch. The objects of keeping the branch accounts acceptable to all businesses are: i) ii) iii) iv) v) To know the profit or loss of each branch separately. To ascertain the financial position of each branch on a particular date. To know the cash and goods requirements of the various branches. To evaluate the progress and performance of each branch. To calculate commission for payment to the managers, if based on profits of branch. vi) To know the profitability of each branch and type of business for expansion of the business. vii) To give concrete suggestions for the improvement in the working of the various branches. viii) To meet the requirements of specific enactments as all branches of a company must keep the accounts for audit purposes.

3.3

TYPES OF BRANCHES For the purposes of accounting, branches may be divided into three

classes namely : 1. Branches which do not keep their accounting records, their accounting is wholly performed at the Head office. 2. 3. Branches which keep their own accounting records independently; and Foreign branches

3.3.1 Branch not keeping full system of Accounting The main features of these type of branches are as follows : (a) These branches sell only those goods which are supplied by the Head office. These branches are not allowed to make any purchases from the outside market. (b) Head office supplies goods to these branches either at the cost price or at the invoice price. (c) All expenses of a regular nature of the branch such as salary, rent, advertisement etc. are paid by the Head Office. (d) Some petty expenses e.g. cartage, entertainment etc. are paid by the branch manager out of the petty cash balance. Petty cash book may be maintained by the branch either on sample basis or on imprest system. (e) Such branches are required to deposit the cash collected by them either by way of cash sales or cash collected from debtors into the bank account opened in the name of the Head office. (f) Sales are made by the branch normally on a cash basis but sometimes the branches are permitted to sell the goods on a credit basis also. 3

(g)

Such branches keep only some memorandum records e.g. stock registers. A copy of the stock register is forwarded to the Head Office every week or every month. This statement will show for each item, the opening stock, the stock received during the period, sales during the period, breakage losses etc. during the month and the closing stock. The sanction of the Head Office will be necessary in order to write off the breakage losses etc. The stock statement will serve the purpose of controlling the stock at the branch and of the purpose of guiding the Head Office as to which stocks should be replenished. This statement is normally required to be submitted by branch to Head office by a fixed day. Since these type of branches do not keep any account, accounts are

maintained by the Head Office. The system of maintaining accounts by the Head office depends on the size of the branch, and the degree of control which the Head office wants to exercise. Keeping in view the above factors the Head office man maintain the accounts of the branch in any one of the following ways : (i) Debtors system : This system is generally adopted in the case of concerns which are fairly of a small size. Under this system for each branch a separate account is opened in the books of Head office in order to record all transactions relating to that branch. (ii) Final Account System : Under this system the office opens a Branch Trading and Profit and Loss Account and a branch account. Branch account opened under this system is quite different from the branch account opened under the debtors system. (iii) Stock and Debtors System : Under this system the head office opens for each branch a Branch Stock Account, Branch Debtors Account, Branch Expenses Account and Branch Adjustment Account in order to find out the profit or loss made by the branch. 4

(iv)

Wholesale branch : This method is adopted when the goods are supplied to the branch at the wholesale price i.e. at the price at which the goods are supplied to the wholesalers. All these systems are explained in the following pages :

1.

Debtors System Under this system a separate account known as the Branch Account

is opened for each branch for the purpose of calculating the profit. Branch account opened in the books of Head office is in the nature of a nominal account. The salient features of this type of accounting are as follows : 1. Stock in the beginning and at the end : Stock in the beginning of the period is shown in the debit side of the branch account while stock at the end of the period is shown on the credit side of the branch account. Stock is shown at the cost price. 2. Goods sent to the branch : Goods sent to the branch during the year is shown on the debit side of the branch account at the cost price. If the goods are returned by branch to the Head office it is shown in the credit side of the Branch Account. Alternatively it can be shown by way of a deduction from the 'Goods sent to the Branch' on the debit side of Branch Account. 3. Branch expenses paid by the Head Office : Branch expenses paid by the Head office are shown in the debit side of branch account. 4. Branch expenses paid by branch office : Expenses paid by the branch do not appear anywhere because they reduce the balance of cash in hand. Reduced balance of cash appears on the credit side of Branch Account.

5.

Treatment of branch expenses paid by office when petty cash system is maintained on the imprest system : If petty cash is maintained at the branch on the imprest system, then the petty expenses paid by the branch manager are reimbursed by the Head office. These expenses then take the form of expenses paid by the head office and are shown in the debit side of the branch account. The petty cash balance at the end of the period must be shown on the credit side of the branch account at the same figure at which it appeared at the commencement of the period.

6.

Depreciation on the branch fixed assets : Depreciation on the branch fixed asset is not shown anywhere in the branch account. Branch Account is debited with the value of branch fixed asset at the commencement and is credited with the adjusted value of branch fixed asset at the end.

7.

Bad debts, discount allowed, allowances etc. : Similarly bad debts, discount allowed to customers, allowances, returns from customers are not shown in the Branch Account because these accounts reduce the figure of debtors at the end.

8.

Cash sales and credit sales : The figure of cash and credit sales are not shown in the Branch Account. These figures are replaced by remittances which is calculated by adding cash sales and cash received from customers.

9.

Purchase of fixed asset : Where some fixed asset is purchased by the branch it increases the book value of the fixed asset on the one hand and reduces the remittances (if purchased on cash) or increases the liabilities (if purchased on credit.

10.

Sale of fixed asset : On the sale of the fixed asset by the branch, the book value of the fixed asset is reduced on the one hand, and on the other hand it increases either the remittances (if the sale is for cash) or increases debtors at the end (if the sale is on credit). 6

Journal Entries : The following journal entries are passed under the Debtor system : 1. When goods are sent to branch Branch Account To Goods sent to Branch Account 2. When goods are returned by branch Goods sent to Branch Account To Branch Account 3. When cheque is sent to the branch for expenses Branch Account To Bank Account 4. When cash/cheque is received from the branch for remittances Bank Account To Branch Account 5. For closing balances of assets at the branch Branch Assets Account To Branch Account The closing balances of assets will be shown in the balance sheet of the Head office. At the beginning of the next accounting period a reverse entry will be passed. 7 Dr. Dr. Dr. Dr. Dr.

Branch Account To Branch Assets Account 6. For closing balances of liabilities at the branch Branch Account To Branch Liabilities Account

Dr.

Dr. Dr.

The closing balances of liabilities will be shown in the Balance Sheet of the Head office. At the beginning of the next accounting period a reverse entry will be passed. Branch Liabilities Account To Branch Account 7. For transferring profit or loss of the branch Branch Account (Profit) To General Profit and Loss Account In case of loss the above entry is reversed General Profit and Loss Account To Branch Account (Loss) 8. For goods sent to branch account Goods sent to Branch Account To Purchases Account (in trading concerns) To Trading Account (in manufacturing concerns) 8 Dr. Dr. Dr. Dr.

Branch Account in the books of Head office will appear as under : BRANCH ACCOUNT
Particulars To Balance b/d (opening balances of assets) Cash in hand Stock in trade (at cost) Sundry debtors Furniture Prepaid Insurance To Goods sent to Branch A/c (at cost) To Bank account (Expenses paid by H.O.) To Balance c/d (closing balance of liabilities) To General Profit and Loss Account (Profit) Rs. Particulars By Balance b/d
(opening balances of liabilities)

Rs.

By Bank Account Cash sales Received from debtors By Balance c/d (closing balances of assets) Cash in hand Stock in trade (at cost) Sundry debtors Furniture Prepaid Insurance By General Profit and Loss Account (Loss)

Illustration 1 : ABC Co. of New Delhi opened a branch at Kanpur. The following is the list of transactions between the Head office and the branch for the year ending March 31, 2001 Rs. Stock at Branch on Ist April, 2000 Goods supplied to Branch during the year Cash sent to Branch for 9 1,500 24,000

 Salaries Rent Telephone expenses Petty Expenses Remittances received from the branch during the year Stock on 31st March,2006 Balance of Petty Cash

1,200 360 100 150 27,500 1,250 10

All the branch expenses are paid by Head office. Give journal entries and show the Branch Account in the Head office books. Solution Journal
Particulars
Branch Account To Branch Stock Account (Being the opening balance of branch stock transferred back) Branch Account To Goods sent to Branch Account (Being the goods sent to the branch during the year) Branch Account To Cash Account (Being the cash sent to branch to meet the following expenses Salaries 1,200 Rent 360 Telephone expenses 100 Petty expenses 150 Cash Account To Branch Account (Being the cash received from the branch) Branch Stock Account Branch Petty Cash Account To Branch Account (Being the closing balances of stock and petty cash Branch Account To General Profit and Loss Account (Being the profit at the branch transferred) Dr.

Rs.
1,500

Rs.
1,500

Dr.

24,000 24,000 1,810 1,810

Dr.

Dr.

27,500 27,500

Dr. Dr.

1,250 10 1,260

Dr.

1,450 1,450

10

BRANCH ACCOUNT

Dr. To Branch Stock Account To Goods sent to Branch To Cash Account Salaries Rent Telephone expenses Petty expenses To General Profit and Loss Account

Cr. 1,500 24,000 1,200 360 100 150 1,450 28,760 By Bank Account Remittances from Branch By Branch Stock Account By Branch Petty Cash Account 27,500 1,250 10

28,760

When goods are sent to branch at Invoice Price Goods are marked on invoice price in order to have effective control on stock and to keep secret from the branch manager the cost price of the goods and profit made, so that he may not start a competing business with the concern. Head Office will maintain branch account on the same lines as already discussed but the entries relating to goods sent to branch, goods returned by the branch to head office, opening and closing stock at the branch will be at invoice price and in order to calculate the net profit of the branch, the following adjustment entries will have to be passed in the head office books at the end of the accounting period: (i) For adjustment of excess price of the Opening Stock at Branch : Stock Reserve Account To Branch Account (ii) For adjustment of excess price of goods sent to branch less returns to head office : Goods Sent to Branch Account To Branch Account Dr. Dr.

11

(iii)

For adjustments of excess price of the closing stock at the Branch : Branch Account To Stock Reserve Account Dr.

Illustration 2 : From the following details prepare Branch Account in the books of Head Office. Rs. Goods sent to Branch at cost Goods returned by Branch at cost Branch Credit Sales Cash Sales at Branch Cash remitted to H.O. by Branch Expenses paid by H.O. Discount allowed to customers by Branch Closing stock with Branch at cost Closing Debtors (Closing Balance) Solution In the books of Head Office Dr. BRANCH ACCOUNT
Rs. 1,000* 47,000

50,000 3,000 51,000 2,500 45,000 10,000 1,800 17,000 7,700

Cr.
Rs.

To Branch Stock at Cost To Branch Debtors To Goods sent to Branch A/c 50,000 Less : Goods returned to H.O. 3,000 To Bank (Expenses paid by H.O.) To General Profit & Loss A/c Profit)

10,000 11,700 69,700

By Remittances by the Branch : Rs. Cash Sales 2,500 Recd. from Debtors 42,500* By Branch stock at cost By Branch Debtors

45,000 17,000 7,700

69,700

12

BRANCH DEBTORS ACCOUNT To Balance c/d To Credit Sales Rs. 1,000 51,000 52,000 By Cash By Discount By Balance c/d Rs. 42,500 1,800 7,700 52,000

2.

Final Account System Sometimes it is required to calculate branch profit or loss by not

preparing Branch Account but preparing Trading and Loss Account at cost and in addition to this, branch account to be prepared under such circumstances will be personal account and not nominal account. The branch account will generally have debit balance which will be equal to net worth at the end. The working of this method will be clear from the following illustration. Illustration 3 : A Delhi merchant has a Branch at Madras to which he charges out the goods at cost plus 25%. The Madras Branch keeps its own Sales Ledger and transmits all cash received to the Head Office every day. All expenses are paid from the Head office. The transactions for the Branch were as follows :
Rs. Stock 1.4.2005 at invoice price(IP)11,000 Debtors 1.4.2000 100 Petty Cash 100 Cash Sales 2,650 Credit Sales 23,950 Goods sent to Branch at I.P. 20,000 Collection on ledger accounts 21,000 Goods returned to H.O. 300 Bad Debts 300 Allowances to Customers 250 Returns Inwards Cheques sent to Branch : Rent Wages Salary and other expenses Stock (31.3.2006) Debtors Petty Cash (31.3.2006) including miscellaneous income Rs. 25 not remitted Rs. 500 600 200 900 13,000 2,000

125

(76) 13

Prepare the Branch Trading and Profit and Loss Account and Branch Account for the year 31.3.2006. Solution : BRANCH TRADING AND PROFIT AND LOSS A/C for the ending 31.3.2006
Rs. To opening Stock (Rs. 11,000-2,200) To Goods Sent to branch A/c (20,000-4,000) 16,000 Less : Returns to H.O. (300-600) 240 To Wages To Gross Profit c/d To bad Debts To Allowances To Rent To Salaries and Other Expenses To Net Profit 8,800 By Sales : Cash Credit Less: Returns By Closing Stock (13,000-2,600) 2,650 23,950 26,600 500 Rs.

26,100 10,400 36,500 11,740 25

15,760 200 11,740 36,500 300 250 600 900 9,715 11,765

By Gross Profit b/d By Accrued Income

11,765

BRANCH ACCOUNT (PERSONAL) A/C Rs. Rs. To Opening Balances : By Remittances (2,650+21,000) 23,650 Stock 8,800 B Balance c/d Debtors 100 (10,400+2,000+125) 12,525 Petty Cash 100 To Goods Sent to Branch 16,000 Less Returns to H.O. 240 15,760 To Bank (Expenses) 1,700 To Profit 9,715 36,175 36,175

14

3. Stock and Debtors System In case of this system, the Head Office maintains a number of accounts for keeping a record of branch transactions in place of one branch account. A brief description of each of these accounts is given below : (i) Branch Stock Account : This account is on the pattern of a goods account. The

account helps the Head Office in maintaining an effective control over the Branch Stock. It tells about shortage or surplus of stock and the closing stock at the Branch. (ii) Branch Debtors Account : The account is maintained to keep a record

of all transactions related to Branch Debtors and ascertainment of the balance of the debtors at the end of the accounting period. (iii) Branch Fixed Assets Account : A separate account for each of the

Branch fixed assets is maintained to record all transactions relating to each of these fixed assets. (iv) Branch Cash Account : The account is maintained to record all cash

transactions of the Branch. This is particularly helpful in those cases where the Branch is not required to send immediately all collections of cash made by it but to remit money at regular intervals. The account helps the Head Office in having control over Branch Cash. (v) Branch Expenses Account : The account is prepared to give to the Head

Office a summary picture of different expenses, bad debts and discounts etc. incurred at the Branch. (vi) Branch Adjustment Account : The account is maintained for

ascertaining the gross profit made at the Branch. All loadings in the goods sent to the branch, opening and closing stocks at the branch and shortage and surplus of stock etc. are recorded in this account.

15

(vii) Branch Profit and Loss Account : The account is prepared to ascertain profit or loss made at the Branch. The gross profit or loss from the Branch Adjustment Account is transferred to this account. It is debited with all other expenses and losses and credited with all gains and profits. The balance of the account represents the net profit or loss. (viii) Goods sent to the Branch Account : The account is prepared to ascertain the net value of goods sent to the Branch. Goods sent to the Branch and goods returned by the Branch and loading included in them are recorded in this account. Journal Entries The following Journal entries are passed in the books of the Head Office in case the transactions are recorded according to the Stock and Debtors System : (i) For goods sent to the Branch (at invoice price) Branch Stock Account To Goods sent to the Branch Account (ii) For goods returned by the Branch to the Head Office (at invoice price) Goods sent to the Branch Account To Branch Stock Account (iii) For Credit Sales at the Branch (at invoice price) Branch Debtors Account To Branch Stock Account (iv) For Cash Sales at the Branch (at invoice price) Cash Account To Branch Stock Account Dr. Dr. Dr. Dr.

16

(v)

For goods returned by Branch Debtors to the Branch (at invoice price) Branch Stock Account To Branch Debtors Account Dr.

(vi)

For goods returned by Branch Debtors directly to the Head Office (at invoice price) Goods sent to the Branch Account To Branch Debtors Account Dr.

(vii) For Goods sent by one Branch to Another It will be recorded as if the Branch has first returned the goods to the Head Office and then the Head Office has sent goods to another Branch. For example, if Branch X sends goods to Branch Y, the following entries will be passed : (a) Goods sent to Branch Account To X Branch Stock Account (b)Y Branch Stock Account To Goods sent to Y Branch Account (viii) For Bad Debts, Discount etc. Branch Expenses Account To Branch Debtors Account (ix) For Expenses at Branch Expenses Account To Bank Account Dr. Dr. Dr. Dr.

17

(x)

For Abnormal Shortage (or pilferage or loss) of Stock Branch Adjustment Account (with the amount of loading) Branch Profit and Loss Account (with shortage at cost) To Branch Stock Account (with the shortage at invoice price) For surplus at Branch, a reverse entry will be passed. Any amount received from the Insurance Company for abnormal Dr. Dr.

loss of stock (if insured), will be debited to Branch Cash Account and Credited to Profit & Loss Account. (xi) For Normal shortage or loss of stock : Branch Adjustment A/c To Branch Stock A/c Any other difference in the Branch Stock Account may also be transferred to Branch Adjustment Account. (xii) For transfer of Branch Expenses Branch Profit and Loss Account To Branch Expenses Account (xiii) For adjustment for loading in the Opening Stock Stock Reserve Account To Branch Adjustment Account (xiv) For adjustment of loading in Closing Stock Branch Adjustment Account To Stock Reserve Account Dr. Dr. Dr. Dr.

18

(xv)

For adjustment of loading in Net Goods sent to the Branch Account

(i.e. goods sent less goods returned by branch) Goods sent to the Branch Account To Branch Adjustment Account (xvi) For transfer of the balance in goods sent to the Branch Account Goods sent to Branch Account To Purchases/Trading Account (xvii) For Transfer of Gross Profit shown by the Branch Adjustment Account Branch Adjustment Account To Branch Profit and Loss Account. In case of gross loss, the entry will be reversed (xviii) For transfer of Net Profit at the Branch Profit and Loss Account To General Profit & Loss Account In case of net loss, the entry will be reversed Illustration 4 : On Ist April, 2006, goods costing Rs. 1,32,000 were invoiced by Madras Head Office to its branch at Delhi and charged at selling price to produce a gross profit of 25 per cent on the selling price. At the end of the month the returns from Delhi Branch showed that the sales were Rs. 1,50,000. Goods invoiced at Rs. 1,200 to Delhi Branch had been returned to Madras Head Office. The closing stock at Delhi Branch was Rs. 24,000 at selling price. Record the above transactions in the Branch Stock Account, Branch Adjustment Account, Goods sent to Branch Account in the Head Office books and close the said accounts on 30th April, 2006 Dr. Dr. Dr. Dr.

19

Solution IN THE BOOKS OF H.O. BRANCH STOCK ACCOUNT

Rs. To Goods sent to Branch A/c (Rs. 1,32,000+1/3 of Rs. 1,32,000) Less : Returns to H.O. 1,76,000 1,200 1,74,800 By Cash By Branch Adjustment A/c (Loading) By Branch P & L A/c (Cost) By Balance c/d 1,74,800 200 600 24,000 1,74,800 Rs. 1,50,000

BRANCH ADJUSTMENT ACCOUNT

To Stock Reserve To Branch Stock A/c (Loading) To Branch Profit & Loss A/c (Gross Profit) Rs. 6,000 200 37,500 43,700 43,700 By Goods Sent to Branch (1/4 Rs. 1,74,800) Rs. 43,700

BRANCH PROFIT & LOSS ACCOUNT

Rs. To Branch Stock A/c (Cost) To General P & L A/c (Net Profit) 600 36,900 37,500 By Branch Adjustment A/c (Gross Profit) 37,500 37,500 Rs.

GOODS SENT TO BRANCH ACCOUNT

Rs. To Branch Adjustment A/c To Purchases A/c 43,700 1,31,100 1,74,800 1,74,800 By Branch Stock A/c Rs. 1,74,800

20

Distinction between wholesale and retail profit at branch

Manufacturers, in addition to selling the goods through the wholesalers, usually sell the goods directly to the consumers by opening retail branches. In such a case good are supplied to the retail branches at the same price at which these are supplied to the wholesalers. The branches in turn sell the goods to the consumers at a price which is more than the wholesale price. Difference between the wholesale price at which the goods are received by these retail branches and the retail prices is the profit earned by these retail branches. Suppose an article cost Rs. 100 to the Head Office which in turn supplies these to the wholesalers and their retail branches as the wholesale price of Rs. 180. The branches sell the goods to the consumers at Rs. 200. The profit made by the retail branch would be Rs. 200-Rs. 180 i.e., Rs. 20. Calculation of this additional profit is an important step due to the fact that it points out that the manufacturers would loose this additional gain in case they do not open retail branches. Also the comparison of the additional supervision cost and additional gain may be of some help to the manufacturers to help in the framing of future policy. If whole of the goods which are sent by the Head Office to the retail branches are sold out then there is no problem. But if some of the goods remain unsold then the Head Office must create a proper reserve by debiting its own profit and loss account in order to show the branch stock at cost in the balance sheet. The point to note is that in order to find out the wholesale profits of branch no reserve for stock are created in the Profit and Loss Account of branch.

21

Illustration 5 : A Ltd. has a retail branch at Patna, goods are sold to the customers at cost plus 100%. The wholesale price is cost plus 80%. Goods are invoiced to Patna at wholesale price. From the following particulars find out the profit made by Head Office and wholesale profits at branch for the year ending 31st March, 2006. Head Office Rs. Stock on Ist April, 2005 Purchases Goods sent to branch (at invoice price) Sales Stock on 31st March, 2006 25,000 1,50,000 54,000 1,53,000 60,000 Branch Rs. 50,000 9,000

Sales at Head Office are made only on wholesale and that at branch only to retail customers. Stock at branch is valued at invoice price. Solution Trading Account for 2005-2006
Particulars Head Branch Office Rs. To Opening Stock To Purchases To goods received from Head Office To Gross Profit 54,000 92,000 2,67,000 5,000 59,000 2,67,000 59,000 25,000 1,50,000 Rs. By Sales By Goods sent to Branch By Closing Stock Particulars Head Office Rs. 1,53,000 54,000 60,000 Rs. 50,000 9,000 Branch

22

Profit and Loss Account for 2005-2006

Particulars To Stock Reserve against Branch Stock To Net Profit 4,000 88,000 92,000 5,000 5,000 92,000 5,000 Head Office Branch Particulars By Gross Profit Head Office 92,000 Branch 5,000

3.3.2 Branch keeping full system of accounting Branches keeping full system of accounting or independent branches are those branches which also purchase goods from the market besides getting the goods from the head office. They can also supply goods to the head office, pay expenses from the cash realised and deposit cash in their own account. In other words, these branches operate as an independent unit for all practical purposes but their only link with the head office is that they are owned by the head office and whatever their profit or loss will be, that belongs to the head office. Such branches keep complete set of double entry books and prepare their own trial balance, trading and profit and loss account and balance sheet. Such branches open head office account in their books. This account is debited by cash sent to the head office, goods supplied to head office, payment made by the branch for purchase of assets and loss to be borne by the head office and credited by cash received from the head office, goods received from the head office, depreciation of branch fixed assets, charge made by head office for rendering services and profit earned by the branch. Similarly the head office will also maintain a branch account for each branch. This account will have the same entries but on the reverse sides.

23

The certain transactions which require special attention are : (i) Purchase of Branch Fixed Assets : Generally the branch fixed assets

are maintained in the books of head office. When an asset is purchased, the following entries are passed. (a) If the payment is made by the branch

Head Office Books Branch Assets A/c To Branch A/c Branch Books Head Office A/c To Cash A/c (b) If the payment is made by the head office Dr. Dr.

Head Office Books Branch Assets A/c To Bank A/c Branch Books No Entry (ii) Depreciation of Fixed Assets : As branch fixed assets are maintained in Dr.

the books of head office so entries relating to depreciation will also be passed through head office account. The following entry will be passed : H.O. Books Branch Account To Branch Asset A/c Dr.

24

Branch Book Profit & Loss A/c To Head Office A/c (iii) Head Office Expenses : If some services such as administration or Dr.

technical are rendered by the head office to the branch then a proportionate charge for such expenses will be made to each branch by the head office and entry for that will be as follows : H.O. Books Branch Account To Profit & Loss A/c Branch Books Profit & Loss A/c To Head Office A/c (iv) Reconciliation of transit items : The balance of head office account (in Dr. Dr.

branch books) and branch account (in head office books) should normally be same and one will make debit and other will credit for all transactions affecting these accounts. But these accounts may differ in balances because of the following reasons : (a) Cash in transit : Sometimes the branch is remitting the cash to the head

office before the close of the accounting year, say on 28 th December, when the accounts are closed on 31st December. While remitting the cash to the head office the branch will debit the head office account but if the remittance is received by the head office after the closing date of accounting year, say on 4th January, then head office will not give a credit for the same amount of remittance on 31st December, so the two balances, i.e. H.O. A/c (in Branch

25

books) and Branch Account (in H.O. books) will differ. In order to reconcile these balances, an adjusting entry will be passed in the books of branch or head office (if the intimation of such remittance is received by the head office). Branch Books Cash in Transit A/c To Head Office A/c OR Head Office Books Cash in Transit A/c To Branch A/c (b) Goods in transit : Similarly the two balances may differ because of Dr. Dr.

goods in transit. Suppose the head office sent goods to the branch on 28th December but those goods were received by the branch on 4th January (next year). Head office must have debited the account of branch in its books but there will be no corresponding credit to head office account in the books but there will be no corresponding credit to head office account in the books of branch; so on the last day of accounting year, i.e., 31st December the head office will pass the following adjusting entry : Goods in Transit A/c To Branch A/c Cash in transit or goods in transit will be shown as an asset in the balance sheet. (v) Inter-branch transactions : If the head office has many branches and Dr.

there is a possibility that some branch may supply goods or send cash to the other branch, such transactions among the branches are called inter branch

26

transactions. Such transactions may be recorded either by maintaining a current account of a branch in another branch's books or such transactions may be recorded by all branches by passing entries through head office account. For example, of goods are supplied by Calcutta branch to Delhi branch and the head office is at Bombay, then the following journal entries will be passed in the books of head office and the branches: Bombay Books Delhi Branch A/c To Calcutta Branch Calcutta Books Head Office A/c To Goods supplied to other branches A/c Delhi Books Goods received from other Branches A/c To Head Office A/c (vi) Cash paid by branch on behalf of Head Office : If the branch has paid Dr. Dr. Dr

some cash (say for purchases made by Head Office) on behalf of Head Office, then the following entries will be passed in the books of Head Office and the branch : Head Office Books Purchases A/c To Branch A/c Branch Books Head Office A/c To Cash A/c 27 Dr. Dr.

(vii) Cash collected by branch on behalf of Head Office : If the branch has collected some cash on behalf of Head Office (say for calls in arrears from the shareholders of Head Office) then the following journal entries will be passed in the books of Head Office and the branch : Head Office Books Branch A/c To Calls in Arrears Branch Books Cash A/c To Head Office A/c (vii) If a bill is drawn by one branch on another branch : If a bill is drawn by Agra Branch on Bombay Branch and the Head Office is at Delhi, then the following entries will be passed in the books of Head Office and branches : Head Office Books Agra Branch A/c To Bills Payable B/R A/c To Bombay Branch Agra Branch B/R A/c To Head Office Bombay Branch Head Office A/c To B/P A/c Dr. Dr. Dr. Dr. Dr. Dr.

28

Illustration 6 : A Calcutta based firm whose accounting year ends on 31st December has two branches - one at Agra and the other at Varanasi. The branches keep a complete set of books. On 31st December, 2005, the Agra and Varanasi Branch Accounts in the Calcutta books showed debit balances of Rs. 30,450 and Rs. 45,000 respectively before taking the following information into account : (a) Goods worth Rs. 2,000 were transferred from Agra to Varanasi under instructions from Head Office. (b) (c) The Agra Branch collected Rs. 2,500 from an Agra customer of the Head Office. The Varanasi Branch paid Rs. 5,000 for certain goods purchased by the Head Office in Varanasi. (d) Rs. 5,000 remitted by the Agra Branch to Calcutta on 29th December, 2005 received in Calcutta on 3rd January next. (e) The Varanasi Branch received on behalf of the Head Office Rs. 1,500 as dividend from a Varanasi Company. (f) For the year 2005, the Agra Branch showed a net loss of Rs. 1,250 and the Varanasi Branch a net profit of Rs. 5,400. Pass Journal entries to record these matters in the Head Office books, and write up the two Branch Accounts therein. Solution : HEAD OFFICE JOURNAL 2005 Dec. 31 Varanasi Branch Account To Agra Branch Account (Being the Goods transferred from Agra to Varanasi Branch) Dr. Rs. 2,000 Rs. 2,000

29

Agra Branch Account Dr. To Sundry Debtors Account (Being debts collected Agra Branch) Purchases Account Dr. To Varanasi Branch Account (Being goods purchased paid for by Varanasi Branch) Cash in Transit Account Dr. To Agra Branch Account (Being cash sent by Agra Branch still in transit) Profit & Loss Account Dr. To Agra Branch (Being Agra Branch Loss for 1998) Varanasi Branch Account Dr. To Profit and Loss Account (Being Varanasi Branch profit for 1998) Agra Branch Account
2005 Dec.31 To Balance b/d To Sundry Debtors Rs. 30,450 2,500 2005 Dec.31

2,500 2,500 5,000 5,000

5,000 5,000 1,250 1,250 5,400 5,400

By Varanasi Branch Account By Cash in Transit Account By Profit and Loss A/c By Balance c/d

Rs. 2,000 5,000 1,250 24,700 32,950

32,950

Varanasi Branch Account

2005 Rs. Dec.31 To Balance b/d 45,000 To Agra Branch A/c 2,000 To Dividend Account 1,500 To Profit and Loss A/c 5,400 53,900 2005 Dec.31 By Purchases A/c By Balance c/d Rs. 5,000 48,900

53,900

30

3.3.3 Foreign Branches When a branch is located in a foreign country it is called a foreign branch. Such branch will keep its books of accounts in foreign currency. The main problem which the head office is to face under this type of branch is to convert the branch trial balance from the foreign currency to the currency of that country where a head office is working in order to incorporate the branch trial balance in the books of head office. Otherwise for all purposes, this branch is treated as an independent branch. Rules for Converting the Branch Trial balance into the Books of Head Office The following are the main rules which should be taken into consideration while converting the figures of foreign trail balance in the books of the head office for the purpose of their incorporation in the books of head office : (1) If the fluctuations in the rate of exchange are neither frequent nor violent

the branch trial balance should be converted at a fixed rate of exchange. (2) If the rate of exchange is subject to frequent and violent fluctuations, then

the following rules should be adopted for converting the branch trail balance : (i) Fixed Assets and Fixed Liabilities : Fixed assets should be converted

at the rate of exchange prevailing on the day when these assets were purchased or on the date of contract. Similarly fixed liabilities should be converted at the rate of exchange ruling on the day when such liabilities were incurred or the payment was made. (ii) Floating Assets/Liabilities : These should be converted at the rate of

exchange prevailing on the last day of the year.

31

(iii)

Revenue Items : These items should be converted at the average rate

of exchange ruling during the period under review. If fluctuations are violent then these should be converted each month at the average rate prevailing during that month. (iv) Head Office Account : It is converted at the same figure at which branch

account appears in the head office books. (v) Remittances : These are converted at the figures at which they appear in

the head office books. (vi) Opening and Closing Stock : Opening stock should be converted at the

rate of exchange prevailing in the beginning of the period and closing stock should be converted at the rate prevailing on the last day of the period. After converting the various items of the branch trial balance according to the above rules, a new trial balance can be prepared but such trial balance will seldom tally. In order to make it agree, sometimes the difference is put against a separate account known as 'Difference in Exchange Account'. If the difference is small, it is closed by transfer to profit and loss account but if the difference is big, it should be put under a separate account called 'Exchange Fluctuations Account' and will be shown in the Balance Sheet either as an asset or as a liability depending on whether its balance is debit or credit. Illustration 7 : ABC Ltd. of Calcutta has a branch in London. The following are the balances of London Branch on 31st March, 2006. The cash remitted from London and the London Branch balance appeared in the Calcutta books at Rs. 19,187 and Rs. 3,27,732 respectively. Convert at the fixed rate of exchange of 1sh 6 d. to the rupee; make the necessary adjustments in the Calcutta books and the Head Office Account in branch books.

32

London Branch

Head Office Account Remittance to Calcutta Creditors Profit and Loss A/c Profit for the year Debtors Furniture Plant and Machinery Stock on 31.3.2001 Cash at bank Cash in Hand 1,440

24,579 32,805 2,973 2,433

25,167 1,410 14,973 16,161 3,492 327 62,790 62,790

Solution LONDON BRANCH Trial Balance as on 31st March, 2006 Rs. Head Office Account Remittance to Calcutta 19,187 Creditors Profit and Loss Account Profit for the year Debtors 3,35,560 Furniture 18,800 Plant and Machinery 1,97,240 Stock on 31.3.2001 2,15,480 Cash at Bank 46,560 Cash in Hand 4,360 Difference in Exchange 25 8,37,212 Rs. 3,27,732 4,37,400 39,640 32,440

8,37,212

33

Calcutta Journal
2006 March 31 Difference in Exchange A/c To London Branch (Being the difference in exchange) London Branch A/c To Profit and Loss A/c (Being London Branch profit fit for the year) CALCUTTA LEDGER LONDON BRANCH 2006 Mar.31 To Balance b/d " To Profit & Loss A/c " To Profit for the year April 1 To Balance b/d 24,579 2,973 2,433 29,985 28,545 Rs. 3,27,732 39,640 32,440 3,99,812 3,80,600 2006 Rs. Mar.31 By Remittance 1,440 19,187 " By Difference in exchange 25 " By Balance c/d 28,545 3,80,600 Dr. Rs. 25 Rs. 25 Dr. 32,440 32,440

March 31

29,985 3,99,812

LONDON LEDGER CALCUTTA HEAD OFFICE A/C 2006 March 31 To Remittance To Balance c/d 1,440 28,545 2006 March 31 By Balance b/d By Profit & Loss A/c By Profit for the year 29,985 April 1 By Balance b/d 24,579 2,973 2,433 29,985 28,545

34

3.4

SUMMARY Sometimes business is carried on in different establishments

which may be in the same town or in various parts of a country or even in distant countries of the world. The main establishment is called the Head Office while the remaining ones are called branches. It is desirable to know the profit or loss made by each branch so that if a branch does not yield into desired result, steps can be taken to remedy the state of affairs. Hence it is necessary to maintain the accounts of the branch in such a manner that profit or loss made at a branch can be ascertained. 3.5 KEYWORDS

Debtor System: Under this system the head office opens a separate account for each branch in order to record all transactions relating to a branch. Final Account System: Under this system, head office opens a Trading and Profit and Loss Account in order to find out profit or loss of each branch and a branch account. Stock and Debtors System: Under this system, head office will open various accounts in order to find the profit or loss of each branch. Foreign Branch: When a branch is located in a foreign country it is called a foreign branch. 3.6 1. SELF ASSESSMENT QUESTIONS How are the figures in foreign branch trial balance converted in the Head office books for the purpose of their incorporation in the Head Office books.

35

2.

Explain fully the various debits and credits on the head office account as would appear in the branch books where the branch maintains an independent set of books.

3.

Explain the adjustments necessary if the goods are invoiced by a Head Office at cost plus profit price to its branch

4.

Jain Bros. operate a retail branch at Delhi. All purchases are made by the head office at Madras; goods being charged out to the branch at cost price. All cash received by the branch is remitted to Madras. Branch petty expenses are paid out of an imprest which is reimbursed by the head office from time to time. From the following particulars relating to Delhi branch, you are required to prepare branch account (for calculating profit) in the books of head office.
Rs.
April 1, 2006:

Rs.

Stock at cost Petty cash Plant March 31, 2001 : Stock at cost

8,000 800 10,000

Petty expenses paid by the branch out of imprest Cash sales during the year Sale of the plant on July 1, 2006 700 70,000

7,000

(book value of the plant on the date of sale Rs. 900) Expenses paid by the head office 800 5,000

Goods sent to branch50,000

It is required to write off the plant at 20% p.a.

36

5.

Shree Nanak of Bombay has a branch at Delhi. Goods are invoiced to the Branch at cost plus 20%. The expenses of the Branch are paid from Bombay and the Branch keeps a Sales Journal and the Debtor's Ledger only. From the information supplied by the Branch, prepare Trading and Profit and Loss Account of the Branch for the year ending 31st March, 2006 and show the account of the Branch as it would appear in the books of the Head Office.
Rs. Opening Stock (at invoice price) Closing Stock (at invoice price) Credit Sales Cash Sales Receipts from debtors Sundry Debtors on 31st March, 2006 12,000 9,000 20,500 8,750 18,950 4,580 Goods received from Head Office Goods in Transit from Head Office on 31st March, 2006 Expenses paid by Head Office for the branch 5,200 1,800 15,000 Rs.

6.

On January 1, 2006 the goods invoiced by Calcutta Head Office of a trader to its Madras Branch were Rs. 48,000 at selling price, being 33% on cost price. For six months ended June 30, 2006, the branch return showed that the sales were Rs. 29,00. The goods invoiced at Rs. 2,000 were returned by the Branch to the Head Office. The closing stock at Madras Branch on June 30, 2006 was Rs. 16,800 at selling price. Record the above transactions showing Madras Branch Stock Account, Madras Branch Adjustment Account, Madras Profit & Loss A/c, and Goods Sent to Branches Account in Calcutta Head Office Books and balance them at June 30, 2006.

37

7.

A trading company has its Head Office in London and a trading branch at Bombay The following is a list of balances on the Bombay books on 31st December, 2006, when the first year's trading ended : Rs. London Account Sales Purchases Wages & Salaries Freight & Insurance 2,08,000 2,25,676 2,61,604 43,868 26,608 General Expenses Bank Account Cash in hand Sundry Debtors Sundry Creditors Rs. 31,248 12,641 1,563 1,06,462 50,318

Stocks at Bombay on 31st December was valued at Rs. 1,48,500. The balance of the London Account represents remittances to Bombay as follows : 8th January 6th April 17th August Rs. 64,000 Rs. 96,000 Rs. 48,000 purchased at Is. 3 (3/4)d. purchased at Is. 2d. purchased at Is. 3d.

Give journal entries to incorporate the Bombay figures and show the Bombay Branch Account in London books from Ist January to 31st December. 3.7 1. SUGGESTED READINGS Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. 2. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi.

38

3.

Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi.

4.

Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi.

5.

Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana.

6.

Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi.

39

Lesson : 4
ROYALTY ACCOUNTS
STRUCTURE 4.0 4.1 4.2 4.3 4.4 Objective Introduction Difference between Royalty and Rent Important terms in connection with Royalty Accounting Procedure 4.4.1 Journal entries in the books of lessee 4.4.2 Journal entries in the books of landlord 4.5 4.6 4.7 4.8 4.0 Summary Keywords Self Assessment Questions Suggested Readings OBJECTIVE

After reading the lesson the students should be able to (i) Understand the meaning of royalty, differentiate royalty and rent, and explain the various terms related to royalty accounts such as lessor, lessee, dead rent and shortworking. Prepare the royalty accounts in the books of both lessor and lessee. INTRODUCTION

(ii) 4.1

Royalty is a periodical payment based on output or sale for the use of a fixed asset or right to its owner. The payment which is made by one person to 1

another for the use of a certain asset is known as Royalty. The person who makes the payment to the owner of the asset is known as lessee and the owner of the asset to whom payment is made is called as lessor or landlord. Thus, royalty is paid by the publisher to the writer of the book, by the manufacturer to the patentee or to the owner of oil-wells. According to J.R.Batliboi The term royalty expresses an amount payable by one person in return of some special right or privilege conceded to him by another person, such as the right to publish a book, or to manufacture and sell a patented article or to work a mine. Royalty account is a nominal account in nature and is synonymous with rent account. Since, it is a nominal account, it is debited in the books of lessee as ordinary business expenditure and credited in the books of landlord as income for him. Royalty account is closed at the end of every accounting year by transferring to Profit and Loss Account. 4.2 DIFFERENCE BETWEEN RENT AND ROYALTY The major differences between rent and royalty are as follows: 1. Rent is paid for the use of tangible assets such as building, machinery, whereas royalty is paid for the use of intangible assets or special right such as mines, patent right. Rent is fixed, but the amount of royalty is not fixed and depends on number of articles produced or sold. IMPORTANT TERMS IN CONNECTION WITH ROYALTY Landlord or lessor :- The person who is the owner of the assets and surrender the right of its use to some other person and receives the consideration as royalty is called Lessor. Lessee :- The person who pays the royalty in consideration for the use of that asset is called Lessee. Minimum or Dead or Fixed Rent :- It is the minimum amount of rent which the lessee is required to pay to landlord whether he (lessee) has desired any 2

2. 4.3 1.

2. 3.

benefit or not out of the right or property rented out to him by the lessor. Thus, such minium rent is fixed at the time of agreement between the two parties. The fixation of such a rent is in the interest of landlord because it guarantees the receipt of the minimum amount in case of low output or sales. So a lessee has to pay minimum rent or royalty, whichever is more. Minimum rent is generally fixed that is why it may be known as Dead or Fixed or Flat Rent but some time it may vary also according to the terms of the agreement. 4. Shortworking :- The excess of minimum rent over royalty calculated on the basis of output or sales is termed as short working. Shortworking = Minimum Rent - Royalty For example if minimum Rent is fixed Rs. 10,000 and actual royalty for Ist and IInd year of output is Rs. 4,000 and 9,500/- respectively, so shortworking will be Rs. 6,000/- and Rs. 500/- for Ist and IInd year respectively. 5. Recoupment of shortworking :- Usually in the first few years of the royalty agreement, the work does not gather the required momentum because of the time taken in the preparation for starting the production, so shortworkings may arise in first few years. Keeping this in view, royalty agreement may contain a clause that shortworking can be recouped by the lessee in the following manner:Without any time limit :- According to this clause in the agreement the time limit for the recoupment of shortworkings is not mentioned. So, the shortworkings, then, may be recouped throughout the period of the lease. In such a case the amount of un-recouped shortworkings will be transferred to the Profit & Loss Account only in the last year of the period of lease and not earlier. When shortworkings can be recouped in a fixed period :- There may be a clause in the agreement that the shortworkings can be recouped in the given first few years of the lease such as first three years, first four years or first five years. For example if a coal mine is leased on Ist Jan. 2000 for a period of 10 years and if shortworkings can be recouped only during the first 4 years of the lease, the shortworkings will be recouped upto 2003 only and not afterwards. The balance of shortworkings in 2003 and thereafter will be transferred to Profit & Loss Account. 3

(i)

(ii)

(iii)

When shortworkings can be recouped in the next few years :- In this clause of agreement, the period allowed for recoupment of each years shortworking is calculated from the year during which the shortworkings arose. For example, if a mine is leased on Ist Jan 1990 for a period of 20 years and if it is given in the agreement that shortworkings can be recouped in the subsequent 3 years, then shortworkings of 1990 can be recouped upto 1993 and shortworkings of 1991 can be recouped upto 1994 and of 1992 upto 1995 and so on. If shortworkings which could not be recouped during the stipulated period of 3 years that shortworkings will be transferred to Profit & Loss Account in the year in which the right of recoupment lapses.

4.4

ACCOUNTING PROCEDURE

The following points need to be noted down before preparing the Royalty Accounts :1. Name of Landlord and Lessee. 3. Commencement of agreement. 5. Minimum Rent. 7. Mode of payment to Landlord. A calculation table may be prepared before making the Journal entries which makes easy solution, The format of table is as follows:Year Output Royalty Short Shortwor- Unrecouped Amount working ing recou- shortworkings paid to ped transferred to Landlord P&L Account Rs. Rs. Rs. Rs. 2. Period of Lease. 4. Royalty Rates. 6. Right of recoupment of shortworkings.

Rs.

4.4.1 Journal entries in the books of lessee There may be three types of situations in order to pass Journal entries in the books of lessee:1. 2. 3. When minimum Rent is more than Royalty. When minimum Rent is equal to Royalty. When minimum Rent is less than Royalty.

Ist Case When Minimum Rent is more than Royalty :(i) When Royalty is due :Royalty A/c Shortworkings A/c To Landlord A/c (Being Royalty and Shortworkings due to Landlord) (ii) When payment is made :Landlord A/c To Cash/Bank (Being Cash paid to Landlord) (iii) Closing entry at the end of the year :Profit & Loss A/c To Royalty A/c (Being Royalty Account transferred to Profit & Loss A/c.) 5 Dr. Dr. Dr. Dr.

IInd Case When Minimum Rent and Royalty are equal (i) When Royalty is due :Royalty A/c To Landlord A/c (Being Royalty due) (ii) When payment is made:Landlord A/c To Cash/Bank (Being Payment made to Landlord) (iii) For closing Royalty A/c at the end of the year Profit & Loss A/c To Royalty A/c (Being Royalty Account transferred to Profit & Loss a/c.) IIIrd Case When Minimum Rent is less than Royalty and Shortworking recouped. (i) For Royalty due Royalty A/c To Landlord A/c (Being Royalty due to Landlord) 6 Dr. Dr. Dr. Dr.

(ii)

For payment & recouped of shortworking Landlord A/c To Cash/Bank To Shortworking (Recouped) Dr.

(Being payment made to landlord and shortworking recouped) (iii) For closing Royalty a/c and unrecouped shortworking :Profit & Loss A/c To Royalty A/c To Shortworking (Unrecouped) (Being Royalty & Unrecouped shortworking transferred to Profit& Loss A/c.) Kinds of Royalties 1. 2. 3. 4. 5. Royalties in connection with mines. Royalties regarding oil-wells. Royalties regarding Brick Making Royalties regarding Patents. Royalties regarding copyright. Dr.

Illustration-1: Bengal Coal Ltd., leased in a colliery on Ist Jan. 2001 at a minimum rent of Rs. 15,000 merging into a royalty of Re 1 per ton with a right to recoup shortworkings over the first three years of the lease. The output for the first four years of the lease was 8,000, 13,000, 21,000 and 18,000 tones respectively. Pass necessary journal entries in the books of the company and show the necessary ledger accounts. 7

Solution Calculation Table

Year Output Royalty Minimum Short Rent Workings Short Workings Recouped 6,000 8,000 7,000 15,000 Unrecoued S.W transfer to P & L A/C. 3,000 Paid to Landlord

2001 2002 2003 2004 2001 Dec 31

8,000 13,000 21,000 18,000

8,000 13,000 21,000 18,000

15,000 15,000 15,000 15,000

7,000 2,000 Dr. Dr.

15,000 15,000 15,000 18,000

Royalties A/c Shortworking A/c

To Landlord A/c (Being royalties and short working due to landlord) Dec 31 Landlord A/c To Cash A/c (Being payment made to landlord) Dec 31 Profit & Loss A/c Dr. 8,000 Dr. 15,000

15,000

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c.) 2002 Dec.31 Royalties A/c Shortworking A/c Dr. Dr. 13,000 2,000

8,000

To Landlord A/c (Being royalties and short workings due to landlord)

15,000

Dec 31

Landlord A/c To Cash A/c (Being cash paid to landlord)

Dr.

15,000 15,000

Dec 31

Profit & Loss a/c

Dr.

13,000 13,000

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c) 2003 Dec 31 Royalties A/c Dr. 21,000

To Landlord A/c (Being royalties due to landlord) Dec 31 Landlord A/c Dr. 21,000

21,000

To Cash A/c To Shortworking A/c (Recouped) (Being cash paid to landlord & excess royalty utilized for recouping the Shortworking) Dec 31 Profit & Loss A/c Dr. 24,000

15,000 6,000

To Royalties A/c To Shortworking A/c (Unrecouped) (Being royalties & Unrecouped shortworkings transferred to Profit & Loss A/c) 2004 Dec 31 Royalties A/c Dr. 18,000

21,000 3,000

To Landlord A/c (Being Royalties due to landlord) Dec 31 Landlord A/c To Cash A/c (Being cash paid to landlord) Dr. 18,000

18,000

18,000

Dec 31

Profit & Loss A/c

Dr.

18,000 18,000

To Royalties A/c (Being Royalty A/c. transferred to Profit & Loss A/c) Dec 31 Profit & Loss A/c Dr. 24,000

To Royalties A/c To Shortworking A/c (Unrecouped) (Being royalties & Unrecouped shortworkings transferred to Profit & Loss A/c) 2004 Dec 31 Royalties A/c Dr. 18,000

21,000 3,000

To Landlord A/c (Being Royalties due to landlord) Dec 31 Landlord A/c To Cash A/c (Being cash paid to landlord) Dec 31 Profit & Loss A/c Dr. 18,000 Dr. 18,000

18,000

18,000

To Royalties A/c (Being Royalty A/c. transferred to Profit & Loss A/c)

18,000

Ledger Accounts Royalties Account

2001 Dec.31 2002 Dec.31 2003 Dec.31 2004 Dec.31 To Landlord A/c. To Landlord A/c. To Landlord A/c. To Landlord A/c. Rs. 8,000 8,000 13,000 13,000 21,000 21,000 18,000 18,000 2001 Dec.31 2002 Dec.31 2003 Dec.31 2004 Dec.31 By P & L a/c By P & L a/c By P & L a/c By P & L a/c Rs. 8,000 8,000 13,000 13,000 21,000 21,000 18,000 18,000

10

Shortworking Account
2001 Dec 31 To Landlord A/c. 2002 Jan 1 To Bal. b/d Dec 31 To Landlord A/c. 2003 Jan 1 Rs. 7,000 7,000 7,000 2,000 9,000 9,000 2001 Dec 31 2002 Dec 31 2003 Dec 31 Dec 31 9,000 By Bal. c/d By Bal. c/d Rs. 7,000 7,000 9,000 9,000 6,000 3,000 9,000

To Bal. b/d

By Landlord A/c By P & L A/c

Landlord Account
2001 Dec 31 To Cash A/c. Rs. 15,000 15,000 2002 Dec 31 To Cash A/c 15,000 15,000 2003 Dec 31 To Cash A/c To Short Working A/c. (recouped) 2004 Dec 31 To Cash A/c 18,000 18,000 21,000 2004 Dec 31 By Royalties A/c 18,000 18,000 21,000 15,000 6,000 2003 Dec 31 By Royalties A/c 21,000 2002 Dec 31 By Royalties A/c By Short Working A/c. 13,000 2,000 15,000 2001 Dec 31 Dec 31 By Royalties A/c By Short Working A/c Rs. 8,000 7,000 15,000

11

Preparation of Minimum Rent A/c:- When it is asked to prepare a Minimum Rent Account in the question, the first entry will be split into two journal entries and other entries will remain same:Journal entries when Minimum Rent Account is to be opened:(i) Royalties A/c Shortworking A/c Dr. Dr.

To Minimum Rent (Being Royalties A/c & Shortworking A/c transferred to Minimum Rent A/c) (ii) Minimum Rent A/c Dr.

To Landlord A/c (Being Minimum Rent due to Landlord) (iii) Landlord A/c Dr.

To Cash A/c (Being Payment made to Landlord) (iv) Profit & Loss A/c Dr.

To Royalties A/c (Being Royalties A/c transferred to P & L A/c) So, Minimum Rent Account is opened only for those years when Royalty is less than Minimum Rent or Shortworking arises and this account is opened only when it is asked to prepare in the question otherwise there is no need to prepare it.

12

Payment of Royalty half yearly and payment of current year Royalty during the next year When Royalty is payable half yearly, Minimum Rent should also be calculated for half year to compare it with Royalty. In such cases Royalty A/c and Shortworking A/c are transferred to Profit & Loss A/c at the end of the year. Similarly some times the current year Royalty is paid in the next year. In such cases the entry of Royalty will be passed in the same year but actual payment of Royalty will be made in the year of payment. Illustration -2 : Hari Ltd., obtained a Coal mine on lease for 15 years from Ist Jan 1990 on a Royalty of Rs. 2 per ton of the output, payable half yearly on 30th June & 31st Dec. every year. The Minimum Rent was fixed at Rs. 8,000 per half year with a power to recoup shortworkings over the first two years of the lease. The output was as follows:30th June 31st Dec 30th June 31st Dec 30th June 31st Dec 1990 1990 1991 1991 1992 1992 800 tons 3600 tons 5000 tons 6000 tons 3650 tons 10,000 tons

Hari Ltd. prepare its final accounts annually on 31st Dec. every year and the Royalty which was due on 31st Dec. 1991 was, infact, paid on 20th January, 1992. Prepare necessary ledger accounts in the books of Hari Ltd., and also show the items in Profit & Loss A/c and Balance Sheet. 13

Solution ANALYTICALTABLE
Half year ending on Output in tonns Royalty Minimum @Rs.2/Rent Per Ton Rs. Rs. 1,600 7,200 10,000 12,000 7,300 20,000 8,000 8,000 8,000 8,000 8,000 8,000 Short Workings Rs. 6,400 800 700 Short Workings Recouped ed Rs. 2,000 4,000 Unrecouped Payment Shortworkings to transferred Landto P&L A/c lord 1,200 700 8,000 8,000 8,000 8,000 8,000 20,000

30.06.90 31.12.90 30.06.91 31.12.91 30.06.92 31.12.92

800 3,600 5,000 6,000 3,650 10,000

Books of Hari Ltd. Royalty Account

1990 Jun 30 Dec 31 To Landlord A/c To Landlord A/c Rs. 1,600 7,200 8,800 1991 Jun 30 Dec 31 To Landlord A/c To Landlord A/c 10,000 12,000 22,000 1992 Jun 30 Dec 31 To Landlord A/c To Landlord A/c 7,300 20,000 27,300 27,300 1992 Dec 31 By P & L A/c 27,300 22,000 1991 Dec 31 By P & L A/c 22,000 8,800 1990 Dec 31 By P & L A/c Rs. 8,800

14

Shortworking A/c
1990 Jun 30 Dec 31 1991 Jan 1 Rs. 6,400 800 7,200 7,200 1990 Dec 31 1991 Jun 30 Dec 31 Dec 31 1992 Dec 31 By Balance c/d Rs. 7,200 7,200 2,000 4,000 1,200 7,200 700

To Landlord A/c To Landlord A/c

To Balance b/d

By Landlord A/c By Landlord A/c By P& L A/c

7,200 1992 Jun 30 To Landlord A/c 700 By P & L a/c

Landlord A/c 1990 Jun 30 Dec 31 Rs. 8,000 8,000 1990 Jun 30 Jun 30 Dec 31 Dec 31 Rs. 1,600 6,400 7,200 800 16,000

To Cash A/c To Cash A/c

By Royalty A/c By S.W. A/c By Royalties By S.W. A/c

16,000 1991 Jun 30 Jun 30 Dec 31 Dec 31 1991 Jun 30 Dec 31

To Cash A/c To S.W.(recouped) To S.W.(recouped) To Bal. b/d

8,000 2,000 4,000 8,000 22,000

By Royalty A/c By Royalty A/c

10,000 12,000

22,000 1992 Jan 01 Jun 30 Jun 30 Dec 31

1992 Jan 20 Jun 30 Dec 31

To Cash A/c To Cash A/c To Cash A/c

8,000 8,000 20,000 36,000 15

By Bal. b/d By Royalty A/c By S.W. A/c By Royalty A/c

8,000 7,300 700 20,000 36,000

Profit & Loss a/c

1990 Dec 31 To Royalty a/c Rs. 8,800 8,800 1991 Dec 31 Dec 31

To Royalty a/c To S.W. a/c

22,000 1,200 23,200

1992 Dec 31 Dec 31

To Royalty a/c To S.W a/c

27,300 700 28,000

Balance Sheet as on 31st Dec. 1990

Rs. Shortworkings (Balance) Rs. 7,200

Balance sheet as on 31st Dec. 1991

Rs. Landlord (Amount Due) 8,000 Rs.

16

Recoupment of Shortworkings in the next or subsequent or following few years Illustration-3 : Bharat Coal Co. took a mine on lease from Vijay Yadav for a period of ten years from 1st January 1991, upon the terms of a royalty of 75 paise per ton with a minimum rent of Rs.15,000 in the first year and then increasing every year by Rs.2,000 ,till it reaches Rs.19,000 when it becomes fixed for all the coming years . Bharat Coal Co. was granted the right of recouping shortworkings of any year in the subsequent three years . The output was as follows :Years Output (in tons) 1991 8,000 1992 18,000 1993 24,000 1994 36,000 1995 44,000

Show Journal Entries in the books of Bharat Coal when :(a) there is no Minimum Rent Account, and (b) there is a Minimum Rent Account . Solution Analytical Table
Year Output in tons Royalty Minimum Rent Rs. 15,000 17,000 19,000 19,000 19,000 Short workings Rs. 9,000 3,500 1,000 S.W Recouped Rs. 8,000 4,500 Unrecouped S.W.transfer to P&L a/c Rs. 1,000 Payment to Vijay Yadav Rs. 15,000 17,000 19,000 19,000 28,500

Rs. 1991 8,000 6,000 13,500 18,000 27,000 33,000

1992 18,000 1993 24,000 1994 36,000 1995 44,000

17

(a)

When there is no Minimum Rent a/c :-

In the Books of Bharat Coal Co., Journal

1991 Dec 31 Royalties A/c Dr. Shortworking A/c Dr. To Vijay Yadav A/c (Being Royalties & shortworkings due to landlord) Vijay Yadav A/c To Cash A/c (Being cash paid to landlord) Dec 31 Profit & Loss A/c Dr. 6,000 6,000 Dr. Rs. 6,000 9,000 Rs.

15,000

Dec 31

15,000 15,000

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c) 1992 Dec 31 Royalties A/c Dr. Shortworkings A/c Dr. To Vijay Yadav A/c (Being Royalties & shortworkings due to landlord) Vijay Yadav A/c Dr. To Cash A/c (Being cash paid to landlord) Profit & Loss A/c Dr. To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c) Royalties A/c Dr. Shortworkings A/c Dr. To Vijay Yadav A/c (Being Royalties and shortworkings due to landlord)

13,500 3,500 17,000

Dec 31

17,000 17,000

Dec 31

13,500 13,500

1993 Dec 31

18,000 1,000 19,000

18

Dec 31

Vijay Yadav A/c To Cash A/c (Being cash paid to landlord)

Dr.

19,000 19,000

Dec 31

Profit & Loss A/c

Dr.

18,000 18,000

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c) 1994 Dec 31 Royalties A/c Dr. 27,000

To Vijay Yadav A/c (Being Royalties due to landlord) Dec 31 Vijay Yadav A/c Dr. 27,000

27,000

To Cash A/c To Shortworkings A/c (Being cash paid to landlord and shortworkings recouped) Dec 31 Profit & Loss A/c Dr. 28,000

19,000 8,000

To Royalties A/c To Shortworkings A/c (recouped) (Being royalties A/c & Unrecouped shortworkings transferred to Profit & Loss A/c) 1995 Dec 31 Royalties A/c Dr. 33,000

27,000 1,000

To Vijay Yadav A/c (Being Royalties due to landlord) Dec 31 Vijay Yadav A/c Dr. 33,000

33,000

To Cash A/c To Shortworkings A/c (Being cash paid and shortworkings recouped) Dec 31 Profit & Loss A/c Dr. 33,000

28,500 4,500

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss Account)

33,000

19

(b)

When there is a Minimum Rent Account:Minimum Rent A/c To Vijay Yadav A/c (Being minimum rent to Landlord) Dr. 15,000 15,000

1991 Dec 31

1991 Dec31

Royalties A/c Shortworkings A/c

Dr. Dr.

6,000 9,000 15,000

To Minimum Rent A/c (Being Royalties A/c & shortwor-kings A/c transferred to Minimum Rent A/c) Dec 31 Vijay Yadav A/c To Cash A/c (Being cash paid to landlord) Dec 31 Profit & Loss A/c Dr. 6,000 Dr. 15,000

15,000

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c) 1992 Dec 31 Minimum Rent A/c To Vijay Yadav A/c (Being Minimum Rent due to landlord) Dec 31 Royalties A/c Shortworkings A/c Dr. Dr. 13,500 3,500 Dr. 17,000

6,000

17,000

To Minimum Rent A/c (Being Royalties A/c & shortworkings A/c transferred to Minimum Rent A/c) Dec 31 Vijay Yadav A/c To Cash A/c (Being cash paid to landlord) Dr. 17,000

17,000

17,000

20

Dec 31

Profit & Loss A/c To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c)

Dr.

13,500 13,500

1993 Dec 31

Minimum Rent A/c To Vijay Yadav A/c (Being minimum rent due to landlord)

Dr.

19,000 19,000

Dec 31

Royalties A/c Shortworkings A/c

Dr. Dr.

18,000 1,000 19,000

To Minimum Rent A/c (Being Royalties & Shortworkings A/c transferred to minimum rent A/c) Dec 31 Vijay Yadav a/c To Cash a/c (Being cash paid to landlord) Dec 31 Profit & Loss A/c Dr. 18,000 Dr. 19,000

19,000

To Royalties A/c (Being Royalties A/c transferred to Profit & Loss A/c)

18,000

Stoppage of work due to strike and lockout If the minimum rent was not attained due to stoppage of work, the Royalty agreements usually contain a provision that the amount of Minimum Rent will be reduced for that year. Provision for the reduction of Minimum Rent may be any of the following types:(i) Minimum Rent is to be reduced proportionately according to the length of stoppage of work due to strike or lockout. (ii) In the year of stoppage, the Minimum Rent is to be reduced by a certain percentage. (iii) In some agreements, it is mentioned that in the year of strike, actual royalties earned for the year will discharge all rental obligations. 21

Illustration- 4 : Haryana Steel Ltd., obtained a lease from Y Ltd., for a coal mine on Ist Jan 1990 on the following terms:1. 2. 3. 4. Royalty at Re. 1 per tonne. Minimum Rent Rs. 12,000 p.a. Recoupment of shortworkings of each year during three years following, subject to a maximum of Rs. 2,500 p.a. In the event of strike, the minimum rent would be taken pro-rata on the basis of actual working days but in the event of lockout, the lessee would enjoy a concession in respect of minimum rent for 50%of the period of lockout.

Besides the above, Haryana Steel Ltd., have been granted a cash subsidy equal to 25% of the unrecoupable shortworkings by the Central Govt. 5. Working upto first 6 years is as follows:1990 Actual Royalty Rs. 7,000 1991 Actual Royalty Rs. 10,200 1992 Actual Royalty Rs. 16,100 1993 Actual Royalty Rs. 13,600 1994 Actual Royalty Rs. 10,800(Strike for 73 days) 1995 Actual Royalty Rs. 9,700(Lockout for 4 months)

Show the Ledger Accounts in the Books of Haryana Steel Ltd. Solution Analytical Table
Year Royalties M.R. S.W. S.W. S.W. Cash Recouped Unrecouped Subsidy 2,500 1,600 1,200 900 600 225[1] 150[1] Transferred Payment to P&l a/c to Lanlord 675 450 12,000 12,000 13,600 12,000 9,600 10,000

1990 1991 1992 1993 1994 1995

7,000 10,200 16,100 13,600 10,800

12,000 12,000 12,000 12,000 9,600[2]

5,000 1,800 300

9,700 10,000[3]

22

Notes:

(1) Cash Subsidy is 25% of Irrecoverable shortworkings. (2) Minimum Rent is reduced for 73 days i.e. 12,000 x 73 = Rs. 2,400 365 Rs. 12,000 - Rs. 2,400 = Rs. 9,600 (3) Minimum Rent for lockout period for 4 months is Rs. 12,000 x 4 = Rs. 4,000 42

Therefore, concession in Minimum Rent will be 50% of Rs.4,000 i.e. Rs. 2,000. Rs. 12,000 - Rs. 2,000 = Rs. 10,000

Books of Haryana Steel Ltd., Royalties Account

1990 Dec 31 1991 Dec 31 1992 Dec 31 1993 Dec 31 1994 Dec 31 1995 Dec 31 To Y Ltd., To Y Ltd., To Y Ltd., To Y Ltd., To Y Ltd., 1990 Dec 31 1991 Dec 31 1992 Dec 31 1993 Dec 31 1994 Dec 31 1995 Dec 31 By P & L A/c By P & L A/c By P & L A/c By P & L A/c By P & L A/c

To Y Ltd.,

7,000 7,000 10,200 10,200 16,100 16,100 13,600 13,600 10,800 10,800 9,700 9,700

By P & L A/c

7,000 7,000 10,200 10,200 16,100 16,100 13.600 13,600 10,800 10,800 9,700 9,700

23

Shortworkings Account
1990 Dec31 1991 Jan01 Dec31 1992 Jan01 1990 Dec31 1991 To bal. b/d To Y Ltd. 5,000 1,800 6,800 6,800 6,800 1993 Jan01 To bal. b/d 4,300 1993 Dec31 Dec31 Dec31 Dec31 1994 Dec31 Dec31 Dec31 1995 Dec31 By Y Ltd. By Cash (Subsidy) By P & L A/c By bal. c/d Dec31 1992 Dec31 By bal. c/d 6,800 6,800 2,500 4,300 6,800 1,600 225 675 1,800 4,300 1,200 150 450 1,800 300 300

To Y Ltd.

5,000 5,000

By bal. c/d.

5,000 5,000

To bal. b/d

By Y Ltd. By bal c/d

4,300 1994 Jan01 To bal. b/d 1,800 By Y Ltd. By Cash (Subsidy) By P & L A/c

1,800 1995 Jan01 To Y Ltd. 300 300 By bal c/d

Y Ltd. Account
1990 Dec31 1990 Dec31 Dec31 1991 Dec31 Dec31

To Cash A/c

12,000 12,000

By Royalties A/c By shortworkings A/c By Royalties A/c By shortworkings A/c

7,000 5,000 12,000 10,200 1,800 12,000

1991 Dec31

To Cash A/c

12,000 12,000

24

1992 Dec31

To Cash A/c To shortworkings A/c

13,600 2,500 16,100

1992 Dec 31

By Royalties A/c

16,100 16,100

1993 Dec31

To Cash A/c To shortworkings A/c

12,000 1,600 13,600

1993 Dec 31

By Royalties A/c

13,600 13,600

1994 Dec31

To Cash A/c To shortworkings A/c

9,600 1,200 10,800

1994 Dec 31

By Royalties A/c

10,800 10,800

1995 Dec31

To Cash a/c

10,000

1995 Dec 31

By Royalties A/c By S.W. A/c

9,700 300 10,000

10,000

4.4.2 Journal Entries in the Books of Landlord In the books of the lessor or landlord the accounting treatment will be the reverse of what we have done so far. The following entries will be recorded: (I) When the royalties received are less than the Minimum Rent and shortworkings are recoverable out of future years (a) Lessees Account Dr.

To Royalties Receivable A/c To Royalties Reserve A/c (Being Minimum Rent due from Lessee) (b) Cash A/c Dr.

To Lessees A/c (Being cash received from Lessee) 25

(c)

Royalty Receivable A/c

Dr.

To Profit & Loss A/c (Being Royalty receivable A/c transferred to Profit & Loss a/c) (II) When Royalties and Minimum Rent both are equal (a) Lessees A/c Dr.

To Royalties Receivable A/c (Being Royalties due from Lessee) (b) Cash A/c Dr.

To Lessees A/c (Being cash received from Lessee) (c) Royalty Receivable A/c Dr.

To Profit & Loss A/c (Being Royalties A/c transferred to Profit & Loss A/c) (III) When the Royalties received are more than the Minimum Rent and power to recoup the shortworkings (a) Lessees A/c Dr.

To Royalties Receivable A/c (Being Royalties due from Lessee) (b) Cash A/c Royalties Reserve A/c Dr. Dr.

To Lessees A/c (Being cash received & shortworkings recouped)

26

(c)

Royalties Receivable A/c Dr. Royalties Reserve A/c Dr.

To Profit & Loss A/c (Being royalty & unrecouped shortworkings transferred to Profit & Loss A/c) Illustration-5 : On Ist Jan., a Coal Co., took a Coal mine on lease for 15 years as the terms of paying a Minimum Rent of Rs. 10,000 per year, merging into a royalty of 50 paise per tonne. The output was as under:Year Output(in tonne) Ist 16,000 2nd 18,000 3rd 20,000 4th 22,000

In terms of the lease provided that the dead rent not merged in Royalty could be deducted out of future royalty in excess of the minimum, provided this recovery was made in the three years following the year in which the shortworking arose. Record these transactions in the books of the landlord. Solution CALCULATION TABLE
Year Output Royalty @.50p per Ton 1. 2. 3. 4. 16,000 18,000 20,000 22,000 8,000 9,000 10,000 11,000 Rs. 10,000 10,000 10,000 10,000 Rs. 2,000 1,000 Rs. 1,000 Minimum Rent Royalty Reserve Royalty Reserve Utilised Transferred to P & L A/c Rs. 1,000 Rs. 10,000 10,000 10,000 10,000 Amount Received

(in tonnes) Receivable

27

Books of Landlord (lessor) JOURNAL

1st Year Dec31 Lessees A/c To Royalty Receivable A/c To Royalty Reserve A/c (For amount of royalty receivable earned and the excess of minimum rent transferred to royalty reserve A/c) Dec31 Cash A/c To Lessees A/c (For amount received from the lessee) Dec31 Royalty receivable A/c To Profit & Loss A/c (For royalty receivable account transferred to Profit & Loss A/c) 2nd year Dec31 Dr. 8,000 8,000 Dr. 10,000 10,000 Dr. 10,000 8,000 2,000

Lessees A/c To Royalty Receivable A/c To Royalty Reserve A/c (For amount of royalty receivable earned and the excess of minimum rent transferred to royalty reserve a/c)

Dr.

10,000 9,000 1,000

Dec31

Cash A/c To Lessees A/c (For amount received from the lessee)

Dr.

10,000 10,000

Dec31

Royalty receivable A/c To Profit & Loss A/c (For royalty receivable account transferred to Profit & Loss A/c)

Dr.

9,000 9,000

28

3rd year Dec31

Lessees A/c To Royalty Receivable A/c (For royalty receivable earned)

Dr.

10,000 10,000

Dec31

Cash A/c To Lessees A/c (For amount received from the lessee)

Dr.

10,000 10,000

Dec31

Royalty receivable A/c To Profit & Loss A/c (For royalty receivable account transferred to Profit & Loss A/c)

Dr.

10,000 10,000

4th year Dec31

Lessees A/c To Royalty receivable A/c (For royalty receivable earned)

Dr.

11,000 11,000

Dec31

Cash A/c Royalty Reserve A/c To Lessees A/c (For royalty reserve written off to the extent of shortworkings recouped by lessee and the balance received in cash)

Dr. Dr.

10,000 1,000 11,000

Dec 31

Royalty Receivable A/c Royalty reserve A/c To Profit & Loss A/c (For royalty receivable and the amount of royalty reserve A/c to the extent of irrecoverable shortworkings transferred to Profit & Loss A/c)

Dr. Dr.

11,000 1,000 12,000

29

Ledger Lessees A/c

Dr. 1st year Dec31 Rs. To Royalty Receivable A/c To Royalty Reserve A/c 8,000 2,000 10,000 2nd year Dec31 9,000 1,000 10,000 3rd year To Royalty Receivable A/c 10,000 Dec31 4th year To Royalty Receivable A/c 11,000 Dec31 By Cash A/c By Royalty Reserve A/c 10,000 1,000 11,000 By Cash A/c 10,000 By Cash A/c 1st Year Dec31 Cr. Rs. 10,000

By Cash A/c

10,000 10,000

2nd year Dec31

To Royalty Receivables A/c To Royalty Reserve A/c

10,000

3rd year Dec31

4th year Dec31

11,000

Royalty Receivable Account 1st year Dec31 2nd year Dec31 3rd year Dec31 4th year Dec31 Rs. 8,000 8,000 9,000 9,000 10,000 10,000 11,000 11,000 1st year Dec31 2nd year Dec31 3rd year Dec31 4th year Dec31 Rs. 8,000 8,000 9,000 9,000 10,000 10,000 11,000 11,000

To P & L A/c

By Lessees A/c

To P & L A/c

By Lessees A/c

To P & L A/c

By Lessees A/c

To P & L A/c

By Lessees A/c

30

Royalty Reserve Account

1st year Dec31 2nd year Dec31 Rs. 2,000 1st year Dec31 2nd year Jan 1 Dec31 Rs. 2,000

To bal c/d

By Lessees A/c

To bal c/d

3,000 3,000

By bal b/d By Lessees A/c

2,000 1,000 3,000

3rd year Dec31 4th year Dec31 Dec31 Dec31

To bal c/d

3,000

3rd year Jan 1 4th year Jan 1

By bal b/d

3,000

To Lessees A/c To P & L A/c To bal c/d

1,000 1,000 1,000 3,000

By bal. b/d

3,000

3,000 5th year Jan 1

By bal b/d

1,000

Sub lease Some times the terms of the original lease may empower the lessee to sublet a part of the land or mine to another person as a sub-lease. It is usual that the terms of agreement between A(original lessee) and B (original lessor) will be quite different to those between A (original lessee) and C (sub lessee). The position of A will be two-fold: as lessee paying royalties to B as landlord receiving royalties to C. First, as lessee A will prepare the following Accounts: (i) (ii) (iii) (i) (ii) Royalty payable Account. Lessor or landlords Account i.e., the account of B. Shortworkings Recoverable Account. Secondly, as landlord A will maintain the following accounts:Royalty Receivable Account. Sub-lessee Account i.e. the account of C. 31

(iii)

Royalty Reserve Account.

A will prepare two analytical tables in his books. First Analytical Table for the calculation of the royalties payable to B and the second Analytical Table for the calculation of royalties receivable from C. Illustration-6 : A obtained on Ist Jan 1990, from B a lease of some coal bearing land. The term being a royalty of Rs. 0.50 per ton of coal raised subject to a minimum rent of Rs. 2,000 p.a. with a right of recoupment of shortworkings over the first four years of the lease. A granted a sub-lease of part of the land to C and a royalty of Rs. 0.75 per ton merging into a minimum rent of Rs. 1,000 p.a. with a right of recoupment of shortworkings during the two years following the shortworkings. The output for the first five years as follows: Year A(tons) C(tons) 1990 2,200 800 1991 2,320 1,080 1992 2,600 1,400 1993 2,800 1,800 1994 3,600 2,400 Give the necessary Ledger Accounts in the books of A . Solution Royalties Payable Account
1990 Dec31 Rs. To B (@ 50P.on 2,200 + 800 tons) 1,500 1990 Dec31 Rs. By Royalties receiveable A/c (@ 50P. on 800 tons) By Production A/c

Total output(tons) 3,000 3,400 4,000 4,600 6,000

1,500 1991 Dec31 To B (@50P.on 2,320 + 1,080 tons) 1991 Dec31 1,700 By Royalties receiveable A/c (@ 50P. on 1,080 tons) By Production A/c

400 1,100 1,500

1,700

540 1,160 1,700

32

1992 Dec31

To B (@50P. on 2,600 + 1,400tons)

1992 Dec31 2,000 2,000

By Royalties receiveable A/c By Production A/c

700 1,300 2,000

1993 Dec31

To B (@50P. on 2,800 + 1,800tons)

1993 Dec31 2,300 2,300

By Royalties receiveable A/c By Production A/c

900 1,400 2,300

1994 Dec31

To B (@50P. on 3,600 + 2,400tons)

1994 Dec 31 3,000 3,000

By Royalties receiveable A/c By Production A/c

1,200 1,800 3,000

The royalties paid on account of production done by C has been credited to Royalties payable account so that amount application on own production (i.e. production done by A) only is transferred to the Production Account) Shortworkings Account
1990 Dec31 Rs. To B (Rs.2,000 - Rs.1,500) 500 500 500 300 800 800 800 800 1992 Dec31 1993 Dec31 Dec31 By bal c/d 1990 Dec31 1991 Dec31 By bal c/d Rs. 500 500 800

1991 Jan01 Dec31

To bal b/d To B (Rs.2,000 - Rs. 1,700)

By bal c/d

800 800 800 300 500

1992 Jan01 1993 Jan01

To bal b/d

To bal b/d

By B By P & L A/c (Irrecoverable Shortworkings)

800

800

33

Bs Account 1990 Dec31 Rs. 2,000 1990 Dec31 Rs. By Royalty Payable A/c By Short Workings A/c 1,500 500 2,000 Rs. By Royalty Payable A/c By Short Workings A/c 1,700 300 2,000

To Bank a/c

2,000 1991 Dec31 Rs. 2,000 1991 Dec31

To Bank A/c

2,000

1992 Dec31

To Bank A/c

2,000 2,000

1992 Dec31

By Royalty Payable A/c

2,000 2,000

1993 Dec31 Dec31

To Short Workings A/c To Bank A/c

300 2,000 2,300

1993 Dec31

By Royalty Payable A/c

2300 2,300

1994 Dec31

To Bank a/c

3,000

1994 Dec31

By Royalty Payable a/c

3,000

Royalties Receivable Account

1990 Dec31 Dec31 Rs. To Royalties Payable A/c To P & L A/c 400 200 600 1991 Dec31 540 270 810 1990 Dec31 Rs. By C(on 800 tons @ 75P.) 600 600

1991 Dec31 Dec31

To Royalties Payable A/c To P & L A/c

By C(on 800 tons @ 75P.)

810 810

34

1992 Dec31 Dec31

To Royalties Payable A/c To P & L A/c

1992 Dec31 700 350 1,050 1993 Dec31 900 450 1,350 1994 Dec31 1,200 600 1,800

By C(on 800 tons @ 75P.)

1,050 1,050

1993 Dec31 Dec31

To Royalties Payable A/c To P & L A/c

By C(on 800 tons @ 75P.)

1,350 1,350

1994 Dec31 Dec31

To Royalties Payable A/c To P & L A/c

By C(on 800 tons @ 75P.)

1,800 1,800

Shortworkings Suspense Account

1990 Dec31 Rs. 400 400 1990 Dec31 Rs. By C (Rs.1,000-600) 400 400 400 190 590

To Bal. c/d

1991 Dec31

To Bal. c/d

590

1991 Jan 1 Dec31

By Bal. b/d By C (Rs.1,000-810)

590 1992 Dec31 1992 Jan 1

To C To P & L A/c(Irrecoverable shortworkingss of 1990) To Bal c/d

50

By Bal. b/d

590

350 190 590 Rs. 190 190 1993 Jan 1

590 Rs. 190 190

1993 Dec31

To C

By Bal. b/d

35

Cs Account
1990 Dec31 Dec31 Rs. To Royalty Receivable A/c To Shortworkings Suspense A/c 600 400 1,000 1991 Dec31 810 190 1,000 1992 Dec31 1,050 1,050 1993 Dec31 To Royalty Receivable A/c 1993 Dec31 1,350 1,350 1994 Dec31 To Royalty Receivable A/c 1994 Dec31 1,800 1,800 1,800 By Bank A/c By Shortworkings Suspense A/c By Bank A/c By Shortworkings Suspense A/c By Bank A/c By Bank A/c 1990 Dec31 By Bank A/c Rs. 1,000

1,000 1,000

1991 Dec31 Dec31

To Royalty Receivable A/c To Shortworkings Suspense A/c

1,000

1992 Dec31

To Royalty Receivable A/c

50 1,000 1,050

190 1,160 1,350 1,800

Production Account
1990 Dec 31 Rs. To Royalty Payable A/c 1,100 Rs.

1991 Dec 31

To Royalty Payable A/c

1,160

1992 Dec 31

To Royalty Payable A/c

1,300

36

1993 Dec 31

To Royalty Payable A/c

1,400

1994 Dec 31

To Royalty Payable A/c

1,800

Profit & Loss Account

Rs. 1990 Dec31 Rs. By Royalty Receiable A/c 200

1991 Dec31

By Royalty Receiable A/c

270

1992 Dec31 Dec31 1993 Dec31 Rs. To Shortworkings 500 1994 Dec31 1993 Dec31

By Royalty Receiable A/c By Shortworkings Suspense A/c By Royalty Receiable A/c

350 350 Rs. 450

By Royalty receiable a/c

600

Royalties regarding Brick-making and Nazrana paid to landlord The royalty for brick-making is paid on sand taken out at the rate of per cubic feet to the owner of the land. Sometimes, in addition to royalty, landlord charges from the lessee a lumpsum amount in the very beginning which is known as Nazrana or Advance Royalty. In such a case a Nazrana Account is opened separately and whole of the amount divided by the period of the lease is debited to Profit & Loss A/c every year the amount so arrived. 37

Illustration-7 : A Brick Co., acquired on a 20 years lease, a large plot of land from Anoop for the purpose of geeing earth. The lease provides that:(a) (b) A premium or Nazrana of Rs. 10,000 is to be paid to the landlord on Ist Jan, 1982 when the period of the lease commenced; and An annual royalty of 20 paise per 100 cubic feet of earth taken out is to be paid to him subject to a minimum rent of Rs. 2,000 per year, any shortworkings to be recouped out of future excess royalty. This annual royalty is to be paid on 31st Dec. each year.

The quantity of earth extracted by the lessee in 1982, 1983 and 1984 was 8,00,000; 9,00,000 and 12,00,000 cubic feet respectively. Enter these transactions in the ledger of the three years in the books of A Brick Co. Solution Analytical table
Year Output Royalties Minimum Rent S.W. S.W. recouped Unrecouped S.W transferred to P & L a/c Payment to land lord

1982 1983 1984

8,00,000 9,00,000 12,00,000

1,600 1,800 2,400

2,000 2,000 2,000

400 200 -

400

2,000 2,000 2,000

Lease premium or Nazrana Account

Dr. 1982 Jan01 To Cash A/c Rs. 10,000 10,000 1982 Dec31 Dec31 By P & L A/c By Bal c/d Cr. Rs. 500 9,500 10,000

38

1983 Jan01

To Cash A/c

9,500 9,500

1983 Dec31 Dec31

By P & L A/c By Bal c/d

500 9,000 9,500

1984 Jan01

To Cash A/c

9,000 9,000

1984 Dec31 Dec31

By P & L A/c By Bal c/d

500 8,500 9,000

Royalties Account
Dr. 1982 Dec31 1983 Dec31 1984 Dec31 To Anoop Rs. 1,600 1,600 1,800 1,800 2,400 2,400 1982 Dec31 1983 Dec31 By P & L a/c Cr. Rs. 1,600 1,600 1,800 1,800 2,400 2,400

To Anoop

By P & L a/c

To Anoop

Dec31

By P & L a/c

Shortworking Account
Dr. 1982 Dec31 1983 Jan01 Dec31 To Anoop Rs. 400 400 400 200 600 1982 Dec31 1983 Dec31 By Bal. c/d Rs. 400 400 600 600 1984 Dec31 Dec31 Cr.

To Bal b/d To Anoop

By Bal. c/d

1984 Jan01

To Bal b/d

600 600

By Anoop By Bal c/d

400 200 600

39

Anoops Account
Dr. 1982 Dec31 Cr. To Cash A/c Rs. 2,000 2,000 1983 Dec31 To Cash A/c 2,000 2,000 1984 Dec31 Dec31 1984 Dec31 1983 Dec31 Dec31 By Royalties A/c By S.W. A/c 1,800 200 2,000 1982 Dec31 Dec31 By Royalties A/c By S.W. A/c Rs. 1,600 400 2,000

To S.W.A/c To Cash A/c

400 2,000 2,400

By Royalties A/c

2,400 2,400

No right to recoup shortworkings Sometimes nothing is mentioned in the question about the recoupment of shortworkings. In such cases, shortworkings account is not to be opened at all and the landlord is to be paid the amount of royalties or the minimum rent, whichever be the higher. There is no need to calculate the short-workings in such type of problems. 4.5 SUMMARY Royalty is a periodical payment based on output or sale for the use of a certain asset or right like mine, copyright or patent to its owner. Royalty account is a nominal account in nature and is synonymous with rent account. Before preparing the royalty accounts, a few points like name of landlord and lessee, period of lease commencement of agreement, royalty rates, minimum rent, right of recoupment of shortworkings and mode of payment to landlord should be noted down. While passing journal entries in the books of lessee, these may be three 40

situations- when minimum rent is more than royalty equal to royalty and less than royalty. In the books of the lessor or landlord, the accounting treatment will be the reverse of lessee. Sometimes, the terms of the original lease may empower the lessee to sublet a part of land or mine to another person as a sub-lease. 4.6 KEYWORDS

Royalty: It is a periodical payment based on output or sale for the use of a fixed asset or right to its owner. Lessor: The person who is the owner of the assets and surrenders the right to its use to some other person and receives the consideration as royalty is known as lessor. Minimum Rent: It is the minimum amount that the lessor or landlord must receive whatever be the production or sales in a particular year. Shortworking: The excess of minimum rent over royalty calculated on the basis of output or sales is known as shortworking. Lessee: The person who pays the royalty in consideration for the use of that asset is called lessee. 4.7 1] SELF ASSESSMENT QUESTIONS (a) What do you understand by Royalty ? How does it differ from Rent? (b) What is shortworking ? Give the rules of accounts in this connection. 2] Explain the following terms: (a) (b) (c) (d) (e) Minimum Rent Sub -Lease Royalty Reserve Advance Royalty Re-coupment of Shortworkings 41

3]

Pass the journal entries in the books of Lessee when : (a) (b) Royalty is more than the minimum rent . Royalty is less than the minimum rent .

4]

Parbhat Coal Company took a lease of coal mine for a period of 10 years

from 1st January, 1979 upon the terms of a royalty of 80 paise per ton with a minimum rent of Rs. 10,000 per annum with power to recoup shortworking over the first five years of the lease. Output are as follows: 1979 1980 4,000tons 1981 6,000tons 1982 10,000tons 1983 16,000tons 1984 25,000tons 30,000tons

Prepare journal entries and ledger accounts in the books of Parbhat Coal Company. 5] On Ist January, 1978 Manoj Coal Co., Ltd. took a lease of Coal Mine from

X at a Royalty of 50 paise per ton raised with a minimum rent of Rs. 5,000 per year and with a right to recoup shortworkings during the first four years of the lease. During the first five years, the output were as follows: Years Output(Tons) 1978 6,000 1979 7,000 1980 10,200 1981 12,000 1982 14,000

Give journal entries and write up the Minimum Rent A/c, Royalty A/c, Landlords A/c and Shortworkings A/c in the books of Manoj Coal Co. 6] Rama Coal Company took a coal mine on lease for a period of 20 years

from 1st Jan., 1992 on a royalty of Rs. 2 per tonne of the output payable half yearly on 30th June and 31st December. The Minimum Rent was fixed at Rs. 24,000 per year with power to recoup shortworkings over the first three years of the lease.

42

The output was as follows:Half year ending 30th June, 1992 Half year ending 31st December, 1992 Half year ending 30th June, 1993 Half year ending 31st December, 1993 Half year ending 30th June, 1994 Half year ending 31st December, 1994 2,000tons 2,500tons 5,000tons 8,000tons 11,000tons 4,500tons

Rama Coal Company prepares its final accounts annually on 31st Dec. every year and the royalty which was due on 31st Dec., 1993 was in fact paid on 10th Jan. 1994. You are required to record the above transactions in the ledger of the Rama Coal Company and also to show the items in the Profit & Loss A/c and Balance Sheet. 7] X leased a coal mine from Y on a royalty of 75 paise per ton with a minimum

rent of Rs. 24,000 per annum. Each years excess of minimum rent over the actual royalties was recoupable during the subsequent three years. The lease, however, stipulated that in the event of strike, the minimum rent would be reduced proportionately. The output was as follows: 1989 1990 1991 1992 1993 1994 6,000tons 18,000tons 36,000tons 50,000tons 44,000tons(Strike for 2 months) 20,000tons(Strike for 73 days)

Prepare necessary accounts in the books of X. Also show the amounts in each years P & L A/c and Balance sheet. 43

8]

The Binnie Colliery Company are lessee of a mine at a dead rent of Rs.

2,000 per annum merging into a royalty of 35 paise per ton. Dead Rent paid in excess of actual royalties is recoupable thereout during the five years succeeding the year in respect of which such excess was paid. In the event of a strike if the actual royalty was less than the dead rent, it was to discharge all rental obligations. The first year in respect of which the dead rent was payable expired on 31st December 1980. The excess paid in comparison to royalty in respect of first year was Rs. 2,000 excess paid in second year was Rs. 1,450 and excess paid third year was Rs. 350. In the fourth year actual royalties amounted to Rs. 2,750, in the fifth year Rs. 3,250, in the sixth year Rs. 3,600 and in the seventh year (in consequent of a strike) Rs. 1,850 only. Pass the necessary journal entries to record these transactions in the books of Binnie Colliery Company. 9] On 1st Jan., 1990 Tagore & Co., took a mine on lease. Under this lease

there is payable a royalty of 80 paise per ton merging in a minimum rent of Rs. 10,000 per year with a right to recoup shortworkings over the first five years of the lease, but (1) the right to recoup shortworkings will not be in that year in which output will be less than 6,000tons. (2) In the year in which royalty will be more than minimum rent, only 40% of the excess will be used for recoupment of shortworkings. During the first five years the coal raised was as below:Year Output in tons 1990 5,000 1991 8,000 1992 12,000 1993 15,000 1994 20,000

Prepare necessary accounts in the books of Tagore & Co. 10] X Co. Ltd. hold a lease of minerals from Y for a period of 20 years from

1st Jan., 1989. Under this lease there is payable a royalty of 25 paise a ton merging in a minimum rent of Rs. 1,000 a year, payable half-yearly on 30th June and 31st Dec. They granted a sub-lease for 15 years from 1st July, 1989 to Z Co. Ltd., of 44

one-half of the area for a royalty of 50 paise a ton merging in a minimum rent of Rs. 750 a year, payable half-yearly on 30th June and 31st Dec. X Co. Ltd. are entitled under the lease from Y to recoup Shortworkings out of subsequent excess workings throughout the term of lease, but the sub-lease only allows Z Co. Ltd. to recoup shortworkings out of excess workings, in any of the three half-years immediately following that in which the shortworkings occurred. Minerals were worked as follows: By X Co. Ltd. Half-year ended 30.06.1989 Half-year ended 30.12.1989 Half-year ended 30.06.1990 Half-year ended 30.12.1990 Half-year ended 30.06.1991 500tons 625tons 2,150tons 3,150tons 2,800tons By Z Co. Ltd. 375tons 450tons 450tons 900tons

Show the necessary accounts in the Books of X which are balanced on 30th June. 11] On 1st January, 1981, Shri Som Nath acquired on lease certain oil wells at

a minimum rent of Rs. 24,000 per annum, merging into a royalty of Re.1 per ton of oil taken out. The shortworkings were recoverable in the next two years, but on the condition that if full shortworkings could not be recovered in the next year of the shortworkings, Som Nath will lose his right to recover 50% of the unrecovered balance of shortworkings. The output of the first four years was 6,000 tons in first year, 15,000 tons in the second year, 30,000 tons in the third year and 28,000 tons in the fourth year. Open the necessary accounts in the books of Shri Som Nath.

45

12] X, the owner of a patent of Sewing Machines, granted on 1st July, 1985, a licence for its manufacture to Y at a royalty of Rs. 20 per machine manufactured subject to a minimum rent of Rs. 50,000 per annum for the first two years and Rs. 60,000 per annum thereafter. If in any year the royalties calculated on the machines manufactured amounted to less than the minimum rent, Y has the right to recoup from the surplus during the next two years. Number of machines manufactured was follows: Upto 30th June, 1986 Upto 30th June, 1987 Upto 30th June, 1988 Upto 30th June, 1989 Upto 30th June, 1990 2,000 Machines 2,200 Machines 2,750 Machines 3,300 Machines 3,500 Machines

Assuming that the annual accounts are closed on 30th June, pass the journal Entries in the books of Y and prepare shortworkings account. 4.8 1. SUGGESTED READINGS Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana. 2. 3. Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi. Principles of Financial Accounting by P.C. Gupta and C.L. Chaturvedi, Shree Mahavir Book Depot, New Delhi. 4. Financial Accounting by A. Karim, S.S. Khanuja and Piyush Mehta, Sahitya Bhawan Publishers, Agra.

46

LESSON : 5
ACCOUNTING FOR PARTNERSHIP : BASIC CONCEPTS AND COMPUTATIONS, ADMISSION OF NEW PARTNER
STRUCTURE 1.0 5.1 5.2 5.3 5.4 5.5 5.6 5.7 5.8 5.9 5.0 Objective Introduction Essential Features of a Partnership Partnership Deed Peculiar Aspects of Accounting for Partnership Firms Admission of a Partner Summary Keywords Self Assessment Questions Suggested Readings OBJECTIVE

After reading this lesson, you should be able to a) b) Explain the important clauses in a partnership deed. Understand the peculiar points relating to accounting for partnership firms. c) 5.1 Compute the value of goodwill of the firm. INTRODUCTION The Indian Partnership Act of 1932 contains the main provisions which are applicable to partnership firms working in India. According to this Act "Partnership is the relation between persons who have agreed to share the profit of the business carried on by all or any of them acting for

all". Individually the persons who work in the firm are called partners and the name with which all partners work collectively is called the firm's name. For example, A, B and C working in a firm will be called partners and 'ABC & Co.', the name with which these partners work collectively will be called firm's name. 5.2 ESSENTIAL FEATURES OF A PARTNERSHIP The following are the essential features of a partnership firm: i) Persons: In order to constitute a partnership firm, there must be at least two persons. The maximum number in partnership is 20 in case the firm is doing ordinary business and 10 in case the firm is engaged in banking business. This is as per Section 11 of the Companies Act, 1956. ii) Agreement: In order to have a partnership, it is necessary that there must be an agreement between partners. iii) Sharing of profits: It is one of the important terms to constitute a partnership firm. Generally sharing of profits (or losses) is one of the important element to constitute a firm. iv) Business: It includes trade, covation and profession. The firm must be engaged in a lawful business. v) Management: The management of the partnership firm will be done either by all the partners or any one of them on behalf of all other partners. There is mutual agency among the partners. Following are the characteristics of partnership : 1. 2. 3. It is a contract between two or more than two persons. A contract is necessary for division of profits/losses. The business may be carried on by all or any of them acting for all.

5.3

PARTNERSHIP DEED A document in which the terms and conditions of partnership are given

is called Partnership Deed. In a partnership deed, the rights and duties of partners are given. If there is no partnership deed of a firm, all the provisions of Partnership Act, 1932 will be applicable with regard to duties, rights and liabilities of partners. A partnership deed should contain the following points : 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. Date of agreement. Name and address of the partnership firm. Name and address of the partners. Nature and place of business. Period of partnership, if any. Capital of partners. Profit sharing ratio. Drawings of partners. Interest on capital and on drawings. Salary and commission of partners, if any. Rights, duties and functions of partners. Method of valuation of goodwill. Accounting method at the time of retirement or death of a partner. Arbitration clause to settle disputes among the partners. Method of distribution of assets on the dissolution of the firm. Accounting treatment or procedure at the time of dissolution. Accounting procedures. Any other provision.

5.4

PECULIAR ASPECTS OF ACCOUNTING FOR PARTNERSHIP FIRMS In sole trading, there is only one owner who invests the capital. The

Capital and Drawing accounts are opened in his name. But in partnership, Capital Account, Current Account and Drawings account of each partner are opened separately. In a partnership contract, all terms and conditions on the basis of which partnership is started are defined. This contract may be oral or written. To avoid future disputes, the contract should be in writing, which is called the partnership deed. In the absence of a written contract, the following rules apply : 1. 2. 3. 4. Distribution of profit and loss among the partners will be equal. No interest on capital will be allowed. No interest will be charged on drawings. No salary is allowable to any partner for doing work in the capacity of a partner. 5. 6. Interest on loan other than capital is allowed @ 6% per annum. Every partner can equally share the assets of firm at the time of dissolution. Profit and Loss Appropriation Account In partnership, the method of preparing final accounts is the same as for sole trading. However, in a partnership firm, Profit and Loss Appropriation Account is required to be prepared to distribute the profits among the partners. The format of the Profit and Loss Appropriation Account is as under :

Profit and Loss Appropriation Account Rs. To Profit and Loss A/c, if any ------(current year loss) To Interest on Capital To Salary to Partners To Commission to Partners ------------------By Profit and Loss A/c (Profit for current year) By Interest on Drawings By Capital Accounts or Current Account of Partners (Division of Loss) Rs. -------------------------

To Interest on Partner's Loan ------To Capital or Current Accounts of Partners (Division of Profit) Fixed and Fluctuational Capitals -------

Capital Accounts of partners may be fixed or fluctuating. If Capital Accounts are fixed, two accounts are prepared for each partner: (i) partner's Capital Account and (ii) partner's Current Account. In case of fixed capital, partners' Capital Account are credited only with that amount of capital at which business is started. Later on, if additional capital is invested, the capital account is credited and it is debited with the amount withdrawn permanently. No other adjustment is made in this account. In partners' Current Accounts, all adjustments regarding interest on capital, salaries, share of profit and drawings are shown. The balance of this account always varies and that of Capital Account remains the same. In case of fluctuating capital, only one account is prepared, which is called Capital Account. In this account, all items relating to additional capital,

interest, drawings, share of profit and salaries, etc. are shown. The balance of this type of Capital Account in the beginning and in the end will be different and, as such, it is called Fluctuating Capital Account. Interest on Capital and Drawings Interest on capital is allowed only if it is allowed and interest on drawings is charged only if there is an agreement in this regard. Interest is calculated by considering the interest rate and time. Interest on capital is written on the Debit side of Profit and Loss Adjustment Account and Credit side of partners' Capital Account or Current Account. On the other hand, interest on drawings is written on the Credit side of Profit and Loss Adjustment Account and again on Debit side or Capital Account of Current Account. Illustration 1: A and B are partners and they had Rs. 1,50,000 and Rs. 2,50,000 in their Capital Accounts as on 1st January, 1993. A paid a further sum of Rs. 50,000 on 1st July, 1993 and another Rs. 25,000 on November 1, 1993. B paid Rs. 1,00,000 on April 1, 1993 and another Rs. 25,000 on August 1, 1993. A withdrew Rs. 1,000 per month at the beginning of every month and B Rs. 1,000 at the end of every month. 5% per annum interest on capital and on drawings is to be considered. Calculate the interest payable and chargeable. Solution Interest on Capital : A Interest on Rs. 1,50,000 of one year = 1,50,000 5/100 = Rs. 7,500 Interest on Rs. 50,000 for 6 months = 50,000 1/25100 = Rs. 1,250 Interest on Rs. 25,000 of 2 months = 25,0002/125/100= Rs. 208.33 8958.33

Alternative Method Product Method: Under this method the product of capital invested and the number of months for which it remained in business are determined first and then interest is calculated for one month on the product. In the above case during first 6 months capital was Rs. 1,50,000, for next four months it was Rs. 2,00,000 and for the last two months it was Rs. 2,25,000. Hence, calculation of interest by product method are as under : Interest (Rs. 150000 6 + 200000 4 + 225000 2) for one month at 5% per annum. =(900000 + 800000 + 450000) 5/100 1/12 = Rs. 8958.33 B
Interest on Rs. 1,00,000 for 9 months = Rs. 1000005/1009/12 Interest on Rs.2,50,000 for one year = Rs. 2500005/100 Interest on Rs.25000 for 5 months = Rs. 250005/1005/12 = Rs. 3,750.00 = Rs. 12,500.00 = Rs. 520.83 ----------16,770.83 ------------

Alternative Method Product Method : (2500003 + 3500004 + 3750005) for 1 month at 5% per annum. = (750000 + 1400000 + 1875000) 5/100 1/12 = Rs. 16770.83 Interest on Drawings Because the same amount either at the beginning or at the end or each month is withdrawn by a partner, the interest can be calculated by the following simple formula : n(n+1) 2 Where, n = the number of months for which interest is payable for the 7

A.

The number of months for which interest is to be calculated =

first installment, here, n = 12 =12(12+1) = 2 78 months

Interest = Rs. 1000 78/12 5/100 = Rs. 325 B or = (Rs. 1000 12) 6 5/100 = Rs. 325 12 Number of months = n(n+1) where n = 11, because the amount 2 is withdrawn at the end of every months. = 11 12/2 = 66 months Interest = Rs. 1000 66/12 5/100 = Rs. 275 or = (Rs. 1000 12) 5 5/100 = Rs. 275 12

Notes 1. If the same amount is withdrawn at the beginning of every month, then 6 month's interest will be calculated on total drawings. 2. If the amount is withdrawn at the end of every month, the interest is calculated on total drawings for 5 months. 3. If the amount is withdrawn in the middle of every months, 6 months' interest is calculated on total drawings. 4. If interest on drawings is being calculated but dates of withdrawal are not given, then 6 months interest will be calculated on total drawings. Minor Partner A partner who has not attained the age of majority is called a minor partner. As

no agreement can be entered into with a minor, he can only be admitted to the benefits of an existing partnership with the consent of all the partners. A minor partner is not personally liable for the debts of the partnership firm but his share in the partnership property and profits of the firm will be liable for firm's debts and obligations. He will not be personally liable for any debt of the firm until he attains the age of majority. He is not liable to share the loss if there is any. Within six months of his attaining majority or when he comes to know that the enjoys the benefits of partnership (whichever date is later), he has to elect whether or not he wants to continue as a partner. He must give public notice if he dos not want to continue as a partner otherwise he will be deemed to have elected to be a partner. He will become liable for the debts of the firm since he was admitted to the benefits of the partnership firm on his election as a partner. Illustration 2: Since 1st January, 1996 A, B and minor C are equal partners. Their Balance Sheet as on 31-12-1999 is as follows: Liabilities Sundry Creditors Accumulated Balance in Profit & Loss A/c Capital Accounts: A B C 40,000 40,000 20,000 1,00,000 2,00,000 9 2,00,000 Sundry Debtors Stock in Trade Plant & Machinery Land & Building 40,500 24,500 35,000 60,000 Rs. 40,000 60,000 Assets Cash in hand Cash at Bank Rs. 15,000 25,000

(i)

Accumulated balance in Profit and Loss Account as given in the Balance

Sheet consists of the following: Profit of 1997 Rs. 36,000, Loss of 1998 Rs. 18,000, and Profit of 1999 Rs. 42,000. (ii) Analysis of the books of accounts disclosed the following errors: (a) A machinery costing Rs. 12,000 purchased in 1998 was debited to Repairs Account. 10% depreciation on reducing balance method is provided on plant and machinery. (b) Rs. 1,080 being the fixed deposit interest due to the firm used by A for his personal expenses in 1999. (c) Goods costing Rs. 12,000 sent on sale or return basis have been recorded as credit sale. The firm's gross profit ratio is 20% on sales. Prepare Partners' Capital Accounts and Balance Sheet of the firm as on 31-12-1999 giving effect to the above adjustments. Solution Calculation of correct profit for various years
1997 Rs. Profit (Loss) as given Add: Machinery wrongly debited to Repairs A/c Add: Fixed deposit interest of the firm used by A for personal expenses 36,000 Less: 10% Depreciation on WDV of Machinery Less: Gross Profit on Rs. 12,000 (Goods on sale or return basis wrongly treated as sale) not yet realised @ 25% on cost Correct Profit (Loss) Share of: A B C (Minor Partner) 36,000 (6,000 (1,200) (7,200) 43,080 1,080 42,000 36,000 1998 Rs. (18,000) 12,000 1,080 1999 Rs. 42,000

36,000 12,000 12,000 12,000

(7,200) (3,600) (3,600) -

3,000 39,000 13,000 13,000 13,000

10

C being minor partner will not share the loss of 1998 as a minor partner can be admitted to the benefits of the firm. Partners' Capital Accounts
A Rs. To Fixed Deposit Interest To Balance c/d 1,080 60,320 B Rs. C Rs. By Balance b/d (Opening Capital) By Profit/Loss (Transfer) (for 3 years) 61,400 61,400 45,000 21,400 61,400 21,400 61,400 25,000 45,000 A Rs. 40,000 B Rs. 40,000 C Rs. 20,000

61,400 45,000

Balance Sheet of A, B and C as at 31-12-1999

Liabilities Sundry Creditors Capital Accounts: A B C

Rs. 40,000

Assets Cash in hand Cash at Bank

Rs. 15,000 25,000 25,500 36,500 44,720

60,320 61,400 45,000

Sundry Debtors (1) Stock in Trade (2) Plant & Machinery (35,000+12,0001,2001,080) Land & Building

60,000 2,06,720

2,06,720

11

(1)

Sundry Debtors as given Less: Goods on approval basis wrongly treated as credit sale (Cost Rs. 12,000+Rs. 3,000 Profit = Rs. 15,000 sale) Debtors

40,500

15,000 25,500 24,500 12,000 36,500

(2)

Stocks as given Add: Cost of goods sent on approval basis Closing Stock

Past Adjustments Sometimes after closing the accounts of a partnership firm, it is discovered that there was some error or omission in those accounts. For example, interest o capitals or drawings may have been omitted at all, charged or allowed at high or too low a rate, profits and losses may have been distributed among the partners in a wrong proportion and so on. In order to correct these errors and omissions, adjustment entries are to be passed in the usual way. Illustration 3: A and B had been in partnership for many years as valuers, sharing profits equally, it had been their custom to ignore fee, earned on uncompleted matters, when preparing annual accounts. On 1st January, 1996 they entered into a new partnership agreement under which the profits earned in any year were to be distributed as follows: Up to Rs. 8,000 equally. Excess over Rs. 8,000 one-third to A and two-third to B. Although they shared profits in accordance with new agreement, they continued to prepare their accounts upon the old basis, i.e., ignoring fees earned on uncompleted work. At the end of 1998, it was pointed out to them that they were not following the terms of their agreement, and it was agreed that such 12

correcting entries as might be necessary should be put through as on 31st December, 1998. The profits already dealt with were as follows: 1996 Rs. 7,500, 1997 Rs. 8,2010; 1998 Rs. 9,350. The outstanding fees not brought into accounts were: Rs. On 31st December 1995 On 31st December 1996 On 31st December 1997 On 31st December 1998 960 1,280 1,550 920

Assuming that the books were duly closed at the end of each year, give the entries necessary to correct the partners' accounts. Solution As the fees outstanding had not been brought into accounts, the profit already dealt with the wrong. The correct profits after taking these fees into account would be as follows:
Year Profit as given (1) (2) Rs. 1995 1996 1997 1998 7,500 8,210 9,350 Add Fees outstanding at the end of the year (3) Rs. 960 1,280 1,550 920 Less Fees outstanding at the beginning of the year (4) Rs. 960 1,280 1,550 (5)=(2)+(3)(4) Rs. 960 7,820 8,480 8,720 Correct Profit

The profit already distributed and the profit as should have been distributed are given in the following Table: 13

Year

Profits as already distributed Profit as given Rs. A's share Rs. 3,750 4,070 4,450 12,270 B's share Rs. 3,750 4,140 4,900 12,790

Profit as should have been distributed Correct Profits Rs. 960 7,820 8,480 8,720 25,980 A's share Rs. 480 3,910 4,160 4,240 12,790 B's share Rs. 480 3,910 4,320 4,480 13,190

1995 1996 1997 1998 Total

7,500 8,210 9,350 25,060

A has been credited with Rs. 12,270 while he ought to have been credited with Rs. 12,790. Thus he should be credited with Rs. 520 (Rs. 12,790 Rs. 12,270) more. B has been credited with Rs. 12,790 while he ought to have been credited with Rs. 13,190. Thus he should be credited with Rs. 400 (Rs. 13,190 Rs. 12,790) more. The following entry is required to correct the Partners' Accounts. Rs. Fee outstanding account To A's Capital Account To B's Capital Account (Being outstanding fee brought into account) Guarantee Sometimes, a partner is taken into the firm on the guarantee that he shall be given a minimum amount of the profits of the firm oven if there are no Dr. 920 520 400 Rs.

14

profits or his share of profit falls short of the guaranteed amount. This guarantee to the new partner can be given by one of the existing partners or all the existing partners. For accounting purposes, the guaranteed amount due to the new partner should be deducted out of the total profits. Then profits of the remaining partners should be ascertained from the residue (i.e. total profit minus the guaranteed amount payable to the new partner) and divide the same in the new profit sharing ratio of the existing partners. This will be more clear from the following illustrations. Illustration 4: Red, White and his son Blue were partners in the firm of M/s Red and White. On 1st April, 1998 Green the Manager was admitted as a partner. Profits and losses in the new partnership were to be shared as follows: Red 4/10, White 3/10, Blue 2/10 and a salary of Rs. 600 per annum, and Green 1/10. Green has previously been paid a salary of Rs. 1,000 per annum and a commission of 3 per cent of the profits, after changing his salary and commission, but before charging any partner's salary. It was agreed that for the first year of the new partnership, any excess of his share of the profit over the sum he would have earned had he remained Manager increased by Rs. 700, should be charged to Red's share of profit. On considering the draft accounts for the year ended 31st March, 1999, the partners agreed to the following adjustments: (a) to provide for a staff bonus of Rs. 5,500. (b) That Red's son Grey, an employee of the partnership, should receive an additional bonus of Rs. 250 chargeable against his father's share of profit. (c) that Rs. 500 of White's share of profit should be credited to his son Blue. 15

The profits for the year, before making the above adjustments and before charging Blue's salary amounted to Rs. 32,000. You are required to prepare a statement showing the division of profits between partners. Solution Profit and Loss Adjustment Account for the year ended 31st March, 1999
Rs. To Green's Capital A/c To Balance c/d 2,590 23,310 25,900 To Red's Capital A/c (4/9) To White's Capital A/c (3/9) To Blue's Capital A/c (2/9) 10,425 7,819 5,213 23,457 By Balance b/d By Red's Capital A/c (Amount of Guarantee) (iii) 147 23,457 25,900 23,310 By Net Profit (i) Rs. 25,900

Statement showing the final summary of division of profit Red Rs. Salary Profits Transfer from White to Blue Bonus payable to Grey Excess amount debited for the guarantee given (-) 147 10,028 16 7,319 6,313 2,590 10,425 (-) 250 White Rs. 7,819 (-) 500 Blue Rs. 600 5,213 (+) 500 Green Rs. 2,590 -

Working Notes (i) Distributable Profit: Profit as disclosed by accounts Less: Staff Bonus Rs. 32,000 5,500 26,500 Salary to Blue Profit to be distributed among partners 600 600 25,900 (ii) Remuneration which Green would have received as Manager: Salary Commission: (26,500 1,000) 3/103 1,000 743 1,743 (iii) Amount now being paid to Green: 1/10 of Profits (Rs. 25,900) Excess amount [2,590 (1,743 + 7000)] debited to Red 5.5 ADMISSION OF A PARTNER Sometimes a running business may require new partner for the following reasons : 1. 2. Need of more capital for expansion of business. Need of expertise in managerial or technical field for running the business. 3. 4. For growth of the business by admitting a reputed person as partner. To admit a new partner in place of an old retiring partner. 2,590 147

When a new partner is admitted in business, he gets two types of rights.

17

1.

Right to Share Future Profit-Loss of the Business When a new partner is admitted in the business, he gets the right to

receive profit in an agreed ratio. This share in profit is sacrificed by the old partners. To compensate the old partners for this sacrifice, the new partner pays a price in the form of goodwill adjustment. The method of valuation of goodwill is usually given in the partnership contract. When new partner comes into partnership, the profit sharing ratio of old partners is changed. 2. Right to Share in Assets of the firm When a new partner is admitted in the firm, he also becomes the owner of firm's assets as per his share, for which he brings in the required capital. Hence, at the admission of a new partner, revaluation of assets and liabilities becomes necessary so that there should be no loss to the old partners or the new partner. At the time of admission of a new partner, the following are the main considerations which must be settled between the old and the new partners: 1. 2. Determination of new profit sharing ratio. Determination of the value of goodwill and its allocation among old partners. 3. 4. 5. Revaluation of assets and liabilities of the existing business. Distribution of accumulated profits, reserves and losses. Determination of the capital to be brought in by the new Partner. Each point is discussed in detail in the following pages : Determination of New Profit Sharing Ratio When a new partner joins the firm, the share of old partners is reduced because they sacrifice some part of their share to the new partner. The determination of new profit-sharing ratio depends upon the agreement among the old and new partners. In what ratio the new partner gets 18

his share from the old partners depends upon their agreement. Thus on admission of a new partner, what the new ratio of all the partners will be is an important question. In various circumstances, the calculation of new profit-sharing ratio is made as follows : If Share of New Partner is Given : When the share of new partner is given and in the absence of any direction, the old partners will continue to share the remaining share in their old profit sharing ratio after deducting the share of the new partner.

Illustration 5 Yogu and Ankit are partners sharing profits and losses in the ratio of 3:2. They admit Atul as a partner for one fourth share in the future profits. Calculate the new profit-sharing ratio of partners. Solution Atul's share is 1/4 Thus remaining share = 1 - = Hence Yogu's share = 3/5 = 9/20 Now Ankit's share = 2/5 = 6/20 and Atul's share = or 5/20 = 9/20 : 6/20 : 5/20 Hence, the new profit sharing ratio will be = 9 : 6 : 5. When the New Partner Purchases His Share From Old Partners in a Certain Ratio In this case, the share of old partners will be calculated by deducting that portion which they have sacrificed in favour of a new partner. The remaining

19

share will be treated as the share of old partners. This will be clear from the following example : Illustration 6 A and B are partners in a firm sharing profits and losses in the ratio of 3: 2. A new partner C is admitted. A surrenders 1/5 share of his profit in favour of C, and B surrenders 2/5 of his share in favour of C. Calculate the new profitsharing ratio of the partners. Solution Sacrifice by A to C Sacrifice by B to C Share of C A's new share B's new share Share of A, B and C = = = = = = = When Sacrificing Ratio is given In this case, the sacrifice made by old partners towards the new partner is given. This is clear from the following example : 3/5 1/5 2/5 2/5 = 3/25 = 4/25

3/25 + 4/25 = 7/25 3/5 - 3/25 2/5 - 4/25 = (15-3)/25 = 12/25 = (10-4)/25 = 6/25

12/25 : 6/25 : 7/25 12 : 6 : 7

Illustration 7 A and B are partners sharing profit or loss in the ratio of 7:5. They admit their manager C into partnership who is to get one sixth share in the profits. He acquires his share as 1/24 from A and 1/8 from B. Calculate the new profit sharing ratio

20

Solution (Old Ratio - Share given to new partner) A = 7/12 - 1/24 = (14-1)/24 = 13/24 B = 5/12 - 1/8 = (10-3)/24 = 7/24 C = 1/6 New ratio = 13/24 : 7/24 : 1/6 = 13 : 7 : 4 Sacrificing Ratio When Old and New Ratios are Given In case, when old and new ratios of partners after admission of a partner are given, it is necessary to calculate the sacrificing ratio of the old partners by the formula: Sacrificing Ratio = Old Ratio - New Ratio. Illustration 8 X and Y are partners sharing profits or losses in the ratio of 4:3. Z is admitted and the new ratios are X-7, Y-4 and Z-3 (7:4:3:). Calculate the sacrificing ratio. Solution Sacrificing Ratio = (Old Ratio - New Ratio) X's sacrifice = 4/7-7/14 = (8-7)/14 = 1/14 Y's sacrifice = 3/7 - 4/14 = (6-4)/14 = 2/14 Thus, sacrificing ratio is 1:2 for X and Y. Goodwill Goodwill is the value of the reputation of a firm. When a new partner is admitted in the partnership, he starts getting share in the profits of the firm immediately on his entrance. He gets the benefit of the firm's reputation which has been developed by old partners through their hard work and efforts. Hence, 21

the old partners want some compensation for their previous labour or efforts made by them to build the firm's reputation. The amount of compensation given by the new partner to old partners is called goodwill. It is an intangible asset which is not visible and touchable, but it is subject to fluctuations. In the words of Lord Macnaugten, "Goodwill is a thing very easy to describe, very difficult to define. It is the benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in customers. It is the thing which distinguishes an old established business from a new business at first start.....Goodwill is composed of a variety of elements. It differs in its composition in different trades and in different business in the same trade." "The probability that the old customers will report to the old place" is called goodwill - Lord Alden. When a new partner gives money for goodwill, he hopes that he would receive some extra profit from this amount,. If a new partner starts a new business, he will have to put in a lot of hard work and face difficulties to create and maintain customers. But when he becomes partner in an old established business, he does not face any such problem, and is therefore, wiling to pay for the effort and money spent on establishing the business and providing credibility to the firm. Thus, we can say that goodwill is the value of the reputation of a firm which is concerned with the earning capacity of the business. Element of Goodwill Goodwill means the capacity of the business to earn more than normal profit. In other words, it is the value of reputation of the business. It attracts more customers. It is an intangible asset of the business. When the reputation 22

of business gets established, its earning capacity becomes automatic. It takes time to develop goodwill which depends on many factors, mentioned as under: 1. 2. 3. 4. 5. 6. Personal reputation of the owners and manager. Speciality of goods or services provided. Favourable location or site. Patents, Copyrights or Trade Marks. Advantage of an important license with the firm. Advantage of selling a special type of product or raw material

For the above reasons, the firm gets or earns more profit and the one who purchases the goodwill of firm also purchases the name of the firm. It is important to note that goodwill exist only when the business is running in profit. In a business which is running at a loss, there will be no goodwill because the value of goodwill arises from the future possibility of the firm to earn profit. Need for valuation of goodwill of a firm : 1. On Admission of a New Partner : When a new partner comes into the

firm, he gets a share in the future profits. The share of the old partners is consequently reduced. So, the new partner has to pay for the goodwill besides his capital. The amount paid for goodwill is distributed among old partners in their sacrificing ratio. Valuation of goodwill depends on the agreement among old and new partners. 2. On Retirement or Death of a partner : As a new partner brings in the

amount of goodwill, in the same way, at the time of retirement, a partner receives his share of goodwill of the firm. At the time of death, the deceased partner's share of goodwill is to be given to his legal representatives. For this, the need for valuation of goodwill arises. 23

3.

On the Amalgamation of firms : When two or more than two firms are

merged and a new firm is formed, it is called amalgamation. At the time of amalgamation, like other assets and liabilities, goodwill is also value and becomes the part of purchase consideration like other assets. 4. On Sale of firm's business to another firm or company, it is very

important to value the firm's goodwill. 5. When profit sharing ratio of the partners is changed, there is a need to

evaluate the goodwill so that the losing partners could be compensated. Methods of Evaluating Goodwill The following are the important methods of valuation of goodwill : (A) Average Profits Method Under this method, the average of the profits of last three or four years is calculated. The average profits is multiplied by number of years in which the anticipated profits will be available. If the goodwill is twice the average profits of last three years, it is to be valued at two years's purchase of the last three years average profit. Value of Goodwill = Average profit Number of year's purchased. Formula = Total profits No. of years purchased No. of years

The following points need to be considered for valuation of average profit: 1. Abnormal Profit : If in any year, a firm earns abnormal profits, then it is

to be deducted from the firm's profits because it is not or usual or recurring nature. For example, profit due to rise in prices at the time of war of after

24

floods, etc. 2. Abnormal Loss : If in any year, a firm incurred any abnormal losses,

them it is added back to the profits. These abnormal losses include loss of stock due to fire, theft or floods, etc. 3. Normal Expenses : If there are any normal expenses which are of

recurring nature and are not deducted from the firm's profit, these should be deducted, such as insurance premium, etc. (B) Super Profit Method In this method, super profit is calculated and it is multiplied with a specific number to find out the goodwill. Super profit is the profit above the normal profit being earned by other firms engaged in the same business. If any old firm is earning equal to the profits being earned by other new firms engaged in the same type of business, there will be no value of the goodwill of the old firm. If the old firm is earning more profits than the new firm, there will be value of the goodwill of the old firm. The greater the difference in such profits, the higher will be the value of goodwill. For example, if the investment in the business is of Rs. 5,00,000 and the rate of profit considered appropriate in similar business is 15%, the normal profit will be Rs. 75,000 (5,00,000 15/100). This normal profit is compared with the actual profit earned. If the actual profit is more than the normal profit, it will be called super profit. Suppose further that the actual profit is Rs. 1,00,000, then (1,00,000 - 75,000) Rs. 25,000 is super profit. Goodwill = Super profit No. of years purchased. If the super profit will be available for three years, the value of

25

goodwill will be : Rs. 25,000 3 = Rs. 75,000 Goodwill = Super profit No. of years purchased Super Profit = Actual or Average Profit - Normal Profit Normal Profit = Capital Invested Normal Rate of Return/100 (C) Capitalisation Method Under this method, it is assumed that if capital invested by the firm earns a normal profit, there is no goodwill, but if firm earns more than normal profit, excess capital which might be invested to earn that excess profit is called goodwill. There are two ways of finding out goodwill under this method: 1. Capitalisation of Average Profit Under this method goodwill is calculated as : Goodwill = Normal Capital Employed - Actual Capital Employed Normal Capital Employed = Profit or Average Profit X 100 Normal Rate of Return

Suppose the normal rate of profit is 10 per cent and the firm earns Rs. 10,000. If the actual capital employed is Rs. 80,000, then normal capital employed is calculated as under: Normal Capital Employed = 10,000 (Profit)100 10 (Normal rate of return) Rs. 1,00,0000

Goodwill = Normal Capital Employed - Actual Capital Employed = 1,00,000 - 80,000 = Rs. 20,000 Thus, the excess of normal capital employed over actual capital is the value of goodwill. 26

2.

Capitalisation of Super Profit Under this method, first the super profit is capitalized and on that

basis the value of goodwill is determined. Here, super profit is : = Actual Profit - Normal Profit Super Profit 100 Normal rate of return

After this goodwill is ascertained with the help of following formula : Goodwill =

Methods of Recording Goodwill on the Admission of a New Partner Various methods of recording goodwill at the time of admission in a firm are as under : 1. The amount of goodwill is paid by new partner to old partners outside

the business. 2. Amount of goodwill is brought in cash by new partners in the firm and is

withdrawn by the old partners. In this way, it does not affect the capitals of partners. 3. When amount of goodwill is bought in cash and retained in the business,

it will increase the capital of the firm. 4. The new partners does not bring in the goodwill in cash but the goodwill

account is raised in the books. Under this method Goodwill Account is debited and old partners' Capital Accounts are credited in their old profit-loss sharing ratio. In this case, Goodwill Account will be shown in the Balance Sheet. If Goodwill Account is written off among all partners in new ratio, it will not be shown in Balance Sheet. Treatment of Goodwill in Account 1. When goodwill is paid by new partner to old partners outside the business:

When the amount of goodwill is received by old partners privately or outside 27

the business in case, no entry will be made in the books of firm. 2. When goodwill is brought by new partner and is withdrawn by old

partners: In such a cash, the receipt of goodwill money is recorded in the books of firm and is transferred to Capital Accounts of old partners in their sacrificing ratio. The amount, thus, transferred is immediately withdrawn by old partners. The following entries are recorded in firm's books in the above case : i) When goodwill is brought in cash Cash Account To Goodwill Account (Being amount of goodwill brought in cash ) ii) Transferring Goodwill old partners in their sacrificing ratio : Goodwill Account Dr. Dr.

To Old Partners' Capital Account (Being amount of goodwill transferred to Capital Account) iii) On withdrawn of goodwill by old partners : Old Partners' Capital Account To Cash Account (Being goodwill withdrawn) Alternative Method Under this method, Cash Account is debited with the amount of goodwill and new partner's Capital Account is credited. Then new partner's Capital Account is debited and old partner's Capital Accounts are credited in the sacrificing ratio. On bringing the goodwill in cash : i) Cash Account Dr. To New Partner's Capital Account Dr.

28

(Being brought by new partner for goodwill) ii) iii) On transferring the goodwill to old partner's Capital Accounts : New Partner's Capital Account To old partners' Capital Accounts (Being amount of goodwill distributed by old partner' in their sacrificing ratio). Old Partners' Capital Account To Cash Account (Being amount of goodwill withdrawn by old partners) Now the question arises as to the ratio in which goodwill is to be distributed among old partners when a new a new partner is admitted. Goodwill will be distributed to old partners in their sacrificing ratio. For example, X and Y are partners sharing profits and losses in the ratio of 3:2. After admission of Z as a partner, their new ratio is 2:2:1. Here, the scarifying ratio of X and Y will be calculated. The scarifying ratio will be calculated as under : X sacrifices = 3/5 - 2/5 =1/5 Y sacrifices= 2/5 = 2/5= 0 In the above case, the amount of goodwill will be given only to X because he has sacrificed it to Z and Y will not get any amount of goodwill as he did not sacrifice any share. If new ratio is not given in the question and it is said that the new partner will be given 1/5 share, it is assumed that old partners sacrifice in their old ratio. 3. Amount of Goodwill retained in the Business : In this method the amount Dr. Dr.

of goodwill is retained in the business. For this, the following entries will be made : i) When amount of goodwill is brought in : Cash Account 29 Dr.

To Goodwill Account OR To New partner's Capital Account (Being amount of goodwill received) ii) Amount of goodwill transferred to old partners' Capital Accounts: New partner's Capital Account OR Goodwill Account Dr. Dr.

To Old Partners' Capital Account (Being amount of goodwill transferred to old partners Accounts in sacrificing ratio) 4. Raising Goodwill Accounts : Sometimes, the amount of goodwill is not

brought in cash by the new partner. Hence, goodwill account is raised with full value of firm's goodwill and capital account of old partners are credited in the old profit sharing ratio. a) When goodwill is raised : Goodwill Account Dr.

To Old Partners' Capital Account

(Being Goodwill Account raised in the books of the firm in old ratio)

b)

When goodwill is written off : All partners' (including new partner) Capital Accounts To Goodwill Account (Being Goodwill Account transferred to all partners' Capital Account in the new profit sharing ratio) Dr.

When goodwill already appears in the books : If goodwill already appears in the books, it is transferred to old partner's Capital Accounts in their old ratio at the time of admission of a new partner. The only entry will be : 30

Old Partners Capital Accounts To Goodwill Account

Dr.

(Being goodwill appeared in B/S is written-off in old ratio) After this, the entries for goodwill brought in by the new partner will be passed. When Goodwill is not brought in Cash and Goodwill Account is raised : When new partner does not bring goodwill in cash and goodwill already appears in the Balance Sheet, goodwill will be dealt with as under : Change in Profit Sharing Sometimes, partners change their profit-loss sharing ratio. In such a case to treat the amount of goodwill, the following entries will be made : 1. Raising Goodwill Account : First of all, goodwill is to raised by debiting

the Goodwill Account with full value and crediting all partner's capital accounts in their old ratio : Goodwill Account To All Partners' Capital Account (Being Goodwill Account raised in old ratio) 2. Writing off the Goodwill Accounts : After having raised the goodwill, Dr.

Goodwill Account will be written off by debiting all partners' Capital Accounts in the new ratio. All Partners' Capital Accounts To Goodwill Account (For Goodwill written off in the new ratio) Revaluation of Assets and Liabilities Revaluation Account is prepared to revalue various assets and liabilities of the firm. When a new partner is admitted into a partnership concern, he 31 Dr.

acquires the ownership rights in the assets of the firm and is also responsible for the liabilities of the firm. It is, therefore, desirable from the point of view of the incoming partner as well as the existing partners that the assets and liabilities as appearing in the Balance Sheet on the date of admission of the new partner should be properly valued. It is possible that some of the assets might have appreciated in value or some of the assets have been shown more than their realizable values. Hence, these assets must be shown at lower values. Some of the liabilities may not have been shown in the books, though they will be paid. Thus, if the values of assets and liabilities as shown in the books of accounts are different than their actual values, adjustments will have to be made. For the adjustment of various assets and liabilities, a Profit and Loss Adjustment or Revaluation Account is prepared. On its debit side is shown decrease in assets, outstanding expenses and increases in liabilities, and on the credit side, increase in assets, prepaid expenses and decrease in liabilities are shown. The balance of this account is transferred to Capital Accounts of old partners in their old ratio. Adjustment for Undistributed Profits or Losses and Reserves i) When a new partner is admitted in the firm, reserves, undistributed

profits and credit or debit balance of Profit and Loss Account are transferred to old partners' Capital Accounts in their old ratio. For this purpose, the following journal entries are passed. Profit and Loss Account (if Profit) General Reserve Account To old partners' Capital Accounts (Being profits & reserve distributed in old partners in old ratio) 32 Dr. Dr.

ii)

If the debit balance of Profit and Loss Account is shown in the

Balance Sheet, then it will also be transferred to old partners' Capital Accounts in old ratio. Old Partners' Capital Accounts To Profit and Loss Account Preparation of Memorandum Revaluation Account Sometimes, the partners agree that the value of assets and liabilities are not to be altered and these are to be shown in the books at their old values. In such a case, increase or decrease in the amount of assets and liabilities will be recorded in a special account known as Memorandum Revaluation Account. No corresponding entry is made in assets and liabilities to record changes in their values. This Memorandum Account is divided into two parts : i) In the first part, Revaluation Account is prepared in the usual way Dr.

as explained earlier and profit or loss is distributed to old partners in old ratio. ii) In the second part, all the entries which were shown in the

Revaluation Account will be reversed. It means those items which were shown on the Debit side of Revaluation Account will now be placed in the credit side of Memorandum Revaluation Account, and all credit items of Revaluation Account will be shown in the Debit side of Memorandum Revaluation Account. Thus, whatever the result (profit or loss) may be, it will be distributed among all the partners (including the new partner) in new profit sharing ratio. It is important to keep in mind that, after preparation of Memorandum Revaluation Account, the result (Profit or Loss) will be reversed as shown by Revaluation Account. If Revaluation Account show profit, the Memorandum Revaluation Account will show loss and vice-versa. Secondly, while preparing the Balance Sheet, all the fixed assets and liabilities (expect cash in hand and 33

bank) are to be shown at original figures. But in capital accounts of partners, adjustments will be made for profit/loss of both the parts of Memorandum Revaluation Account. 5.6 SUMMARY Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all. The document which contains the terms and conditions regarding the conduct of partnership business is called partnership deed. The capital accounts of the partners may be fixed or fluctuating. A minor partner is not personally liable for the debts of the partnership firm but his share in the partnership property and profits of the firm will be liable for firm's debts and obligations. The guarantee of the new partner can be given by one or all the existing partners. Whenever a partner is admitted into partnership firm, he acquires two rights namely the right to share in the assets of the partnership and the right to share in the profits of the business. The main points which require attention at the time of admission of a partner are calculation of new profit sharing ratio, revaluation of assets and liabilities, treatment of goodwill adjustment of undistributed profits and losses and adjustment of capitals in order to bring these in proportion to profit sharing ratio. 5.7 KEYWORDS

Partnership: It is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Partnership Deed: A document which contains details of an express written agreement between the partners is called partnership deed. 34

Minor Partner: A parties who has not attained the age of majority is called a minor partner. Sacrificing Ratio: It means the forgoing a fraction of share in favour of a new partner by the old over. Goodwill: Goodwill is the value of the reputation of a firm in respect of profits expected in future over and above the normal rate of profits. 5.8 1. SELF ASSESSMENT QUESTIONS P, Q and R are in the partnership and on 1st January, 1995 their respective capitals were Rs. 20,000, Rs, 12,000 and Rs, 10,000. Q is entitled to a salary of Rs. 2,500 and R Rs. 2,000 per annum, payable before division of profits. Interest is allowed on capital @ 5% per annum but is not charged on drawings. Of the net divisible profits of first Rs. 10,000; P is entitled to 40%, Q to 35% and R to 25% and over that amount profits are shared equally. The profit for the year ended 31st December, 1995 after debiting partnership salaries, but before charging interest on capitals, was Rs. 18,000 and partners had withdrawn Rs. 800 each. Prepare partners' accounts for the year. 2. Kakku and Polu started a partnership business on 1st January, 1985. They contributed Rs. 80,000 and Rs. 60,000 respectively, as their capitals. The terms of the partnership agreement are as under : (a) (b) Interest on capital and drawings @ 12% per annum. Kakku and Polu to get a monthly salary of Rs. 2,000 and Rs. 3,000 respectively. (c) Sharing of profit or loss to be in the ratio of their capital contribution. 35

The profit for the year ended 31st December, 1985 before making above appropriations was Rs. 1,00,300. The drawings of Kakku and Polu were Rs. 40,000 and Rs. 5,000 respectively. Interest on drawings amounted to Rs. 2,000 for Kakku and Rs. 2,500 for Polu. Prepare the Profit and Loss Appropriation Account and partners' Capital Account assuming that their capitals are fluctuating. 3. 4. Explain goodwill and describe various methods of valuing goodwill. Explain the treatment of goodwill in case of admission of a new partner with journal entries. 5. What is Revaluation Account ? How is it prepared ? How is it different from Memorandum Revaluation Account ? 6. A and B share profits in the proportions of 3/4th and 1/4. Their Balance Sheet as on 31st December, 1990 was as follows : Liabilities Sundry Creditors Capital Accounts A B 30,000 16,000 RS 41,500 Assets Cash at Bank Bills Receivable Debtors Stock Fixtures Land & Building 87,500 Rs 22,500 3,000 16,000 20,000 1,000 25,000 87,500

36

On January 1, 1991, C was admitted into partnership on the following terms : i) That C pays Rs. 10,000 for goodwill. Half of this sum is to be withdrawn by A and B . He pays for 1/5 share Rs. 7,500. ii) The stock and fixtures are to be reduced by 10 per cent. 5% provision for doubtful debts is to be created on Sundry Debtors and Bills Receivable. iii) iv) That the value of Land and Building is to be appreciated by 20% There being a claim against the firm for damages, a liability to the extent of Rs. 1,000 should be created. v) An item of Rs. 650 included in Sundry Creditors is not likely to be claimed and hence should be written back. Draws up Capital Account, Cash Account, Profit and Loss Adjustment Account and the Balance Sheet of A, B and C. Also indicate the future sharing ratio, assuming the profit sharing ratio between A and B has not changed. 7. The following was the Balance Sheet of Anurag and Bhawna who were sharing profits in the ratio of 2/3 and 1/3 on 31st December, 1990. Liabilities Creditors Capitals : Anurag Bhawna 30,000 20,000 Rs. 65900 Assets Cash at Bank Sundry Debtors Stock Plant & Machinery Building 1,15,900 Rs. 1,200 9,700 20,000 35,000 50,000 1,15,900

37

They agreed to admit Monika into partnership on the following terms : a) Monika was to be given 1/3 share in profits, and was to bring Rs. 15,000 as capital and Rs. 6,000 as share of goodwill. b) c) d) e) f) The value of stock and plant were to be reduced by 10%. A provision of 5% was to be created for doubtful debts. The building account was to be appreciated by 20% The goodwill amount was to be withdrawn by the old partners. Investment worth Rs. 1,400 (not mentioned in the Balance Sheet were to be taken into account. Show the Revaluation Account, Capital Accounts and prepare the opening Balance Sheet of the new firm. 5.9 SUGGESTED READINGS 1. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. 2. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. 3. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. 4. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi. 5. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana.

38

LESSON : 6 RETIREMENT AND DEATH OF A PARTNER STRUCTURE 6.0 6.1 6.2 Objective Introduction Accounting Procedure at the time of retirement of a Partner 6.2.1 Treatment of Goodwill 6.2.2 Revaluation of Assets and Liabilities 6.2.3 Adjustment of Accumulated Reserves and Losses 6.2.4 Calculating the amount due to the retiring partner and its payment 6.3 Death of a Partner 6.3.1 Calculation of Deceased Partner's Share of Profit 6.3.2 Treatment of Life Policy 6.4 6.5 6.6 6.7 6.0 Summary Keywords Self Assessment Questions Suggested Readings OBJECTIVE

After reading this lesson, you should be able to a) b) Discuss the accounting procedure at the time of retirement of a partner. Explain the procedure of calculation of profit and treatment of life policy at the time of death of a partner. 6.1 INTRODUCTION A new partner is admitted in the firm when such a need arises, the same way, a partner may like to retire after giving due notice. His accounts are settled upto the date on which he retires. He will have his share of profit (or loss) upto that date, a share in
1

the old reserves and the Goodwill of the firm. A balance sheet is prepared on the day of his retirement and his capital account is completed upto the date. Either he is paid cash in full for his capital account or partly he is paid with a promise to pay the balance at a future date. In such a case his capital account is transferred to the Loan A/c and shown as a liability in the balance sheet. It may be paid in instalments afterwards. Usually, the manner, in which a partner shall retire is mentioned in the partnership deed. When a partner retires he is entitled to his share in the following accounts: 1. The retiring partner is entitled to his share out of the past accumulated profits

and reserves in his profit-sharing ratio. 2. He is also entitled to his share of profit upto the date of his retirement. Suppose

the books of accounts of the firm are closed on 31st March every year and the partner is retiring on 30th June. He is entitled to his share of profit for this 3 months' period i.e., from 1st April to 30th June. 3. 4. When a partner retires he is paid for his share of goodwill in the firm. According to the terms of the Partnership Deed the value of all assets and

liabilities are revalued on the retirement of a partner. For this purpose, a Revaluation Account is prepared. He is entitled to his share of profit (or loss) on the revaluation of assets and liabilities. In the absence of any agreement to the contrary, the profit sharing ratio between the remaining partners remains unchanged after his retirement. 6.2 ACCOUNTING PROCEDURE AT THE TIME OF RETIREMENT OF A PARTNER The following problems arise when a partner retires from the firm and remaining partners continue with the business :

1. 2. 3. 4.

Treatment of goodwill Revaluation of assets and liabilities Adjustments of accumulated reserve and losses Calculating the amount due to the retiring partner and its payment.

6.2.1 Treatment of Goodwill When a partner retires from the firm remaining partners are benefitted because future profit is shared only by them. For example, if A, B and C are partners and their profit sharing ratio is 2 : 2: 1. If B retires from the firm, A and C will distribute the profits in 2:1 ratio or a new ratio. A and C will get share of B. Hence, A and C will compensate the retiring partner B in the gaining ratio. When a new partner is admitted in the firm, he pays the amount of goodwill and if a partner retires from the firm, the remaining partners compensate the retiring partner by paying for the goodwill. Gaining ratio is the difference of new ratio and old ratio. If there is no other agreement, remaining partners will share the profits in the same ratio in which they shared earlier before the retirement of a partner. In such a situation, the gaining ratio of the remaining partners would be their old ratio. For example, A B and C are sharing profits in the ratio 3:2:1. C retires from the firm. In this case, new ratio of A and B will be 3:2. Illustration 1 i) A, B and C were sharing profit and loss in the ratio of 2:3:1. Calculate the new

ratio and the gaining ratio when (a) A retires, (b) B retires and (c) C retires. ii) A, B and C were partners sharing profit and loss in the ratio of 2:3:1. C retires

and A and B decide to share future profit and loss in the ratio of 3:4. Calculate the gaining ratio.
3

iii)

A, B and C were partners sharing profit and loss in the ratio of 2:3:1. C retires

and his share is taken by A and B in the ratio of 2:1. Find the new ratio. Solution i) (a) When A retires, the new ratio of B and C will be 3:1. This will also be their gaining ratio. (b) When B retires, the new ratio of A and C will be 2:1. This will also be their gaining ratio. (c) When C retires, the new ratio of A and B will be 2:3 This will also be their gaining ratio. ii) Gaining Ratio = New Ratio Old Ratio Gain of A = 3/7 - 2/6 Gain of B = 4/7 - 3/6 = = 4/42 3/42

Thus, the gaining ratio of A and B is 4/42 : 3/42 or 4:3 iii) Share got by A from C = 1/6 2/3 = 2/18 Share got by B from C = 1/6 1/3 = 1/18 New ratio of A = 2/6 + 2/18 = 8/18 New ratio of B = 3/6 + 1/18 = 10/18 Hence, new ratio of A and B = 8/18 : 10/18 or 8 : 10 or 4 : 5 Adjustment of Goodwill Having understood the gaining ratio of new partners, let us discuss how the goodwill will be adjusted in accounts. The following are the methods of treating goodwill in books in case of retirement : 1. When Goodwill account is raised with full value Under this method, Goodwill Account is debited with full value of Goodwill and the partners Capital Accounts, including retiring partners Capital Account are credited in the old ratio. Goodwill will be show in the Balance Sheet at full value.
4

2.

When goodwill account is raised with full value and written off by remaining partners Under this method, first of all Goodwill Account is debited with full value and

all partners (including retiring partner) Capital Accounts are credited in the old ratio. Secondly, remaining partners Capital Accounts are debited in new ratio and Goodwill Account is credited. Hence, the Goodwill Account is closed. It will be shown in Balance Sheet. 3. When goodwill is raised only with the share of the retiring partner and then written off by remaining partners In this case, firstly Goodwill Account is debited and retiring partners Capital Account is credited with his share of goodwill. Secondly, Capital Accounts of remaining partners are debited in their gaining ratio and Goodwill Account is credited. Hence, Goodwill Account will be closed. 4. When retiring partners share of Goodwill is to be adjusted in the Capital Accounts of remaining partners without raising Goodwill Account In this case, the retiring partners share of goodwill is calculated and debited to continuing partners Capital Accounts in their gaining ratio with corresponding credit being given to retiring partners Capital Account. Note : From the above explanation, it is clear that when we deal with the total value of goodwill (Opening Goodwill Account or Closing Goodwill Account), we should use either the old ratio or the new ratio. If we adjust the share of goodwill of the retiring partner only we should use only the gaining ratio. Illustration 2 A, B and C are partners sharing profits and losses in the ratio of 4:3:2. B retires and on retirement the goodwill of the firm is valued at Rs. 43,200, No goodwill appears
5

in the books. A and C agree to share future profits in the ratio of 5:3. Find the gaining ratio and pass the journal entries for goodwill in each of above cases. Solution Old ratio between A, B and C = 4:3:2 New Ratio between A and C = 5:3 Gaining ratio = New ratio old ratio A = 5/8 - 4/9 = (45 - 32)/72 = 13/72 C = 3/8 - 2/9 = (27 - 16)/72 = 11/72 Hence, A and C will compensate B in the ratio of 13 : 11 (a) When the full value of goodwill is raised in the books : Rs. 43,200 Rs. 19,200 14,400 9,600

Goodwill A/c To As Capital A/c To Bs Capital A/c To Cs Capital A/c (Goodwill raised and credited to partners capital accounts in old ratio)

Dr.

Note : Goodwil will appear in the Balance Sheet as an asset until it is written off. (b) When the full value of goodwill is raised in the books and written off : Rs. 43,200 Rs. 19,200 14,400 9,600

Goodwill A/c To As Capital A/c To Bs Capital A/c To Cs Capital A/c (Being the Goodwill credited to all partners in old ratio) As Capital A/c Cs Capital A/c

Dr.

Dr. Dr.

27,000 16,200 43,200

To Goodwill A/c (Being the Goodwill written off in the new ratio)
6

(c)

When the retiring partners share of goodwill is raised and written off : Rs. Goodwill A/c To Bs Capital A/c (Being Bs share of Goodwill) As Capital A/c Cs Capital A/c To Goodwill A/c (Goodwill written off in the gaining ratio of 13:11) Dr. Dr. 7,800 6,600 14,400 Dr. 14,400 14,400 Rs.

(d)

When the goodwill is adjusted in Capital Account without opening a Goodwill Account : Rs. As Capital A/c Cs Capital A/c To Bs Capital A/c (Being due to B adjusted between A and C in their gaining ratio) Note : In all the above cases, B gets a credit for Rs.14,400 being his share of Dr. Dr. 7,800 6,600 14,400 Rs.

goodwill of the firm which comes from A and C in their gaining ratio of 13:11. When goodwill already exists in the books at the time of retirement, the need for its revaluation arises to find out increase or decrease in its value. If the value has increased, Goodwill Account will be debited and Capital Accounts of all partners will be credited in their old ratio with the amount of increase. On decrease in its value, a reverse entry will be made.

6.2.2 Revaluation of Assets and Liabilities Revaluation of assets and labilities is also required at the time of retirement of a partner in the same way as it is done in case of admission of a partner. The profit or loss which results from revaluation will be transferred to all partners Capital Accounts in their old profit sharing ratio. For this purpose, a Revaluation Account or Profit and Loss Adjustment Account is prepared. If the remaining partners wish to show assets and liabilities at their old values Memorandum Revaluation Account will be prepared. 6.2.3 Adjustment of Accumulated Reserves and Losses At the time of retirement, if general reserve, credit balance of Profit and Loss Account or other undistributed profits are given in the Balance Sheet, they are credited in the old partners Capital Accounts in old profit sharing ratio. For this, the following journal entry is made: Reserve or Profit and Loss A/c To Partners Capital A/c (Old ratio) If the partners want that only retiring partners Capital Account be credited with his share in undistributed profits, then the following entry will be made. Reserves or Profit and Loss A/c To Retiring Partners Capital A/c (With the share of retiring partner) Remaining undistributed profits will be shown in the Balance Sheet after retirement. If the remaining partners want that, without changing the amount of reserves or profit, share be given to retiring partner, the following entry will be made : Dr. Dr.

Continuing Partners Capital A/c (In their gaining ratio) To Retiring Partners Capital A/c

Dr.

6.2.4 Calculating the amount due to the retiring partner and its payment The retiring partners Capital Account is credited with his share of capital, share of goodwill, share of profit on account of revaluation and undistributed profits and reserves of last years. This account will be debited with his drawings, share in revaluation loss and other losses. If payment is no made to the retiring partner, the amount due is transferred to his loan account. According to Section 37 of Partnership Act, the retiring partner can have either interest @ 6% per annum on this amount due or the profit earned by remaining partners with the help of this amount from the date of retirement. For this, the journal entry will be : Retiring Partners Capital A/c To Retiring Partners Loan A/c If remaining partners bring cash to pay off the retiring partner then, journal entry will be : Bank A/c To Continuing Partners Capital A/c (For cash brought in by partners in the agreed ratio to pay off the retiring partner) Payment in Instalments Capital Account of the retiring partner is settled as per agreement. It may be settled in two ways : 1) 2) Payment in instalments with interest Payment in a fixed number of instalments of equal amount (including interest). Amount of instalment can be calculated with the help of Annuity Table.
9

Dr.

Dr.

Note : In the absence of any information, balance of retiring partners Capital Account will be transferred to his Loan Account. Illustration 3 A, B and C were carrying on business in partnership sharing profits and losses in the ratio of 3 : 2 : 1, respectively. On 31st December, 1985, the Balance Sheet of the firm stood as follows : Liabilities Sundry Creditors Capital Accounts : A : 15,000 B : 10,000 C : 10,000 35,000 48,590 B retires on the above mentioned date on the following terms : (i) (ii) (iii) Building be appreciated by Rs. 7,000. Provision for bad debts be made @ 5% on Debtors. Goodwill of the firm be valued at Rs. 9,000 and adjustment in respect be made without raising a Goodwill Account. (iv) Rs. 5,000 be paid to B immediately and the balance due to him be treated as loan carrying interest @ 6% per annum. Such loan is to be paid in three equal annual instalments together with interest. Pass the journal entries to record the above mentioned transactions and show the Balance Sheet of the firm as it would appear immediately after Bs retirement. Prepare Bs Loan Account till it is finally closed. 48,590 Rs. 13,590 Assets Cash Debtors Stock Building Rs. 5,900 8,000 11,690 23,000

10

Solution Journal Dr. Particulars Building A/c To Revaluation A/c (Being appreciation in the value of Building) Revaluation A/c To Provision for Bad Debts (Being provision for bad debts created on debtors) Revaluation A/c To As Capital A/c To Bs Capital A/c To Cs Capital A/c (Being profit on revaluation credited to old partners) As Capital A/c Cs Capital A/c To Bs Capital A/c (Being Bs share of goodwill adjusted in gaining ratio of 3:1 in A and C) Bs Capital A/c To Bank A/c (Being the amount paid to B on retirement) Bs Capital A/c To Bs Loan A/c (Balance of amount due to B transferred to his loan account)
11

Cr. Rs.

Rs. Dr. 7,000

7,000

Dr.

400 400

Dr.

6,600 3,300 2,200 1,100

Dr. Dr.

2,250 750 3,000

Dr.

5,000 5,000

Dr.

10,200 10,200

Balance Sheet as on 1st January, 1986 Liabilities Sundry Creditors Bs Loan A/c Capital Accounts : A : 16,050 B : 10,350 26,400 Rs. 13,590 10,200 Assets Cash Debtors 8,000 Rs. 900

Less : Prov. for bad debts 400 7,600 Stock Building 23,000 30,000 50,190 11,690

Add : Appreciation 7,000 50,190

Bs Loan Account 1986 Dec.31 To Bank To Balance c/d Rs. 3,816 6,996 10812 1987 Dec. 31 To Bank To Balance c/d 3,816 3,600 7,416 1988 Dec.31 To Bank 3,816 1988 Jan. 1 By Balance b/d 3,600 216 3,816 1987 Jan. 1 By Balance b/d 6,996 420 7,416 1986 Jan. 1 By Balance b/d Rs. 10,200 612 10,812

Dec. 31 By Interest A/c

Dec.31 By Interest A/c

Dec. 31 By Interest A/c 3,816 Working Notes (i) New Profit-Loss sharing Ratio :

Old Profit-sharing Ratio of A, B and C = 3/6 : 2/6 : 1/6, After Bs retirement the ratio between A & C will be = 3 : 1 or 3/4 : 1/4
12

(ii)

Gaining Ratio of A and C : Gain to A = 3/4 - 3/6 = (18-12)/24 = 6/24 Gain to C = 1/4 - 1/6 = (6-4)24 = 2/24 Hence the gaining ratio is 6/24 : 2/24 or 3 : 1

(iii)

According to Annuity Table .37410981 should paid every your to repay rupee one with 6 per cent interest in 3 years. The annual instalment for payment of Rs. 10,200 comes to Rs. 10,200 .37410981 = Rs. 3,816

Illustration 4 P and Q were working in partnership profits and losses equally. On 31 December, 1996, P decided to retire and in his place his son R was admitted as partner from 1 January, 1997, with 1/3 share of profit. Balance Sheet as on December 31, 1996 Liabilities Sundry Creditors Capital Accounts : P : 54,300 Q : 48,000 1,02,300 Rs. 14,700 Assets Goodwill Land & Building Motor Car Furniture Sundry Debtors Cash at Bank 1,17,000 It was decided that: a) b) c) The goodwill would be raised to Rs. 20,000. The car would be taken over by P at its book value. The value of land and buildings would be increased by Rs. 8,280. Rs. 15,000 40,050 12,000 9,300 24,150 16,500 1,17,000

13

d)

Q and R would introduce sufficient capital to pay off P and to leave thereafter a sum of Rs. 7,350 as bank balance, so as to make their capital proportionate to their share of profits.

e) f)

The Capital payable by R was to be gifted to him by his father. The new partners decided not to show goodwill as an asset.

The new arrangements were duly complied with. Show the partners Capital Account and the Bank Account. Solution Capital to be brought in by the partners : Total Capital of the new firm : Rs. Goodwill Land and Buildings Furniture Sundry Debtors Cash at Bank Total Assets Less : Creditors Total Capital of Q and R Qs Capital = 94,430 2/3 Rs Capital = 94,430 1/3 Amount payable to P : Rs. Ps Capital His share of profit on revaluation : Goodwil Land & Buildings 5,000 8,280 13,280 1/2 =
14

20,000 48,330 9,300 24,150 7,350 1,09,130 14,700 94,430 62,953 31,477

54,300

6,640

60,940 Less : Capital of R to be gifted by P 31,477 29,463 Less : Car taken over Balance payable in cash Amount to be brought in by Q : Qs Capital His share, 1/2 of profit on revaluation Existing Capital Qs share in the new firm 12,000 17,463 Rs. 48,000 6,640 54,640 62,953

Cash to be brought in by Q = Rs. 62,953 - Rs. 54,640 = Rs. 8,313 Capital Accounts
P Rs. To Rs Capital A/c To Motor Car A/c To Bank A/c To Goodwill A/c To balance c/d 31477 12000 17463 Q Rs. 13333 R Rs. 6667 By Balance b/d By Revaluation A/c By Bank A/c By Ps Capital A/c P Rs. Q Rs. R Rs. 31477

54300 48000 6640 6640 8313 -

49620 24810 60940 62953 31477

60940 62953 31477

Bank Account Rs. To Balance b/d To Qs Capital A/c 16500 8313 24813 By Ps Capital A/c 17463 By Balance c/d 7350 24813 Rs.

15

Illustration 5 A, B and C share profits and Losses as 1 : 2 : 2. On 31 st December, 1989 when A decided to retire, their capitals were Rs. 27,000; Rs. 54,000 and Rs. 54,000 respectively. A agreed to keep his capital in the firm as a loan subject to 6% per annum interest. However, he was to receive a share in the profits after charging interest on capital and loan of new firm for the year 1990, of only an amount equal to 1/3 of his share in the old firm. On 1st January, 1990 D was admitted who paid Rs. 18,000 for his capital and Rs. 12,000 for his 1/7 share of goodwill. The goodwill was shared by B and C in their respective ratios. In 1990, the firm earned a profit of Rs. 67,020, before charging interest on loan of A and on capital @ 5 percent. Show the profit sharing ratios for the year 1990. Also show the Capital of the partners on 31st December. 1990. Solution Profit and Loss Account for the year ended 31st December, 1990 Particulars To interest on As Loan (6% on Rs. 27,000) To Interest on Capital : (@ 5%) B on Rs. 60000 3000 C on Rs. 60000 3000 D on Rs. 18000 900 To As Loan A/c (1/15 of Rs. 58,500) To Profit Transferred to Capital Accounts B : 3/7 23400 C : 3/7 23400 D : 1/7 7800 Rs. 1620 Particulars By Net profit Rs. 67020

6900 3900

54600 67020
16

67020

Capital Accounts
P Rs. 1990 Dec. 31 To Balance c/d 86400 86400 26700 Q Rs. R Rs. 1990 Jan. 1 By Balance b/d By Goodwill A/c By Cash Dec. 31 By Interest A/c By P & L A/c 86400 86400 26700 3000 3000 900 54000 54000 6000 6000 18000 P Rs. Q Rs. R Rs.

23400 23400 7800 86400 86400 26700

Working Notes (1) (2) A is entitled to 1/3 of his previous share = 1/5 1/3 = 1/15 Profit sharing ratio among B, C and D for 1990 and 1991 and 1991 will be 3/7, 3/7 and 1/7 respectively, calculated as : B + C = 1 - 1/7 = 6/7 Bs Share = 6/7 1/2 = 3/7 Cs Share = 6/7 1/2 = 3/7 (3) As share in firms profit = Rs. (Rs. 67,020 - Rs. 1,620 - Rs. 6,900) 1/15 = Rs. 3,900 6.3 DEATH OF A PARTNER The accounting treatment at the time of death of a partner is same as at the time of retirement. Main difference between the two is that of closing of the account of business. Deceased partners capital account is credited with his opening capital, interest on capital up to his death, his share in undistributed profits, revaluation profits, firms

17

profits from the date of the last balance sheet up to his death and with his share of goodwill. Drawings, interest on drawings and losses are debited in the deceased partners Capital Account and the remaining amount is transferred to his legal representatives account. Legal representative can receive either interest at 6 per cent per annum, on the amount due from the date of death to the date of settlement or the profit earned with the help of that amount. Most of the points have already been discussed in the retirement of a partner but the following two points require special attention: i) ii) Calculation of deceased partner's share of profit. Treatment of life policy or policies. These will be discussed one by one. 6.3.1 Calculation of Deceased Partner's Share of Profit The deceased partner's share of profit is to be determined either on the basis of time or turnover. (a) On the basis of time: In this case, it is assumed that the profit during the

previous year has been earned uniformly in all months during the year, provided previous year is taken as the base for calculation of profit. Sometimes average profits of the past three or four years is taken as base rather than the previous year. Whatever base may be taken, it is to be multiplied by the period for which the deceased partner remained in the firm and also his profit sharing ratio at the time of his death. For example A, B, and C are partners in a firm sharing profits and losses in the ratio of 3 : 2 : 1. B dies on 14th March, 1996. The average of the last three years is Rs. 30,000. B's share of profit on the basis of time is calculated as under: Average yearly profit = Rs. 30,000 Profit for 73 days i.e., Jan. 1 to March 14, 1996 = B's share = 2/6 6,000 = Rs. 2,000
18
Rs. 30,000 73 = Rs. 6,000 365

(b)

On the basis of turnover: In this method, average past profit is divided

into two portions i.e., before the death and after the death on the basis of ratio of turnover to the date of death to average turnover and then deceased partner's share is calculated and credited to his capital account. For example, A, B and C are partners in a firm sharing profits and losses in the ratio of 3 : 2 : 1. B dies on 14th March, 1996. Turnover from 1st January, to 14th March, 1996 is Rs. 42,000. Average turnover of the last three years is Rs. 60,000 and profit is Rs. 30,000. B's share of profit on this basis will be calculated as under: Average turnover = Rs. 60,000 Sales to the date of death = Rs. 42,000. Profit to the date of death = Rs. 42,000 . = Rs. 21,000 B's share of profit = 21,000 = Rs. 7,000.

6.3.2 Treatment of Life Policies

1 To make an arrangement for the payment of amount belonging to deceased partner

to his legal representative, the firm can get insured the life of all the partners jointly or individually. Premiums on life policies are paid out of firms funds and this is debited to firms Profit and Loss Account. Amount received in the form of claim from the life insurance company is credited to all the partners in their profit/loss sharing ratio. In the case of individual policies also, the deceased partner is entitled to his share in the surrender value of policies of all the partners. Other partners are also entitled to their respective share in the amount of policy of the deceased partner. Illustration 6 Brown and Smith are partners. The partnership deed provides inter alia: i) ii) That the Account be balanced on 31st December each year. That the profits be divided as follows : Brown 1/2; Smith 1/3 and carried to a Reserve account 1/6.

19

iii)

That in the event of the death of a partner, his executors be entitled to be paid :

(a) (b) (c)

The capital to his credit at the date of death. His proportion of reserve at the date of last balance sheet. His proportion of profit to date of death based on the average profits of the last three completed years.

(d)

By way of goodwill his proportion of the total profits for the three preceding years.

On 31st December, 1989, the Ledger balance were : Rs. Browns Capital Smiths Capital Reserve Creditors Bills Receivable Investments Cash 2,000 5,000 14,000 21,000 The profit for three years were : 1987 Rs. 4200, 1988 Rs. 3900, 1989 Rs. 4500. Smith died on 1st May, 1990 Show the accounts as between the firm and Smiths died on 1st May, 1990 Solution Effective profit sharing ratio between Brown and Smith is 3 : 2 Smiths share in the profits to the date of death : 21,000 Rs. 9,000 6,000 3,000 3,000

20

Rs. Profit for 1987 Profit for 1988 Profit for 1989 Total Profits Average = Rs. 12,600/3 = Rs. 4,200 Profit for 4 months upto May 1, 1990 = 4,200 1/3 = Rs. 1,400 Smiths share therein = Rs. 1,400 2/5 = 560 Smiths share in Goodwill : Goodwill = Rs. 12,600 Smiths share = Rs. 12,600 2/5 = Rs. 5,040 Smiths Capital Account Rs. 1990 May, 1 To Smiths Executors A/c 12,800 1990 May 1 By Balance b/d By Reserve A/c By P & L suspense A/c (Profit upto death) By Goodwill A/c 12,800 Smiths Executors Account Rs. 1990 May 1 By Smiths Capital A/c 12,800 12,800
21

4,200 3,900 4,500 12,600

Rs.

6,000 1,200 560

5,040 12,800

Joint Life Policy Accounting treatment of Joint Life Policy may be done by any of following methods: 1. First Method: When payment of premium is considered as a business

expenditure Under this method, the amount of premium is charged to Profit and Loss Account of each year and the amount received from insurance company on the death of any partner is treated as income. Bank Account will be debited and Joint Life Policy Account will be credited with the amount received from the insurance company on the death of a partner. Then Joint Life Policy Account is closed by transferring it to all the partners Capital Accounts (including the deceased partner) in their profit sharing ratio. The main problem in this method is that no surrender value of policy is shown in the books. 2. Second Method : When surrender value is treated as an asset In this method at the time of payment of premium, the Joint Life Policy Account is debited and Bank Account is credited. That amount of premium which is more than surrender value at the end of year, it is assumed as loss with which Profit and Loss Account is debited and Joint Life Policy Account is credited. Joint Life Policy Account (Surrender Value) is shown as asset in the Balance Sheet. At the time of death of any partner, Bank Account is debited and Joint Life Policy Account is credited with the amount received. Credit balance of Joint Life Policy Account is considered as profit and transferred to all partners capital accounts in their profit-loss sharing ratio. The main advantage of this method is that surrender value is considered as an asset and disadvantage is that the premium is not shown fully as an expense in Profit and Loss Account.

22

3.

Third Method : When premium is considered as an asset With the amount of premium paid, Joint Life Policy Account is debited and

Bank Account is credited. Joint Life Policy Account is shown as an asset in the Balance Sheet. At the time of death of any partner, Bank Account is debited and Joint Life Policy Account is credited. After his, if there is any credit balance in Joint Life Policy Account, it is distributed among all partners in their profit sharing ratio. 4. Fourth Method : When payment of premium is treated as an investment and a Reserve Account is opened 1. 2. Premium is debited to Joint Life Policy Account. Every year amount equal to the premium is debited to Profit and Loss Appropriation Account and credited to Joint Life Policy Reserve Account. 3. Joint Life Policy Account and Joint Life Policy Reserve Account are adjusted in such a way that the balance in each account is equal to surrender value of the policy. 4. At the death of a partner Joint Policy Account is credited with the amount received. Credit balance of Joint Policy Reserve Account is transferred to Joint Life Policy Account and Joint Life Policy Account is closed by transferring to Capital Accounts of all the partners in their profit sharing ratio. Under this method, surrender value is shown on the assets side and Joint Life Policy Reserve Account on liabilities side of Balance Sheet. Main advantage of this method is that surrender value is shown in Balance Sheet and all premium is charged from Profit and Loss Appropriation Account. Illustration 7: (a) A and B are partners in a firm. On April 1, 1997 they took out a Joint Life Policy without profits for Rs. 30,000 upon which an annual premium of Rs. 1,400 is payable. A and B share profits in the ratio of 2 : 1. On March 31, 1998
23

B died and Rs. 30,000 is received from the Insurance Company. Journalise the above transactions. Premium is to be adjusted through Profit and Loss Account. (b) A and B who shared profits in the ratio of 3 : 2 took a joint life policy on May 1, 1995 for Rs. 30,000. The annual premium was Rs. 1,300. The surrender value of the policy was: 1995 Nil; 1996 Rs. 400; 1997 Rs. 900; 1998 Rs. 1,450 B died on September 15, 1995 and the amount of the policy was received on Dec. 341, 1998. The books are closed on Dec. 31, each year. Show Joint Life Policy Account and Joint Life Policy Reserve Account assuming that premiums were written off through Joint life Policy Reserve Account. Solution Journal Entries 1997 April 1 Joint Life Policy Premium A/c To Bank A/c (Being the payment of annual premium) 1998 Mar. 31 Profit and Loss Account To Joint Life Policy Premium A/c (Being Premium charged to P & L A/c) Mar. 31 Insurance Company A/c To Joint Life Policy A/c (Being the amount of J.L.P. due for receipt) Dr. 30,000 30,000 Dr. 1,400 1,400 Dr. Rs. 1,400 1,400 Rs.

24

Mar. 31 Bank Account To Insurance Company A/c

Dr.

30,000 30,000

(Being the receipt of claim from Insurance Company) Mar. 31 Joint Life Policy A/c To As Capital A/c To Bs Capital A/c (Being the amount of policy distributed between partners in the ratio of 2 : 1) (b) 1995 May 1 1996 May 1 To Bank A/c 1,300 To Bank A/c Joint Life Policy Account Rs. 1,300 1995 Dec. 31 1996 Dec. 31 By J.L.P. Reserve A/c By Balance c/d 1,300 1997 Jan. 1 May 1 To Balance b/d To Bank A/c 400 1,300 1,700 1998 Jan. 1 May 1 To Balance b/d To Bank A/c 900 1,300 1998 Sept. 15 By Bank A/c By J.L.P. Reserve A/c 30,000 900 1997 Dec. 31 By J.L.P. Reserve A/c By Balance c/d 800 900 1,700 900 400 1,300 By J.L.P. Reserve A/c Rs. 1,300 Dr. 30,000 20,000 10,000

Dec. 31 To Capital A/c: A B 17,220 11,480 30,900 30,900

25

Joint Life Policy Reserve Account 1995 Dec. 31 To Joint Life Policy A/c 1996 Dec. 31 To Joint Life Policy A/c To Balance c/d 900 400 1,300 1997 Dec. 31 To Joint Life Policy A/c To Balance c/d 1,700 1998 Sept. 15 To Joint Life Policy A/c 6.4 SUMMARY The only difference between admission and retirement of a partner is that in case of the former, the new partner joins the firm whereas in case of retirement, an old partner leaves the firm because of certain reasons. The main points which require attention in case of retirement of partner are treatment of goodwill, revaluation of assets and liabilities, adjustment of accumulated reserves and losses, and calculation of total amount due to the retiring partner. The problems which arise in case of death of a partner are similar to those of a retiring partner except that the death of a partner may occur at any time whereas the retirement of a partner is planned. The points which 900 1998 Sept. 15 By Balance b/d 900 800 900 1,700 1997 Dec. 31 By Balance b/d By P & L Approp. A/c 400 1,300 1,300 1,300 1996 Dec. 31 By P. & L Approp. A/c 1,300 Rs. 1995 Dec. 31 By P & L Approp. A/c 1,300 Rs.

26

require special attention at the time of death of a partner are calculation of deceased partner's share of profit and treatment of life policy or policies 6.5 KEYWORDS

Gaining Ratio: The ratio in which the continuing partners acquire the outgoing partner's share is called as gaining ratio. Surrender value: It is the value which is payable immediately to the insured on surrendering all rights of the policy (policies) to the insurer. Memorandum Revaluation Account: Sometimes it may be derived not to alter the value of assets and liabilities in the books, a Memorandum Revaluation Account will be opened. 6.6 1. SELF ASSESSMENT QUESTIONS What is goodwill ? Explain the different methods of treating goodwill in accounts at the retirement of a partner. 2. What is a joint life policy? What is its objectives? Discuss the various methods of recording joint life policy amount in partnership books. 3. A, B and C were partners sharing profit and losses in the ratio of 1:2:1 respectively. The following are some of the particulars relating to the firm : a) The firm had taken life insurance policy on their lives independently; A for Rs. 5,000; B for Rs. 7,500 and C for Rs. 5,000 b) The partnership Deed provides that in the event of death of a partner, his share of profits for the portion of the current year in which the partner was alive should be calculated on the basis of the average profit of the previous two completed years. d) Goodwill should be calculated on the basis of two yours purchase of average profit of the previous two completed years.

27

e)

The capitals of the partners as on December 31, 1983 were- A : Rs. 25,000; B : Rs, 37,500 and C : Rs. 22,500 carrying 6 per cent per annum interest on capital.

C died on April, 1984 and had drawn Rs. 3000 from 1st January to the date of his death. The Insurance Company paid the amount due on Cs Policy on 1st June, 1984 and the surrender value of the remaining policies was one-fifth of the sums assured. The firms profits for the previous three years were; 1981 Rs. 10,500, 1982 Rs. 11,000 and 1983 Rs. 11,500. Prepare the Capital Account of C and also ascertain the amount due to his legal representative. 4. Ravi, Shanker and Sastry are partners sharing profits and losses as 6:5:4. They

have a Joint Life Policy for Rs. 2,00,000 on which they pay Rs. 7,500 per annum as premium and debit the same to Profit and Loss Account as premium. Accounts are closed annually on 31 December. Shanker died on 1st April, 1995 and his legal representatives are entitled to : i) ii) iii) His capital as appearing in the last Balance Sheet. Interest on capital at 6 per cent per annum to the date of death. His share of profit calculated till date of his death on the basis of the previous years profit; and iv) His share of goodwill calculated as two years purchase on the average of the last three years profit before inclusion of the policy premium as business expense. Shankers drawing in 1995 amounted to Rs. 3000. His capital shown in 1994 Balance Sheet was Rs. 80000. The profit for the three years 1992, 1993 and 1994 after inclusion of the policy premium as business expense amounted to Rs. 65000, Rs. 64000 and Rs. 69000 respectively. Prepare Shankers Capital Account
28

5.

A, B and C were carrying on business with the following assets with effect from

1-1-1980; Furniture Rs. 18,000; Machinery Rs. 72,000, Cash Rs. 10,000, Debtors Rs. 20,000. Their profit-sharing ratio was 5 : 3 : 2. Capital is also shared in the same ratio. B died on 30-6-80. His son claimed his fathers interest in the firm. The following was the settlement : a) b) c) Allow his capital to his credit on the date on death. Give 5% per annum interest on his capital. He had been drawing at Rs. 600 per month which he with drew in the beginning of each month. He be allowed to retain these drawings as a part of his share of profit. d) e) Interest at 6% per annum be charged on his drawings. They had separate life policies for which the premium had been paid out of Profit and Loss Account of the firm : A Rs. 50,000; B Rs. 60,000 and C Rs. 30,000. The surrender value of As policy was 50 per cent whereas of Cs policy it was 40 per cent. f) Goodwill was evaluated twice the average of profits which were Rs. 3,600. Prepare Bs Personal Account. 6. Azad, Binod and Chandan sharing profits in the ratio of 2 : 2 : 1 took out a joint life policy in 1995 for Rs. 3,00,000. A premium of Rs. 18,000 being paid annually on January 1. The surrender value of the policy on 31st December of various years was as follows: 1995 1996 1997 1998 1999 Binod died on May 15, 1998.
29

Nil Rs. 5,400 Rs. 12,000 Rs. 23,400 Rs. 40,000

Prepare the necessary ledger accounts along with journal entries assuming: (i) no joint life policy account is maintained, (premium paid is treated as on expense). (ii) Joint life policy account is maintained as an asset at surrender value. (iii) Joint life policy is maintained on as asset at surrender value along with a joint life policy reserve account. 6.7 1. SUGGESTED READINGS Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. 2. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi. 3. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. 4. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi. 5. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana. 6. Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi.

30

LESSON : 7
AMALGAMATION OF PARTNERSHIP FIRMS
STRUCTURE 7.0 7.1 7.2 7.3 7.4 7.5 7.6 7.7 7.0 Objective Introduction Accounting Treatment in the Books of the Amalgamating Firms Books of the New Firm Summary Keywords Self Assessment Question Suggested Readings OBJECTIVE After reading this lesson you should be able to know (a) Accounting entries to be passed to close the books of the amalgamated firms. (b) Treatment of assets and liabilities not taken over by the new firms in the books of amalgamated firms 7.1 INTRODUCTION Amalgamation of firms takes place when two or more firms working independently amalgamate themselves and in their place a new firm is formed to take over their businesses. This is done to avoid competition, to reduce unnecessary advertisement expenditure, to gain monopoly in the market, to have more capital and skill and to have internal and external economies of large scale production. The following problems may arise when existing firms are amalgamated to form a new company: 1

(a)

The new firm may take over some assets and liabilities at book value and some assets and liabilities at revised values.

(b)

The new firm may not take over some assets and liabilities of the existing firms.

(c)

The new firm may agree to pay some amount for the goodwill which may be more or less than the amount of goodwill, if any, already appearing in the books of the existing firms.

7.2

ACCOUNTING TREATMENT IN THE BOOKS OF THE AMALGAMATING FIRMS

The following steps may be taken to close the books of the old firms: (i) All assets and liabilities should be revalued in order to ascertain the true capital

brought by each partner into the new firm. For this purpose each firm will prepare a revaluation account relating to its own assets and liabilities and profit or loss on revaluation will be transferred to the partners capital accounts in the profit sharing ratio. This revaluation is done in the same way as was done at the time of admission or retirement of a partner. (ii) All reserves, profits and losses appearing in the balance sheets of old firms are

transferred to the partners capital accounts in their profit sharing ratio. (iii) If some assets and liabilities are not taken over by the new firm, these are closed

by transfer to capital accounts of the partners in the ratio of their capitals and not in the profit sharing ratio. Division of assets and liabilities taken over by the partners is done in the ratio of capitals because it amounts to return or addition of Capital. (iv) Goodwill, if valued, should be raised in the firms books by passing necessary

entries. (v) New firms account is debited with the difference of assets and liabilities taken

over by passing the following entry: 2

New Firms A/c Liabilities A/c To Assets A/c

Dr. Dr.

Assets and liabilities are taken at revised values for the purpose of the above entry. (vi) Partners capital accounts (i.e. final amount due) are closed by transfer to the

new firms account by passing the following entry: Partners Capital A/cs To New Firms A/c 7.3 BOOKS OF THE NEW FIRM Books of the new firm are opened by passing the following entries: (i) Assets (taken over) To Liabilities (taken over) To Capital A/cs of the Partners as calculated in step (vi) above. (ii) Adjust capital accounts of the partners in the light of the requirements of the Dr. Dr.

new firm such as a partner brings in capital or withdraws it; entry for that is passed. Illustration 1 On 1st January, 1985, A & B and X & Y who had previously been engaged in competitive business agreed to amalgamate. The Balance Sheets of the two firms on 31st December, 1984 were as follows :

Liabilities

A&B Rs.

X&Y Rs. 12500 ---5150 -----26250 26250

Assets

A&B Rs.

X&Y Rs. 22000 38000 ---10000

Creditors B/P Bank Overdraft A's Capital B's Capital X's Capital Y's Capital

1500 3000 ---25000 25000 -------

Stock Debtors Building Plant & Machinery Bank Furniture National Saving Certificate

15500 24500 10000 2500

750 250 1000

---150 ----

54500

70150

54500

70150

A valuation of assets of both the firms was made, and it was agreed that the building and plant and machinery belonging to A & B should be taken over by the new firm at Rs. 12500 and Rs. 5000 respectively. X & Y were to be credited with Rs. 2500 as the value of certain patent rights they possessed became the property of the partnership and were not included in their Balance Sheet. All the other assets and liabilities were taken over at the values stated in the respective Balance Sheet except the National Saving Certificate belonging to A & B, which were not taken over. It was agreed that A & B should introduce cash to make their capital equal to total of X & Y. Pass Journal entries in the books of the old firms and opening entries in the books of the new firm. Also prepare the Balance Sheet of the new amalgamated firm.

Solution Books of A & B Journal Entries Dr. Particulars Building Account Plant & Machinery A/c To Revaluation Account (Being increase in the value of assets) Revaluation Account To A's Capital Account To B's Capital Account (Being profit on revaluation transferred to Capital Accounts in equal ratio) M/s. A & B, X & Y Account To Building Account To Plant & Machinery Account To Furniture Account To Stock Account To Debtors Account To Bank Account (Being Assets taken over transferred to new firm) A's Capital Account B's Capital Account To NSC Account (Being taking NSC by A & B in the ratio of their Capitals) A's Capital Account B's Capital Account To A & B, X and Y Account (Being transfer of Capital of A & B to new firm) 5 Dr. Dr. 27000 27000 54000 Dr. Dr. 500 500 1000 5000 250 15500 24500 750 Dr. 58500 12500 Dr. 5000 2500 2500 Dr. Dr. Rs. 2500 2500 5000 Rs. Cr.

Books of X & Y Journal Entries Dr. Rs. Patents Account To X's Capital Account To Y's Capital Account (Being unrecorded patents created in books in Profit and Loss Ratio) M/s. A & B, X & Y Account To Stock Account To Debtors Account To Plant & Machinery Account To Furniture Account To Patents Account (Being assets take over by new firm) Creditors Account Bank Overdraft To M/s. A & B, X & Y Account (Being liabilities transferred to new firm) X's Capital Account Y's Capital Account To M/s A & B, X & Y Account (Being transfer of Capital Accounts of X and Y new firm) Dr. Dr. 27500 27500 55000 Dr. Dr. 12500 5150 17650 10000 150 2500 Dr. 72650 22000 38000 Dr. 2500 1250 1250 Cr. Rs.

Books of A & B, X, & Y Journal Entries Dr. Particulars Bank Account Building Account Plant & Machinery Account Furniture Account Stock Account Debtors Account To Creditors Account To B/P Account To A's Capital Account To B's Capital Account (Being Assets and Liabilities of M/s. A & B and Capital Accounts taken over by new firm recorded) Stock Account Debtors Account Plant & Machinery Account Furniture Account Patents Account To Bank Overdraft To Creditors Account To X's Capital Account To Y's Capital Account (Being Assets and Liabilities of M/s X & Y and Capital Accounts taken over by new firm recorded) Bank Account To A's Capital Account To B's Capital Account (Being Cash brought by A & B) Dr. 1000 500 500 Dr. Dr. Dr. Dr. Dr. 22000 38000 10000 150 2500 5150 12500 27500 27500 Dr. Dr. Dr. Dr. Dr. Dr. Rs. 750 12500 5000 250 15500 24500 1500 3000 27000 27000 Cr Rs.

Balance Sheet of M/s A & B, X & Y as on 1st January 2005 Liabilities Capital Accounts A B X Y Bank Overdraft Creditors B/P Illustration 2 The balance sheets of M/s A & B and M/s C & D as on December 31, 1996 were as follows : Liabilities Capital A/c A B C D Creditors Loan Outstanding Expenses 10000 10000 --------15000 ----2000 --------10000 10000 10000 10000 3000 A&B Rs. C&D Rs. Land & Workshop Machinery & Tools Furniture & Fixtures Debtors Cash at Bank Stock 37000 43000 8 8000 37000 10000 43000 6000 3000 8500 1000 3000 3500 7000 8000 Assets A&B Rs. 10000 C&D Rs. 12000 27500 27500 27500 27500 3400 14000 3000 130400 130400 Rs. Assets Stock Debtors Furniture Patents Building Plant & Machinery Rs. 37500 62500 400 2500 12500 15000

The two firms decided to amalgamate to form ABCD & Co. on 1 January, 1997. The partners continue to share equally as they were doing before the merger. Prior to amalgamation the following revaluation of assets and liabilities should be made: A&B Land and Workshop Machinery and tools Furniture and Fixtures Debtors Stock Outstanding Expenses 10000 7000 2500 5500 8000 2000 C&D 10000 8000 2500 7000 8000 2000

In addition, the following things are to be carried out : a) b) The new firm will not take over the loan of C & D. The goodwill of A and B and that of C and D should be valued initially at Rs. 10000 and Rs. 5000 respectively, but for the purpose of the new firm, the combined goodwill of the firm should be Rs. 12000/e) Each partner should have Rs. 14000 as capital in the new firm and that cash should be brought in, if necessary. Show : i) ii) iii) The Two Revaluation accounts Capital Accounts before and after the amalgamation The Opening Balance Sheet of the new firm.

Solution In the Books of A&B Revaluation Account Dr. Particular To Furniture & Fixtures Account To Debtors Accounts To Profit: A 4500 B 4500 9000 10000 Capital Accounts Dr. Particulars To ABCD & Co. Account 14500 14500 A Rs. 14500 B Rs. 14500 By Balance c/d By Revaluation Account (Profit) 14500 14500 In the Books of C & D Revaluation Account Rs. To Land & Workshop A/c To Furniture & Fixtures Account To Debtors Account To Stock Account To Outstanding Expenses Account 500 7000 7000 1500 2000 1000 2000 By Goodwill Acount By Loss : C 1000 D 1000 2000 Rs. 5000 Particulars A Rs. 10000 4500 B Rs. 10000 4500 Cr. 10000 500 Rs. 500 Particular By Goodwill Account Rs. 10000 Cr.

10

Capital Account Dr. Particulars C Rs. To Revaluation A/c (Loss) To ABCD & Co. 14000 15000 14000 15000 Capital Accounts Dr. Particulars
To Goodwill Account To Balance c/d 14000 14000 14000 14000 14750 14750 14750 14750 14750 14750 14750 14750

Cr. D Rs. 1000 By Balance c/d By Loan Account Particulars C Rs. 10000 5000 15000 D Rs. 10000 5000 15000

1000

In the Books of ABCD & Co. Cr. A Rs.

750

B Rs.
750

C Rs.
750

D Rs.
750

Particulars
By Sundries By Cash

A Rs.
14500 250

B Rs.
250

C Rs.
250

D Rs.
250

14500 14500 14500

Balance Sheet of ABCD & Co. as on January, 1997

Liabilities Capital Accounts A B C D Creditors Outstanding Exps.

Rs. 14000 14000 14000 14000 25000 5500

Assets Goodwill Land & Workshop Machinery & Tools Furniture & Fixtures Debtors Stock Cash 14500 Less : Provision 2000 18000 Less : Provision 2000

Rs. 12000 20000 15000 5000 12500 16000 6000 86500

86500 Note : Since the goodwill of the new firm is Rs. 12000, Rs, 3000 has been written off. 11

Illustration 3 Two partnership firms, carrying on business under the names of Black & Co. and White & Co., decide to amalgamate into Grey & Co. with effect from April 1, 1999. The respective Balance Sheets as on March 31, 1999 are given below : Balance Sheet of Black & Co. as on March 31, 1999 Liabilities B's Capital A/c Sundry Creditors Bank Overdraft Rs. 19000 10000 15000 44000 A and B share profits and losses in the proportion of 1:2. Balance Sheet of White & Co. as on March 31, 1999 Liabilities X's Capital A/c Y's Capital A/c Sundry Creditors Rs. 10000 2000 28000 Assets Goodwill Stock in trade Sundry debtors Cash in hand Cash at bank 40000 X and Y share profits and losses equally. The following further information is given : 1. 2. 3. 4. 5. All fixed assets are to be devaluated by 20% All stock in trade is to be appreciated by 50% Black & Co. owe Rs. 5000 to White & Co. as on March 31, 1999 Goodwill is to be ignored for the purpose of amalgamation. The fixed Capital Account in the new firm are to be : 12 Rs. 10000 5000 10000 6000 9000 40000 Assets Plant & Machinery Stock in trade A's Capital A/c Rs. 20000 20000 4000 44000

Rs. A B 6. 2000 ; 1000 ; B Y

Rs. 3000 4000

B takes over the bank overdraft of Black & Co., and gifts to A the amount of money to be brought in by A to make up his capital contribution.

7.

X is paid off in cash from White & Co., and Y brings in sufficient cash to make up his required capital contribution.

Pass journal entries to close the books of both the firms as on March 31, 1999 Solution Journal Entries in the books of Black & Co. Dr. Particulars Revaluation A/c To Plant & Machinery A/c (Being plant and Machinery devalued by 20%) Stock in Trade A/c Sundry Creditors A/c To Revaluation A/c (Being appreciation in stock in trade and gain in settling debt) Revaluation A/c To A's Capital A/c To B's Capital A/c (Being the profit on revaluation) Bank Overdraft A/c To B's Capital A/c (Being the bank overdraft taken by B) Dr. 15000 15000 Dr. 11000 3667 7333 Dr. Dr. 10000 3000 13000 Dr. Rs. 2000 2000 Rs. Cr.

13

B's Capital A/c To A's Capital A/c (Being the deficiency of A's Capital A/c made good by B to have a balance of Rs. 2000 in A's Capital A/c) Grey & Co. A/c Sundry Creditors A/c To Plant & Machinery A/c To Stock in trade A/c To Sundry Debtors A/c

Dr.

2333 2333

Dr. Dr.

41000 7000 8000 30000 10000

(Being the assets and liabilities transferred to Grey & Co. for closing the books of the firm) A's Capital A/c B's Capital A/c To Grey & Co. (Being the Capital Account of the partners closed by transferring to Grey & Co.) Journal Entries in the books of White & Co. Dr. Particulars Stock in Trade A/c To Revaluation A/c (Being the appreciation in the value of stock in trade) Revaluation A/c To Sundry Debtors A/c To Goodwill A/c (Being debt due from Black & Co. settled at the concession of Rs. 3000 and goodwill written off) Dr. 13000 3000 10000 Dr. Rs. 2500 2500 Rs. Cr. Dr. Dr. 2000 39000 41000

14

X's Capital A/c Y's Capital A/c To Revaluation A/c (Loss transferred to Capital Account) X's Capital A/c To Cash A/c (Being excess capital refunded to X) Cash A/c To Y's Capital A/c

Dr. Dr.

5250 5250 10500

Dr.

3750 3750

Dr.

7250 7250

(Being cash brought by Y to make his capital of Rs. 4000) Grey & Co. A/c Sundry Creditors A/c To Stock in trade A/c To Sundry Debtors A/c To Cash in hand A/c To Cash at Bank A/c (Being the assets and liabilities transferred to Grey & Co. to close the books of the firm) X's Capital A/c Y's Capital A/c To Grey & Co. (Being Partners' Capital Account closed by transferring to Grey & Co.) Note : The excess amount of Rs. 36000 in B's Capital Account will be treated as loan from B in the books of Grey & Co. as the company has no liquid assets from which this amount can be paid to A. Dr. Dr. 1000 4000 5000 Dr. Dr. 5000 28000 7500 7000 9500 9000

15

Illustration 4 The balance sheets of two firms M/s Good & Better and M/s Slow & Fast, as on January 1, 1999 were : Balance Sheet Good & Slow & Better Liabilities Creditors Reserves Capital A/c : Good Better Fast 25000 18750 ------63750 -------12500 37500 60000 63750 60,000 Rs. 12500 7500 Fast Rs. 10000 ---Assets Building Plant Stock Debtors Cash Good & Slow & Better Rs. 18750 25000 12500 6250 1250 Fast Rs. ------32500 18750 8750

Good & Better shared profits in the ratio of 3 :2 and Slow & Fast in the ratio of 5 :3. The two firms decided to amalgamate and the new profit sharing ratio among Good, Better, Slow and Fast was to be 3:2:3:2. The other terms were: 1. Goodwill of M/s Good & Better was valued at Rs. 25000/- and that of M/s Slow & Fast at Rs. 18750/-. The new firm was not to retain goodwill in the books. 2. Stock of M/s Slow & Fast was valued at Rs. 31250 and a provision of 5% was required against the debtors. 3. In the case of M/s Good & Better, Rs. 750 of the debtors was to be written off. Building were valued at Rs. 25000 and the Plant at Rs. 22500. 4. The total capital of the firm was fixed at Rs. 1,00,000 to be contributed by partners in their profit sharing ratio and necessary adjustments were to be made in cash. Show the incorporating entries and the Balance Sheet of the new firm called M/s Good and Fast. 16

Solution Journal Entries in the books of Good and Fast Dr. Particulars Goodwill A/c Building A/c Plant A/c Stock A/c Debtors A/c Cash A/c To Creditors A/c To Goodwill A/c To Better's Capital A/c (Being the assets and liabilities taken over from Good and Better) Goodwill A/c Stock A/c Debtors A/c Cash A/c To Creditors A/c To Reserve for bad debts A/c To Slow's Capital A/c To Fast's Capital A/c (Being the assets and liabilities taken over from Slow and Fast) Dr. Dr. Dr. Dr. 18750 31250 18750 8750 10000 938 47851 18711 Dr. Dr. Dr. Dr. Dr. Dr. 25000 25000 22500 12500 5500 1250 12500 46300 32950 Cr. Rs. Rs.

17

Good's Capital A/c Better's Capital A/c Slow's Capital A/c Fast's Capital A/c To Goodwill A/c (Being the goodwill written off) Cash A/c To Fast's Capital A/c (Being the cash brought in by Fast to adjust his capital) Good's Capital A/c Better's Capital A/c Slow's Capital A/c To Cash A/c

Dr. Dr. Dr. Dr.

13125 8750 13125 8750 43750

Dr.

10039 10039

Dr. Dr. Dr

3175 4200 4726 12101

Balance Sheet as on January 1, 1999 Liabilities Sundry Creditors Capital Account : Good Better Slow Fast 30000 20000 30000 20000 122500 Rs. 22500 Assets Building Plant Stock Debtors 24250 23312 7938 122500 Rs. 25000 22500 43750

Less : Provision 938 Cash

18

Working Good Rs. Capital before adjustment Profit on revaluation Reserve Capital on the date of amalgamation 25000 16800 4500 46300 Better Rs. 18750 11200 3000 32950 47851 18711 Slow Rs. 37500 10351 Fast Rs. 12500 6211

M/s Good and Fast Cash Account Dr. Particulars To Good and Better To Slow and Fast To Fast's Capital A/c Rs. 1250 8750 10039 Particulars By Good's Capital A/c By Better's Capital A/c By Slow's Capital A/c By Balance c/d 20039 Illustration 5 X and Y are partners of X & Co. sharing profits and losses in the ratio of 3:1 and Y and Z are partners of Y & Co. sharing profit and losses in the ratio of 2:1. On 31st March, 1998 they decide to amalgamate and form a new firm M/s XYZ & Co., where X, Y and Z would be partners sharing profits and losses in the ratio of 3:2:1. The Balance Sheets of two firms on the above date are as under : Cr. Rs. 3175 4200 4726 7938 20039

19

Balance Sheet X & Co. Y & Co. Liabilities Capital X Y Z Reserves Creditors Due to X & Co. Bank Loan 480000 320000 --100000 240000 --160000 --Rs. Rs. Assets Fixed Assets : Building 100000 300000 40000 --320000 12000 X & Co. Y & Co. Rs. Rs.

400000 Machinery 200000 Furniture 300000 Current Assets : 232000 Stock 200000 Debtors --Cash at Bank Cash in Hand Due from Y & Co. Advances

240000 320000 60000 40000 200000

280000 400000 180000 20000 ---

--1300000

120000 1332000

1300000 1332000

The amalgamated firm took over the business on the following terms (a) Building of X & Co. was valued at Rs. 200000, (b) Machinery of X &

Co. was valued at Rs. 450000 and that of Y & Co. at Rs. 400000, (c) Goodwill valued X & Co. Rs. 100000 and Y & Co. Rs. 82000 but the same will not appear in the books of XYZ & Co., (d) Partners of the new firm will bring the necessary cash to pay other partners to adjust their capitals according to the profits sharing ratio. Show journal entries in the books of M/s. XYZ & Co. and prepare the Balance Sheet as on 31.3.1998.

20

Solution Particulars Goodwill A/c Building A/c Machinery A/c Furniture A/c Stock A/c Debtors A/c Cash at Bank A/c Cash in Hand A/c Due from Y & Co. A/c To Creditors A/c To Bank Loan A/c To X's Capital A/c To Y's Capital A/c (Being the Assets and Liabilities of X & Co. taken over) Goodwill A/c Machinery A/c Furniture A/c Stock A/c Debtors A/c Cash at Bank A/c Advances A/c Cash in Hand A/c To Creditors A/c To Due to X & Co. A/c To Y's Capital A/c To Z's Capital A/c (Being the Assets and Liabilities of Y & Co. taken over) 21 Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr. 82000 400000 12000 280000 400000 180000 120000 20000 232000 200000 708000 354000 Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr. (Rs.) 100000 200000 450000 40000 240000 320000 60000 40000 200000 240000 160000 817500 432500 Cr. (Rs.)

X's Capital A/c Y's Capital A/c Z's Capital A/c To Goodwill A/c (Being Goodwill written off) Bank A/c To X's Capital A/c To Z's Capital A/c (Being the cash brought in by X and Z to make capital proportionate) Y's Capital A/c To Bank A/c

Dr. Dr. Dr.

91000 60667 30333 182000

Dr.

369833 338500 31333

Dr.

369833 369833

(Being the excess capital withdrawn by Y) Due to X & Y Co. To Due from Y & Co. A/c (Being the elimination of mutual indebtedness of the merged firm X & Co. and Y & Co.) Balance Sheet of M/s XYZ & Co. as on 31.3.98 Liabilities Capital : X Y Z Creditors Bank Loan Rs. Building 10,65,000 7,10,000 3,55,000 4,72,000 1,60,000 Assets 2,00,000 Machinery Furniture Stock Debtors Advances Cash at Bank Cash in hand 27,62,000 22 8,50,000 52,000 5,20,000 7,20,000 1,20,000 2,40,000 60,000 27,62,000 Rs. Dr. 200000 200000

Working Notes (i) Assets Goodwill Building Machinery Furniture Stock Debtors Cash at Bank Cash in Hand Due from Y & Co. Advances Liabilities Creditors Due to X & Co. ---Bank Loan Purchase Consideration (assets - liabilities) (ii) Statement showing the Computation of Proportionate Capitals Rs. 182000 2130000 10,65,000 7,10,000 3,55,000 Particulars M/s XYZ & Co. (Rs. 1250000 + 1062000) 2312000 Less : Goodwill Adjustment Total Capital of new firm X's proportionate Capital (Rs. 2130000 x 3/6) Y's proportionate Capital (Rs. 2130000 x 2/6) Z's proportionate Capital (Rs. 2130000 x 1/6) 23 240000 200000 160000 400000 1250000 ---432000 1062000 232000 100000 200000 450000 40000 240000 320000 60000 40000 200000 ---1650000 Statement showing the Computation of Purchase Consideration : Dr. (Rs.) Cr. (Rs.) Rs. 82000 ---400000 12000 280000 400000 180000 20000 ---120000 1494000 Rs. Particulars

(iii)

Statement showing the Computation of Capital Adjustments : X Rs. Y Rs.

432500 708000 1140500

Particulars

Z Rs.
---354000 354000

Total Rs.
1250000 1062000 2312000

Balance transferred from X & Co. Balance transferred from Y & Co.

817500 ---817500

Less : Goodwill written off in the ratio of 3 : 2 : 1 a) Existing Capital b) Proportionate Capital c) Amount to be paid in [paid off] (a - b) 338500 [369833] 31333 ---91000 7,26,500 10,65,000 60667 10,79833 7,10,000 30333 3,23,557 3,55,000 182000 21,30,000 21,30,000

Capital Account (In the Books of X & Co.) Dr. Particulars X. Rs. To Capital A/c M/s XYZ & Co. (transfer) Y Rs. Particulars X Rs. Y Rs. Cr.

817500 432500 By Balance b/d By Reserve (3:1)

480000 320000 75000 25000 25000 62500

By Goodwill ( 3:1) 75000

By Realisation A/c*

187500

817500 432500 *For Building Rs. 100000 and Machinery Rs. 150000

817500 432500

24

Capital Account (In the Books of Y & Co.) Dr. Particulars X. Rs. To Capital A/c M/s XYZ & Co. (transfer) Y Rs. Particulars X Rs. Y Rs. Cr.

708000 354000 By Balance b/d By Reserve (2:1) By Goodwill (2:1)

400000 200000 200000 100000 54667 27333 26667

By Realisation A/c* 53333 708000 354000 *For Machinery Rs . 80000 7.4 SUMMARY

408000 354000

When two or more firms carrying on business of same or similar nature, it would be natural if they amalgamate their business to avoid competition. It involves closure of old firms and birth of a new firm. The accounting implication of this exercise is the closing of the books of the amalgamating firms and opening of the books of the new firm. The new firm taken over the assets/liabilities of the amalgamating firms at their current net worth and values them accordingly. The assets/liabilities not taken over by the new firm are realised by the partners of amalgamating firms themselves. 7.5 KEYWORDS

Amalgamation of Firm: It takes place when two or more firms working independently amalgamate themselves and in their place a new firm is formed to take over their business. Amalgamating Firm: In case of amalgamation, the firms amalgamating (old firms) are known as amalgamating firms.

25

7.6 1. 2. 3.

SELF ASSESSMENT QUESTIONS Define amalgamation of firms? What entries are passed to close the books of How will you treat asset and liabilities not taken over by the new firms in the The Balance Sheet of two firms M/s Slow & Speed and M/s Sure & Steady as on Balance Sheet Slow & Speed Rs. 10000 6000 20000 15000 -----51000 Sure & Steady Rs. 8000 ---------30000 10000 48000 51000 48000 Slow& Speed Rs. 15000 20000 10000 5000 1000 Surr & Steady Rs. ------26000 15000 7000

the firms which are amalgamated. books of the amalgamated firms? January 1, 1995 were:

Liability Creditors Reserves Capital Slow Speed Sure Steady

Assets Building Plant Stock Debtors Cash

Slow & Speed shared profits in the ratio of 3 :2 Sures Steady shared profits in the ratio of 5:3. The two firms decided to amalgamate and the new profit sharing ratio among Slow & Speed, Sure & Steady was to be 3:2:3:2. The other terms were : a. b. c. d. 4. Goodwill of Slow & steady was valued at Rs. 2000 and that of Sure & Steady at Rs. 15000. The new firm was not to retain goodwill in the books. The stock of Sure & Speed was valued at Rs. 20,000 and a provision of 5% was required against their debtors. In the case of Slow & Speed, Rs. 600 of the debtors was to be written off. Building were valued at Rs. 20000 and plant at Rs. 18000. The total capital of the firm was fixed at Rs. 80000 to be contributed by partners in their profit sharing ratio and necessary adjustments were to be made by cash. M/s Mani & Co. having Vairamani and Velumani as equal partners, decided to amalgamate with M/s Swami & Co. having Radhaswami and Rangaswamy as equal partners on the following terms and conditions : 26

a.

The new firm named M/s Mani Swami & Co., to take over the investments at 10% depreciation; land at Rs. 40,000; premises at Rs. 22,500; machinery at Rs. 4500 and to take over only the trade liabilities of both the firms. The debtors is taken at book value including reserve.

b. c. d. e. f.

M/s Mani Swami & Co. to pay Rs. 6000 to each firm for goodwill. Typewriters at the written off value of Rs. 400 belong to Swami & Co. and not appearing in the Balance Sheet, were not taken over by the new firm. It was also agreed that the furniture belonging to both the firms should not be taken over by the new firm. All the four partners in the new firm to bring Rs. 80000 as capital in equal share. The following were the Balance Sheets of both the firms on the date of amalgamation : Balance Sheet Mani & Co. Rs. 10000 2500 1000 3000 ---17500 11000 ------1000 50000 Swami & Co. Rs. 5000 ---5000 ------------18000 10000 1500 500 40000 50000 40000 Mani & Co. Rs. 7500 5000 Swami & Co. Rs. 4000 4000

Liabilities S. Creditors Bills Payable Bank Overdraft Vairamani's Loan Capital A/c Vairamani Velumani Radhaswami Rangaswami Investment Fluctuation fund

Assets Cash at Bank Investments Debtors 5000 Less : Reserve Furniture Premises Land Machinery Goodwill 500

4500 6000 15000 ---7500 4500

4000 3000 ---25000 -------

General Reserve 4000

Pass journal entries in the books of both the firms and show the Balance Sheet of M/s. Mani Swami & Co.

27

5.

B and S are partners of S & Co. sharing profits and losses in the ratio of 3:1 S

and T are partners of T & Co. sharing profits and losses in the ratio of 2:1. On October 31, 1999 they decided to amalgamate and form a new firm M/s B S T & Co. wherein B, S and T would be partners sharing profits and losses in the ratio of 3 : 2 : 1. Balance Sheet S & Co. Liabilities Due to X & Co. Due to S & Co. Other Creditors Reserve Capital A/c B S T 120000 80000 ------Rs. 40000 ---60000 25000 T & Co. Rs. ---50000 58000 50000 Assets Cash in hand Cash at bank
Due from T&Co.

S & Co. Rs. 10000 15000 50000

T & Co. Rs. 5000 20000 ---30000 70000 100000 3000 80000 ------308000

Due from S&Co. ---Stock Other Debtors 60000 80000 10000 ---75000 25000 325000

100000 Furniture 50000 Vehicles Machinery Building

325000

308000

The amalgamation firm took over the business on the following understanding : 1. Goodwill of S & Co. was worth Rs. 60000 and that of T & Co. Rs. 50000, Goodwill account was not to be opened in the books of the new firm, the adjustments being recorded through Capital Accounts of the partners. 2. Building, Machinery and Vehicles were taken over at Rs. 50000, Rs. 90000 and Rs. 100000, respectively. 3. Provision for doubtful debts has to be carried forward at Rs. 4000 in respect of the debtors of S&Co. and Rs. 5000 in respect of the debtors of T & Co.

28

It is requested to : (a) (b) Compute the adjustment necessary for goodwill. Pass Journal entries in the books of M/s BST & Co., assuming that excess/

deficit capital (taking T's capital as base) with reference to share in profits are to be transferred to Current Accounts. 7.7 1. SUGGESTED READINGS Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. 2. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi. 3. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. 4. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana. 5. 6. Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi. Principles of Financial Accounting by P.C. Gupta and C.L. Chaturvedi, Shree Mahavir Book Depot, New Delhi.

29

LESSON : 8
DISSOLUTION OF THE FIRM
STRUCTURE 8.0 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.0 Objective Introduction Modes of Dissolution of Firm Settlement of Accounts on Dissolution Accounting Treatment on Dissolution of a Partnership Firm Summary Keywords Self Assessment Questions Suggested Readings OBJECTIVE After reading this lesson, you should be able to (a) (b) Do the settlements as per Section 48 of the Indian Partnership Act, 1932. Pass journal entries and close the books of the firm in case of dissolution of a partnership firm. 8.1 INTRODUCTION The Indian Partnership Act, 1932 recognizes the difference between the 'dissolution of partnership' and dissolution of firm'. The dissolution of partnership between all the partners of a firm is called the dissolution of the firm. Thus, it is the complete breakdown of a partnership and partners do not continue them. On the other hand, dissolution of the partnership means a reconstitution of the firm due to the retirement of a partner or the insolvency of a partner or the death of a partner and the 1

remaining partners provide for the continuance of the firm in pursuance of an express or implied agreement to that effect. On dissolution of a firm the firm's assets are realised and the liabilities are discharged because the firm is to be closed, whereas on dissolution of a partnership, the share of the outgoing partner is ascertained and the firm is not closed. 8.2 MODES OF DISSOLUTION OF FIRM The various ways in which a firm may be dissolved are given as under: (1) Dissolution by agreement. A firm is dissolved when all the partners agree that it should be dissolved. A partnership firm is the creation of an agreement; similarly a firm can be dissolved by an agreement. (2) Dissolution on the happening of contingencies. A firm is dissolved in any of the following ways unless there is a contract between the partners to the contrary. These are: (i) by the expiry of the term of duration of the firm, (ii) by the completion of the adventure for which the firm was constituted, (iii) by the death of a partner, and (iv) by the adjudication of a partner as insolvent. (3) Dissolution by notice of partnership at will. When the partnership is at will, the firm may be dissolved at any time by any partner giving notice in writing to all the other partners of his intention to dissolve the firm. (4) Compulsory dissolution or dissolution by the operation of law. A firm is compulsorily dissolved-different ways as: (i) When all the partners except one become insolvent. (ii) When all the partners become insolvent. (iii) When the business becomes illegal. (iv) Where the number of partners exceed twenty in case of ordinary business or ten in case of banking business. (5) Dissolution by the court. At the suit of a partner, a court may order the dissolution of the firm in different ways as: (i) when a partner becomes of unsound mind, (ii) when

a partner suffers from permanent incapacity and becomes incapable of performing his duties as a partner, (iii) when a partner is guilty of misconduct affecting the business of the firm, (iv) when a partner commits wilful or persistent breaches of agreement, (v) when a partner has transferred the whole of his interest in the firm to a third party or when his share has been attached under a decree or sold under process of law, (vi) when the business of the firm cannot be carried on except at a loss, and (vii) when the court is satisfied as to grounds which render it just and equitable to dissolve the firm. 8.3 SETTLEMENT OF ACCOUNTS ON DISSOLUTION The mode of settlement of accounts on a dissolution of the firm is as follows as given in Section 48 of the Indian Partnership Act, 1932. Section 48 of the Indian Partnership Act, 1932 governs the settlement of accounts on the dissolution of firm. The main points of this section are enumerated below: 1. All the assets of the firm (including the original contribution of the partners, additional contribution of the partners and the additional contribution made to make up deficiencies of capital) must first be applied in paying of all the debts of the firm, i.e., the money due to the third parties. 2. If after paying these liabilities, there is surplus left, the same should be applied in repaying the loans taken from the partners over and above the capital contributed by such partner. If the surplus is not sufficient to pay loans of all the partners, advances should be paid rateably. 3. The residue shall be compared with total of the capitals of the partners. The difference between the residue and the total capital should be transferred to the capital accounts in the ratio in which the partners share the profits and losses. This will make the total of the balances in the capital account equal to cash available and then the cash will be paid to each partner equal to the amount due (after adjusting profit or loss). 3

To summarize the above provisions, following procedure must be carefully followed :1. 2. Pay the outsiders ie. the third parties first. For this apply the assets of the firm. Then surplus, if any, may be used to repay loans received from the partners of the dissolved firm. 3. Any remaining amount is to be compared with the total capital of the firm. Any difference is to be transferred to the respective partners accounts in the profit/ loss sharing ratio. This will lead to the total cash available after the above adjustments. The same will be paid to each partner as per the balances of capital accounts. Firm Debts and Private Debts Where there are partnership debts and private debts of the partners in their individual capacity, the assets of the firm shall be applied in the first instance in payment of the debts of the firm and surplus of assets, if any, would be paid to the partners in the proportion in which they were entitled to share profits. similarly, the private property of each partner shall be applied first in the payment of his private debts, and the surplus of private assets, if any, would be handed over to the firm if the firm needs it for the payment of its debts. 8.4 ACCOUNTING TREATMENT ON DISSOLUTION OF A PARTNERSHIP FIRM On dissolution of a firm, the books of account will have to be closed. But this is not possible until all the assets of the firm have been realised in cash or otherwise disposed off (may be taken over by the partners of the erstwhile dissolved firm.) Further, all the liabilities of the firm including partners loans and capital should be paid off. 4

To close the books of account, following steps have to be followed :1. Realisation account is opened and all assets except cash or bank balances are transferred to the debit side of the realisation account at book values. Realisation account To stock To debtors To investments To plant and machinery etc. Note :- This way the accounts of these assets will stand closed. The assets against which some fund, reserve or provision is created should be debited to realisation account at gross value. The provision should be credited to the realisation account. This way the relevant account will stand closed. 2. The account of liability to third party (excluding partner's loans and capitals) should be transferred to the credit side of realisation account at book value. The entry will be:Sundry creditors A/c Bills payable A/c To Realisation A/c 3. When assets are sold for cash, the actual amount received should be debited to cash or bank account and credited to realisation account. If a partner takes asset then following entry is done Partner's Capital To Realisation A/c A/c Dr Dr Dr Dr

The account will be credited with the value agreed upon

4.

For expenses incurred during the course of the dissolution of the firm, following entry shall be made:Realisation A/c To cash/bank Dr

5.

For liabilities towards third party, following entry shall be done Sundry Creditors To cash/bank A/c Dr

If a partner agrees to discharge a liability, then the entry will be Realisation A/c Dr

To partner's capital account. 6. The difference of two sides of the realisation account now represents profit or loss on realisation. The amount so obtained should be transferred to the capital account of the partners in the ratio in which they share profits. Realisation account will be debited (if credit side is bigger or credited if the debit side is bigger. 7. Partner's loan should then be paid off. The entry will be: Partner's loan To cash/bank 8. If there is reserve fund or profit and loss account in the books, it should be transferred to capital account in the profit sharing ratio. 9. Now the balance, if any, standing to the debit of a partner's capital account will be brought in by him. Dr

Entry will be:Cash A/c To Partner's Capital A/c 10. The amount standing to the credit of the partner's capital account will then be paid off. Entry will be:Partner's capital A/c To cash account. Note : the above steps will close all the accounts. If an account remains open that means there has been some mistake. Illustration 1: A, B and C were in partnership sharing profits and losses in the proportion of one-half, one-third and one-sixth respectively. On June 30, 1998 they dissolved the partnership. The following Balance Sheet represented the position of the firm on that date: Balance Sheet as at ......... Liabilities Creditors Reserve for Contingencies Bank Loan Cs Loan A/c As Capital A/c Bs Capital A/c Cs Capital A/c Rs. 15,000 5,000 5,000 5,000 30,000 15,000 5,000 80,000 80,000 Assets Cash at Bank Stock Debtors Bills Receivable Buildings Rs. 1,500 25,000 24,000 1,000 28,500 Dr

Stock, Debtors and Buildings realised Rs. 16,500, Rs. 20,000 and Rs. 18,500 respectively. Bills Receivable were realised in full. Rs. 10,000 were spent in meeting 7

the contingent liabilities for which only Rs. 5,000 were reserved. The Creditors were paid at a discount of Rs. 500. The expenses of realisation amounted to Rs. 600. Close the books of the firm and draw the necessary ledger accounts. Solution Journal Entries 1998 June 30 Realisation A/c To Stock A/c To Sundry Debtors A/c To bills Receivable A/c (Being the transfer of Stock, Sundry Debtors, Bills Receivable and Buildings to Realisation A/c at Book value) June 30 Sundry Creditors Reserve for Contingencies Bank Loan A/c To Realisation A/c (For various liabilities transferred to Realisation A/c at Book value) June 30 Bank A/c To realisation A/c (Being the amount realised on sale of assets) Stock Sundry Debtors Bills Receivable A/c Buildings 16,500 20,000 1,000 18,500 56,000 8 Dr. 56,000 56,000 Dr. Dr. Dr. 15,000 5,000 5,000 25,000 Dr. Rs. 78,500 25,000 24,000 1,000 Rs.

June 30

Realisation A/c To Bank A/c (Being payment of Realisation Expenses)

Dr.

600 600

June 30

Realisation A/c To Bank A/c

Dr.

29,500 29,500

(Being Sundry liabilities paid at discount of Rs. 500) S. Cr. at a Dis. of Rs. 500 Contingencies Bank Loan 14,500 10,000 5,000 29,500 June 30 As Capital A/c Bs Capital A/c Cs Capital A/c To Realisation A/c (Being loss on realisation transferred to Partners Capital A/c) June 30 Cs Loan A/c To Bank A/c (For Cs Loan paid) June 30 As Capital A/c Bs Capital a/c Cs Capital A/c To Bank A/c (Being Balance Paid to partners) Dr. Dr. Dr. 16,200 5,800 400 22,400 Dr. 5,000 5,000 Dr. Dr. Dr. 13,800 9,200 4,600 27,600

Ledger Realisation Account Rs. To Sundry Assets A/c To Bank A/c (expenses) To Bank A/c (Sundry Liabilities paid) 78,500 By Sundry Liabilities A/c 600 By Bank A/c (Assets realised) 29,500 By Capital A/c (loss transferred) A 1/2 Share B 1/3 Share C 1/6 Share 1,08,600 Bank Account Rs. To Balance b/d To Realisation A/c (Sale Proceeds of Assets) 56,000 1,500 By Realisation A/c (expenses) By Realisation A/c (Payment of Liabilities) By Cs Loan A/c By As Capital A/c By Bs Capital A/c By Cs Capital A/c 57,500 29,500 5,000 16,200 5,800 400 57,500 Rs. 600 13,800 9,200 4,600 1,08,600 Rs. 25,000 56,000

10

Cs Loan Account Rs. To Bank A/c Partners Capital Accounts

Particulars A Rs. To Realisation A/c To Bank A/c 13,800 16,200 30,000 B Rs. 9,200 5,800 15,000 C Rs. 4,600 400 5,000 30,000 15,000 5,000 By Balance b/d Particulars A Rs. 30,000 B Rs. 15,000 C Rs. 5,000

Rs. 5,000

5,000 By Balance b/d

Illustration 2:J, S and R were in partnership sharing profits and losses in the ratio of 3 : 2 : 1. Their Balance Sheet as on 31st December, 1998 was as follows: Balance Sheet Rs. Capital Accounts J S R Reserve Fund Employees Provident Fund Depreciation Reserve Creditors 12,000 8,600 10,400 31,000 3,000 3,000 5,000 11,000 53,000 11 53,000 Buildings Plant Stock Joint Life Policy Debtors Accrued Interest Cash Rs. 10,000 22,000 6,000 6,200 5,000 1,000 2,800

It was agreed to dissolve the firm, and the terms of the dissolution were: (i) (ii) J took over Buildings at Book Value and agreed to pay off creditors. Accrued Interest was not collected whereas there was a contingent liability of Rs. 600 which was met. (iii) (iv) Other assets realised: Plant: Rs. 25,000, Stock: Rs. 5,000, Debtors Rs. 4,600. Realisation expenses Rs. 600

Prepare Realisation Account, Capital Accounts and Cash Account. Solution Dr. Particulars To Buildings A/c To Plant A/c To Stock A/c To Joint Life Policy A/c To Debtors A/c To Accrued Interest A/c To Js Capital A/c (Creditors taken over) To Cash A/c (Payment of Contingent Liability) To Cash A/c (Expenses paid) To Cash (Employees P.F.) 600 600 3,000 11,000 Realisation Account Rs. 10,000 22,000 6,000 6,200 5,000 1,000 Particulars By Employees Provident Fund A/c By Depreciation Reserve A/c By Creditors A/c By Js Capital A/c (Building taken over) By Cash A/c (Assets realised): Plant Stock Debtors By Capital Accounts: (Loss transferred) J S R 65,400 Rs. 900 600 300 1,800 65,400 Rs. 25,000 5,000 4,600 34,600 3,000 5,000 11,000 10,000 Cr. Rs.

12

Capital Accounts
Particulars J Rs. To Realisation A/c (Building taken over) To Realisation A/c (Loss on Realisation) To Cash A/c (Final payment) 24,500 9,600 10,900 24,500 9,600 10,900 13,600 9,000 10,600 900 600 300 10,000 S Rs. R Rs. By Balance b/d By Reserve Fund By Realisation A/c (Creditors taken over) 11,000 Particulars J Rs. 12,000 1,500 S Rs. 8,600 1,000 R Rs. 10,400 500

Cash Account Rs. To balance b/d To Realisation A/c (Sales of Assets) 2,800 34,600 By Realisation A/c (Contingent Liabilities) By Realisation A/c (Realisation Expenses) By Realisation A/c (E.P.F.) By Js Capital A/c By Ss Capital A/c By Rs Capital A/c 37,400 3,000 13,600 9,000 10,600 37,400 600 Rs. 600

13

Sale To A Company Often a Partnership firm converts itself into a joint stock limited company or sells its business to an existing one. Broadly, the procedure already discussed above will be followed for closing the books of the firm. Realisation A/c will be opened and assets transferred to it, so also liabilities (but not if liabilities are not taken over by the company). The purchase consideration paid by the company is credited to, Realisation A/c. If expenses are incurred by the firm, the amount will be debited to the realisation account. If the creditors are taken over by the company, no further treatment is necessary (beyond transferring them to the realisation account). But if the creditors are to be paid by the firm, the actual amount paid to them will be debited to liability account concerned. The difference between the book figure and the actual amount paid should be transferred to the realisation account. The profit or loss on realisation will be transferred to the capital account in the profit sharing ratio. Usually, the company takes over all the assets including cash. The same will be transferred to the realisation account. Further, the company will discharge the amount due from it in the form of cash, debentures and shares. Separate accounts will be opened for debentures and shares received. Partners will divide the debentures and shares among themselves in the absence of an express agreement in the ratio of their final claims, ie; in the ratio of capitals standing after the loss or profit on realisation (and other reserves and profits) has been transferred.

14

Illustration 3: Mr. M and Mr. D were carrying on business as equal partners. The firms Balance Sheet as on 31st December, 1998 was as follows: Liabilities Sundry Creditors Bank Overdraft Bills Payable Capital Accounts: M D 1,50,000 1,48,000 Rs. 65,500 30,000 12,500 Assets Stock Plant and Machinery Office Furniture Book Debts Joint Life Policy Leasehold Premises Profit and Loss A/c (debit balance) Drawings Account: M D 4,06,000 9,000 3,000 4,06,000 Rs. 54,000 1,82,000 15,000 73,000 9,500 34,500 26,000

The business was carried on till 30th June 1999. The partners withdrew in equal amounts half the amount of profits made during the period of six months (from JanuaryJune 1999) after 10% p.a. had been written off leasehold premises, 10% p.a. off plant and machinery and 5% p.a. off office furniture. Meanwhile sundry creditors were reduced by Rs. 10,000. On 30th June, 1999 stock was valued at Rs. 63,400. Bills payable were reduced by Rs. 2,300 and bank overdraft by Rs. 15,000. Book debts were valued at Rs. 65,000, the joint life policy was realised for Rs. 9,5000 and the amount was utilised to reduce the bank overdraft and other items remained the same as on 31st December, 1998. On 30th June, 1999 the firm sold the business to a Limited Company. The value of the goodwill was estimated at Rs. 1,08,000 and the rest of the assets were valued on the basis of the Balance Sheet as on 30th June 1999. The Company paid the purchase consideration in fully paid equity shares of Rs. 10 each, at par. 15

You are required to prepare a Realisation Account and Capital Accounts of the partners as on 30th June 1999. Solution Realisation Account
1999 June 30 To Leasehold Premises To Plant & Machinery To Office Furniture To Stock To Book Debts To Profit on Realisation transferred to: (3) Ms Capital A/c 54,000 Ds Capital A/c 54,000 1,08,000 4,56,700 4,56,700 Rs. 32,775 1,72,900 14,625 63,400 65,000 1999 June 30 By Sundry Creditors By Bank Overdraft (Rs. 30,000Rs. 15,000 Rs. 9,500 Proceeds of Joint Life Policy) By Bills Payable By Limited Company 10,200 3,85,500 Rs. 55,500 5,500

16

Partners Capital Accounts

1999 M Rs. Jan. 1 To Profit & Loss A/c (Debit Balance) Jan. 1 June 30 To Drawings To Drawings (Half of Profit upto June 30, 1999 withdrawn) June 30 To Shares in Limited Company 1,90,750 1,94,750 2,21,500 2,19,500 2,21,500 2,19,500 9,000 8,750 3,000 8,750 June 30 13,000 D Rs. 13,000 Jan. 1 June 30 By Balance b/d By Profit & Loss A/c (2) By Realisation A/c Profit 17,500 54,000 17,500 54,000 1999 M Rs. 1,50,000 D Rs. 1,48,000

Working Notes (1) Statement Showing Value of Net Assets as at 30th June, 1999. Rs. Leasehold Premises Less: Depreciation @ 10% p.a. for 6 months Plant and Machinery Less: Depreciation @ 10% p.a. for 6 months Furniture Less: Depreciation @ 5% p.a. for 6 months Stock Book Debts 34,500 1,725 1,82,000 9,100 15,000 375 14,625 63,400 65,000 3,48,700 1,72,900 32,775 Rs.

17

Less: Sundry Creditors Bank Overdraft (Rs. 15,000 Rs. 9,500 Proceeds of Joint Life Policy. It has been assumed that bank overdraft of Rs. 15,000 is before crediting proceeds of Joint Life Policy) Bills Payable

55,500

5,500 10,200 71,200

Value of Net Assets as on June 30, 1999 (2) Calculation of Profit Earned from Jan. 1, 1999 to June 30, 1999. Rs. Net Assets as on 30th June, 1999 Less: Net Assets as on 1st January, 1999: Stock Plant and Machinery Office Furniture Book Debts Joint Life Policy Leasehold Premises 54,000 1,82,000 15,000 73,000 9,500 34,500 3,68,000 Less: Sundry Creditors Bank Overdraft Bills Payable 65,500 30,000 12,500 1,08,000

2,77,500

Rs. 2,77,500

2,60,000 Increase in Net Assets after Drawings Add: Profit withdrawn by partners Net Profit for 6 months from 1-1-99 to 30-6-99 18 17,500 17,500 35,000

(3)

Calculation of Purchase Consideration: Rs.

Value of Net Assets as on 30th June, 1999 as per Working Note (1) Add: Goodwill Purchase Consideration Insolvency of partners

2,77,500 1,08,000 3,85,500

If at the time of dissolution, a partner owes a sum of money to the firm. He has to make payment to the firm. However, if he is insolvent, it may not be possible to recover the whole of the amount. Thus, the sum which is recoverable from an insolvent partner is a loss the question arises, what entry should be made in the books of account of the firm to take care of such a loss. ? Whether to treat it as an ordinary loss to be shared by the solvent partners in the profit sharing ratio or whether to treat it as an extraordinary loss. To decide the treatment, decision in "Garner vs. Murray" is followed. In this case, the court decided that such loss shouldn't be treated as an ordinary loss. The judgement in this case gave a detail account of the treatment to be done, which is as follows: The solvent partners should bring in cash equal to their share of loss on realisation. The loss due to the insolvency of a partner should be divided among the other partners in the ratio of capitals then standing (ie: after partners have brought in cash equal to their share of the loss on realisation) In other words, the loss due to the insolvency of partner has to be borne by the solvent partners in the ratio of their capitals standing just prior to dissolution.

19

Illustration 4 A, B and C were equal partners. On 31st December, 1999, the position was as follows:Rs. A's Capital 2,000 Cash 1,500 B's Capital 600 C's Capital 200 Loss on 900 Realisation 2,600 C is insolvent and can pay nothing. Close the books of the firm. Solution Cash Account 1999
31st Dec To Balance b/d 31st Dec To A's Capital 31st Dec To B's Capital

2,600

Rs. 1,500 300 300 2,100

31st Dec By A's capital A/c 31st Dec By B's Capital

Rs. 1,615 485 2,100

Capital Account A Rs. To Bal b/d To Loss on Realisation To C's Cap A/c - Loss written off in the ratio of 20:06 To cash 300 385 B Rs. 300 115 C Rs. 200 By bal b/d 300 By cash-to make loss on realisation By A's capital By A's capital A Rs. 2,000 300 B Rs. 600 300 C Rs.

385 115

1,615 2300

485 900 500 2300 900 500

Fixed and Fluctuating capital If the ratio in which an insolvent partner 's loss is to be written off is the ratio of capitals just prior to dissolution or as last agreed upon, the fact of capital being fixed or fluctuating is important. If the capital is fixed, this ratio will be used to divide the insolvent partner's loss But if the capital is fluctuating, following step will be taken :-

20

a)

Make adjustment in respect of reserves or profit and loss account, etc.

However, no adjustment will be made in respect of loss on realisation (b) Then the insolvent partner's loss will be divided in the ratio of capital after making adjustment in reserves as discussed above. An example will make the point clear. Suppose there are three partners A,B,C sharing profit and loss equally. A's capital is Rs. 10,000 B's capital is Rs. 6,000 C's capital is Rs. 4,000 (debit balance) There is a reserve fund of Rs. 6,000. Here firstly, the reserve fund will be divided among A,B,C. Hence, partners will be credited with Rs. 2,000 each. Now C is insolvent then:If the capitals are fixed, the loss on C's capital account will be borne by A and B in the ratio of 10:6, i.e.: capitals without adjustment for reserve. If the capitals are fluctuating, the loss on C's capital account will be borne by A and B in the ratio of 12:8 ie capitals after adjustment for reserve. Note : The rule of Garner Vs Murray need not always result in equitable distribution.; It considers only the capitals standing in the books and not the private estates of solvent partners. It is possible that a partner who has contributed large capital, is made to bear a large proportion of an insolvent partner's loss as compared to a partner who is richer but has not contributed so much capital. If a partner is lucky to have withdrawn all his money away before the dissolution, so that his capital account doesn't show a credit balance. In this case, he will bear no part of the loss due to a partner's insolvency. To avoid such an eventuality, there is generally a clause in the partnership deed laying down how a loss on an insolvent partner's Capital account will be shared by the solvent partners. If such a clause exists, the same will preferred over the Garner Vs Murray decision. 21

Illustration 5: X, Y and Z are partners sharing profits and losses in the ratio of 4 : 2 : 3. On 1st January, 1999, they agreed to dissolve the partnership on which date their Balance Sheet was as follows: Liabilities Profit and Loss Reserve Fund Bills Payable Sundry Creditors Loan from X Capital Accounts: Z Y X 3,000 46,000 68,000 1,51,200 Rs. 4,500 12,600 4,100 9,000 4,000 Assets Buildings Machinery Furniture Stock Debtors Investments Bills Receivable Cash at Bank Cash in hand Rs. 45,000 15,000 3,700 19,400 31,000 24,000 5,600 6,500 1,000 1,51,200

The assets realised: Investments Rs. 20,400; Bills Receivable and Debtors Rs. 28,000; Stock Rs. 14,550; Furniture Rs. 2,050; Machinery Rs. 8,600; Buildings Rs. 26,400. All the liabilities were paid off. The cost of realisation was Rs. 600, Z had become bankrupt and Rs. 1,024 only was recovered from his estate once and for all. Partners were finally paid off. Show the realisation account, the Bank account, and the capital accounts of the partners, when the capitals are fluctuating.

22

Solution Realisation Account

Rs. To Buildings To Machinery To Furniture To Stock To Debtors To Investments To Bills Receivable To bank (Bills Payable & Creditors) To Bank (Cost of Realisation) 45,000 By Bills Payable 15,000 By Sundry Creditors 3,700 By Bank (Assets Realised) 19,400 By Loss on Realisation transferred 31,000 24,000 5,600 13,100 600 1,57,400 To Capital A/cs X Y Z 19,600 9,800 14,700 44,100 1,57,400 Rs. 4,100 9,000 1,00,200

Capital Accounts
X Rs. To Realisation A/c (Loss) To Zs Capital A/c (Rs. 4,976 in the ratio of 75,600: 49,800) To Bank A/c 3,000 1,976 By Bank Account (Realisation loss brought in) By Bank Account By Xs Capital A/c By Ys Capital A/c 95,200 59,600 14,700 95,200 19,600 9,800 1,024 3,000 1,976 59,600 14,700 75,600 49,800 8,700 19,600 9,800 14,700 Y Rs. Z Rs. By Profit & Loss A/c By Profit & Loss A/c By Reserve Fund X Rs. 2,000 2,000 5,600 Y Rs. 1,000 1,000 2,800 Z Rs. 1,500 1,500 4,200

72,600 47,824

23

Bank Account Rs. To Balance b/d To Cash in hand To Realisation A/c To Xs Capital A/c To Ys Capital A/c To Zs Capital A/c 6,500 1,000 1,00,200 19,600 9,800 1,024 1,38,124 When all partners are insolvent If all the partners are insolvent, the creditors can't be expected to be paid in full. All the cash available, together with whatever can be received from the private estates of the partners, will be paid to the creditors after the expenses of realisation are met. The realisation account should be prepared in the usual course. However, creditors shouldn't be transferred to this account nor will payment to creditors be debited to this account. The loss on realisation should be transferred to the capital accounts of partners in the profit sharing ratio. The available cash should then be paid to the creditors. The amount remaining unpaid should be transferred to Deficiency account. The balances of Partner's Capital accounts should also be transferred. Thus, the books will be closed. Illustration 6: A, B and C are three partners sharing profits and losses in the ratio of 2 : 2 : 1. They decide to dissolve the firm and following is their Balance Sheet on the date of dissolution: 1,38,124 By Realisation A/c By Realisation A/c By Xs Loan A/c By Xs Capital A/c By Ys Capital A/c Rs. 13,100 600 4,000 72,600 47,824

24

Rs. Creditors Reserve Fund Profit and Loss Account As Capital Account Bs Capital Account 13,000 10,000 5,000 20,000 10,000 Cash Stock Sundry Debtors Furniture Plant and Machinery Cs Capital Account 58,000 The assets realised as follows: Stock Rs. 11,400; Sundry Debtors Rs. 12,200 and Furniture Rs. 2,400.

Rs. 4,500 12,300 15,600 4,200 16,000 5,400 58,000

Plant and Machinery is taken over by A at Rs. 12,500. Creditors were paid off in full. A contingent liability for Bills Receivable discounted materialized to the extent of Rs. 400. C is insolvent but his estate pays Rs. 2,400. Give accounts to close the books of the firm: (1) (2) Solution If the capitals are fixed. If the capitals are fluctuating.

25

(1) If the Capitals are fixed Realisation Account Rs. To Stock To Sundry Debtors To Furniture To Plant & Machinery To Cash Account (Creditors paid) To Cash Account (Bills Discounted) 400 By As Capital A/c: (Plant & Machinery taken) By Loss on Realisation transferred to Capital Accounts: A2/5 B2/5 C1/5 61,500 Cash Account Rs. To Balance b/d To Realisation Account (Assets realised) To Cs Capital Account To As Capital Account To Bs Capital Account 26,000 2,400 4,000 4,000 40,900 26 4,500 By Realisation Account (Creditors paid) By Realisation Account (Bills discounted) By As Capital Account By Bs Capital Account 400 12,167 15,333 40,900 13,000 Rs. 4,000 4,000 2,000 10,000 61,500 12,500 12,300 15,600 4,200 16,000 13,000 By Creditors By Cash Account: Stock Sundry Debtors Furniture 11,400 12,200 2,400 26,000 Rs. 13,000

As Capital Account Rs. To Realisation Account (Loss on Realisation) To Realisation Account (Plant & Machinery taken) 12,500 To Cs Capital Account (2/3rd share of Cs deficiency) To Cash Account 1,333 12,167 30,000 Bs Capital Account Rs. To Realisation Account (Loss on Realisation) To Cs Capital Account (1/3rd share of Cs deficiency) To Cash Account 667 15,333 20,000 Cs Capital Account Rs. To Balance b/d To Realisation Account (Loss on Realisation) 2,000 5,400 By Reserve Fund By Profit & Loss Account By Cash Account By As Capital Account (2/3rd share of deficiency) By Bs Capital Account (1/3rd share of deficiency) 7,400 27 667 7,400 1,333 Rs. 2,000 1,000 2,400 20,000 4,000 By Balance b/d By Reserve Fund By Profit & Loss Account By Cash Account Rs. 10,000 4,000 2,000 4,000 30,000 4,000 By Balance b/d By Reserve Fund By Profit & Loss Account By Cash Account Rs. 20,000 4,000 2,000 4,000

(2) If the Capitals are fluctuating There will be no difference in Realisation Account, so it should not be prepared again. Cash Account Rs. To Balance b/d To Realisation Account (Assets realised) To Cs Capital Account To As Capital Account To Bs Capital Account 26,000 2,400 4,000 4,000 40,900 As Capital Account Rs. To Realisation Account (Loss on Realisation) To Realisation Account (Plant & Machinery taken) 12,500 To Cs Capital Account (13/21rd share of Cs deficiency) To Cash Account 1,238 12,262 30,000 30,000 4,000 By Balance b/d By Reserve Fund By Profit & Loss Account By Cash Account Rs. 20,000 4,000 2,000 4,000 4,500 By Realisation Account (Creditors paid) By Realisation Account (Bills discounted) By As Capital Account By Bs Capital Account 400 12,262 15,238 40,900 13,000 Rs.

28

Bs Capital Account Rs. To Realisation Account To Cs Capital Account (8/21) share of Cs deficiency To Cash Account 762 15,238 20,000 Cs Capital Account Rs. To Balance b/d To Realisation Account (Loss on Realisation) 2,000 5,400 By Reserve Fund By Profit & Loss Account By Cash Account By As Capital Account (13/21 share of deficiency) By Bs Capital Account (8/21 share of deficiency) 7,400 762 7,400 1,238 Rs. 2,000 1,000 2,400 20,000 4,000 By Balance b/d By Reserve Fund By Profit & Loss Account By Cash Account Rs. 10,000 4,000 2,000 4,000

Note: Deficiency has been divided in proportions to capitals which stood before the date of dissolution. A Rs. Capital Reserve Fund Profit & Loss Account 20,000 4,000 2,000 26,000 Therefore, ratio of capitals 26,000 : 16,000 or 13 : 8. B Rs. 10,000 4,000 2,000 16,000

29

Gradual Realisation of the Assets And Piecemeal Distribution Now the main point is to find out how to distribute cash among partners for return of capital. The available cash can't be distributed in profit sharing ratio (unless the capitals are in profit sharing ratio.) The cash available can't also be distributed in the ratio of capitals which may be different from the profit sharing ratio. The rule to follow in piecemeal distribution is that the partners whose capital is more than proportionate to other partner's capitals (considering the profit sharing ratio) should first be refunded so much to bring their capitals to proportionate levels. After this, the cash available should be distributed among the partners in the profit sharing ratio. Each partner's position has to be compared with that of others. Illustration 7: A, B and C share profits and losses in the ratio of 3 : 2 : 1. Their Balance Sheet is as follows: Rs. Creditors As Loan Capitals: A B C 50,000 10,000 40,000 1,60,000 The partnership is dissolved and the assets are realised as follows: 1st Realisation 2nd Realisation 3rd Realisation 4th Realisation Rs. 40,000 Rs. 30,000 Rs. 54,000 Rs. 7,000 30 1,60,000 50,000 10,000 Land & Buildings Plant and Machinery Stock Debtors Cash Rs. 70,000 40,000 25,000 20,000 5,000

Prepare a statement showing how the distribution should be made. Solution Statement showing distribution of cash
Creditors As Loan Rs. Amount due Cash in hand paid to Creditors 50,000 5,000 45,000 Amount on 1st Realisation paid to Creditors 40,000 5,000 Amount on Second Realisation Less: Paid to Creditors Rs. 30,000 5,000 25,000 Less: As Loan paid 10,000 15,000 Less: Paid to C 15,000 50,000 Amount on 3rd Realisation Less: Paid to C 54,000 8,333 45,667 Less: Paid to A and C 45,667 Amount on 4th Realisation Less: Paid to A and C 7,000 1,000 6,000 Less: Paid to Partners A, B & C Balance unpaid as Realisation Loss 6,000 750 15,000 3,000 12,000 10,000 2,000 8,000 250 5,000 1,000 4,000 50,000 34,250 15,750 10,000 10,000 8,333 16,667 11,417 5,250 10,000 15,000 25,000 5,000 10,000 Rs. 10,000 As Capital Rs. 50,000 Bs Capital Rs. 10,000 Cs Capital Rs. 40,000

31

Explanation: In the 2nd Realisation, there remains a balance of Rs. 15,000 to be utilised towards repayment of capitals. Capitals are not in their profit-sharing ratio : Bs Capital for 2/6th share is Rs.10,000. So As Capital must be Rs. 15,000 and Cs Capital Rs. 5,000. Thus, their capitals are in excess of their profit-sharing ratio by Rs. 35,000 each. Between A and C, the ratio is 3 : 1; so first Rs. 23,333 (Rs. 15,000 out of the second realisation and Rs. 8,333 out of the third realisation) are paid to C to make his capital equal to his profit sharing arrangement with A. The balance of Rs. 45,667 of the third realisation is distributed between A and C in the ratio of 3 : 1. The capitals of these partners being still proportionately in excess of Bs Capital by Rs. 750 and Rs. 250 respectively, so they are paid Rs. 750 and Rs. 250 respectively. Now capitals of all the partners come in their profit sharing arrangement. The balance of Rs. 6,000 of the fourth realisation is distributed between them in their profit sharing ratio of 3 : 2 : 1. 8.5 SUMMARY Dissolution means termination of a partnership agreement. Dissolution of partnership means a change in the relationship of the partners. Dissolution of partnership firm means that the firm comes to an end and ceases to function as a firm. Any partnership may be dissolved on account of many reasons. On dissolution of the firm, the settlement of accounts among partners is done in accordance with the partnership deed. In the absence of any agreement, the rules stated in Section 48 of the Partnership Act shall apply when the partnership firm is dissolved, a Realisation Account is opened for disposing of all the assets of the firm and making payments to all the creditors. No special treatment is given to goodwill, it is treated like other assets. If a partner is insolvent, then his deficiency which he is not able to bring will be borne by the other solvent partners in accordance with the decision in Garner vs. Murray. While determining the capital ratio of the solvent partners, distinction should be observed between fixed and fluctuating capital. When there is gradual realisation of assets, it is necessary to avoid the unpleasant consequences of a partner's account being overdrawn distributing 32

case of various realizations of assets in such a way that the final unpaid balance of the capital of each partner is left in his profit-sharing ratio. 8.6 KEYWORDS

Dissolution of Partnership: It means a change in the relationship of the partners. Dissolution of Partnership Firm: It refers to the winding up of business in partnership. Garner vs. Murray Decision: In the absence of any agreement to the contrary, the deficiency on the insolvent partner's capital account must be borne by other solvent partners the proportion to their capitals which stood before the dissolution of the firm. 8.7 1. SELF ASSESSMENT QUESTIONS Differentiate between dissolution of partnership and dissolution of firm. State how and under what circumstances a firm may be dissolved. 2. 3. Give the entries needed to close the books of the firm upon its dissolution. Examine the underlying principles of Garner vs. Murray decision in the dissolution of partnership with suitable illustrations. 4. The Balance Sheet of a firm on 31st March, 1999 was as follows :Rs. 5,000 4,000 3,000 2,000 14,000 Assets Freehold Prop Investments Book Debts Cash at Bank Rs. 8,000 2,000 1,000 3,000 14,000

Liabilities X's Capital Y's Capital Z's Capital Sundry Creditor:

The Partnership was dissolved as on 31 March, 1999. The sundry creditors were paid at a discount of 5% X agreed to takeover the Freehold Property at Rs. 9,000. Y the investments at rs. 1,500 and Z the book debts at Rs. 600. The expenses of realisation came to Rs. 110. 33

Close the books of the firm. 5. A, B and C sharing profits in the proportion of 3:2:1 agreed upon dissolution of their Partnership on 31 march, 1999. The balance sheet on this day was as follows:Liabilities Capital Accounts A B 40,000 20,000 60,000 10,000 18,500 14,000 6,000 Rs. Assets Machinery Stock In Trade Investments Joint Life Policy Debtors 9,300 less:- prov. 600 Current AccountCash at Bank 108,500 8,700 11,500 5,420 108,500 Rs. 40,500 7,550 20,830 14,000

Mrs. A's Loan Creditors Life Insurance Fund Investment Fluct. Fund

The Life Policy is surrendered for Rs. 12,000. The investments are taken over by A for Rs. 17,500 A agrees to discharge his wife's loan. B takes over all the stock at Rs. 7,000 and Debtors amounting to Rs. 5,000 at Rs. 4,000. Machinery is sold for Rs. 55,000. The remaining Debtors realise 50% of book value. The expenses of realisation amount to Rs. 600. It is found that an investment not recorded in the books is worth Rs. 3,000. The same is taken over by one of the creditors at this value. Final accounts of the partners on completion of the dissolution of the firm. 6. Slow, Sure and Fast were Partners sharing profits and losses in the ratio of 3:2:1 On 31st March, 1998 their Balance Sheet was as follows:-

34

Liabilities Sundry Creditors Bills payable Slow's Loan A/c Capitals Account Slow Sure Fast Reserve Fund

Rs. 15,400 3,600 10,000

Assets Cash at Bank Stock Debtors Less:- Provision

Rs.

Rs. 3,500 19,800

15,000 1,000 14,000 4,000 43,700

20,000 16,000 8,000 12,000 85,000

Joint Life Policy Plant and Machine

85,000

The firm was dissolved on 1st April, 1999. Joint Life Policy was taken over by Slow at Rs. 5,000. Stock realised Rs. 18,000. Debtors realised Rs. 14,500. Plant and Machinery was sold for Rs. 36,000. Liabilities were paid in full. In addition one bill for Rs. 700 under discount was dishonoured and had to be taken up by the firm. Assume there were no expenses. Give Journal entries and the necessary ledger accounts to close the books of the firm. 7. A,B and C commenced business on 1st April, 1998 with capitals of Rs. 50,000,

Rs. 40,0000 and Rs. 30,000. Profits and Losses were shared in the ratio of 4:3:3. Capitals carried interest at 5% per annum. During 1998 and 1999, they made profits of Rs. 20,000 and Rs. 25,000 (before allowing interest) Drawings of each partner were Rs. 5,000 per year. On 31st March, 1999 the firm is dissolved. Creditors on that date were Rs. 12,000. The assets realised Rs. 1,30,000 net. Give the necessary accounts to close the books of the firm.

35

8.8 1. 2. 3. 4. 5. 6.

SUGGESTED READINGS Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana. Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi. Principles of Financial Accounting by P.C. Gupta and C.L. Chaturvedi, Shree Mahavir Book Depot, New Delhi. Financial Accounting by A. Karim, S.S. Khanuja and Piyush Mehta, Sahitya Bhawan Publishers, Agra.

36

LESSON -9 COMPANY ACCOUNTS : ACCOUNTING FOR SHARES AND SHARE CAPITAL

STRUCTURE 9.0 9.1 9.2 9.3 9.4 9.5 Objective Introduction Meaning and Characteristics of a Company Types of Shares Types of Share Capital Issue of Shares 9.5.1 Accounting for Issue of Shares 9.5.2 Under-Subscription 9.5.3 Over-Subscription 9.5.4 Issue of Shares at a Premium 9.5.5 Issue of Shares at a Discount 9.5.6 Calls in Arrears 9.5.7 Calls in Advance 9.5.8 Forfeiture of Shares 9.5.9 Reissue of Forfeited Shares 9.5.10 Surrender of Shares 9.5.11 Redemption of Preference Shares 9.6 9.7 9.8 9.9 Summary Keywords Self Assessment Questions Suggested Readings

9.0

OBJECTIVE At the end of this lesson, you would be familiar with

(a) (b) (c) 9.1

Accounting Treatment for Issue of Shares Forfeiture of Shares Redemption of Preference Shares INTRODUCTION To overcome the limitations of inadequacy of funds and unlimited liability of

sole-proprietorship and partnership firms, one of the most convenient form of organisation that grew with expansion of business requiring huge funds is the joint stock company form of organisation or simply, a company. In India, joint stock companies are governed by the provision of the Companies Act, 1956. 9.2 MEANING AND CHARACTERISTICS OF A COMPANY Section 3(1) (i) of the Companies Act, 1956 defines a Company as " a company formed and registered under this Act or an existing company". An "existing company" means a company formed and registered under any of the former Companies Act. In common parlance, a company may be defined as an artificial person created by law, having a corporate and legal personality distinct and separate from its members, perpetual succession and a common seal. The essential characteristics of a company are: 1. 2. 3. 4. 5. It is a voluntary association of persons. It is an incorporated (registered) association. It is an artificial person created by law. It has a separate legal entity. It has a perpetual succession. This means that it can be created and woundup by the law only. 6. It has a common seal i.e. official signature of the company.

7.

The liability of the members is generally limited to the extent of the unpaid value of the shares held by them.

8.

The shares of a company are freely transferable except in case of a private limited company.

9.3

TYPES OF SHARES The capital of the company is usually divided into certain indivisible units of a

fixed amount. These units are called shares. Share means share in the capital of a company. The person owing a share or shares of a company is called a shareholder. A share is evidenced by a share certificate which is issued by a company under the common seal. It specifies the number of shares held by each shareholder. Shares are movable property and are transferable in the manner provided in the articles of association. There are two types of shares which a company may issue i.e. (1) Preference Shares (2) Equity Shares. 1. Preference Shares Preference shares are those which carry : (a) a preferential right as to the payment of dividend during the lifetime of the company- it may be fixed or a fixed rate, and (b) a preferential right as to the return of capital when the company is wound up.

Preference Shares are of the following types : (a) Cumulative Preference Shares A preference share is said to be cumulative when the arrears of dividend are cumulative and such arrears are paid before paying any dividend to equity shareholders. Unless otherwise stated, a preference share is always to be a cumulative one.

(b)

Non-cumulative Preference Shares In case of these shares dividend is not allowed to accumulate. The right to claim

dividend will lapse if there are no sufficient profits in a particular year. (c) Participating Preference Shares These are those shares which are entitled not only to a fixed rate of dividend but also to a share in the surplus profits which remain after dividend has been paid at a certain rate to equity shareholders. (d) Non-Participating Preference Shares Non-participating preference shares are entitled only to a fixed rate of dividend and do not share in the surplus profits. Unless otherwise stated, the preference shares are presumed to be non-participating. (e) Convertible Preference Shares These are those shares which can be converted into equity shares within a certain period. (f) Non-convertible Preference Shares There preference shares do not carry the right of conversion into equity shares. (g) Redeemable Preference Shares The shares which can be redeemed after a fixed period or after giving the prescribed notice, as desired by the company. After the commencement of Companies (Amendment) Act, 1988, no company limited by shares can issue any preference share which is irredeemable.

2.

Equity Shares
Shares which are not preference shares, are known as equity shares. These shares

do not carry any preferential right. Equity shareholders enjoy voting rights. But there is 4

no obligation to the company to pay dividends at a fixed rate every year. Even at the time of winding up of a company, they receive their capital only after payment to preference shareholders. 9.4 TYPES OF SHARE CAPITAL Share capital means capital raised by a company by the issue of shares. The main divisions of share capital are: (a) Authorised or Registered or Nominal Capital The amount of capital with which the company intends to be registered is called authorised capital or registered capital or nominal capital. It is the maximum amount which the company is authorised to raise by way of public subscription. This is mentioned in the 'Capital Clause' of the Memorandum of Association and beyond which the company cannot raise unless the capital clause in the Memorandum of Association is altered in accordance with the provisions of Section 94 of Companies Act, 1956. (b) Issued Capital The part of the authorised capital which is offered to the Public for subscription is called issued capital. (c) Subscribed Capital The part of the issued capital for which applications are received from the public is called subscribed capital. (d) Called up Capital This is the part of subscribed capital which has been called up. (e) Paid up Capital The part of called up capital which is actually paid by the members is known as paid up capital. That part of called up capital which has not yet been received is known as 'Calls in Arrear'. Thus, Called up Capital-Calls in Arrear = Paid up Capital. 5

(f)

Reserve Capital It refers to that portion of uncalled share capital which shall not be capable of

being called up except in the event and for the purpose of the company being wound up. 9.5 ISSUE OF SHARES A company can issue shares in two ways : 1. 2 for consideration other than cash for cash. These shares may be issued at par or at a premium or at a discount. Such issue price may be payable either in lumpsum alongwith application or in instalments at different stages e.g. partly on application, partly on allotment, partly on call.

9.5.1 Accounting for issue of Shares

(1) For consideration other than cash When a company purchases a running business and pay to vendors the purchase consideration in the form of shares instead of making the payment to the vendor in cash, it issues its fully paid shares, such issue of share is called as the issue of shares for consideration other than cash. Such issue of shares are disclosed separately under the head 'Share Capital' (Sub-head-Subscribed Capital) in the Balance Sheet of a company. The accounting entries to be made are : a) On purchase of assets Sundry Assets A/c To Vendor's A/c (Being purchase of business) b) On issue of shares Vendor's A/c To Share Capital A/c (Being issue of shares as payment of the price of the business) 6 Dr. Dr.

(2)

For Cash The Companies Act stipulates that when shares are issued to public for cash, the

company has to come out with prospectus. The procedure involved is as follows : (a) Application To collect capital from public, a public company issues a prospectus inviting the public to submit applications to take up shares of the company. The prospectus contains the details of the amount which the applicants have to pay as application money and allotment money. The company may demand the full value of share on application itself or it may demand only a part of it. However, the application money demanded should not be less than 5% of the nominal value of the share. On receipt of application money, the journal entry will be as follows: Bank Account Dr.

To Share Application A/c (Being receipt of application money - shares @ Rs.----per share) (b) Allotment After receiving the applications, the directors take steps to allot the shares. Allotment of shares means acceptance of the offer of the applicant for the purchase of shares. Directors have discretionary power either to reject or to accept partially or to accept all the applications. Applicants to whom the shares will be allotted will be issued letters termed as "Letter of Allotment" to that effect. They will also be required to pay allotment money as per terms of the prospectus. The journal entries will be as follows : On acceptance of Applications Share Application A/c To Share Capital A/c (Being the application money transferred to Share Capital A/c) Dr.

Those applicants who could not be allotted any share, their application money will be returned. The necessary journal entry is : Share Application A/c To Bank A/c (Being the application money of shares returned) Once the allotment is made and any further amount is required to be paid on each share, the allotment money becomes due to the company which the allottees are liable to pay. For this the following entry will be passed: Share Allotment A/c To Share Capital A/c (Being money due on allotment as per resolution no......dated .......) On the receipt of allotment money Bank A/c Dr. Dr. Dr.

To Share Allotment A/c (Being money received on allotment) (c) Calls The balance due, if any, on shares after taking into account application money and allotment money may be asked for by the Board of Directors in a number of instalment depending upon the terms of issue . Each such instalment is known as a "Call". There can be maximum three calls. The journal entries are as follow: On making the first call Share First Call A/c To Share Capital A/c (Being the first call money due as per resolution no........... dated ..................) Dr.

On receipt of the money of first call Bank A/c Dr.

To Share First Call A/c (Being money received on first call) Notes: (i) Similar entries may be made for the second and third call through Share Second Call Account and Share Third Call Account, respectively. In case of last call, the word 'final' is also added to the concerned "Share Call Account'. In case the entire balance is payable on a single call, usually, the term 'Share Call Account' is used. (ii) In order to distinguish one type of share from the other one, the name of the share i.e. Equity or Preference must be prefixed with the word 'Share' e.g. Preference Share Capital A/c, Equity Share Capital A/c. ILLUSTRATION I : ABC Corporation Ltd. was registered on Ist January, 1998 with a capital of Rs.10,00,000 divided into 1,00,000 shares of Rs.10 each. The company offered 44,000 shares; applications were received for the whole of shares and Re. 1 per share was received with application. On Ist February, these shares were allotted and Rs.2 per share was duly received on 28th February as allotment money. A first call of Rs.3 per share was made on Ist March and the call money on all shares were received. The final call of Rs.4 per share was made on Ist June and the amount due, was received by 30th June. Pass the necessary Journal entries and prepare Balance Sheet as at 30 the June, 1998.

Solution

Journal
Date 01.01.98 Particulars L.F. Dr.(Rs.) Bank A/c Dr. 40,000 To Share Application A/c (Being the application money received on 40,000 shares @ Re.1 per share) Share Application A/c Dr. 40,000 To Share Capital A/c (Being the application money adjusted) Share Allotment A/c Dr. 80,000 To Share Capital A/c (Being the allotment due on 40,000 shares @ Rs.2 per share) Bank A/c Dr. 80,000 To Share Allotment A/c (Being the allotment money received) Share Ist Call A/c Dr. 1,20,000 To Share Capital A/c (Being the Ist Call money due on 40,000 shares @ Rs.3 per share) Bank A/c Dr. 1,20,000 To Share Ist Call A/c (Being the share Ist call money received on 40,000 share @ Rs. 3 per share) Share Second & Final Call A/c Dr. 1,60,000 To Share Capital A/c (Being the share second & final call money due on 40,000 shares @ Rs.4 per share) Bank A/c Dr. 1,60,000 To Share Second & Final Call A/c (Being the share second & final call money received on 40,000) Cr.(Rs.) 40,000

01.02.98

40,000

02.02.98

80,000

28.02.98

80,000

01.03.98

1,20,000

01.03.98

1,20,000

01.06.98

1,60,000

30.06.98

1,60,000

10

Balance Sheet as on 30th June 1998 Liabilities Share Capital Authorised Capital : 1,00,000 shares of Rs.10 each 10,00,000 Issued Capital: 40,000 shares of Rs.10 each Subscribed Capital: 40,000 shares of Rs.10 each 4,00,000 4,00,000 4,00,000 4,00,000 Rs. Assets Current Assets : Cash at Bank Rs. 4,00,000

9.5.2 Under Subscription

When the number of shares applied for is less than the number of shares offered by the company, such a situation is known as under-subscription of shares. For Example, a company has offered 10,000 shares to public but the public applied for 8000 shares only, it is called a case of under-subscription. In such a case, it must be ensured that the company has received the minimum subscription and the entries for application, allotment and calls will be made only for 8000 shares.

9.5.3 Over-Subscription
Shares are said to be over-subscribed when the numbers of shares applied is more than the number of shares offered. For example a company has offered 10,000 shares to public but the public applied for 18,000 shares, it is called a case of over-

subscription. The company may treat the excess applications received in one or more of the following ways: (a) Certain applications may straightway be rejected. Application money will be

refunded to such applicants. The necessary journal entry in this case will be : Share Application A/c To Bank A/c (Being refund of the application money) 11 Dr.

(b)

Partial allotment may be done. Partial allotment means allotment of a smaller

number of shares than the number of shares applied for. (c) Pro-rata allotment may be done. Allotment on pro-rata basis means that allotment

is made to each applicant or some applicants on a proportionate basis. For example a company offers 10000 shares to the public, applications are received for 18,000 share. No allotment is made to applicants for 3000 shares and the rest are allotted shares on a pro-rata basis. It means applicants for 15,000 shares have been allotted 10,000 shares or every applicant of this group has been allotted two shares for three applied. In case the company adopt (b) or (c) alternative, the company has to adjust the excess application money received. Company can use the excess application money received, for money due on allotment. For example, Ram applies for 150 shares and pays Rs.2 per share as application money. He gets only 120 shares and the money due on allotment is Rs.3 per share. The following journal entry will be passed to transfer excess application money from "Share Application Account" to "Share Allotment Account". Share Application A/c Dr. 60 60

To Share Allotment A/c

(Being excess money received on application transferred to Share Allotment A/c) Surplus money exceeding that due on allotment should be refunded to the allottees within eight days after the company becomes liable to pay. ILLUSTRATION 2: A company offers 10,000 shares of Rs.10 each to the public for subscription. The money is payable as follows: Rs. 2 on Application Rs. 3 on Allotment, and Rs. 5 on First & Final Call

12

The company receives applications for 12,000 shares. The shares are allotted on a pro-rata basis. All allottees pay the allotment and final call moneys on due dates. Make the necessary journal entries. Solution : Journal Entries Particulars (1) Bank Account To Share Application Account (Being application money received in cash on 12,000 shares @ Rs. 2 per share) (2) Share Application Account To Share Capital Account To Share Allotment Account (Being transfer of application money due on 10,000 shares and adjustment of excess money to share allotment account) (3) Share Allotment Account To Share Capital Account (Being allotment money due on 10,000 shares @ Rs.3 per share) (4) Bank Account To Share Allotment Account (Being allotment money received) (5) Share First & Final Call Account To Share Capital Account (Being Ist & Final Call money due on 10,000 shares @ Rs. 5 per share) (6) Bank Account To Share First & Final Call Account (Being receipt of first & final call money) Dr. 50,000 50,000 Dr. 50,000 50,000 Dr. 26,000 26,000 Dr. 30,000 30,000 24,000 20,000 4,000 Dr. (Rs.) 24,000 24,000 Cr.(Rs.)

13

9.5.4

Issues of shares at a premium

When a share is issued at a price which is above its face value then it is said to

be issued at a premium. The excess of issue price over the face value is called as the amount of 'Share Premium'. The abolition of the Controller of Capital Issues and the introduction of free pricing by companies for their issues of shares and debentures has encouraged many companies to issue shares at a premium. According to Sec.78 of Companies Act, the amount of share premium received by a company must be credited to a separate account called the Share Premium account. The amount of share premium may be used by the company only for the following purposes: (a) (b) (c) for the issue of fully paid bonus shares to the members. for writing off preliminary expenses. for writing off the expenses of or the commission paid or discount allowed on any issue of shares or debentures of the company. (d) for providing premium payable on the redemption of any redeemable preference shares or debentures of the company.

Accounting Entries
(a) passed: (i) Bank A/c To Share Application A/c (Being share application money, alongwith premium received) (ii) Share Application A/c To Share Capital A/c To Share Premium A/c (Share application money transferred to Share Capital A/c and Share Premium A/c) Dr. Dr. If the premium is paid with application money, the following entries will be

14

(b)

If the share premium is received alongwith the allotment money, then the

following entries will be passed : (i) Share Allotment A/c To Share Capital A/c To Share Premium A/c (Being the allotment money and share premium money due on........... Shares) (ii) Bank Account To Share Allotment Account (Being the receipt of allotment money alongwith share premium account) (c) If the share premium is received in parts say, on application as well as allotment Dr. Dr.

or allotment and first call, entries on the same pattern discussed above can be passed. Alternative method There is an alternative method for treatment of share premium. No entry is passed for share premium when if becomes due. But on the receipt of share premium, the 'Share Premium Account' is credited with the amount of share premium received. The advantage of this method is that the Share Premium Account will not have to be debited in the event of the forfeiture of shares in case share premium money has not been received. ILLUSTRATION 3: XYZ Co. Ltd. was registered with an authorised capital of Rs.5,00,000 divided into 50,000 shares of Rs.10 each Of this, 20,000 shares were issued for public subscription. The share amount was called up as under : On Application....... On Allotment......... Rs.2 per share Rs. 5 per share (including premium Rs.2 per share)

15

On First Call.......... On Final Call.........

Rs.2 per share Rs. 3 per share.

Public applied for 25, 000 shares. The Directors decided to refund the application money on 3,000 shares and adjust on remaining 2,000 shares towards allotment money due. All the amounts were duly received. Pass Journal Entries. Solution Journal Entries in the Books of XYZ Co. Ltd.

Particulars (1) Bank A/c Dr. To Share Application A/c (Being application money of Rs.2 per share received on 25,000 shares) Share Application A/c Dr. To Share Capital To Bank A/c (3,000 x Rs.2) To Share Allotment A/c (2000 x Rs.2) (Being application money on 20,000 shares transferred to capital A/c, excess application money on 3,000 shares refunded and on 2,000 shares transferred towards allotment) Share Allotment A/c Dr. To Share Capital A/c To Share Premium A/c (Being allotment money of Rs.3 per share and share premium of Rs.2 per share due on 20,000 shares allotted) 16

Dr. Rs. 50,000

Cr. Rs. 50,000

(2)

50,000 40,000 6,000 4,000

(3)

1,00,000 60,000 40,000

(4)

Bank A/c To Share Allotment A/c (Being allotment money alongwith share premium duly received)

Dr.

96,000 96,000

(5)

Share First call A/c To Share Capital A/c (Being Ist call of Rs.2 per share due on 20,000 shares allotted)

Dr.

40,000 40,000

(6)

Bank A/c To Share First Call A/c (Being Ist call money duly received)

Dr.

40,000 40,000

(7)

Share Final Call A/c To Share Capital A/c (Being a final call of Rs.3per share due on 20,000 shares allotted)

Dr.

60,000 60,000

(8)

Bank A/c` To Share Final Call A/c (Being final call money duly received)

Dr.

60,000 60,000

9.5.5 Issues of shares at a discount

When the amount payable on shares is less than the face value of the shares, it is said to have issued them at a discount. According to Section 79 of the Companies Act, 1956 a company can issue shares at a discount if the following conditions are satisfied: a) The shares which are to be issued at a discount should be of a class which has already been issued.

17

b)

This should be authorised by passing a resolution at the general meeting and sanctioned by the Company Law Board.

c)

The maximum rate of discount at which the shares are to be issued should be specified in the resolution and the maximum limit is 10%.

d)

At least an year should have been collapsed from commencement of the business by the company before the shares are issued at a discount.

e)

The share should be issued at a discount before two months after the sanction from the Company Law Board has been obtained or as specified by the Company Law Board. The 'Discount on Issue of Shares Account' appears on the assets side of the

Balance Sheet under the head "Miscellaneous Expenditure" and is written-off against Profit and Loss Account or Share Premium Account over a period of years.

9.5.6 Calls in arrears

Some shareholders may not pay allotment money or call money in time. If any amount has been called by the company and a shareholder has not paid that money till the last date fixed for the payment thereof, this is known as calls in arrears. The amount of calls in arrears in shown by way of deduction from the called-up capital in the Balance Sheet. The directors can charge interest on calls-in-arrears at a rate specified in the Articles of Association from the last date fixed for payment to the date of actual payment. But if the Articles of Association are silent, Table A shall be applicable which empowers the Board of Directors to charge interest at a rate not exceeding 5% p.a. However, the directors have the authority to waive the payment of interest on calls in arrears at their discretion.

18

The journal entries in respect of calls in arrears are as follows: When a call becomes due Share...........Call A/c To Share Capital A/c (Being call money due) When money of a call is received Bank A/c To Share..........Call A/c (with the amount actually received excluding the amount of a call in arrear) At the end of the accounting year, the amount outstanding on account of a call will be transferred to 'Calls in Arrears A/c'. Calls in Arrears A/c Dr. Dr. Dr.

To Share ....... Call A/c In case shareholders makes payment of a call in arrear with interest, the entry will be : Bank A/c To Calls in Arrears A/c To Interest A/c (Being interest received on call in arrear) Dr.

9.5.7 Calls in advance

A company, if its Articles of Association permit, may receive from shareholders the amount remaining unpaid on shares held by them even though the amount has not been called up. The amount so received is credited to Calls in Advance Account. When a call is made, the appropriate amount is transferred from Call in Advance Account to the relevant call. Table A gives a power to the company to accept calls in advance

19

from its shareholders and also provides for payment of interest at a rate not exceeding 6% per annum. The journal entries in respect of calls in advance are as follows : Bank A/c To Call in Advance A/c (Being the amount of calls received in advance) Share .......Call A/c To Share Capital A/c (Being the amount due on ......call on all shares including those on which call has been received in advance) Bank A/c Calls in Advance A/c To..... Call A/c (Being the amount received on ...........call) ILLUSTRATION 4: On Ist March, 1999 X Ltd., makes an issue of 20,000 equity shares Rs.10 each payable as below: On application Rs.2; on allotment Rs.3(including premium); on first and final call Rs.6 (three months after allotment). Applications were received for 26,000 shares and Directors made allotment in full to the applicants demanding ten or more shares and returned money to the applicants for 6,000 shares. One shareholder who was allotted 40 shares paid first and final call with allotment money and another shareholder who was allotted 60 shares did not pay allotment money on his shares, but later on he paid allotment money with the first and final call. Directors have decided to charge and allow interest, as the case may be, on calls in arrears and calls in advance respectively according to the provisions of Table A. Give the necessary journal entries in the books of the company. Dr. Dr. Dr. Dr.

20

Solution Journal Entries 1999 Particulars Mar.1 Bank A/c To Share Application A/c (For application money received on 26,000 shares @ Rs. 2 per share) Mar.1 Share Application A/c To Share Capital To Bank A/c (For application money of 20,000 shares transferred to share capital account and application money of 6,000 shares refunded) Mar.1 Share Allotment A/c To Share Capital A/c To Share Premium A/c (For allotment money and share premium due on 20,000 shares @ Rs.2 and Re.1 per share respectively as per resolution of the Board of Directors dated..............) Mar.1 Bank A/c To Share Allotment A/c To Calls in Advance A/c (For the receipt of allotment money @ Rs.3 on 19,940 shares and advance call money on 40 shares @ Rs.6 each) Dr. 60,060 59,820 240 Dr. 60,000 40,000 20,000 Dr. 52,000 40,000 12,000 Dr. Dr. (Rs.) Cr. (Rs.) 52,000 52,000

21

June1 Share First and Final Call A/c To Share Capital A/c (For the amount due in respect of First and Final Call on 20,000 shares @ Rs.6 per share as per resolution of the Board of Directors dated ........) Bank A/c To Share First Call A/c To Share Allotment A/c (For the amount received on account of First and Final call on 19,960 shares @ Rs.6 and calls in arrears of allotment)

Dr.

1,20,000 1,20,000

Dr.

1,19,940 1,19,760 180

Calls in Advance A/c To Share First & Final Call A/c (Adjustment of calls in advance against the First and Final Call)

Dr.

240 240

Interest on Calls in Advance A/c To Bank A/c`

Dr.

3.60 3.60

(Interest paid on Calls in advance i.e. Rs.240 for 3 months @ 6% p.a.)

Bank A/c To Interest on Calls Arrears A/c (Receipt of interest on calls in arrear i.e. Rs.180 for 3 months @ 5% p.a.)

2.25 2.25

22

9.5.8 Forfeiture of shares

When a shareholder who has been called upon to pay the amounts due on the shares held by him defaults such payment, the company can exercise the right to forfeit the shares. Forfeiture of shares means the cancellation of allotment to defaulting shareholders and to treat the amount already received on such shares as forfeited to the company. However, the following conditions must be satisfied in order to be sure that the forfeiture of shares is valid : a) b) c) d) The power to forefeit shares must be expressly given by the company's Articles. The procedure given in the Articles must be followed. There should be a default by the shareholder in payment of a valid call. A notice of demand, requiring the shareholder to pay calls within the specified period and specifying the amount, must be given. e) The Board of Directors must pass a resolution for forfeiture of shares. The following points should be kept in mind while passing an accounting entry for forfeiture of shares : a) b) c) the amount called up on the share forfeited. the amount unpaid on various calls (including allotment) on the shares forfeited. the amount received on the shares forfeited. The following journal entry is passed at the time of forfeiture of shares considering the terms of issue: Forfeiture of Shares Issued at Par Share Capital A/c To Unpaid Calls A/c To Forfeited Shares A/c Dr. (with the amount called up on shares forfeited) (with the amount which became due but not paid) (with the amount already received) (Being ..............shares forfeited for non-payment of .........)

23

Forfeiture of Shares Issued at Premium If the forfeited shares were issued at a premium, the Share premium account would be debited only if the amount of the premium remained unpaid; otherwise no debit can be given to share premium account in view of the restriction imposed by Sec. 78(2) of Companies Act, 1956. The journal entry for forfeiture will be: Share Capital A/c Dr. (with the amount called up on Shares forfeited) Share Premium A/c Dr. (with the amount of premium not received) To Unpaid Calls A/c (with the amount which became due but not paid) To Forfeited Shares A/c (with the amount already received)

(Being .........shares forfeited for non-payment of ...............) Forfeiture of Shares issued at Discount Share Capital A/c Dr. (with the amount called up on shares forfeited) To Unpaid Calls A/c (with the amount which became due but not paid) To Discount on Issue of Shares (with the amount of discount originally allowed) To Forfeited Shares A/c (with the amount already received)

(Being............shown forfeited for non-payment of ..............)

24

9.5.9 Reissue of forfeited shares

Forfeited shares become the property of the company and the directors of the company are empowered to reissue the forfeited shares if authorised by its Articles of Association. Such reissue can be at par, premium or discount. However, in case they are reissued at discount, the amount of discount should not exceed the actual amount received on forfeited shares. In other words, there cannot be any loss on account of reissue of forfeited shares. The purchaser of forfeited reissued shares is liable for payment of all future calls duly made by the company. The accounting entries for the reissue of forfeited shares in various cases are : On reissue of forfeited shares originally issued at par or at a premium Bank A/c Forfeited Shares A/c To Share Capital A/c (Being reissue of forfeited Shares) On reissue of forfeited shares originally issued at a discount. Bank A/c Discount on Issue of Shares A/c Forfeited Shares A/c To Share Capital A/c (Being reissue of forfeited shares) Treatment of Balance Left on the Forfeited Shares Account If all the forfeited shares have been reissued, the balance standing to the credit of Forfeited Shares Account is a capital profit and, therefore, it will be transferred to Capital Reserve Account. The journal entry will be Dr. Dr. Dr. (with the amount received on reissue) ( with the discount originally allowed) (with the discount allowed on reissue) (with the amount credited as paid up) Dr. Dr. (with the amount received on reissue) (with the discount allowed on reissue) (with the amount credited as paid up)

25

Forfeited Shares A/c

Dr. A/c

To Capital Reserve

(Being profit on reissue of forfeited shares transferred to capital reserve) In case only a part of the forfeited shares have been reissued, only the proportionate profit on reissue of forfeited shares will be transferred to Capital Reserve Account and the balance on the Forfeited Shares Account relating to shares not yet reissued is carried forward and is shown by way of addition to Paid-up capital in the Balance Sheet. ILLUSTRATION 5: A holds 100 shares of Rs.10 each on which he has paid Re. 1 per share as application money. B holds 200 shares of Rs.10 each on which he has paid Re 1 on application and Rs.2 on allotment. C holds 300 shares of Rs.10 each and has paid Re 1 on application, Rs.2 on allotment and Rs.3 for the first call. They all fail to pay their arrears and the second call of Rs.2 per share and the Directors, therefore, forfeited their shares. The shares of C were then reissued at Rs.7 per share as fully paid-up. Give the necessary journal entries to record the above transactions.

26

Solution : JOURNAL Rs. Share Capital A/c To Share Allotment A/c To Share First Call A/c To Share Second Call A/c To Forfeited Shares A/c (Being forfeiture of 600 shares) Bank A/c Forfeited Shares A/c To Share Capital A/c (Being 300 shares reissued at Rs.7 each fully paid up) Forfeited Shares A/c To Capital Reserve A/c (Being surplus on forfeiture and reissue of 300 shares transferred to capital reserve) Working Notes : 1. Amt. not paid : Allotment A B C 200 200 First Call 300 600 900 Second Call 200 400 600 1,200 Dr. 900 900 Dr. Dr. 2,100 900 3,000 Dr. 4,800 200 900 1,200 2,500 Rs.

27

2.

The amount transferred to Capital Reserve has been calculated as follows : Rs. Amount received on C's shares (300 x 6) Less Discount allowed on reissue (300 x 3) Net gain 1,800 900 900

Forfeiture and reissue of shares when there is over subscription and pro rata allotment
In the case of over-subscription, some application are rejected altogether, some applications are allotted in full and others are allotted on pro-rata basis. When there is a pro-rata allotment and some share are forfeited, then the calculation of amount to be forfeited poses a problem. In such case the following procedure may be adopted : (a) Calculate the total number of shares applied for on the basis of allotted shares or vice-versa. (b) Calculate the total amount received on application by multiplying the number of shares with application money. This is the amount which is to be forfeited on default. (c) Deduct the amount due on application on allotted shares and calculate balance i.e., money received in advance and to be adjusted on allotment. (d) Calculate the amount due on allotment on such shares and deduct the amount already received as advance on application. This gives the amount in arrear on allotment and is credited to share allotment account at the time of forfeiture of shares. ILLUSTRATION 6: The Satara Chemicals Works Ltd. issued for public subscription 1,00,000 shares of Rs.100 each at a premium of Rs.20 per share, payable as under :

28

Rs.20 per share on application; Rs.50 per share on allotment (including premium); Rs.20 per share on first call and balance on final call. Applications were received for 1,50,000 shares. The shares were allotted prorata to the applicants of 1,20,000 shares, the remaining applications being rejected. Money overpaid on application was utilised towards sums due on allotment . Kisan Lal to whom 4000 shares were allotted failed to pay allotment and calls money and Ram Lal, to whom 5,000 shares were allotted failed to pay the two calls. These shares were forfeited after the second call made. Give Journal Entries Solution Journal of Satara Chemicals Works Ltd. Dr. Rs. (1) Bank A/c To Share Application A/c (Being application money of Rs.20 per share received on 1,50,000 shares applied for) (2) Share Application A/c To Share Capital A/c To bank A/c To Share Allotment A/c (Transfer of application money on 1,00,000 shares actually allotted to Capital A/c; on 30,000 shares refunded; and on 20,000 shares (being pro-rata basis allotment) to share allotment A/c) 29 Dr. 30,00,000 20,00,000 6,00,000 4,00,000 Dr. 30,00,000 30,00,000 Cr. Rs.

(3)

Share Allotment A/c Dr. 50,00,000 To Share Capital A/c To Share Premium A/c (Being allotment money of Rs.30 and Premium of Rs.20 per share due on 1,00,000 shares allotted) (4) Bank A/c Dr. 44,16,000 To Share Allotment A/c (Being receipt of the remaining allotment money) (5) Share First Call A/c Dr. 20,00,000 To Share Capital A/c (Being Ist Call of Rs.20 per share due on 1,00,000 shares) (6) Bank A/c Dr. 18,20,000 To Share First Call A/c (Being receipt of Ist Call money on 91,000 shares i.e.; 1,00,000 shares - 4000 - 5000 shares on which call not received) (7) Share Final Call A/c Dr. 30,00,000 To Share Capital A/c (Being a final call of Rs.30 per share due on 1,00,000 shares) (8) Bank A/c Dr. 27,30,000 To Share Final Call A/c (Being final call money received on 91,000 shares) (9) Share Capital A/c Dr. 9,00,000 Share Premium A/c 80,000 To Share Forfeited A/c To Share Allotment A/c To Share First Call A/c To Share Final Call A/c (Being forfeiture of 9,000 shares of Rs.100 each fully called-up; for non-payment of various calls, and amount of premium not received on 4,000 shares debited to share premium A/c)

30,00,000 20,00,000

44,16,000

20,00,000

18,20,000

30,00,000

27,30,000

3,46,000 1,84,000 1,80,000 2,70,000

30

9.5.10 Surrender of shares

After the allotment of shares, sometimes a shareholder is not able to pay the further calls and returns his shares to the company for cancellation. Such voluntary return of shares to the company by the shareholder himself is called surrender of shares. Surrender of shares has no separate accounting treatment but it will be like that of forfeiture of shares. The same entries (as are passed in case of forfeiture of shares) will be passed in case of surrender of shares.

9.5.11 Redemption of preference shares

According to Sec.100 of the companies Act, a company is not allowed to return to its shareholders the share capital without the permission of the Court. However the company can issue a special category of shares known as Redeemable Preference Shares, which the company can redeem during its life time as per the provisions of Sec.80 of the Companies Act. The following important provisions regarding the redemption of Preference Shares are given under Section 80 of the Companies Act. 1. 2. Such Shares cannot be redeemed unless they are fully paid-up. Such shares can be redeemed either out of profits which would be available for dividend or out of the proceeds of a fresh issue of shares made with the object of redemption. 3. When shares are redeemed out of profits available for distribution for dividend, a sum equal to the nominal amount of the shares so redeemed must be transferred out of profits to a reserve account to be called 'Capital Redemption Reserve Account'. 4. Capital Redemption Reserve Account can be used for issuing fully paid bonus shares to the shareholders.

31

5.

Any premium payable on redemption of preference shares should be provided either out of profits or out of the share premium account.

Accounting Entries The following are the accounting entries to be passed in the books of a company which wants to redeem its redeemable preference share capital: (i) For making partly paid up shares fully paid up (a) Redeemable Preference Share Final Call A/c To Redeemable Preference Share Capital A/c (Being final call being made) (b) Bank A/c To Redeemable Preference Share Final Call A/c (For money realised on final call) (ii) For redeeming out of profits Profit & Loss A/c/Revenue Reserve A/c To Capital Redemption Reserve A/c (iii) For a fresh issue of shares Bank A/c To Share Capital A/c (In case of issue of shares at premium or discount, the relevant account should be credited or debited) iv) Making provision for payment of premium on redemption of preference shares Share Premium/Profit and Loss/Revenue Reserve A/c To Premium on Redemption of Preference Shares A/c Dr. Dr. Dr. Dr. Dr.

32

(v)

For money due to redeemable preference shareholders Redeemable Preference Share Capital A/c Premium on Redemption of Preference Shares A/c Dr. Dr.

To Redeemable Preference Shareholders/Preference Shares Redemption A/c (vi) For making payment to redeemable preference shareholders Dr.

Redeemable Preference Shareholders A/c To Bank A/c (vii) For issue of bonus shares (a)

Capital Redemption Reserve/Share Premium/ Revenue Reserve A/c To Bonus Payable A/c Dr.

(b)

Bonus Payable A/c To Share Capital A/c

Dr.

ILLUSTRATION 7: Following is the Balance Sheet of Moon Ltd., as on 31st December 1998. Balance Sheet Liabilities Share Capital 50,000 Equity Shares of Rs.10 each 2,000 6% Redeemable Preference Shares of Rs.100 each Profit and Loss A/c Sundry Creditors 2,00,000 50,000 50,000 8,00,000 8,00,000 5,00,000 Rs. Assets Sundry Assets Rs. 8,00,000

33

The Directors of the company decided to issue 20,000 equity shares of Rs.10 each at par and use the proceeds to redeem the preference shares. Pass the journal entries and show the Balance-Sheet after the redemption is completion is complete. Solution Journal Entries Date Particulars Dr. Rs. 31.12.98 Redeemable Preference Share Capital A/c To Preference Shareholders A/c (Being amount of capital Payable on redemption) 31.12.98 Bank A/c To Equity Share Capital A/c (Being amount received on issue of 20,000 equity shares of Rs.10 each, for the purpose of redemption) 31.12.98 Preference Shareholder's A/c To Bank (Being the payment of the amount due to the redeemable preference shareholders) Dr. 2,00,000 2,00,000 Dr. 2,00,000 2,00,000 Dr. 2,00,000 2,00,000 Cr. Rs.

34

Balance Sheet
Liabilities Share Capital 70,000 Equity Shares of Rs.10 each Profit and Loss A/c Sundry Creditors 7,00,000 50,000 50,000 8,00,000 8,00,000 Rs. Assets Sundry Assets Rs. 8,00,000

Note : The Redeemable preference Share Capital is now replaced by additional Equity Share Capital. Equity shares will now be 70,000. (50,000 as per balance-sheet + newly issued 20,000 shares). 9.6 SUMMARY A company si a voluntary and autonomous association of certain persons with capital divided into numerous transferable shares formed to carry out a particular purpose in common. These are two types of shares which a company may issue i.e. preference shares and equity shares. Share capital of a company is divided into different categories namely authorised, issued, subscribed, called-up, paid-up and reserve capital. A company can issue shares for cash and for consideration other than cash. When shares and issued to public for cash, the company issues prospectus, receive applications, make allotments and make calls. In case the issue price of a share is more than the fixed value/par value of a share, the issue of shares is said to be at a premium. If a shareholder defaults in payment of instalments of issue price of a share called by the company, the Board of Directors may decide to forfeit the shares held by the defaulting shareholder by following the procedure laid down in the articles of association of the company.

35

9.7

KEYWORDS

Company: It is a voluntary and autonomous association of persons with capital divided into numerous transferable shares formed to carry out a particular purpose in common. Paid-up Capital: The part of the called up capital which is offered and is actually paid by the members is known as paid-up capital. Share: Authorised capital of a company is split up into units with definite face value called shares. Preference Shares: These are those shares which carry certain priorities in regard to the payment of dividend and return on capital over the equity shares. Under-Subscription: When the number of shares applied for by the public is less than the number of shares issued by the company, the issue is said to be under-subscribed. Surrender of Shares: Voluntary return of shares to the company by the shareholder himself is called surrender of shares. 9.8 1. SELF ASSESSMENT QUESTIONS What is meant by Share Capital? Explain the different categories of share capital with the help of an illustration. 2. Distinguish between (a) (b) (c) 3. Over-subscription and under-subscription. Calls in arrears and calls in advance. Forfeiture of shares and surrenders of shares.

Give the journal entries only with narration of the following: (a) (b) (c) (d) Forfeiture of shares issued at a premium. Forfeiture of shares issued at a discount. Redemption of redeemable preference shares. Interest on calls in advance.

36

4.

What are the provision of Companies Act, 1956 regarding redemption of redeemable preference shares?

5.

A limited company offered for subscription 50,000 equity shares of Rs.10 each at a premium of Rs.1.25 per share and 2,500 six per cent cumulative preference shares of Rs.100 each at par. The shares were payable as follows : On application Rs.3.75 per equity share (including the premium) and Rs.25 per preference shares ; on allotment Rs.2.50 per equity share and Rs.25 per preference share; on first and final call the balance due in both cases. The public applied for 80,000 equity shares and 2,000 preference shares. Applications for 5,000 equity shares were declined, the application money being returned. The remaining applicants received allotment for two-thirds of their applications. Applications for preference shares were allotted in full. Give journal entries to record these transactions in the company's books.

6.

New Ventures Ltd. made an offer of 1,00,000 Equity Shares of Rs.10 each payable as follows: On application On allotment On first call On second call Rs.2 per share Rs. 2 per share Rs. 3 per share Rs.3 per share

Applications were received for 1,60,000 shares and allotments were made prorata to the applicants for 1,50,000 shares, the remaining applications being refused and money refunded. Application money paid in excess by the allottees was adjusted with the money due on allotment. Romesh the holder of 200 shares failed to pay the allotment money and on his failure to pay the first call, the shares were forfeited. Karim another shareholder to whom 500 shares were allotted failed to pay the first and second call amounts and his shares were also forfeited after making the second call.

37

Out of the forfeited shares, 600 shares were reissued as fully paid on payment of Rs.9 per share. You are required to show the journal entries for recording the forfeitures and re-issue of the shares. 7. A company has 4,000 6% redeemable preference shares of Rs.100 each fully paid. The company decides to redeem the shares on December 31, 1998 at a premium of 5 per cent. The company makes the following issues: (a) (b) 1,000 equity shares of Rs.100 each at a premium of 10 percent. 1,000 9% debentures of Rs.100 each.

The issue was fully subscribed and all the amounts were received. The redemption was duly carried out. The company has sufficient profits. Give journal entries. 9.9 1. SUGGESTED READINGS Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. 2. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi. 3. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana. 4. 5. Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi. Principles of Financial Accounting by P.C. Gupta and C.L. Chaturvedi, Shree Mahavir Book Depot, New Delhi.

38

LESSON -10 ACCOUNTING FOR DEBENTURES

STRUCTURE 10.0 Objective 10.1 Introduction 10.2 Classification of Debentures 10.3 Distinction between Debentures and Shares 10.4 Issue of Debentures 10.5 Interest on Debentures 10.6 Redemption of Debentures 10.7 Summary 10.8 Keywords 10.9 Self Assessment Questions 10.10 Suggested Readings 10.0 OBJECTIVE By reading this lesson, you would know about (a) (b) Accounting Treatment for issue of debentures Entries for issue and redemption of debentures

10.1 INTRODUCTION The financial requirements of a company may be met by raising share capital or by going for public borrowing. One kind of such a public borrowing is issue of debentures. Debenture is the acknowledgment of a debt given under the seal of the company and contains a contract for the repayment of the principal at a specified date and for the payment of interest at fixed rate percent until the principal sum is repaid. A debenture holder is not entitled to vote in the meetings of the company. Rate of interest payable on debenture is fixed and generally less than the rate of dividend payable on

equity shares. One advantage to the company in issuing debentures is the interest on debentures is allowed to be deducted for the purpose of taxable income computation of the company. 10.2 CLASSIFICATION OF DEBENTURES A company may issue various kinds of debentures with different rights as given below : (A) 1. From Security Point of view Naked Debentures Naked debentures or unsecured debentures are those which are not secured on any asset. The general solvency of the company is the only security for the holders of these debentures. 2. Secured Debentures Secured debentures are those which are secured either on a particular asset or on all the assets of the company. In India, only the secured debentures can be issued. (B) 1. From Redemption Point of view Redeemable Debentures These are the debentures under which the principal money is paid off to the debenture holders on the expiry of the fixed term. 2. Irredeemable Debentures In the case of irredeemable debentures the company does not give any undertaking of repaying the money borrowed by issuing debentures, after a fixed time or within a fixed period during the continuance of business by the company. Company may repay debentures at any time it may choose to do so, but the creditors cannot compel the company to repay them at any certain time. They shall, however, be repaid when the company goes into liquidation or makes a default in the payment of interest.

(C) 1.

From Conversion Point of view Convertible Debentures Convertible debentures are those which give an option to debenture

holders to convert them into equity or preference share at a stated rate of exchange after a certain period. 2. Non-Convertible Debentures These are those debentures, the holders of which do not have a right to convert them into shares. (D) 1. From Priority Point of view First Debentures First debentures are those debentures which are paid first before any payment is made to another type of debentures. 2. Second Debentures Debentures which are payable after the redemption of the first debentures are known as second debentures. (E) 1. From Transferability Point of view Registered Debentures Registered debentures are those which are payable to the persons whose name appears in the Register of Debenture holders. Interest is paid to the registered holder. These can be transferred only by executing a transfer deed. 2. Bearer Debentures Bearer debentures are treated as negotiable instruments and are transferable by delivery alone. The names of the holders of such debentures are not required to be registered in the Register of Debenture holders. Interest is paid to the person who produces the interest coupon attached to it.
3

10.3 DISTINCTION BETWEEN DEBENTURES AND SHARES The following are the points of distinction between debentures and shares : (i) Creditorship Security v. Ownership Security : Whereas a debenture

is a creditorship security, a share is an ownership security. It means that a debentureholder is a creditor of the company, while a shareholder is a partowner of the company. It is the fundamental distinction between a debenture and a share. (ii) Certainty of return : A debentureholder is certain of return on his

investment. The company has to pay interest on debentures at the fixed rate agreed upon at the time of issue even if it suffers heavy losses. A shareholder cannot get dividends if the company does not earn profits. As a matter of fact, even when a company earns a profit, its Directors may decide to plough back the profits and not declare a dividend. Thus, there is no certainty of return on investment in shares. (iii) Order of repayment on winding up : In case of winding up of a

company, the amount of debentures will be repaid before any amount is paid to shareholders to return share capital. (iv) Restrictions on issue at a discount : There are not restrictions on

issue of debentures at a discount, but there are legal conditions which have to be fulfilled to issue shares at a discount. (v) Mortgage : There can be mortgage debentures. It means that assets

of the company can be mortgaged in favour of debentureholders by way of security. But there can be no mortgage shares. (vi) Convertibility : Debentures which can be converted into shares at

the option of debentureholders can be issued. But shares convertible into debentures cannot be issued.

10.4 ISSUE OF DEBENTURES The entries for issue of debentures is exactly the same as in the case of shares. The only differences are that the term 'Debenture' is substituted for the word 'Share' and the percentage of interest is pre-fixed to term 'Debenture'. They can also be issued at par, premium or discount. However, the legal restrictions regarding use of premium money or issuing at discount applicable in case of shares, are not applicable to debentures. A company can issue debentures in any of the following ways : a) b) c) for cash for consideration other than cash as collateral security

Issue of debentures for cash

The debentures can be issued at par value, at premium or at discount. The cash receivable on issue of debentures can be collected in one lump sum or by installments as is done in the case of shares. The accounting entries are given below : 1. For receipt of application money Bank A/c 2. On allotment of debentures Debenture Application A/c To Debentures A/c (Being transfer of debenture application money) Debenture Allotment A/c To Debentures A/c (For allotment money due) Bank A/c Dr. To Debenture Allotment A/c (Being receipt of allotment money) Dr. Dr. Dr. To Debenture Application A/c

In case allotment is made at premium and premium is to be received on allotment, the entry for amount due on allotment will be : Debenture Allotment A/c To Debentures A/c To Debenture Premium A/c In case allotment is made at discount, the entry will be : Debenture Allotment A/c To Debentures A/c 3. On First call: Debentures First Call A/c To Debentures A/c (Being First/Second/Final call due) Bank A/c Dr. To Debenture First Call A/c (Being First call money received) Note : Similar entries may be made for the Second Call and Third Call through Debenture Second Call Account & Debenture Third Call Account respectively. In case of last call the word " Final" is also added to the concerned Debenture Call Account. ILLUSTRATION 1 : A company issued 10,000 debentures of Rs.100 each for subscription. The debenture money was payable money was payable as follows: Rs.30 on application, Rs.40 on allotment, Rs.20 on first call and Rs.10 on second and final call. A person who holds 200 debentures failed to pay the amount due on allotment. He, however, pays this amount with the first call money. Another person who is holding 400 debentures paid all the calls in advance on allotment. Give journal entries in the books of the company. Dr. Dr. Discount on issue of Debentures A/c Dr. Dr.

Solution JOURNAL Dr. Rs. Bank Account Dr. 3,00,000 To Debentures Application Account (Being the receipt of the application money on 10,000 debentures @ Rs.30 per debenture) Debenture Application Account Dr. To Debenture Account (Being the transfer of the application money on 10,000 debentures to debentures account) 3,00,000 3,00,000 Cr. Rs.

3,00,000

Debenture Allotment Account Dr. To Debentures Account (Being the allotment amount due on 10,000 debenture @ Rs.40 per debenture) Bank Account Dr. To Debentures Account To Debenture calls in advance Account (Being the receipt of allotment money on 9,800 debentures and call money @ Rs.30 per debenture on 400 debentures)

4,00,000 4,00,000

4,04,000 3,92,000 12,000

Debenture First Call Account Dr. 2,00,000 To Debentures Account (Being the first call due on 10,000 debentures @ Rs.20 per debentures) Debentures call in advance Account Dr. To Debenture First Call Account (Being the transfer of Rs.8,000 received in advance on 400 debenture first call account) Bank Account Dr. To Debenture First Call Account To Debenture Allotment Account (Being the receipt of the arrears of the allotment and the amount due on account of first call)
7

2,00,000

8,000 8,000

2,00,000 1,92,000 8,000

Debenture Second & final Call AccountDr. To Debentures Account (Being the amount due on 10,000 debentures @ Rs.10 per debenture) Bank Account Dr. Debenture calls in advance Account Dr. To Debentures Account (Being the adjustment of debentures calls in advance and receipt of second call on debentures)

1,00,000 1,00,000

96,000 4,000 1,00,000

Terms of issue of debentures

A company is free to issue the debentures on any terms it likes. These terms may not only relate to issue but also to redemption. The following possibilities of the issue and redemption of debentures may, however, be considered : Case No. I II III IV V 1. Conditions of Issue Issue at par Issue at premium Issue at discount Issue at par Issue at discount Conditions of Redemption Redemption at par Redemption at par Redemption at par Redemption at premium Redemption at premium

Debentures issued at par and payable at par On issue of debentures Bank A/c To Debentures A/c On Payment Debentures A/c To Bank A/c In case money is received in different installments, say on application, Dr. Dr.

allotment, first call etc., entries will be made in the manner already discussed in the previous pages.

2.

Debentures issued at discount and payable at par On Issue Bank A/c To Debentures A/c In case money is received in installments, the entry for discount will Dr. Discount on issue of debentures A/c Dr.

be made with money due on allotment. Debenture allotment A/c Discount on issue of debentures A/c To Debentures A/c On payment Debentures A/c To Bank A/c 3. Debenture issued at premium payable at par On issue Bank A/c To Debentures A/c To Premium on issue of debentures A/c In case money is received in installments, the entry for premium, will be made with money due on allotment unless otherwise stated. Debenture Allotment A/c To Debentures A/c To Premium on Issue of Debentures On payment Debentures A/c To Bank A/c 4. Debentures issued at par, payable at premium On issue Bank A/c Loss on issue of debentures A/c To Debentures A/c To Premium on redemption of debentures A/c
9

Dr. Dr.

Dr.

Dr.

Dr. A/c

Dr.

Dr. Dr.

In case the money is received on debentures in installments, the entry for the amount of premium payable on redemption, will be made with the entry for money due on allotment. Debenture allotment A/c Loss on issue of debentures A/c To Debentures A/c To Premium on redemption of debentures A/c On payment Debentures A/c Premium on redemption of debentures A/c To Bank A/c 5. Dr. Dr. Dr. Dr.

Debentures issued at discount, payable at premium On issue Bank A/c Loss on issue of debentures A/c To Debentures A/c To Premium on redemption of Debentures A/c In case money on debentures is received in installments, the entry of Dr. Dr.

loss on issue will be made with allotment at in case of point (4). On payment The entry on payment will also be the same as indicated in point (4).

Issue of shares for consideration other than cash

Sometimes the companies may go for issue of debentures towards consideration for purchase of any fixed asset. In such cases the journal entry would be : i) For purchase of asset Asset A/c To Vendor A/c (Being purchase of assets) Dr.

10

ii)

For issue of debentures Vendor A/c To Debentures A/c (Being issue of debentures) Dr.

Issue of debentures as collateral security

When a company borrows money from the outsiders like, banks, financial institutions it may issue debentures as an additional security besides giving the principal security on assets. These debentures are issued to the lender on the understanding that in case the company pays back the loan they will be returned to the company, but in case it fails to pay the loan, the lender will be the debenture holder to the extent of debentures so held and will have all the rights which are available to the debenture holders of that class. There are two ways of dealing with such debentures in the accounts of the company. 1. No entry is made in the books of accounts of the company. A note is given in the Balance Sheet regarding depositing of the debentures as collateral security. 2. The transaction may be recorded in the books of accounts of the company by passing the following entry: (a) On the issue of such debentures Debenture Suspense A/c To Debenture A/c (b) On release of such debentures Debentures A/c Dr. To Debenture Suspense A/c ILLUSTRATION 2: A Ltd. made the following issue of debentures: (i) For cash at 90 per cent but payable at 110 per cent; debentures of Rs.10,000. Dr.

11

(ii) (iii)

To a creditor who supplied machinery costing Rs.1,00,000; 1,100 debentures of Rs.100 each. To Bank for a loan of Rs.7,00,000 as collateral security, 10,000 debentures of Rs.100 each. Journalise the transactions.

Solution JOURNAL Dr. Rs. (i) Bank A/c Loss on issue of Debentures A/c To Debentures A/c To Premium on redemption of Debenture A/c (Being issue of 100 debentures of Rs.100 each 90 per cent but payable at 110 per cent) (ii) Vendor's A/c Discount on Issue of Debentures A/c To Debentures (Being allotment of 1,100 debentures of Rs.100 each to the vendor in discharge of the purchase consideration of Rs.1,00,000 for machinery purchased) (iii) Either no entry may be passed and simply a note to that effect may be given in the Balance Sheet or the following entry may be passed : Debenture Suspense A/c To Debentures A/c (Debentures issued by way of collateral security to the bank) Dr. 10,00,000 10,00,000 Dr. Dr. 1,00,000 10,000 1,10,000 Dr. Dr. 9,000 2,000 10,000 1,000 Cr. Rs.

12

Writing off the loss on issue of debentures

The loss on issue of debentures i.e., the discount on issue of debentures or premium payable on redemption of debentures appears on the assets side of the Balance Sheet as a fictitious Asset and it is prudent to write it off as early as possible. The loss can be written-off from any capital profit including the share premium or revenue profit by the following entry: Capital Reserve/P&L A/c Dr. To Loss (discount) on issue of debentures However writing off the loss on issue of debentures is not a legal necessity. In case such loss is written off from Profit and Loss Account as a deferred revenue expenditure, the amount to be written off each year will be calculated as follows : 1) When debentures are to be redeemed after a fixed period. When the debentures are to be redeemed after a fixed period, the amount of loss is written off evenly over the years after which the debentures will be redeemed as the company enjoys the benefits evenly throughout the period of debentures. 2) When debentures are to be redeemed in installments. When the debentures are to be redeemed in installments, the funds used each year go on diminishing and hence the loss on issue of debentures is also divided over different years in the ratio of amount of debentures outstanding at the beginning of each year. ILLUSTRATION 3: On Ist January, 1994, a limited company issue debentures of the face value of Rs.1,00,000 at a discount of 6%. The debentures were repayable by annual drawings of Rs.20,000 made on 31 December each year. The directors decided to write off the discount on

13

issue over the period of the debentures in such a way as to charge each year with an amount proportionate to debentures outstanding in that year. Show the amount of the discount that should be written off in each of the five years. Solution Year Total amount of debentures outstanding 1,00,000 80,000 60,000 40,000 20,000 Ratio Proportion to be written off 5/15 4/15 3/15 2/15 1/15 Amount to be written off 5/15 4/15 3/15 2/15 1/15 of of of of of Rs.6,000=2,000 Rs.6,000=1,600 Rs.6,000=1,200 Rs. 6,000= 800 Rs. 6,000= 400 6,000

1994 1995 1996 1997 1998

5 4 3 2 1 15

10.5 INTEREST ON DEBENTURES Interest on debentures is charged to the Profit and Loss Account. While paying the interest on debentures, it is the obligation on the company concerned to deduct the income-tax before making payment of interest to debenture holder. The following journal entries and passed in this connection : (i) When interest on debentures is due Interest on Debentures Account (with gross amount) To Income-tax Account (with income-tax) To Debentureholders Account (with net amount) (ii) When net amount due is paid Debentureholders Account To Bank Account Dr. Dr.

14

Interest on debentures is transferred to the debit side of Profit and Loss Account. The credit balance of Income-tax Account is shown on the liabilities side of the Balance Sheet. As and when it is paid to the Government this account is debited and bank account will be credited. 10.6 REDEMPTION OF DEBENTURES Redemption of debentures means to discharge the liability on account of debentures. The terms of redemption are stated in the prospectus inviting application for debentures. The various sources out of which the debentures may be redeemed are (a) out of profits (b) out of capital (c) Redemption by conversion (d) Redemption by purchase of debentures in the open market, and (e) out of provisions made for redemption.

1.

Redemption out of profits

When debentures are redeemed out of profits, profits of the company

are utilised for the purpose of redemption with holding the same for dividend. In such a case, the following journal entries will be passed : (a) If the debentures are to be redeemed at par Debentures A/c To Debenture-holders' A/c (b) If the debentures are to be redeemed at a premium Debentures A/c Dr. Dr.

Premium on Redemption of Debentures A/c Dr. To Debenture-holder's A/c (c) If the debentures are to be redeemed at a discount Debentures A/c To Debenture-holders' A/c To Profit on Redemption of debentures A/c Dr.

15

(d)

For amount paid on redemption Debenture holder Account To Bank Dr.

(e)

For transfer of Profit Profit & Loss Appropriation Account To Debentures Redemption Reserve Account Dr.

(f)

When balance of Debentures Redemption Reserve Account is not

required for redemption and is transferred to General Reserve Account Debenture Redemption Reserve Account To General Reserve The balance of general reserve is a free reserve and will be available for all purposes. Dr.

2.

Redemption out of capital

If debentures are redeemed out of capital or profits are not utilised

for redemption of debentures, such redemption is said to be out of capital. When debentures are redeemed out of capital, the following journal entry is made: Debentures A/c To Bank A/c Such redemption will not affect the balance of either Profit and Loss Account or Debentures Redemption Reserve Account. This method is preferred as it does not mix the amount unpaid to debentureholders with the debentures account. Dr.

3.

Redemption by conversion
Redemption by conversion means redeeming the debentures by

converting them into new class of debentures or shares. Such option is

16

exercised by the debentureholders only when they find it beneficial from their viewpoint. The new shares or debentures can be issued either at par or at a premium or at a discount. The following journal entry will be made : Old Debenture A/c Dr. To New Debentures or Share Capital A/c In case the new issue is at discount/premium Old Debenture A/c Dr. Dr.

Discount on Issue of Shares/ Debentures A/c To New Share Capital/Debenture A/c To Premium on Issue of Shares/Debentures A/c

ILLUSTRATION 4: On July 1, 1996 A Ltd. gave notice of its intention to redeem its outstanding Rs.4,00,00,000 4% Debenture stock on January 1, 1997 at 102 per cent and offered the holder, the following options : (1) To apply the redemption money to subscribe for : (a) 6% Cum. Pref. shares of Rs.20 each at Rs.22.50 per share

accepted by the holders of Rs.1,71,00,000 stock, or (b) 6% Debenture stock of Rs.96% accepted by the holders of

Rs.1,44,000 stock, or (2) To have their holdings redeemed for cash if neither of the options

under (1) was accepted. You are required to show the journal entries necessary to record the redemption and allotments under (1) and (2) and to state the amount of cash required to satisfy the option.

17

Solution JOURNAL Dr. Rs. 4% Debentures A/c Premium on Redemption of Debentures A/c To Debenture-holders A/c (Redemption of Debentures of Rs.4,00,00,000 at 102 per cent) Dr. 4,00,00,000 Dr. 8,00,000 4,08,00,000 Cr. Rs.

Debentureholders A/c To 6% Cum. Preference Share Capital A/c To Share Premium A/c (Debenture holders of Rs.1,71,00,000 (Reredemption value Rs.1,74,42,000) accepted Cum. Pref. Shares of Rs.20 each at Rs.22.50 per share) Debenture-holders A/c Discount on Issue of Debentures A/c To 6% Debentures A/c (Debenture-holders of Rs.1,44,00,000 (redemption value Rs.1,46,88,000) issued new 6% Debentures at Rs.96 per cent) Debenture-holders A/c To Bank Debenture holders of Rs.85,00,000 (Redemption value Rs.86,70,000) paid in cash). Total amount required for Redemption is Rs.4,08,00,000, i.e. 4,00,00,000 x 102 100

Dr. 1,74,42,000 1,55,04,000 19,38,000

Dr. 1,46,88,000 Dr. 6,12,000 1,53,00,000

Dr.

86,70,000 86,70,000

18

4.

Redemption by purchase of debentures in the open market

A company can purchase its own debentures in the open market i.e.

in a stock exchange either for immediate cancellation or for the purpose of keeping them as investments. This kind of purchase will be generally taken up specially when they are quoted at the low prices. The advantage in this method is that the company can redeem the debentures at its convenience, i.e. whenever it has surplus funds. The purchase may be at the prices less than the paid up value of the debentures. In such case the company earns profits on cancellation of such debentures. The said profit is a capital profit and it can be used for writing-off of any capital loss such as discount on issue of debentures, etc., or it can be transferred to capital reserve. Some times the debentures may be purchased in the open market at the higher prices than the nominal value of the debentures. In such cases, the company suffers a loss and again it is a capital loss which can be written off either from the Profit & Loss Account or from any capital profit. The journal entries which are required to passed are given below : 1. When debentures are purchased in the open market for immediate cancellation (a) On purchase of own debentures for immediate cancellation on profit Debentures A/c To Bank A/c To Profit on Redemption of Debentures A/c (b) On purchase of own debentures for immediate cancellation on loss Debentures A/c Dr. Dr.

Loss on Redemption of Debentures A/c Dr. To Bank A/c

19

(c)

On transfer of profit on redemption Profit on Redemption of Debentures A/c To Capital Reserve A/c Dr.

II

When debentures are purchased in the open market for investment purpose

(a)

On purchase of own debentures Own Debentures A/c To Bank A/c Dr.

(b)

On cancellation of own debentures Debentures A/c To Own Debentures A/c To Profit on Redemption of Debentures A/c Dr.

(c)

On transfer of profit on redemption Profit on Redemption A/c To Capital Reserve A/c Dr.

5.

Redemption out of provisions

It is always a wise policy for the company to make arrangements in

advance to repay the known liability for redemption of debentures. This can be done by making provision otherwise it will be difficult for the company to arrange lumpsum to repay debts. This is possible by adopting either the sinking fund method or insurance policy method. Sinking fund method Sinking fund is created by setting aside every year a certain sum of money in Profit and Loss Appropriation Account, investing it in outside securities and reinvesting the interest received. Thus investments accumulate to the desired figure at the end of the desired period When the time of redemption comes the securities are realised and the sale proceeds
20

are utilised for the purpose of redemption. The amount to be invested annually can be ascertained from the Sinking Fund Tables. This method resembles with that of Depreciation Fund Method. The accounting entries in such case are : (A) At The End of the First year (1) Profit and Loss Appropriation A/c To Debenture Sinking Fund A/c (Being Amount set aside from profits for redemption) (2) Sinking Fund Investment A/c To Bank A/c (Being amount set aside invested in securities) (B) At the End of Second Year & Subsequent Year (1) Bank A/c Dr. Dr. Dr.

To Interest on Sinking Fund Investment A/c (Being Interest received on the investments at ...%) (2) Interest on Sinking Fund Investment A/c To Sinking Fund A/c (Being interest on investment transferred and credited to Fund A/c) (3) Profit and Loss Appropriation A/c To Sinking Fund A/c (Being amount set aside from profits for redemption of debentures) (4) Sinking Fund Investment A/c To Bank A/c (Being amount set aside plus interest received invested in securities) Dr. Dr. Dr.

21

(C)

At the End of Last Year (When Debentures Are to be Redeemed) (1) Bank A/c Dr.

To Interest on Sinking Fund Investment A/c (Being interest received) (2) Interest on Sinking Fund Investment A/c To Sinking Fund A/c (Being interest transferred) (3) Profit and Loss Appropriation A/c To Sinking Fund A/c (Being sales proceeds of investments) (4) Bank A/c To Sinking Fund Investment A/c (Being sales proceeds of investments) (5) Sinking Fund Investment A/c To Sinking Fund A/c (Being profit on sale of investment transferred) OR Sinking Fund A/c To Sinking Fund Investment A/c (Being loss on sale of investment transferred) (6) Debentures A/c To Bank A/c (Being debentures redeemed) (7) Sinking Fund A/c To General Reserve A/c (Being transfer of Sinking A/c balance) Dr. Dr. Dr. Dr. Dr. Dr. Dr.

22

ILLUSTRATION 5: A Company issued Rs.2,00,000 in 5% Debentures of Rs. 100 each at par, repayable at the end of 5 years at a premium of 6% . A Sinking Fund at 4% compound interest is created for the redemption of debentures. You are required to prepare Sinking Fund Account and Sinking Fund Investment Account for 5 years (Re. 1 per year at 4% compound interest amounts to Rs.5.4613 in 5 years). Solution : When the amount is Rs.5.4163, the annual instalment is Re.1
When the amount is Rs.2,12,000 (Rs.2,00,000 Debentures

+ Rs.12,000 premium on redemption of debentures), The annual instalment is 2,12,000 5.4163 = Rs. 39,141

23

SINKING FUND ACCOUNT

Dr. Year1 To Balance c/d Year2 To Balance c/d Rs. 39,141 Year 1 79,848 Year 2 By P & L Appropriation A/c By Balance b/d By Interest on Sinking Fund Investment A/c By P & L Appropriation A/c Cr. Rs. 39,141 39,141

1,566 39,141 79,848

79,848 Year 3 To Balance c/d 1,22,183 Year 3 By Balance b/d By Int. on Sinking Fund Investment A/c By P & L. Appropriation A/c

79,848 3,194 39,141 1,22,183

1,22,183 Year 4 To Balance c/d 1,66,211 Year 4

By Balance b/d 1,22,183 By Int. on Sinking Fund Investment A/c 4,887 By P & L Appropriation A/c 39,141 1,66,211 By Balance b/d 1,66,211 By Int. on Sinking Fund Investment A/c 6,648 By P & L Appro39,141 priation A/c 2,12,000

1,66,211 Year 5 To Loss on issue Year 5 of Debentures A/c 12,000 To General Reserve A/c 2,00,000 2,12,000

24

SINKING FUND INVESTMENT ACCOUNT Dr. Year 1 To Bank A/c Year 2 To Balance b/d To Bank A/c Rs. 39,141 Year 1 39,141 Year 2 40,707 79,848 Year 3 To Balance b/d To Bank A/c 79,848 Year 3 42,335 1,22,183 Year 4 To Balance b/d BY Bank A/c 1,22,183 Year 4 44,028 1,66,211 Year 5 To Balance b/d 1,66,211 Year 5 By Bank A/c 1,66,211 1,66,211 By Balance c/d 1,22, 183 1,66,211 By Balance c/d 79,848 1,22,183 By Balance c/d By Balance c/d Cr. Rs. 39,141 79,848

Insurance policy method The company may take an insurance policy for redemption of debentures in place of purchasing investments. The policy will be taken for a period which will enable the company to get the required money on the required date. The amount of premium will have to be paid in the beginning of the year. Accounting Entries In the first and subsequent accounting years On payment of premium: Debenture Redemption Fund Policy A/c To Bank A/c At the end of the accounting year For setting aside the amount of premium P & L Appropriation A/c To Debenture Redemption Fund A/c Dr. Dr.

25

In the last year On payment of premium Debenture Redemption Fund Policy A/c To Bank A/c For setting aside the amount of premium P & L Appropriation A/c To Debenture Redemption Fund A/c On realising the amount of policy Bank A/c To Debenture Redemption Fund Policy A/c On payment of debentures Debenture A/c To Bank A/c On transfer of Debenture Redemption Fund to General Reserve Debenture Redemption Fund A/c To General Reserve A/c ILLUSTRATION 6: A company issued Debentures of Rs.3,00,000 on 1 January 1992 and decided to provide for their redemption by means of an insurance policy Rs.3,00,000. The annual premium was Rs. 95,000. Prepare the necessary ledger accounts assuming that the amount of policy was duly realised and debentures were paid. Dr. Dr. Dr. Dr. Dr.

26

Solution DEBENTURES ACCOUNT Rs. 1992 31Dec. To Balance c/d 1992 3,00,000 1 Jan. By Bank 3,00,000 1993 31Dec. To Balance c/d 1993 3,00,000 1 Jan. By Balance b/d 3,00,000 1994 31 Dec. To Bank 1994 3,00,000 1 Jan. By Balance b/d 3,00,000 3,00,000 3,00,000 3,00,000 3,00,000 Rs. 3,00,000 3,00,000

1992 31Dec.

DEBENTURES REDEMPTION FUND ACCOUNT Rs. 1992 To Balance c/d 95,000 31Dec. By Bank 95,000

Rs. 95,000 95,000

1993 31Dec. To Balance c/d

1993 1,90,000 1 Jan. By Balance b/d 95,000 95,000 1,90,000 1994 By Balance b/d 1,90,000

31Dec. By P&L App.A/c 1,90,000 1994

31 Dec. To General Res. 3,00,000 1 Jan.

31Dec. By P & L App. A/c 95,000 By Deb. Red.Fund 15,000 Policy A/c 3,00,000 3,00,000

27

DEBENTURES REDEMPTION FUND POLICY ACCOUNT Rs. Rs. 1992 1992 1Jan. To Bank 95,000 31Dec. By Balance c/d 95,000 95,000 1993 1Jan. To Balance b/d 1 Jan. To Bank 95,000 95,000 1,90,000 1994 1 Jan. To Balance b/d 1 Jan. To Bank 31 Dec.To Debenture Red. Fund A/c 15,000 3,00,000 10.7 SUMMARY A debenture is a written acknowledgement of debt by a company under its common seal. A company may issue various kinds of debentures with different rights. A company can raise funds for operation of busienss by issue of shares and debentures. However, these two ways of raising funds can be differenciated. A company can issue debentures for cash, for consideration other than cash and as collateral security. A company is free to issue the debentures on any terms it likes. These terms may not only relate to issue but also to redemption. The various sources out fo whcih the debentures may be redeemed are out of profits, out of capital, redemption by conversion, redemption by purchase of debenture in the open market and out fo provisions made for redemption. 10.8 KEYWORDS Debenture: It is a written acknowledgement of debt by a company under its common seal. 3,00,000 1,90,000 95,000 1994 31Dec. By Bank 3,00,000 1,90,000 1993 31Dec. By Balance c/d 1,90,000 95,000

28

Registered Debenture: These are those debentures which are payable tot he persons whose name appear in the register of debenture holders. Redemption of Debentures: Repayment of amount due to the debenture holders at an agreed date is called redemption of debentures. Collateral Security: When debentures are issued as subsidiary to the principal security against a loan or bank overdraft, such an issue of debentures is known as issue of debentures as collateral security. 10.9 SELF ASSESSMENT QUESTIONS 1. What is a debenture? Describe the various methods for redemption of debentures. Give Illustrations. 2. 3. 4. (a) (b) (c) (d) 5. Explain with the help of journal entries how Sinking Fund Method for redemption of debentures is used. State how will you deal with loss on issue of debentures in the books of accounts. Journalise the following transactions : Debenture issued at 95 payable at 100. Debenture issued at 95 repayable at 105. Debenture issued at 100 repayable at 105. Debenture issued at 105 repayable at 100. A company issued debentures of the face value of Rs.100,000 at a discount of 6%. The debentures were repayable by annual drawings of Rs.20,000. How would you deal with the discount on debentures? Show the discount account in the company's ledger for the period of duration of debentures? 6. On Ist January 1987, a company issued 20,000 Debentures of Rs.100 each for 10 years on the condition that debentures could be redeemed by the company at a premium of 2% by giving six months notice at any time after 5 years, either by payment of cash or by allotment of

29

shares or by other debentures according to the option of the debenture holders. Necessary notice was given on Ist March, 1992 informing the debenture holders about the company's intention to redeem debentures on Ist Sept., 1992, either by payment of cash, or by allotment of 8% preference shares of Rs.100 each at Rs.120 per share or by issuing 4% debentures of Rs.100 each at Rs.98. Holders of 4,000 debentures accepted preference shares, holders of 9,800 debentures accepted preference shares, holders of 9,800 debentures accepted the offer of 4% debentures and the rest claimed cash. Pass necessary journal entries for the redemption of debentures. 7. The Debenture Redemption Fund of Export Industries Ltd. stood at Rs.16,000 represented by Rs.20,000 (nominal) investments. The debentures stood in the books at Rs.50,000 and the company sold Rs.12,000 (nominal) investments at Rs.84 for the purpose of redeeming Rs.10,000 debentures at a premium of 1 per cent. You are required to show the ledger accounts to record the above transactions (Ignore interest and brokerage). 10.10 SUGGESTED READINGS 1. Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. 2. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. 3. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. 4. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi.
30

LESSON -11 PREPARATION OF FINAL ACCOUNTS OF A COMPANY

STRUCTURE 11.0 11.1 11.2 11.3 11.4 11.5 11.6 11.7 11.8 11.9 Objective Introduction Preparation of Final Accounts Profit and Loss Account Profit and Loss Appropriation Account Balance Sheet Special Points to be noted while preparing Final Accounts Summary Keywords Self Assessment Questions

11.10 Suggested Readings 11.0 OBJECTIVE After reading this lesson, you will be conversant with (a) (b) (c) Requirements of the Companies Act for presentation of Profit and Loss Account and Balance Sheet Profit and Loss Appropriation Account Accounting Treatment of Special Items while preparing Final Accounts of a company.

11.1 INTRODUCTION Final accounts, as we know, are prepared to show business profit over a period of time and to reveal the business position (financial) at a point of time. A company, like any other forms of business organisation, has also to prepare its final accounts every year. Preparation of final accounts is
1

compulsory for a company. The Companies Act has made it obligatory for every limited company to prepare, present and publish its final accounts every year, in order to protect and safeguard the interest of the owners. Section 209 and Section 210 deal with the provisions of preparation of final accounts for a company. Section 209 makes it compulsory for a company to keep certain books of account and Section 210 governs the preparation of the final accounts. 11.2 PREPARATION OF FINAL ACCOUNTS The principles and methods of preparing the final accounts of joint stock companies are the same as in the case of the sole proprietorship or partnership firms. However, in addition to these principles, a joint stock company must conform to certain legal provisions as given in the Companies Act, in respect of form and content of the final accounts. The final accounts of a company consists of : (i) (ii) (iii) Profit and Loss Account (Inclusive of Manufacturing & Trading A/c) Profit and Loss Appropriation Account Balance Sheet

11.3 PROFIT AND LOSS ACCOUNT The Companies Act does not give any fixed form of Profit and Loss Account but 'Requirement as to Profit and Loss Account' are given in PartII of Schedule VI. Generally, it consists of Manufacturing and/or Trading Account. Form and contents of Profit and Loss Account Sub-section (2) of Section 211 of the Companies Act, 1956 requires "Every Profit and Loss Account of a company shall give true and fair view of the profit or loss of the company for the financial year and comply with
2

the requirements of Part II of Schedule VI so far as they are applicable thereto. Provided that nothing contained in this sub-section shall apply to any insurance or banking company, or any company engaged in the generation or supply of electricity or to any other class of company for which a form of Profit and Loss Account has been specified in or under the Act governing such class of company". It is also given in sub-section (3) of Section 211 that the Central Government may, by notification in the Official Gazette exempt any class of companies from the compliance with any of the requirements in Schedule VI if, in its opinion, it is necessary to grant exemption in the public interest. Any such exemption may be granted either unconditionally or subject to such conditions as may be specified in the notification. Requirements of companies act with respect to Profit and Loss Account Part II of Schedule VI of the Companies Act does not prescribe any format for the Profit and Loss Account but only outlines the information to be included. In general, the Profit and Loss Account should be so made out as to clearly disclose the result of the working of the company during the period covered by the account. The Profit and Loss Account should also disclose every material feature, including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature. The various items of receipts and expenses should be arranged under the most convenient heads. Revenues With respect to revenues received by a company, the following are

required to be shown as per Part II of Schedule VI: a) The turnover or the aggregate amount of sales effected by the company. If more than one class of goods have been sold by the company, then the amount of sales in respect of each class of goods sold along with details of quantities sold should be disclosed. b) In the case of companies rendering or supplying services, the gross income derived from services rendered or supplied. c) Amount of income from investment distinguishing between trade investments and other investments. d) e) f) Other income by way of interest, specifying the nature of income. Profits on investments. Profits (which are material in amount) in respect of transaction which are of a kind not usually undertaken by the company or undertaken in circumstances of an exceptional or non-recurring nature. g) h) Miscellaneous income. Dividends from subsidiary companies.

Expenses The following are the expenses which must be disclosed in the Profit and Loss Account : a) In the case of manufacturing companies, the value of the raw materials consumed, giving item-wise break up and the quantities consumed. While giving this break up, as far as possible, all important basic raw materials should be shown as separate items. In the case of intermediates or components procured from other manufacturers and consumed, if the number of items are too many to be included in the break up, then such items should be grouped under suitable headings without mentioning the quantities. However, all those items which in

value individually account for 10 per cent or more of the total value of the raw material consumed should be shown distinctly in the break up with details of quantities consumed. b) In the case of manufacturing companies, the opening and closing stock of good produced, giving break up in respect of each class of goods indicating the quantities of each class of goods produced. c) In the case of trading companies, the value of purchases made and of the opening and closing stocks. This information should be provided in respect of each class of goods traded by the company. The quantity details should also be provided. d) If a company is both a manufacturing and a trading company, it is sufficient if the total amounts are shown in respect of the opening and closing stocks, purchases, sales and consumption of raw material with value and quantity details. e) In the case of companies having works in progress, the opening and closing values of the works in progress. f) The amount provided for depreciation, renewals or diminution in value of fixed assets. If no provision has been made for depreciation, this fact should be stated and the quantum of arrears of depreciation should be disclosed by way of a note. g) h) i) j) k) l) m) n) Consumption of stores and spare parts. Power and fuel. Rent. Repairs to buildings. Repairs to machinery. Salaries, wages and bonus. Contribution to provident fund and other funds. Workmen and staff welfare expenses.

o) p) q)

Insurance. Rates and taxes, excluding taxes on income. Miscellaneous expenses. Any item under which expenses exceed one per cent of the total revenue of the company or Rs.5,000 whichever is higher must be shown as a separate and distinct item against an appropriate account head in the Profit and Loss Account and should not be combined with any other item and shown under this head of 'Miscellaneous Expenses'.

r) s)

Losses on investments. Losses on transaction which are of a kind, not usually undertaken by the company or undertaken in circumstances of an exceptional or nonrecurring nature, if material in amount.

t)

The amount of interest on the company's debentures and other fixed loans stating separately the amount of interest if any, paid or payable.

u) v)

The amount of income tax payable. The aggregate amount of the dividends paid, and proposed, and stating whether such amounts are subjected to deduction of income tax or not.

w) x)

Provisions for losses of subsidiary companies. Amounts reserved for repayment of share capital and repayment of loans.

y)

Any material amounts set aside to reserves, but not including provisions made to meet any specific liability, contingency or commitment. Any material amounts withdrawn from such reserves.

z)

Any material amounts set aside to provisions made for meeting specified liabilities, contingencies or commitments. Any material amounts withdrawn from such provisions, as no longer required.

In addition to the above expenses, expenses relating to sales such as commission paid to sole selling agents and other selling agents, brokerage and discount on sales, other than the usual trade discount should also be shown separately. The amount by which any items shown the Profit and Loss Account are affected by any change in the basis of accounting if material should be disclosed separately. In respect of all items shown in the Profit and Loss Account, the corresponding amounts for the immediately proceeding financial year should also be given. Notes to Profit and Loss Account Accounting to Part II of Schedule VI, certain information has to be provided by way of notes to Profit and Loss Account. The information to be so provided is outline below : 1. The following payments provided or made during the financial year

to the directors (including managing directors or manager, if any, of the company, the subsidiaries of the company and any other person): i) Managerial remuneration paid or payable under Section 198 of the Companies Act ii) Other allowances and commission including guarantee commission iii) Any other perquisites or benefits in cash or in kind (stating approximate money value where practicable) iv) v) vi) Pensions Gratuities Payments form provident funds, in excess of subscriptions and interest thereon

vii)

Compensation for loss of office

viii) Consideration in connection with retirement from office If commission is payable to the directors including managing director or manager as a percentage of profits, then the notes should give a statement showing the computation of net profit in accordance with the provisions of the Companies Act and also give details of the calculation of such commission. 2. The notes should contain detailed information with regard to amounts

paid to the auditor, whether as fees, expenses or otherwise for services rendered. These payments should be classified into payments received by the auditor as, a) b) auditor as advisor, or in any other capacity, in respect of i) ii) iii) c) 3. taxation matters company law matters managements services and

in any other manner.

In the case of manufacturing companies, the notes should give detailed

quantitative information in respect of each class of goods manufactured with regard to the following: a) b) c) 4. the licensed capacity (where license is in force) the installed capacity and the actual production

The notes to the Profit and Loss Account should also contain the

following information: a) Value of imports calculated on C.I.F. basis by the company during the financial in respect of :

i) ii) iii) b)

raw materials components and spare parts capital goods expenditure in foreign currency during the financial year on account of royalty, know-how, professional, consultation fees, interest and other matters.

c)

value of all imported raw materials, spare parts and components consumed during the financial year and the value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to total consumption.

d)

the amount remitted during the year in foreign currencies on account of dividends, with a specific mention of the nonresident shareholders and the number of shares held by them on which dividends were paid.

e)

earnings in foreign exchange classified under the following heads, namely:

i) ii) iii) iv) 5.

export of goods calculated in F.O.B. basis. royalty, know-how, professional and consultation fees interest and dividend other income, indicating the nature thereof.

The notes to the Profit and Loss Account should also contain break up of the expenditure incurred on employees who

i)

if employed throughout the financial year were in receipt of remuneration for that year which in the aggregate was not less than Rs.300,000 or

ii)

if employed for part of the financial year were in receipt of remuneration for any part of that year at a rate which in the aggregate was not less than Rs.25,000 per month.
9

This note should also indicate the number of employees falling in each of the above two categories. Usually the remuneration paid is broken up into a) b) Salaries, Perquisites etc. and Contribution to Provident and other funds.

11.4 PROFIT AND LOSS APPROPRIATION ACCOUNT The account showing the disposal of profits is known s Profit and Loss Appropriation Account. The balance on Profit and Loss Account is transferred to this Profit and Loss Appropriation Account. Profits available for dividend to shareholders are known as divisible profits. The Directors may decide to retain a certain amount to strengthen the companies finances. The amount retained may take the form of transfer to various reserves and funds. It is a wise policy to keep aside certain portion of divisible profit in the form of reserves and funds before distributing entire divisible profits among the shareholders as dividend. Therefore, the account which shows how the divisible profits of the company have been dealt with is known as Profit and Loss Appropriation Account, as appropriation means to keep aside. The amount brought forward from the previous year is put on the credit side together with current year's profit. On the debit side of this account, the following items are usually found : i) ii) Transfer to General Reserve. Transfer to Divided Equalisation Fund - (Dividend Equalisation Fund means a fund created out of profits available for dividend for the purpose of stable dividend policy i.e. making the rate of dividend uniform from year to year). iii) iv) v) Transfer to Sinking Fund for Redemption to Debentures. Dividend (Interim/Final, paid or proposed). Balance if any, carried to B/Sheet. Therefore, this Account, generally

appears as under :

10

Profit and Loss Appropriation Account Dr. Particulars To Bal. b/d (Dr. bal. from last year if any , as per Trial Balance) To Net Loss during the year, if any To General Reserve (transfer) To Dividend Equalisation Fund (transfer) To Sinking Fund for Redemption of Debentures To Transfer to other Reserves & Funds To Dividend (Interim or Final; Paid/or proposed) To Balance c/d to Balance Sheet Rs. Particulars By Balance b/d from last year (As per Trial Balance) By Savings in the provision for Taxation By Net Profit during the year (as per P & L A/c) By Transfer from Reserves, if any By Bal. c/d to Balance Sheet Cr. Rs.

Profit and Loss Appropriation Account is a part and parcel of Profit and Loss Account showing the disposal of divisible profits. The balance on this account is shown as a separate item in the Balance Sheet. 11.5 BALANCE SHEET According to Section 210 of the Companies Act, a company is required to prepare a Balance Sheet at the end of each trading period. Section 211 requires the Balance Sheet to be set up in the prescribed form. This provision is not applicable to banking, insurance, electricity and the other
11

companies governed by special Acts. The Central Government has also the power to exempt any class of companies from compliance with the requirement of the prescribed form if it deems to be in public interest. The object of prescribing the form is to elicit proper information from the company so as to give a 'true and fair' view of the state of the company's affairs. As a matter of fact both window dressing and creating secret reserves will be considered against the provisions of Section 211. Section VI, Part I gives the prescribed form of a company's Balance Sheet. Notes and instructions regarding various items have been given in brackets below each item. It may be noted that if information required to be given under any of the items or sub-items in the prescribed form cannot be conveniently given on account of lack of space, it may be given in a separate schedule or schedules. Such schedules will be annexed to and form part of the Balance Sheet. Schedule VI, Part I permits presentation of Balance Sheet both in horizontal as well as vertical forms. The forms with necessary notes, explanations, etc., are given below:

12

(A) HORIZONTAL FORM OF BALANCE SHEET SCHEDULE VI PART I

(See Section 211) Balance Sheet of ..................(Here enter the name of the company) as on ...........(Here enter the date as which the Figures for the current year Rs. (6)

13

balance sheet is made out) Figures Figures Figures for the for the for the previous Liabilities current previous Assets year year year Rs. Rs. Rs. (1) (2) (3) (4) (5) Fixed Assets: Share Capital : Distinguishing as for as possible Authorised......Shares of Rs........each between expenditure upon Issued : (distinguishing between the (a) goodwill various classes of capital and stating the (b) land particulars specified below, in respect (c) buildings of each class)....shares of Rs........each. (d) leaseholds (e) railway sidings Subscribed : (distinguishing between (f) plant and machinery the various classes of capital and stating (g) furniture and fittings the particulars specified below, in (h) development of property respect of each class).......shares of (i) patents, trade marks and designs Rs............each ........Rs.called up. (j) livestock, and (Of the above shares.........shares are (k) vehicles, etc. allotted as fully paid up pursuant to a (Under each head the original cost and contract without payments being the additions thereto and deductions received in cash. Of the above therefrom during the year, and the total shares......shares are allotted as fully depreciation written off or provided up paid up by way of bonus shares) to the end of the year is to be stated.

(1) Depreciation written off or provided shall be allotted under the different asset heads and deducted in arriving at the value of Fixed Assets.

(2)

(3)

(4)

(5)

(6)

Specify the source from which bonus shares are issued, e.g.....capitalisation of profits or Reserves or from Shares Premium Account. Less : Calls unpaid (i) By Directors (ii) By Others Add : Forfeited shares (amount originally paid up)

(Any capital profit on reissue of forfeited shares should be transferred to Capital Reserves).

14

Notes : 1. Te r m s o f r e d e m p t i o n o r conversion (if any) of any redeemable preference capital are to be stated together with earliest date of redemption or conversion.

In every case where the original cost can not be ascertained, without unreasonable expense or delay, the valuation shown by the books is to be given. For the purpose of this paragraph, such valuation shall be the net amount at which on asset stood in the company's books at the commencement of this Act after deduction of the amounts previously provided or written off for depreciation or diminution in value, and where any such asset is sold, the amount of sale proceeds shall be shown as deduction.

2. Particulars of any option on unissued Share Capital are to be specified. 3. Particulars of the different classes of preference shares are to be given.

Where sums have been written off on a reduction of capital or a revaluation of assets, every Balance Sheet, (after the first Balance Sheet) subsequent to the reduction or revaluation shall show the reduced figures with the date of the reduction in place of the original cost. Each Balance Sheet for the first five

(1) years subsequent to the date of the reduction, shall show also the amount of the reduction made. Similarly, where sums have been added by writing up the assets, every Balance Sheet subsequent to such writing up shall show the increased figures with the date of the increase in place of the original cost. Each Balance Sheet for the first five years subsequent to the date of the writing up shall also show the amount of increase made. Showing nature of investments and mode of valuation, for example, cost or market value, and distinguishing between: (1) Investments in Government or Trust Securities. (2) Investments in shares, debentures or bonds. (Showing separately shares fully paid up and partly paid up and also distinguishing the different classes of shares and showing also in similar details investments in shares, debentures or bonds of subsidiary companies). (3) Immovable properties.

(2)

(3)

(4)

(5)

(6)

These particulars are to be given alongwith Share Capital.

In the case of subsidiary companies, the number of shares held by the holding company as well as by the ultimate holding company and its subsidiaries shall be separately stated in respect of Subscribed Share Capital. The auditor is not required to certify the correctness of such share-holdings as certified by the management).

15

(1) Capital Reserves (2) Capital Redemption Reserves (3) Share Premium Account (showing details of its utilisation in the manner provided in Section 78 in the year of utilisation). (4) Other Reserves specifying the nature of each Reserve and the amount in respect thereof. Less: Debit balance in Profit and Loss Account (if any). (The debit balance in the Profit and Loss Account shall be shown as a deduction from the uncommitted

(1) (4) Investments in the capital of partnership firms. (Aggregate amount of company's quoted Investments and also the market value thereof shall be shown).

(2)

(3)

(4)

(5)

(6)

reserves, if any). (5) Surplus, i.e., balance in Profit and Loss Account after providing for proposed allocations, namely: Dividend, Bonus or Reserves. (6) Proposed additions to Reserves. (7) Sinking Funds.

16

Additions and deductions since last Balance Sheet to be shown, under each of the specified heads. The word "fund" in relation to any "Reserve" should be used only where such under Reserve is specifically represented by earmarked investments).

Secured Loans: (1) Debentures. (2) Loans and Advances from Banks. (3) Loans and Advances from subsidiaries. (4) Other Loans and Advances. (Loans from directors and/or manager should be shown separately). Interest accrued and due on Secured Loans should be included under the appropriate sub-heads under the head

(Aggregate amount of company's unquoted investments shall also be shown). Current Assets, Loans and Advances: (A) CURRENT ASSETS : (1) Interest accrued on Investments. (2) Stores and spare parts. (3) Loose Tools. (4) Stock-in-trade. (5) Work-in-Progress. (In respect of (2) and (4), mode of valuation of stock shall be stated and the amount in respect of raw materials shall also be stated separately where practicable. Mode of valuation of workin-progress shall be stated). (6) Sundry Debtors. (a) Debts outstanding for a period exceeding six months. (b) Other debts Less Provisions:

(1)

(2)

(3)

(4)

(5)

(6)

"Secured Loans."

The nature of security to be specified in each case.

Where loans have been guaranteed by managers and/or directors, a mention thereof shall also be made and also the aggregate amount of such loans under each head. (a)

(The amounts to be shown under Sundry Debtors shall include the amounts due in respect of goods sold or services rendered or in respect of other contractual obligations but shall not include the amounts which are in the nature of loans or advances). In regard to Sundry Debtors particulars to be given separately of :

In case of Debentures, terms of redemption or conversion (if any) are to be stated together with earliest date of redemption or conversion. (b)

17

Unsecured Loans : (1) Fixed Deposits. (2) Loans and Advances from subsidiaries. (3) Short Term Loan and Advances: (a) From Banks. (b) From Others. (Short term loans include those which are due for repayment not later than one year as at the date of the Balance Sheet. (4) Other Loans and Advances : (a) From Banks (c)

debts considered goods and in respect of which the company is fully secured; debts considered good for which the company holds no security other than the debtor's personal security; and debts considered doubtful or bad.

Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in which any directors is a partner or a director or a member to be separately stated. Debts due from other companies under the same management within the meaning of

(1) sub-section (IB) of Section 370 to be disclosed with the names of the companies. The maximum amount due by directors or other officers of the company at any time during the year to be shown by way of a note.

(2)

(3)

(4)

(5)

(6)

(b) From Others (Loans from directors and/or manager should be shown separately).

Interest accrued and due on Unsecured Loans should be included under the appropriate sub-heads under the head "Unsecured Loans."

18

The Provision to be shown under this head should not exceed the amounrt of debts stated to be considered doubtful or bad and any surplus of such Provision, if already created, should be shown at every closing under "Reserves and Surplus" (in the Liabilities side) under a separate sub-head "Reserve for Doubtful or Bad Debts.") (7A) Cash balance on hand. (7B) Bank Balances: (a) with Scheduled Banks. (b) with others. (In regard to bank balances particulars to be given separately of (a) the balance lying with Scheduled Banks on current accounts, call accounts and deposit accounts. (b) the names of the bankers other than Scheudled Banks and the balances

(Where Loans have been guaranteed by manager, and/or directors, a mention thereof shall also be made together with the aggregate amount of such loans under each head. This does not apply to Fixed Deposits). Current Liabilities and Provisions: A Current Liabilities: (1) Acceptance. (2) Sundry Creditors. (3) Subsidiary Companies. (4) Advance payments and unexpired discounts for the portion for which value has still to be given, e.g. in the case of the following companies: Newspaper, Fire Insurance, Theatres, Clubs, Banking, Steamship companies, etc.

(1)

(2)

(3)

(4)

(5) (6) lying with each such banker on current account, call account and deposit account and the maximum amount outstanding at any time during the year with each such banker; and (c)

(5) Unclaimed Dividends. (6) Other Liabilites (if any), (7) Interest accrued but not due on loans. B. Provisions (8) Provision for Taxation. (9) Proposed Dividends. (10) For contingencies. (11) For Provident Fund Scheme (12) For insurance, pension and similar staff benefit schemes.amounts (13) Other provisions.

19

A foot-note to the Balance Sheet may be added to show separately (1) Claims against the company not acknowledged as debts. (2) Uncalled liability on shares partly paid. (3) Arrears of fixed cumulative dividends.

(The period for which the dividends are in arrears or if there is more than one class of shares, the dividends on each such class that are in arrear, shall be stated. The amount shall be stated

the nature of the interest, if any, of any director or his relative in each of the bankers (other than Scheduled Banks referred to in (b) above] B) Loans and Advances : (8) (a) A d v a n c e s a n d l o a n s t o subsidiaries. (b) Advances and loans to partnership firms in which the company or any of its subsidiaries is a partner. (9) Bill of Exchange. (10) Advances recoverable in cash or in kind or for value to be r e c e i v e d , e . g . , R a t e s , Ta x e s , Insurance, etc. (11) Balances with Customs, Port Trust, etc. (where payable on demand). The instructions regarding Sundry Debtors apply to "Loans and Advances"

(1)

(2)

(3)

(4)

before deduction of income-tax, except that in the case of tax-free dividends the amount shall be shown free of incometax and the fact that it is so shown shall be stated). (4) Estimated amount of contracts remaining to be executed on capital account and not provided for. (5) O t h e r m o n e y s f o r w h i c h t h e company is contingently liable. Miscellaneous Expenditure : (to the extent not written off or adjusted). (1) Preliminary expenses. (2) Expenses including commission or brokerage or underwriting or subscription of shares or debentures. (3) Discount allowed on the issue of shares or debentures. (4) Interest paid out of capital during construction (also stating the rate of Interest). (5) Development expenditure not adjusted. (6) Other sums (specifying nature). Profit and Loss Account (Show here the debit Balance of Profit and loss Account carried forward after deduction of the uncommitted reserves, if any).

(5) (6) also. The amounts due from other companies under the same management within the meaning of sub-section (IB) of Section 370 should also be given with the name of the companies; the maximum amount due from every one of these at any time during the year must be shown).

20

(The amount of any guarantees given by the company on behalf of directors or other officers of the company shall be stated and where practicable, the general nature and amount or each such contingent liability, if material, shall also be specified).

Notes : (1) (2) Paise can also be given in addition to Rupees, if desired. Dividends declared by subsidiary companies after the date of the Balance Sheet should not be included unless they are in respect of a period which closed on or before the date of the Balance Sheet. (3) Any reference to benefits expected from contracts to the extent not executed shall not be made in the Balance Sheet but shall be made in the Board's report. (4) Particulars of any redeemed debentures which the company has power to issues should be given. (5) Where any of the company's debentures are hold by a nominee or a trustee for the company the nominal amount of the debentures and the amount at which they are stated in the books of the company shall be stated. (6) A statement of investments (whether shown under "investment" or under "Current Assets " as Stock-in-Trade) separately classifying trade investments and other investments should be annexed to the Balance Sheet, showing the names of the bodies corporate (including separately the names of the bodies corporate under the same management) in whose shares or debentures, investments have been made (including all investments whether existing or not, made subsequent to the date as at which the previous Balance Sheet was made out) and the nature and extent of the investments so made in each such body corporate; provided that in the case of an investment company, that is to say, a company whose principal business is the acquisition of shares, stock , debentures or other securities, it shall be sufficient if the statement shows only the investments existing on the date as at which the Balance Sheet has been made out. In regard

21

to the investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given in the statement. (7) If, in the opinion of the Board, any of the current assets, loans and advances have not a value on realisation in the ordinary course of business at least equal to the amount at which they are stated, the fact that the Board is of that opinion shall be stated. (8) Except in the case of the first Balance Sheet laid before the company after the commencement of the Act, the corresponding amounts of the immediately preceding financial year for all items shown in the Balance Sheet shall be also given in the Balance Sheet. The requirements in this behalf shall, in case of companies preparing quarterly or half-yearly accounts, etc., relate to the Balance Sheet for the corresponding date in the previous year. (9) Current accounts with Directors and Manager, whether they are credit or debit, shall be shown separately. (10) The information required to be given under any of the items or subitems in the Form, if it cannot be conveniently included in the Balance Sheet itself, shall be furnished in a separate Schedule or Schedules to be annexed to and forming part of the Balance Sheet. This is recommended when items are numerous. (11) Where the original cost (of fixed assets) and additions and deductions thereto, relate to any fixed asset which has been acquired from a country outside India, and in consequence of a change in the rate of exchange at any time after the acquisition of such assets, there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset, or for repayment of the whole or a

22

part of monies borrowed by the company from any person, directly or indirectly, in any foreign currency specifically for the purpose of acquiring the assets (being in either cases the liability existing immediately before the date on which the change in the rate of exchange takes effect), the amount by which the liability is so increased or reduced during the year, shall be added to, or as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed assets. Explanation :1. This paragraph shall apply in relation to all Balance Sheet

that may be made out as at the 6th day of June 1966, or any day thereafter and where, at the date of issue of the notification of the Government of India, in the Ministry of Industrial Development and Company Affairs (Department of Company Affairs), G.S.R.No.129, dated the 3rd day of January, 1968, any Balance Sheet in relation to which the paragraph applied, has already been made out and laid before the company in annual general meeting, the adjustment referred to in this paragraph may be made in the first Balance Sheet made out after the issue of the said notification. Explanation 2: In this paragraph, unless the context otherwise requires, the expression "rate of exchange", "Foreign currency" and "Indian currency" shall have the meanings respectively assigned to them Under Subsection (1) of Section 43A of the Income-tax Act, 1961 (43 of 1961), and Explanation 2 and Explanation 3 of the said sub-section shall as far as may apply in relation to the said paragraph as they apply to the said sub-section (1). B) VERTICAL FORM OF BALANCE SHEET Vertical form of Balance Sheet inserted as Part B of Part I of Schedule VI to the Companies Act 1956 by G.S.R. No.220(E) dated 12.3.1979 is as follows :
23

Name of the Company........... Balance Sheet as at ............... Schedule No. Figures as at all the end of current financial year 3 Figures as the end of previous financial year 4

1 2 1. Source of Funds (1) Shareholder's funds: (a) Capital (b) Reserves and surplus (2) Loans funds : (a) Secured loans (b) Unsecured loans Total II. Application of Funds (1) Fixed assets : (a) Gross block (b) Less : depreciation (c) Net block (d) Capital work-in-progress (2) Investments (3) Current assets, loans and advances : (a) Inventories (b) Sundry debtors (c) Cash and Bank balance (d) Other current assets (e) Loans and advances Less: Current liabilities & provisions (a) Liabilities (b) Provisions Net current assets. (4) (a) Miscellaneous Expenditure to the extent not written off or adjusted (b) Profit and Loss Account Total

24

Notes : 1. Details under each of the items in Vertical Balance Sheet be given in separate Schedules. 2. The Schedules referred to above, accounting policies and explanatory notes that may be attached shall form an integral part of the Balance Sheet. 3. The figures in the Balance Sheet may be rounded off to the nearest '000 or '00 as may be convenient or may be expressed in terms of decimals of thousands. 4. A foot note to the Balance Sheet may be added to show separately contingent liabilities. In India, a joint stock company can prepare its Balance Sheet either in horizontal or vertical form. Of the two forms of the Balance Sheet, vertical form is a better form because it speaks out the correlation of every item with the other items and conveys more meaning to the layman. 11.6 SOME SPECIAL POINTS TO BE NOTED WHILE PREPARING FINAL ACCOUNTS (1) Interest on Debentures Debentures carry a fixed rate of interest. Profit or no profit, interest on debentures must be paid and debited to Profit and Loss A/c. If the Trial Balance does not indicate the payment of interest at all or in full the unpaid amount is to be shown in the Balance Sheet alongwith Debentures, if it is outstanding or under 'Current Liabilities', if it is accrued. (2) Interest on Investment Interest for the full period or for the period of investments standing in the books must be provided for and credited to Profit and Loss A/c.

25

(3)

Discount on Debentures/Shares, Preliminary Expenses, Underwriting Commission, Advertising Suspense A/c etc. The amount asked to be written off should be debited to Profit

and Loss A/c and remaining balance (i.e. to the extent not written off) should be shown in the Balance Sheet under the heading,"Miscellaneous Expenditure". (4) Profit on sale of Fixed Assets Profit on sale of asset should be treated as Capital Profits, and shown under the heading "Reserves and Surplus" on the liabilities side. (5) Debenture Interest and Dividend Paid - Less Tax X% Companies are required to deduct Income-tax at source. The amount deducted from Debenture interest or Dividend (by way of tax deducted at source) is payable to Government. Debit Profit and Loss A/c with the gross amount (100%) and Tax-deducted at source is to be shown under "Current Liabilities". (6) Receipts of Interest/dividend - less Tax X% Sometimes company receives interest or dividend from other company-less tax, deducted at source. Amount deducted at source is advance payment of tax Credit Profit and Loss A/c with the amount of gross income (100%) and Tax deducted at source to be shown on asset side under the heading "Loans and Advance" or to be adjusted against tax payable by the company. (7) Depreciation of Fixed Assets According to the requirements of the Companies Act, fixed assets are to be shown in the Balance Sheet at their cost price less depreciation written off the date of purchase of asset to the date of Balance Sheet. If Depreciation Fund is given in he Trial Balance it is to be deducted from the respective assets.

26

(8)

Interest on Sinking Fund Investments Interest received on sinking fund investments is to be credited

to Sinking Fund for Redemption of Debentures and not Profit and Loss A/c. (9) Calls-in-Advance & Share Forfeited A/c Calls in-Advance A/c is shown in the Balance Sheet on the liability side under the heading "Share Capital" or under "Unsecured Loans". If the forfeited shares are not reissued then the balance on Share Forfeited A/c is to be shown under the heading 'Subscribed Capital' on the liability side as addition thereto. (10) Share premium A/c This is shown on the liability side of the Balance Sheet under the heading, "Reserves and Surplus". (11) Provision for Taxation (a) Provision for taxation to be made in the current year (given in the adjustment) is to be debited to Profit and Loss A/c. (b) (i) If given in the Trial Balance : (Previous Year's) If no payment of tax is made, then this provision plus current year's provision to be shown under the heading "Provisions" on the liability side of the Balance Sheet. (ii) If payment of tax is also shown in the Trial Balance, the amount paid is to be deducted from the amount of provision for taxation and if there is any balance of provision for taxation it is to be credited to Profit & Loss Appropriation A/c. If the provision made (last year's) is less than the actual Income-tax paid for the last year, it is adjusted against (i.e. balance) current year's provision to be made).

27

(12) Dividend The share in the profits payable to shareholders is known as Dividend. A dividend once declared , becomes a debt. Dividend is paid out of profits on paid-up capital of the company. Calls-in-Advance cannot be treated as part of paid up capital for declaration of dividends. (a) Proposed Dividend : Unless otherwise stated, the dividend at given

rate is calculated on paid-up capital and it is (amount of proposed dividend) is debited to Profit and Loss A/c Appropriation A/c and shown on the liability side of the Balance Sheet under the heading "Provisions". (b) Interim Dividend : An Interim Dividend is a dividend paid by the

directors at any time between two annual general meetings. It is always debited to Profit and Loss Appropriation A/c. The interim dividend is usually paid for a period of six months. Its calculation depends upon the language of the rate of dividend. The directors may recommend another dividend when the final figures of profits are available. Such dividend is known as final dividend. When final dividend is declared, interim dividend is not adjusted unless the resolution specifies otherwise. (c) Unclaimed Dividend : Dividend declared but not claimed by some

shareholders for some reason, such amount of dividend (not claimed) is known as "Unclaimed Dividend". It is always shown on the liability side of the Balance Sheet under the heading "Current Liabilities ". (13) Managerial Remuneration The total managerial remuneration payable by a company to its managerial personnel for any financial year must not exceed eleven per cent of the net profits of the company of that financial year. In any year if profits are inadequate then the company, with the approval of the Central Govt.

28

may pay by way of minimum remuneration up to Rs.50,000. Net profits of the company for this purpose are to be computed as per Sections 349-351. ILLUSTRATION I : The following balances appeared in the books of Moon light Co. Ltd. as on 31st March, 1999. Dr. Issued, Subscribed and Paid up Capital : (60,000 Equity shares of Rs.10 each) General Reserve Unclaimed dividends Trade creditors Building Purchases Sales Manufacturing expenses Establishment General Charges Machinery Motor vehicles Furniture Opening Stock Book debts Investments Depreciation reserve Cash Director's fees Interim dividend Interest on investments Profit & Loss A/c Ist April 1998 Staff provident fund 20,11,223 72,240 1,800 15,000 8,544 16,848 37,500 20,11,223 3,59,000 26,814 31,078 2,00,000 15,000 5,000 1,72,058 2,23,380 2,88,950 71,000 1,00,000 5,00,903 9,83,947 Rs. Cr. Rs. 6,00,000 2,50,000 6,526 36,858

29

From these balances and the following information, prepare the company's Balance Sheet as on 31st March, 1999 and its Profit and Loss Account for the year ended on that date. (a) (b) The stock on 31st March, 1999 was valued at Rs.1,48,680. Provide Rs.10,000 for depreciation on fixed assets, Rs.6,500 for managing director's commission and Rs.1,500 for the company's contribution to the staff provided fund. (c) (d) (e) (f) Solution Moonlight Co. Ltd. Trading and Profit and Loss Account for the year ended 31st March, 1999 Dr. To Opening stock To Purchases To Manufacturing Exp. To Gross profit transferred to Profit & Loss Account 1,00,666 11,32,627 To Establishment Exp. 26,814 To General charges 31,078 To Directors fees 1,800 To Depreciation reserve 10,000 To Commission to managing director 6,500 To Staff Provident fund 1,500 To Provision for taxation 8,000 To Net profit transferred to Profit & Loss App. A/c 26,268 1,11,960
30

Interest accrued on investments amounted to Rs.2,750. A provision of Rs.8,000 for taxes in respect of the profit for 1998-99 is considered necessary. The directors propose a final dividend @ 4%. A claim of Rs.2,500 for workmen's compensation is being disputed by the company.

Rs. 1,72,058 5,00,903 3,59,000

By Sales By Closing Stock

Cr. Rs. 9,83,947 1,48,680

By Gross profit By Interest on Investment 8,544 Add Interest accrued 2,750

11,32,627 1,00,666

11,294

1,11,960

Profit and Loss Appropriation Account To Interim dividend To proposed dividend To balance c/d 15,000 24,000 4,116 43,116 Moonlight Co. Ltd. Balance Sheet as on 31st March, 1999 Share Capital Authorised 60,000 Equity shares of Rs. 10 each Issued and Subscribed 60,000 Equity shares of Rs. 10 each Reserve & Surplus Profit and loss account Secured loans Unsecured loans Current liabilities and Provisions (A) Current Liabilities Trade creditors 36,858 Unclaimed dividends 6,526 Commission to managing director 6,500 (B) Provisions Staff provident fund 39,000 Provision for taxation 8,000 Proposed dividend 24,000 9,75,000 Rs. Fixed Assets Buildings Machinery 6,00,000 Furniture 1,00,000 2,00,000 5,000 Rs. By balance b/d By Net Profit for the year 43,116 16,848 26,268

Motor vehicles 15,000 3,20,000 6,00,000 Less Depreciation 2,50,000 reserve 4,116 Investments Nil Current Asses, Loans Nil and Advances (A) Current Assets 81,000 2,39,000 2,88,950

Interest accrued on Investments 2,750 Stock 1,48,680 Book debts 2,23,380 Cash 72,240 (B) Loans & Advances Nil Misc. Expenditure Nil

9,75,000

Contingent Liabilities : Claim of Rs. 2,500 for workmen's compensation is being disputed by the company.

31

11.7 SUMMARY The procedure of finalisation of accounts of companies is similar to that of a non-corporate entity except for certain legal requirements and certain peculiar items in case of company final accounts. Section 211 of the Companies Act deals with preparation and presentation of final accounts of companies. Part II of Schedule VI deals with the preparation of the Profit and Loss Account of Companies and Provision Contained therein hold good for the Income and Expenditure Account prepared by non-profit organisations. In India, a company can prepare its balance sheet either in horizontal or vertical form. Of the two forms of the balance sheet, vertical form is a better form because it speaks out the correlation of every item with the other item and conveys more meaning to the layman. 11.8 KEYWORDS Final Accounts: It is popularly used in respect of two basic financial statements namely Profit and Loss Account and the Balance Sheet. Capital Reserves: It includes amounts which are not earned during normal operations of the business and are not available for distributed. Surplus: It refers to the credit balance of Profit and Loss Account after proposed allocations or appropriations for dividend, bonus, transfer to reserves, etc. Current Liability: It means those liabilities which fall due for payment within one year as at the date of balance sheet. Preliminary Expenses: Preliminary expenses are those expenses which are incurred on the formation of the company.

32

11.9 SELF ASSESSMENT QUESTIONS 1. "Every Balance Sheet of Company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall subject to the provision of Sec 211 of the Companies Act, be in the form set out in Part I of Schedule VI ....................". Amplify and give the form of Balance Sheet. 2. What are the various heads under which profits are usually appropriated by companies and for what reason? 3. The following is the Trial Balance on March 31, 1998 of the Partial Manufacturing Co. Ltd. Rs. 7,500 24,500 5,000 700 750 495 1,705 500 400 3,750 2,900 1,620 325 158 50,303 Stock on 30th June 1960 Rs.8,200. You are required to make out the Trading Account, Profit and Loss account for the year ended 31st March, 1998, and the Balance Sheet as on that date. You are also to make provision in respect of the following.
33

Rs. 35,000

Stock on 1st April, 1997 Sales Purchases Productive wages Discounts Salaries Rent General expenses (including insurance) Profit and loss account 1st April, 1997 Dividend paid August 1997 Interim dividend paid February 1998 Capital 10,000 Re.1 shares fully paid Debtors and creditors Plant and machinery Cash in hand and at bank Reserves Loan to managing director Bad debts

500

1,503

10,000 1,750

1,550

50,303

(1) (2) (3) (4)

Depreciate machinery @10% per annum. Reserve 5% discount on debtors. Allow 2% discount on creditors. Provide managing director's commission 15% of the net profit before deducting his commission.

(5) (6)

One month rent Rs.45 per mensem was due on 30th June. Six months insurance included in general expenses was unexpired at Rs.75 per annum.

11.10 SUGGESTED READINGS 1. Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. 2. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. 3. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. 4. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi. 5. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. 6. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi. 7. Financial Accounting by P.C. Tulsian, Pearson Education, New Delhi.

34

LESSON : 12 AMALGAMATION, ABSORPTION AND RECONSTRUCTION STRUCTURE 12.0 Objective 12.1 Introduction 12.2 Meaning of Amalgamation, Absorption & Reconstruction 12.3 Purchase consideration 12.4 Accounting treatment of Amalgamation, Absorption and External Reconstruction 12.5 Inter-Company Owings 12.6 Inter-Company Holding 12.7 Internal Reconstruction or Capital Reduction 12.8 Summary 12.9 Keywords 12.10 Self Assessment Questions 12.11 Suggested Readings 12.0 OBJECTIVE After reading this lesson, you should be able to a) b) c) Define amalgamation, absorption and reconstruction. Appreciate the different modes of determining the purchase consideration. Know the accounting treatment in the books of transferor company and transferee company. 12.1 INTRODUCTION Sometimes companies carrying on similar business combine with each other to obtain the economies of large scale production or to avoid the disastrous results of cut throat competition. It is being done by Amalgamation and Absorption. The term

amalgamation is used when two or more companies carrying on similar business go into liquidation and a new company is formed to take over their business. The term absorption is also used when an existing company takes over the business of one or more existing companies. These concepts have been modified by the Accounting Standard 14 (AS-14) "Accounting for Amalgamation", issued by the Institute of Chartered Accountants of India. This standard is applicable in respect of accounting periods commencing on or after 1st April, 1995 and is mandatory in nature. This standard specifies the procedure of accounting for amalgamations and the treatment of any resultant goodwill or reserve. 12.2 MEANING OF AMALGAMATION, ABSORPTION AND RECONSTRUCTION Amalgamation Amalgamation means, when two or more existing companies go into liquidation and a new company is formed to take their business e.g. A Ltd. And B. Ltd. are two companies, they decide to liquidate and a new AB Ltd. is formed. A Ltd. and B Ltd. lose their separate legal entity as soon as they merge into new company AB Ltd. Absorption Absorption means when one or more existing companies go into liquidation and an existing company take over their business e.g. if existing A Ltd. goes into liquidation and another existing company B Ltd. take over its business. The legal entity of A Ltd. will come to an end when it is take over by B Ltd. Reconstruction The object of reconstruction of a company is not to bring about a merger but to re-organize or reconstitute its business/capital structure. Reconstruction is of two types:-

a) External reconstruction : External reconstruction means when an existing company usually a loss making company liquidates and a new company or an existing sound company takes over that company. b) Internal reconstruction : Internal reconstruction is a process of reduction in the capital of existing company without going into liquidation. 12.3 PURCHASE CONSIDERATION The agreed price payable by the purchasing company to the vendor company (liquidating company) for the acquisition of business is called purchase consideration. The purchase consideration is determined keeping in view the value of assets and liabilities of vendor company. The purchase consideration may be determined following any of the following methods :i) Lump sum Method : When the amount of purchase consideration is fixed in a lump sum it is called lump sum method. Both purchasing and vendor company bargain and determine this price. ii) Net Assets Method : Under net assets method the value of purchase consideration is fixed by deducting from the value of taken over by purchasing company, the value of liabilities taken over. For example if the assets are of Rs. 5,00,000 and liabilities of Rs. 1,00,000, the purchase consideration will be Rs. 4,00,000. Under this method only those assets and liabilities will be considered in calculating the purchase consideration which have been actually agreed to be taken over. Other items like Reserves and Surpluses, miscellaneous expenditure, capital loss (shown in assets side of balance sheet) and fictitious assets will not be considered for calculating purchase consideration.

Illustration 1 : The following is a balance sheet of A Ltd. Balance Sheet of A Ltd. as on Liabilities Share capital 5000 equity share of Rs. 10/ each 5% Debentures Sundry Creditors General reserves Profit & Loss A/c 10,000 8,000 2,000 10,000 Land & Building Plant & Machinery Stock Debtor Cash Preliminary Expenses 80,000 15,000 25,000 10,000 6,000 2,000 2,000 80,000 Rs. 50,000 Assets Goodwill Rs. 20,000

B Ltd. another company takes over the business of company A Ltd. and take over the following assets and liabilities on agreed value. Assets are Goodwill Rs. 18,000, Land & Building Rs. 20,000, Plant & Machinery Rs. 30,000, Stock Rs. 8,000, Debtors Rs.5,000 and Liabilities are Sundry Creditors Rs.6,000. Calculate purchase consideration. Solution: The Calculation of Purchase consideration Value of assets taken over by B Ltd. Goodwill Land & Building Plant & Machinery Stock Debtors 18,000 20,000 30,000 8,000 5,000 81,000

Less liabilities taken over by B Sundry creditors Purchase consideration 6,000 75,000

Points to be considered while calculating purchase consideration under net assets method : a) Assets include cash in hand and cash at bank unless otherwise stated, but shall not include any fictitious assets like preliminary expenses, underwriting commission, discount on issue of shares and debentures, profit and loss (Dr.) etc. b) If any particular assets is not taken over by purchasing company, it shall not be included in purchase consideration. c) Liabilities include all third party liabilities like creditor, bills payable etc. d) Liabilities shall not include any past accumulated profits or reserves such as general reserve, capital reserve, dividend equalization fund, share premium, sinking fund, etc. e) If any liability is not taken over by the purchasing company, it shall not be considered in the calculation of purchase consideration. iii) Net Payment Method : Under this method, the purchase consideration is calculated by adding the payments made by the purchasing company in the form of shares, debentures and cash. Illustration 2 : In the above illustration suppose B Ltd. agrees to give for every 10 shares in A Ltd. 15 shares of Rs. 10 each, Rs. 8 paid up. B Ltd. also agree to discharge the debentures at a premium of 5% by the issue of its own debenture and pay Rs. 5,000 in cash to discharge the creditor Solution: The purchase consideration will be

(i)

Shareholder of A Ltd. will get 5000X15/10 = 7500 share of Rs. 10 each, Rs. 8 paid up

Rs. 60,000 10,500 5,000 75,500

(ii) (iii)

Debenture holders of A Ltd. will get debentures in B Ltd. Cash for creditors

Points to be considered at the time of calculating purchase consideration under Net Payment Method a) All the payments made by the purchasing company to shareholders, debenture holders and other creditors of vendor company in the form of cash, share or debentures must be taken into account. b) The assets and liabilities taken over by the purchasing company will not be considered in calculating purchase consideration. c) If the liquidation expenses of vendor company are paid by the purchasing company as part of purchase consideration, the same should be added to the purchase consideration. 12.4 ACCOUNTING TREATMENT OF AMALGAMATION, ABSORPTION AND EXTERNAL RE-CONSTRUCTION Closing entries in the books of vendor company 1) For transferring assets taken over by purchasing company through realisation account. Realisation a/c To various Assets (Individually at book value) 2) For transferring liabilities taken over by purchasing company. Various liabilities a/c To Realisation a/c 3) For purchase consideration due Purchasing companys a/c To Realisation a/c 6 Dr. (with the purchase consideration) Dr. ( individually at book value) Dr.

4) For receiving purchase consideration from purchasing company Bank a/c Shares in purchasing company a/c Debentures in purchasing company a/c To purchasing companys a/c 5) For assets sold by the vendor company not taken over by the purchasing company Bank a/c Realisation a/c (if loss on sale of assets) To assets a/c To realisation a/c (if profit on sale of assets) 6) For liquidation expenses a) If the expenses are to be met by vendor company Realisation a/c To Bank a/c b) if the expenses are paid by purchasing company No entry c) If the expenses are included in purchase consideration and not paid separately by purchasing company Realisation a/c To Bank a/c 7) For liabilities not taken by the purchasing company when paid by the vendor company Various liabilities a/c Realisation a/c (if excess payment is made) To Bank a/c Or Shares in purchasing Co. a/c Or Debentures in purchasing Co. a/c To realisation a/c ( if less payment is made) Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr.

8) For closing realisation account a) If profit Realisation a/c To Equity Shareholders a/c b) If loss Equity Shareholders a/c To realization a/c 9) For transferring preference share capital Preference share capital a/c To preference shareholder a/c 10) For transferring equity share capital and accumulated profit Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr. Dr.

Equity share capital a/c General reserve a/c Debenture redemption fund a/c Dividend equalization reserve Share premium a/c Accident compensation fund (to that extent it does not denote liability) Share forfeiture a/c Any other reserve or fund a/c To equity shareholder a/c

Dr. Dr.

11)For transferring accumulated losses and expenses not written off Equity shareholder a/c To profit and loss a/c To discount or commission on share or debentures To preliminary expenses Dr.

12)

For paying shareholders Dr. Dr.

Preference shareholders a/c Equity shareholder a/c

To bank or share or debentures in purchasing company. Opening entries in the Books of the Purchasing Company 1) On acquisition of business from vendor company Dr.

Business purchase a/c To liquidator of vendor Co. (with the amount of purchase consideration) 2)

When the assets and liabilities are taken over from the Vendor company Dr. (with the revalued value)

Sundry assets (individually) a/c

To business purchase (Purchase consideration) Note i) If the debit total is greater than the credit total, the difference has to treated as capital profit and credited to capital reserve a/c. ii) If the credit total is greater then the debit total, the difference has to treated as capital loss and debited to goodwill a/c. 3) When the purchase consideration is satisfied : Dr. (with purchase consideration)

Liquidator of vendor Co. a/c

To preference share capital a/c (with the preference share issued by purchasing company) To equity share capital (with the equity share issued by purchasing company) To share premium (if new share will be issued on premium) to debentures a/c (debentures issued by purchasing company) To Bank a/c (cash paid by the purchasing company)

4)

If the liquidation expenses of the vendor company are born by the purchasing

company, the same is to be treated as capital loss. Goodwill a/c Dr.

To Bank a/c (with the amount of expenditure) 5) With the formation expenses of the purchasing company, if any Dr.

Preliminary Expenses a/c To Bank a/c 6)

If there are both goodwill and capital reserve, Goodwill may be written off against

capital reserve Capital Reserve a/c Dr.

To Goodwill (with the amount written off) Note Either Goodwill a/c or Capital reserve a/c whichever is greater will appear in the Balance sheet. 7) If any liability is discharged by the purchasing company Dr.

Respective liability a/c To Share Capital a/c To Debentures a/c To Bank A/c Illustration 3 (Amalgamation of Companies)

The following are the balance sheet of X Co. Ltd. and Y Co. Ltd. on 31st March, 1998:

10

X Co. Ltd. Liabilities Share Capital 4000 Equity share of Rs.10/Each fully paid up General Reserve Profit and Loss a/c 15,000 5,000 Machinery Stock Debtors Cash 40,000 15,000 10,000 2,000 Rs. 40,000 Assets Building Rs. 20,000

6% Debentures of Rs.100/ 20,000 each Trade Creditors 5,000

Employees Provident Fund 2,000 87,000 Y Co. Ltd. Liabilities Share Capital 2,500 equity share of Rs.10/fully paid up Trade Creditors 25,000 5,000 Rs. Assets Machinery Stock Debtors 5000 Less provision For Doubtful Debts 500 Cash 30,000 4,500 500 30,000 Rs. 20,000 5,000 87,000

The two companies agree to amalgamate and form a new company called Z Co. Ltd. which takes over the assets and liabilities of both the companies on 1st April, 1998. The Assets of X Co. Ltd. are taken over at a reduction of 10% with the exception of buildings which is taken at its book value. Y Co. Ltd. will receive 10% of the net

11

valuation of their respective business as Goodwill. The entire purchase price is to be paid by Z Co. Ltd. in fully paid equity shares of Rs.10/- each. Give journals entries to close the books of X Ltd. and Y Ltd. and show opening entries in the books of Z Ltd. Also prepare the opening balance sheet in the books of Z Co. Ltd. as on 1st April, 1998., Solution Calculation of Purchase Consideration X Co. Ltd. Rs. Assets taken over Building Machinery Stock Debtors Cash Gross Assets Less Liabilities taken over 20,000 36,000 13,500 9,000 2,000 80,500 X Co. Ltd. Rs. 6% Debentures Trade Creditors Employees Provident Fund Provision for Doubtful Debts 20,000 5,000 2,000 27,000 Net Assets Add : Goodwill @ 10% on Net Assets Purchase Consideration 53,500 53,500 20,000 5,000 5,000 500 30,500 Y. Co. Ltd. Rs. 5,000 500 5,500 25,000 2,500 27,500 Y. Co. Ltd. Rs.

12

Journal of X Co. Ltd. 1998 April 1 Realisation a/c To Building a/c To Machinery a/c To Stock a/c To Debtor a/c To Cash a/c (Being transfer of Sundry assets at their book value) 6% Debenture a/c Trade Creditors a/c Employees Provident Fund a/c To Realisation a/c (Being transfer of sundry liabilities at their book value) Z Co. Ltd. a/c To Realisation a/c (Being purchase Consideration due) Equity Shareholder a/c To Realisation a/c (Being transfer of loss on realisation) Equity share in Z Co. Ltd. a/c To Z Co. Ltd. (Being receipt of purchase consideration) 53,500 53,500 6,500 6,500 53,500 53,500 20,000 5,000 2,000 27,000 Dr. (Rs.) 87,000 20,000 40,000 15,000 10,000 2,000 Cr. (Rs.)

13

Equity Share Capital a/c General Reserve a/c Profit and Loss a/c To Equity Shareholder a/c (Being transfer of share capital and Past Accumulated profit and reserves) Equity shareholder a/c To Equity Share in Z Co. Ltd. a/c

40,000 15,000 5,000 60,000

53,500 53,500

(Being final payment to equity shareholder) Realisation a/c of X Co. Ltd. Particulars Amount Rs. To Building a/c To Machinery a/c To Stock a/c 20,000 40,000 15,000 By 6% Debenture a/c By Trade Creditors a/c By Employees Provident Fund a/c To Debtors a/c To Cash a/c 10,000 2,000 By Z Co. Ltd. (Purchase Consideration) By Equity shareholder A/c (Loss on realisation a/c) 87,000 87,000 6,500 53,500 Particulars Amount Rs. 20,000 5,000 2,000

14

Journal of Y Co. Ltd. 1998 1 April Realisation a/c To Machinery a/c To Stock a/c To Debtor a/c To Cash a/c (Being transfer of sundry assets at their book value) Provision for Doubtful Debts a/c Dr. Trade Creditors a/c To Realisation a/c Z Co. Ltd. a/c To Realisation a/c (Being purchase consideration due) Realisation a/c To Equity shareholder a/c (Being transfer of profit on realisation) Equity share in Z Co. Ltd. a/c To Z Co. Ltd. a/c (Being receipt of Purchase Consideration) Equity share Capital a/c To Equity Shareholder a/c (Being transfer of share capital) Equity shareholder a/c Dr. 27,500 27,500 Dr. 25,000 25,000 Dr. 27,500 27,500 Dr. 2,500 2,500 Dr. 27,500 27,500 500 Dr. Dr. (Rs.) 30,500 20,000 5,000 5,000 500 Cr. (Rs.)

Dr. 5,000 5,500

To Equity share in Z Co. Ltd. a/c (Being final payment to equity shareholders)

15

Realisation a/c Y Co. Ltd. Particulars Amount Rs. To Machinery a/c 20,000 By Provision for Doubtful Debts To Stock a/c To Debtor a/c 5,000 5,000 By Trade Creditors By Z Co. Ltd. (Purchase Consideration) To Cash a/c To Equity share holder a/c (Profit on realisation) 33,000 Journal of Z Co. Ltd. Dr. (Rs.) 1988 April 1 Business purchase a/c To Liquidator of X Co. Ltd. To Liquidator of Y Co. Ltd. Dr. 81,000 53,500 27,500 Cr. (Rs.) 33,000 500 2,500 5,000 27,500 Particulars Amount Rs. 500

(Being acquisition of business of X Co. Ltd. and Y Co. Ltd.) Good will a/c Buildings a/c Machinery a/c Stock a/c Debtors a/c Cash a/c Dr. Dr. Dr. Dr. Dr. Dr. 2,500 20,000 56,000 18,500 14,000 2,500 500 20,000 10,000

To Provision for Doubtful Debts a/c To 6% Debentures a/c To Trade Creditors a/c 16

To Employees Provident Fund a/c To Business Purchase a/c

2,000 81,000

(Being taking over of assets and liabilities of the vendor companies) Liquidator of X Co. Ltd. Liquidator of Y Co. Ltd. To Equity share Capital a/c Dr. Dr. 53,500 27,500 81,000

(Being allotment of 8100 equity shares to Vendors as fully paid up for consideration other than cash) Opening Balance Sheet of Z Co. Ltd. as on 1 April, 1998 Liabilities Share Capital Authorized Capital Issued and subscribed Capital 8100 Equity share of Rs. 10 each fully paid up 6% Debentures of Rs. 100 each Unsecured loans Current Liabilities and Provisions A. Current Liabilities Trade Creditors B. Provision Employees Provident Fund 2,000 1,13,000 1,13,000 10,000 Nil Less provision for Doubtful Debts 500 13,500 Cash 2,500 81,000 20,000 xxx Rs. Assets Fixed Assets Goodwill Buildings Machinery Current Assets Stock Debtors 18,500 14000 2,500 20,000 56,000 Rs.

17

Illustration 4 (Amalgamation of Companies) B Ltd. and C Ltd. were competing companies both of which had incurred losses in recent years. Their respective balance sheet as on 30th June 1998 were as follows : Balance Sheet of B. Ltd. Liabilities Issued Capital 10,000 equity shares of Rs. 10 each fully paid up Bank overdraft Creditors 1,00,000 6,050 18,560 Rs. Assets Patents Plant Furniture & Fittings Stock Debtors P & L a/c 1,24,610 Balance Sheet of C Ltd. Liabilities Issued Capital 12,000 equity shares of Rs.5 each fully paid P & L a/c Creditors 640 8,310 60,000 Goodwill Patent Plant Furniture & Fittings Stock Debtors Cash 68,950 3,280 16,990 9,550 130 68,950 10,000 8,000 21,000 Rs. Assets Rs. 4,600 42,460 15,630 19,420 1,24,610 Rs. 2,500 40,000

In order to eliminate competition and provide for more economical working as well as to make it possible to introduce fresh capital, the following arrangements were made and carried into effect : 18

a)

Both companies were to be wound up, a new company A Ltd. being formed to take over both business.

b)

A Ltd. took over the floating assets of both companies at book values and the fixed assets at the following valuations : B.Ltd. C. Ltd. 1,000 2,000 11,000 2,300 16,300

Goodwill Patents Plant Furniture and Fittings

1,000 500 27,000 3,000 31,500

c)

The consideration for the assets of B Ltd. was satisfied by the issue of 1,200, 9% preference shares of Rs.10 each and Rs. 64,490 in Rs. 10 equity shares of A Ltd. fully paid and the balance in cash; whereas and for the assets of C Ltd. Rs.34,300 in Rs. 10 equity shares of A Ltd. and the balance in cash.

d)

The liquidator of B Ltd. transferred the preference shares to a loan creditor for Rs. 12,000 in satisfaction of his claim. The equity shares were distributed prorata among the shareholders of each of the original companies, the cash being just sufficient to satisfy the creditors of each company and the expenses of liquidation which amount to Rs. 500 and Rs. 300 respectively. For B. Ltd. and C Ltd.

e)

In order to provide the necessary cash A Ltd. issued 100, 7.5% debentures of each Rs.100 each at a discount of 5% and 1800, 9% preference shares of Rs.10 each at par; these were fully paid up.

19

You are required to show the (i) necessary ledger accounts in the books of B Ltd. and C Ltd. (ii) Opening entries in the books of A Ltd. and (iii) to prepare the opening balance sheet of A Ltd. Solution: Calculation of Purchase Consideration : Assets taken over Goodwill Patents Plant Furniture and Fittings Stock Debtors Net Assets or Purchase consideration C Ltd. Rs. 1,000 500 27,500 3,000 42,460 15,630 89,590 B Ltd. Rs. 1,000 2,000 11,000 2,300 16,990 9,550 42,840

Purchase consideration to be satisfied as follows : 9% Preference shares in A Ltd. Equity shares in A Ltd. Cash 12,000 64,490 13,100 89,590 B Ltd.s Ledger Realisation Account Dr. To Patents To Plant To Furniture & Fittings To Stock To Debtors To cash (expenses) Rs. 2,500 40,000 4,600 42,460 15,630 500 1,05,690 20 1,05,690 By A Ltd. By Creditors a/c By equity share holders a/c Rs. 89,590 10 16,090 Cr. 34,300 8,540 42,840

A Ltd. To Realisation a/c 89,590 By 9% Pref.shares In A Ltd. By equity shares in A Ltd. By Cash a/c 89,590 Bank Overdraft Account To cash a/c 6,050 By Balance b/d 6,050 13,100 89,590 64,490 12,000

Creditors Account To 9% Preference share In A Ltd. To Cash a/c To Realisation a/c 6,550 10 18,560 9% Preference Shares in A Ltd. To A Ltd. 12,000 12,000 Equity Shares in A Ltd. To A Ltd. 64,490 By equity share Holder a/c 64,490 64,490 64,490 By Creditors a/c 12,000 12,000 18,560 12,000 By Balance b/d 18,560

21

Cash Account To A Ltd.s a/c 13,100 By Realisation a/c (exp.) By Bank overdraft By Creditors 13,100 Equity Shareholders Account To Realisation a/c To P/L a/c To equity share in A Ltd. 16,090 19,420 64,490 1,00,000 C Ltd.s Ledger Realisation Account Rs. To Goodwill To Patents To Plant To furniture & fittings To Stock To Debtors To Cash (exp.) To Creditors 10,000 8,000 21,000 3,280 16,990 9,550 300 60 69,180 69,180 By A Ltd. By equity share holders a/c Rs. 42,840 26,340 1,00,000 By equity share 1,00,000 6,050 6,550 13,100 500

22

A Ltd. To Realisation a/c 42,840 By equity shares in 34,300 A Ltd. By Cash 42,840 Creditors Account To Cash a/c 8,370 By Balance b/d By Realisation a/c 8,370 Equity Share in A Ltd. To A Ltd. 34,300 By equity share Holder a/c 34,300 Cash Account To Balance b/d To A Ltd.s a/c 130 8,540 By Realisation (exp.) By Creditors 8,670 Equity Shareholders Account To Realisation a/c To equity share in A Ltd.s a/c 60,640 26,340 34,300 By equity share Capital a/c By Profit & Loss a/c 640 60,640 60,000 8,370 8,670 300 34,300 34,300 8,310 60 8,370 8,540 42,840

23

A Ltd.s Journals Dr. Business Purchase a/c To Liquidator of B Ltd. To Liquidator of C Ltd. (Being acquisition of business of B Ltd. as per agreement dated..) Goodwill a/c Patents a/c Plants a/c Dr. Dr. Dr. 2,000 2,500 38,000 5,300 59,450 25,180 1,32,430 1,32,430 89,590 42,840 Cr.

Furnitures & Fittings Dr. Stock a/c Debtors Dr. Dr.

To Business Purchase a/c (Being taking over of assets and liabilities of the vendor companies Bank a/c Dr. 27,500

To 9% Pref. Share application and Allotment a/c To 7 %Debenture application and Allotment a/c (Being application money on 1800 9% preference shares @ Rs.10 per share and 100 7 % Debenture of Rs. 100 each and Rs. 95 each)

18,000

9,500

24

9% Preference share application & Allotment a/c 7% Debenture app. & allotment a/c Discount on issue of debenture a/c To 9% Preference share capital a/c To 7 % Debenture a/c (Being allotment 1800 9% Preference shares of Rs.100 each at per and 100 7 % Debentures of Rs.100 each at a discount of 5% as per Boards resolution dated.) Liquidator of B Ltd. Liquidator of C Ltd. To 9% Pre. Share capital a/c To equity share capital a/c To Bank a/c (Being allotment of 1200 9% Preference shares of Rs. 10 each and 9,879 equity shares of Rs.10 each issued to vendors as fully paid Up for consideration other than cash and The payment of balance in cash as per Boards resolution dated.) Dr. Dr. Dr. Dr. Dr.

18,000

9,500 500 18,000 10,000

89,590 42,840 12,000 98,790 21,640

25

Balance Sheet of A Ltd. as at 30th June 1997 Liabilities Share Capital : Authorised Capital Rs. Assets Fixed Assets : Goodwill Patents Plant Furniture & Fittings Issued or Subscribed Capital : 3,000, 9% Preference Shares of Rs. 10 each Fully paid up 9879 Equity shares of Rs. 10 each Fully paid up (Of the above shares, 1200, 9% Preference shares and 9,879 Equity shares issued to vendors for consideration other than cash). B. Loans and Advances Miscellaneous Expenditure : Discount on Issue of Debenture. Reserve & Surplus Secured Loan : 100, 7-1/2% Debenture of Rs. 100 each Unsecured Loan : Current Liabilities and Provisions 1,38,790 1,38,790 10,000 NIL NIL NIL 500 98,790 30,000 Current Assets : Loans and Advances : A Current Assets : Stock Debtors Bank Balance 59,450 25,180 5,860 Investments 2,000 2,500 38,000 5,300 NIL Rs.

26

Illustration : 5(Absorption) The following is the Balance Sheet of Dee Ltd. As on 31.12.98 Liabilities Share Capital : 40,000 equity shares of Rs.10 each General Reserve Profit & Loss A/c 5% Debentures Creditors 50,000 29,600 2,50,000 1,28,700 8,58,300 Investment Debtors Stock Cash at Bank 50,600 1,40,500 80,700 16,500 8,58,300 4,00,000 Rs. Assets Buildings Plant & Machinery Rs. 1,70,000 4,00,000

Dee Ltd. was absorbed by Comet Ltd. on the above mentioned dated on the following terms and conditions : Comet Ltd. to(a) assume all liabilities and to acquire all assets except investment which were sold by Dee Ltd. for Rs. 45,000, (b) Discharge the Debentures of Dee Ltd. at a discount of 5% by the issue 6% Debentures of Rs. 100 each in Comet Ltd., (c) Issue two equity shares of Rs. 5 each in Comet Ltd. at Rs. 6 per share and also to pay Rs. 2 per share in cash to the shareholders of Dee Ltd. in exchange of every share in Dee Ltd., (d) Pay the cost of absorption Rs. 2,500 as part of purchase consideration. Dee Ltd. sold in the open market 1/4th of the shares received from Comet Ltd. at the average rate of Rs. 5.50 per share. Show the necessary Ledger accounts in the books of Dee Ltd. and the Opening entries in the books of Comet Ltd.

27

Solution :Particulars Shareholders(i)

Calculation of Purchase Consideration Amount (Rs.) Mode of Payment

80,000 equity shares 40,000x2 of Rs.5 each at Rs. 6 each, i.e. 80,000xRs.6 4,80,000 80,000 Equity Shares Cash

(ii) (iii)

Cash 40,000xRs.2 Debenture holders5% Debentures 2,50,000 Less : Discount @ 5% 12,500

2,37,500 2,500 8,00,000

6% Debentures Cash

(iv)

Cost of absorption

Dr. To Building A/c To investment A/c To Debtors A/c To Stock A/c To Bank A/c To Cash A/c (Exp.) To Equity Share in Comet Ltd. (Loss on Sale) To Equity Shareholders A/c (Profit transferred)

Dee Ltds Ledger Realisation Account Rs. Cr. 1,70,000 50,600 1,40,500 80,700 16,500 2,500 10,000 By Creditors A/c By Comet Ltd. By Cash A/c (Investment Realised) By 5% Debentures A/c (Discount)

Rs. 1,28,700 8,00,000 45,000 12,500

To Plant & Machinery A/c 4,00,000

1,15,000 9,86,200 28 9,86,200

Comet Ltd. Dr. To Realisation A/c Rs. 8,00,000 Cr. By Equity Shares in Comet Ltd. By 6% Debentures in Comet Ltd. By Cash 8,00,000 Equity Shares in Commet Ltd. To Comet Ltd.s A/c 4,80,000 By Cash A/c By Realisation A/c By Equity Share Holder/s A/c 4,80,000 6% Debentures in Comet Ltd. To Comet Ltd. 2,37,500 By 5% DebentureHolders A/c Cash Account To Comet Ltd. 82,500 By Realisation A/c (Exp.) To Realisation To Equity Share in Comet Ltd.s A/c 1,10,000 2,37,500 2,37,500 45,000 By Equity Shareholders A/c 2,35,000 2,500 2,37,500 3,60,000 4,80,000 1,10,000 10,000 82,500 8,00,000 2,37,500 Rs. 4,80,000

29

5% Debenture Holders Account To Realisation A/c To 6% Debentures in Comet Ltd. 2,37,500 2,50,000 Equity Shareholders Account Rs. To Equity Share in Comet Ltd.s A/c To Cash A/c 3,60,000 2,35,000 By Equity Share Capital A/c By General Reserve A/c By P/L A/c By Realisation A/c 5,95,000 Comet Ltds Journal Dr. 8,00,000 Cr. 8,00,000 29,600 1,15,400 5,95,000 4,00,000 50,000 Rs. 2,50,000 12,500 By 5% Debentures A/c 2,50,000

Business Purchase A/c Dr. To Liquidators of Dee Ltds A/c (Being acquisition of the business of Dee Ltd. as per agreement dated__________) Building A/c Dr. Plant & Machinery Dr. Debtors A/c Dr. Stock A/c Dr. Bank A/c Dr. Goodwill A/c Dr. To Creditors A/c To Business Purchase A/c (Being taking over of assets and liabilities of the vendor Company) 30

1,70,000 4,00,000 1,40,000 80,700 16,500 1,21,000 1,28,700 8,00,000

Liquidator of Dee Ltds A/c To equity share Cap. A/c To Share Premium A/c To 6% Debenture A/c To Bank A/c

Dr.

8,00,000 4,00,000 80,000 2,37,000 82,500

(Being allotment of 80,000 equity shares of Rs.5 each at a Premium of Re.1 each and 2,375 6% Debenture of Rs.100 each issued to vendors as Fully paid up for consideration other than cash and the balance paid in cash as per Boards resolution dated) Illustration6 (Absorption) Thin and Co. Ltd. was absorbed by Jhick & Co. Ltd., as on 31st March, 1998. All the assets and liabilities of Thing & Co. Ltd. was taken over by Thick & Co. Ltd. The valuation at which the assets were taken up was as follows : (i) (ii) (iii) (iv) (v) Stock at 15% above book-value. Plant and Machinery at 20% above book value; Goodwill at Rs.1,00,000; Debtors were taken subject to a provision of 10% for doubtful debts; The fire insurance policy against which premium was paid in advance could not be assigned and so lapsed; (vi) The income-tax refund claim was taken at Rs.5,000. There was a claim of Rs.3,000 against the workmens Compensation Fund which was admitted by the Company but was not paid. The purchase consideration was paid in so many fully paid shares of the Thick & Co. Ltd. as may be distributed at three shares to the holders of every two shares of Thin

31

& Co. Ltd. and the balance in cash. The following are the balance sheets of both the Companies as on 31.03.1998. Liabilities Thick of Co. Ltd. Authorised Capital, Equity Share of Rs.10 Each. 15,00,000 15,00,000 Thin of Co.Ltd. Goodwill Plant & Machinery Stock in Trade 3,12,000 Sundry Debtor 2,65,000 Issued & Subscribed Capital Equity Shares of Rs.10 each Fully Paid-up General Res. P/L A/c Workmens Compensation Fund 12,000 9,000 30,456 8,00,000 1,00,000 20,502 2,00,000 50,000 12,900 Prepaid Insurance Income Tax Refund Cash in Hand Cash in Bank 869 14,000 6,000 356 8,300 1,00,000 80,000 56,000 700 Assets Thick & Co. Ltd. 2,00,000 Thin & Co. Ltd. 60,000

Sundry Creditor 58,567 Staff Provident Fund Provisional Taxation 12,000 10,13,069 10,000

4,000

5,000 3,11,356 10,13,069 3,11,356

32

You are required to(i) (ii) (iii) Show the necessary ledger accounts in the books of Thin & Co. Ltd. Show the necessary Journal entries in the books of Thick & Co. Ltd. Prepare the Balance sheet of Thick & Co. after absorption. Calculation of Purchase Consideration Rs. Rs. 1,00,000 1,20,000 92,000 50,400 5,000 356 8,300 3,76,056

Solution:-

Assets taken over Goodwill Plant & Machinery (1,00,000+20%) Stock in trade Sundry Debtors (80,000+15%) (56,000-10%)

Income Tax Refund Claim Cash in Hand Cash at Bank Gross Assets taken over Less : Liabilities taken over Sundry Creditors Staff Provident Fund Provision For Taxation Workmens Compensation Fund 30,456 4,000 5,000 3,000

42,456 3,33,600

Net Assets or Purchase Consideration Purchase consideration to be satisfied as follow : 20,000x2/3 = 30,000 equity share of Rs.10 each Cash

3,00,000 33,600 3,33,600

33

Ledger of Thin & Co Ltd. Realisation Account Rs. Goodwill To Plant & Machinery A/c To Stock-in-Trade A/c To Sundry Debtors A/c To Income Tax Refund Claim A/c To Prepaid Insurance To Cash in Hand A/c To Cash at Bank A/c To equity share holder A/c Profit 64,700 3,76,056 Thick & Co. Ltd. To Realisation A/c 3,33,600 By equity Shares in Thick & Col. Ltd. By Cash A/c 3,33,600 Equity Shares in Thick & Co. Ltd. To Thick & Co. Ltd. 3,00,000 By equity shareholders A/c 3,00,000 3,00,000 33,600 3,33,600 3,76,056 6,000 700 356 8,300 60,000 1,00,000 80,000 56,000 By Sundry Creditors A/c By Workmens Compensation Fund A/c By Staff Provident Fund A/c By Provision For Taxation A/c By Thick & Co. Ltd. 5,000 3,33,600 4,000 3,000 Rs. 30,456

34

Cash Account To Thick & Co Ltds A/c 33,600 By equity shareholders A/c 33,600

Equity Shareholders Account To equity shares in Thick & Co. Ltd. A/c To Cash A/c 3,00,000 33,600 By equity Share Capital A/c By General Reserve A/c By Profit & Loss A/c By Workmens Compensation Fund A/c By Realisation A/c 3,33,600 Journal of Thick & Co. Ltd. Dr. (Rs.) Goodwill A/c Plant & Machinery A/c Stock-in-trade A/c Sundry Debtors A/c Cash in Hand A/c Cash at Bank Dr. Dr. Dr. Dr. Dr. Dr. 1,00,000 1,20,000 92,000 56,000 5,000 356 8,300 5,600 30,456 4,000 5,000 3,000 3,33,600 Cr. (Rs.) 6,000 64,700 3,33,600 2,00,000 50,000 12,900

Income Tax Refund Claim Dr.

To Provision for Doubtful Debts A/c To Sundry Creditors A/c To Staff Provident Fund A/c To Provision for Taxation A/c To Workmens Compensation Fund A/c To Liquidator of Thin & Co. Ltds A/c date______)

(Being taking over of assets and liabilities of Thin & Co. Ltd. as per agreement

35

Liquidator of Thin & Co. Ltds A/c To Equity Share Capital A/c To Bank A/c

Dr.

3,33,600 3,00,000 33,600

(Being allotment of 30,.000 equity shares of Rs. 10 each issued to vendors as fully paid up for consideration other than cash and the balance paid in cash as per Board Resolution date__________) Balance Sheet of Thick & Co. Ltd. as at 31st March, 1988 Liabilities Share Capital : Authorised Capital 1,50,000 Equity shares of Rs. 10 each 15,00,000 Issued & Subscribed Capital : 1,10,000 equity shares of Rs.10 each fully paid up 11,00,000 Reserves & Surplus : General Reserve 1,00,000 Profit & Loss A/c 20,502 Workmens Compensation Fund 15,000 Secured Loan : Bank overdraft 11,300 Unsecured Loan : NIL Current Liabilities & Provisions : A. Current Liabilities : Sundry Creditors 89,023 B. Provisions : Provision for taxation 17,000 Staff Provident Fund 14,000 13,66,825 Assets Fixed Assets : Goodwill Plant & Machinery Investment : Current assets, Loans and Advances : A. Current Assets : Stock in Trade Sundry Debtors = 2,77,200 Less:Provision=5,600 Cash Balance in Hand B. Loans & Advances : Income Tax Refund Claim Misc. Expenditure

3,00,000 4,32,000

3,57,000

2,71,600 1,225

5,000 NIL

13,66,825

36

Illustration No. 7 (External Reconstruction) The following is the Balance Sheet of Rocket Ltd. as at 31st March, 1998 : Liabilities Authorised and Issued Capital : 50,000 equity shares of Rs.10 each fully paid up 5,00,000 Patents Freehold Property Stock-in-Trade Debtors 60,000, 6% Preference shares of Rs.5 each fully paid up 5% Debentures Sundry Creditors Accured Interest on Debenture 32,000 11,92,000 11,92,000 3,00,000 2,00,000 1,60,000 Cash at Bank Profit & Loss A/c 1,50,000 2,00,000 1,70,000 2,60,000 6,000 4,06,000 Rs. Assets Rs.

The following scheme of reconstruction was passed and sanctioned : (1) A new company by the name of Rocket (1998) Ltd. to be formed to take over the entire business of Rocket Ltd. (2) One equity share of Rs.10, Rs.5 per share paid up is to be given in exchange of every two equity shares of Rocket Ltd. (3) One 5% Preference Share of Rs.100 each is to be given in exchange of every 30 preference share of Rocket Ltd. (4) 5% Debentures of Rocket Ltd. will be discharged together with the amount of interest accured by the issue of equity shares of Rs.10 each fully paid. (5) The Creditor will receive 50% of their dues in cash and 25 % in equity shares of Rs. 10 each and the balance is to be forgone.

37

(6)

The equity shares issued as Rs.5 per share paid-up to be made Fully paid up receiving cash from the holders.

(7)

The Authorised Capital of Rockets (1998) Ltd. is to be Rs.8,00,000 divided into 60,000 equity shares of Rs.10 each and 2,000, 5% Preference shares of Rs.100 each.

You are required to(i) (ii) (iii) Show the closing entries in the books of Rocket Ltd. Show the opening entries in the books of Rocket (1998) Ltd. and Prepare the opening Balance Sheet of Rocket (1998) Ltd. utilising any Profit on taking over to write down the value of the Patents. The Preliminary Expenses amounted to Rs.6,000. Solution Calculation of Purchase Consideration Particulars Equity Shareholders:25000 equity shares (i.e. 50,000/2) of Rs.10 each, Rs.5 per Share credited (25,000x5) 6% Preference Shareholders2,000 Preference Share (i.e. 60,000/30) of Rs.100 each Fully paid up (2,000x100) 5% Debenture holdersDebenture Add Accured Int. Creditors (i) (ii) 50% of Rs.1,60,000 25% of Rs.1,60,000 80,000 40,000 6,77,000 38 Cash 4,000 equity shares of Rs. 10 each 2,00,000 32,000 2,32,000 23,200 equity shares of Rs.10 each 2,00,000 5% Preference Shares 1,25,000 Equity Shares Amount (Rs.) Mode of Payment

Net Payment or Purchase Consideration

Journal of Rocket Ltd. Dr. Realisation A/c To Patent A/c To Freehold Property A/c To Stock-in-Trade A/c To Debtors A/c To Cash at Bank A/c Dr. 7,86,000 1,50,000 2,00,000 1,70,000 2,60,000 6,000 Cr.

(Being transfer of Sundry Assets on sale of business to Rocket (1998) Ltd.) Rocket (1998) Ltd. To Realisation A/c (Being purchase Consideration becoming due) Sundry Creditors A/c To Realisation A/c (Being amount Foregone by the Creditors) Equity Shares in Rocket (1998) Ltd. A/c Dr. 5% Pref. Shares in Rocket (1998) Ltd. Cash A/c To Rocket (1998) Ltd. (Being receipt Purchase Consideration) 5% Debentures A/c Accrued Int. on Debentures A/c Dr. Dr. 2,00,000 32,000 2,32,000 Dr. Dr. 3,97,000 2,00,000 80,000 6,77,000 Dr. 40,000 40,000 Dr. 6,77,000 6,77,000

To 5% Debenture-holders A/c (Being amount due on redemption) 5% Debenture-holders A/c Dr. 2,32,000

To Equity Share in Rocket (1998) Ltd.

2,32,000

(Payment to Debenture-holders in the Form of equity shares received from the purchasing Company). 39

Sundry Creditors A/c

Dr.

1,20,000 40,000 80,000

To Equity Share in Rocket (1998) Ltd. To Cash A/c (Being payment to Sundry Creditors) 6% Preference Share Capital A/c Dr. 3,00,000

To 6% Preference Shareholders Ltd.

3,00,000

(Being transfer to Pref. Share Capital to Preference Shareholders A/c) 6% Preference Shareholders A/c To Realisation A/c (Being amount Foregone by the Preference Shareholders) Realisation A/c To Equity Shareholders A/c (Being profit on realisation transferred) 6% Pref. Shareholders A/c To 5% Pref. Shares in Rocket Ltd. (Being payment to Prefer. Shareholders) Equity Share Capital A/c To Equity Shareholders A/c (Being transfer of Equity Share Capital to Equity Shareholders A/c) Equity Shareholders A/c To Profit & Loss A/c (Being transfer of accumulated losses to equity Shareholders A/c) Equity Shareholders A/c To Equity Shares in Rocket Ltd. (Being payment to Equity Shareholder) Dr. 1,25,000 1,25,000 Dr. 4,06,000 4,06,000 Dr. 5,00,000 5,00,000 Dr. 2,00,000 2,00,000 Dr. 31,000 31,000 Dr. 1,00,000 1,00,000

40

Journal of Rocket (1998) Ltd. Dr. Patents A/c Freehold Property A/c Stock-in-Trade A/c Debtors A/c Cash at Bank A/c Dr. Dr. Dr. Dr. Dr. 1,50,000 2,00,000 1,70,000 2,60,000 6,000 6,77,000 1,09,000 Cr.

To Liquidator of Rocket Ltd. To Capital reserve A/c

(Being taking over of the assets of Rocket Ltd. as per agreement dated____________). Capital reserve A.c To Patent A/c Dr. 1,09,000 1,09,000

(Being writing off of Patents against the Profit on taking over the business of Rocket Ltd.) Liquidator of Rocket Ltd. To Equity Share Capital To 5% Pref. Share Cap. A/c To Bank A/c Dr. 6,77,000 3,97,000 2,00,000 80,000

(Being allotment of 25,000 equity shares of Rs.10 each, Rs. 5 Share being paid up, 27,200 equity shares of Rs.10 each Fully paid up, 2,000 5% Pref. Shares of Rs.100 each Fully paid up to vendors. For consideration other than cash and the Balance paid in cash as per Boards resolution dated ____________) Bank A/c Dr. 1,25,000 1,25,000

To Equity Shares Capital A/c (Being call Money on 25,000 Equity Shares @ Rs.5 per Share) Preliminary Expenses A/c To Bank A/c (Being payment of Preliminary Expenses) Dr. 6,000

6,000

41

Balance Sheet of Rocket (1998) Ltd. as at 31st March, 1998 Liabilities Share Capital : Authorised Capital6,00,000 Rs. Assets Fixed Assets : Patents Freehold Property Investments : Current Assets, Loans Advances : 8,00,000 A. Current Assets Stock-in-trade Issued and Subscribed Capital : 52,200 Equity Shares of Rs.10 each Fully paid up. 2000, 5% Pref. Shares of Rs.100 each, Fully Paid up. 2,00,000 (All the above shares are issued to vendors for consideration other than cash). 7,22,000 12.5 INTER COMPANY OWINGS If there are inter-company owings resulting from purchase and sale of goods between the vendor company and the purchasing company, the same have to be cancelled in the books of the purchasing company when the accounts are consolidated. The following are the examples of such items : 1. Common Debts-(I) If the purchasing company owes an amount to the vendor 7,22,000 5,22,000 B. Loans & Advances : Miscellaneous Expenditure Preliminary Expenses 6,000 Debtors Bank Balance 1,70,000 2,60,000 45,000 Rs. 41,000 2,00,000

60,000 equity shares of Rs.10 each 2000 5% Pref. Shares of Rs.100 each. 2,00,000

company, the same is in the Sundry Debtors of the vendor company and Sundry Creditors

42

of the purchasing Company. If the vendor company owes an amount to the purchasing company the same is in the Sundry of purchasing company and Sundry Creditors of the vendor company. The entry for the cancellation of this common item will be follows in the book of purchasing company. Sundry Creditor Account Dr. (with the amount of inter company owing) To Sundry Debtors A/c Note : (i) The above entry for cancellation of common items has to be passed after the acquisition entries are passed in the usual way. (ii) Such an item will not affect the vendor company in any way and hence no entry will be required in the books of vendor. 2. Adjustment of unrealised profit included in the unsold stock of the vendor company which was sold by the purchasing company (i) Stock of the vendor company includes goods sold by the purchasing company. For this, no separate entry is required to be passed in the books of purchasing company, only the amount of stock has to be reduced while passing the entries on acquisition. (ii) Stock of purchasing company includes goods sold by the vendor company at a profit. The following adjustment entry has to be passed in the books of purchasing company. Goodwill or Capital Reserve A/c Dr.

To Stock A/c (with the amount of unrealised profit)

43

12.6 INTER-COMPANY HOLDINGS Inter Company holdings may be possible in any of the following ways : i) ii) iii) a) Share may be held by the purchasing company in the vendor Company or Share may be held by the vendor company in the purchasing company, or Share may be held by both companies in each other. If share are held by purchasing company in the vendor company : In such a case the purchase consideration has to be adjusted for shares already held by the purchasing company since the purchasing company is the owner of the proportionate assets of vendor company. Under the net assets method of calculating purchase consideration, it should be reduced proportionately. While under the net payment method, purchase consideration should be calculated on the basis of outside shareholder and creditors only. As the vendor company is not supposed to received any price of the share held by the purchasing company, it has to close that part of share capital by transfer to the Realisation A/c. Entry will be Share Capital A/c To Realisation A/c (With the paid up values of the share held by the purchasing company) Similarly, the purchasing company has to cancel its investment in share of the vendor company since it has got no value after the merger. The entry required for this is : Goodwill or Capital Reserve A/c To Investment in share A/c (as the case may be with the cost of shares) Dr. Dr.

44

Note : It would be better, however to credit the investment in Share A/c alongwith the entry recorded the assets and liabilities taken over. In such a case, the goodwill or capital reserve will be automatically adjusted. b) If share are held by the vendor company in the purchasing company In such a case, share held by the vendor company in the purchasing company will appear as an asset in the books of vendor company. But it is important to note here that at the time of taking over the assets of the vendor company, the purchasing company can not take over its own shares. The treatment of this item in the books of both companies will be as follows. In the books of the vendor, such share held in the purchasing company should not be transferred to Realisation A/c. Instead such share should be applied in paying off the share holders of the company. But if such shares are revalued at the time of sale of the business, the profit or less on revaluation should be adjusted through the Realisation A/c by debiting or crediting the same in Purchasing Company A/c. In the books of the purchasing company, no debit should be given for this asset of the vendor company at the time of acquisition of assets. If purchase consideration is determined under the net payment method, the purchasing company must deduct the number of share already held by the vendor company from the purchase consideration while making payment to the vendor company. For example, the purchasing company acquires the business of the vendor company and in exchange allots 3 shares of Rs. 10 each for every share of Rs. 20 each. If the vendor companys share Capital consists of 10,000 share of Rs. 20 each, it is supposed to received 10000 x 3 = 30,000 shares of Rs. 10 each. Now, if 5000 shares of the purchasing company are already held by the vendor company the purchasing company will issue only (30000 5000) 25,000 shares to the vendor company in the satisfaction of purchase consideration.

45

c)

If shares are held by both the companies in each other In such a case the value of share of both the companies has to be ascertained

first with the help of an algebraic equation because the value of shares in one company will affect the value of shares in the other company. From the value of share of both the companies, thus determined, the proportionate value of shares held by both the companies in each other has to be deducted to arrive at the amount due to the outsiders. The purchase consideration in such a case has to be determined on the basis of the amount due to outsiders. Illustration No. 8 The following are balance sheets of A Co. Ltd. and B. Co. Ltd. on 31.12.1998. Liabilities A Ltd. Rs. Share Capital Profit & Loss A/c Creditors 75,000 1,25,000 6,00,000 2,75,000 1,25,000 4,00,000 B. Ltd. Rs. 1,50,000 Assets A.Ltd. Rs. Sundry Assets 5,60,000 Goodwill Profit & Loss A/c 6,00,000 25,000 2,75,000 40,000 B.Ltd. Rs. 2,00,000 50,000

A Ltd. holds 1000 shares in B. Ltd. at cost Rs.25,000 and B. Ltd. holds 500 share in A Ltd. at cost Rs. 70,000 in each case included in the Sundry Assets. The shares of A Ltd. are of Rs.100 each fully paid, the share of B Ltd. are Rs. 50 each, Rs. 30 paid. The two companies agree to amalgamate and form a new company AB Ltd. on the basis : j) The shares which each company holds in the other are to be valued at book value having regard to the goodwill valuation as A Ltd. Rs.1,50,000 and for b Ltd, the value of goodwill is Rs.25,000. 46

ii)

The new shares are to be a nominal value of Rs.50 each, credited as Rs.25 paid. Prepare balance sheet of AB Ltd. and a statement showing shareholdings in the

new company attributable to the members of the old companies. Solution Balance Sheet of AB Ltd. as on 31.12.98 Liabilities Share Capital : Authorised Issued & Subscribed Capital 23,500 share of Rs.50 each, Rs.25 per share paid. (consideration other than cash) Current Liabilities : Sundry Creditor A Ltd. B Ltd. 1,25,000 1,25,000 2,50,000 8,40,000 8,40,000 Sundry Assets A Ltd. B Ltd. 5,35,000 1,30,000 6,65,000 5,90,000 Rs. Assets Fixed Assets : Goodwill A Ltd. B Ltd. 1,50,000 25,000 1,75,000 Rs.

Statement of Shareholder in the New Company AB Ltd. A Ltd. Purchase Consideration ::Number of share to be issued by the new company 5,07,950 25 = 20,318 82,050 25 = 3,282 5,07,950 B.Ltd. 82,050

47

Number of shares held by outsiders at Present

(4000-500) (5000-1000) -3500 -4000

::Ratio in which shares are to be distributed to the members. 3500:20318 4000:3282

Note : It is evident from the above that fraction certificate has to be issued by the company to facilitate distribution of shares among the members. Working Notes 1) Value of Shares of A Ltd. and B Ltd. other than mutual holdings : A Ltd. Rs. Sundry Asset excluding Share held by A Ltd. and B Ltd. Goodwill 5,35,000 1,50,00 6,85,000 Less Creditors Value of Shares other than mutual holdings. 2) Total value of Share : A Ltd. = 5,60,000 x 1/5th of the value of Shares in B Ltd. B Ltd. = 30,000 x 1/8th of the value of Shares in A Ltd. Let A denotes the value of share in A Ltd. And B denotes the value of share in B Ltd. A 5,60,000 + 1/5 B B = 30,000 + 1/8 A (i) & (ii) 1,25,000 5,60,000 1,30,000 25,000 1,55,000 1,25,000 30,000 B.Ltd. Rs.

48

Substituting the value of A in equation (ii) we get B = 30,000 + 1/8 (5,60,000 + 1/5 B) = 30,000 | 70,000 | 1/40 B B = 1,02,564 (approx.) Now putting the value of B in equation (i) we get A = 5,60,000 + 1/5 x 102564 A = 5,80,513 (Approx.) Value of each share in A Ltd. = 5,80,513/4000 = 145.13 (approx.) B Ltd. = 1,02,564/5000 = 20.51 (approx.) Purchase Consideration A Ltd. Rs. Total value of Shares Less: 1/8th share held by B Ltd. Less: 1/5th share held by A Ltd. Amount due to outsiders Cr. 5,80,513 72,564 5,07,949 5,07,950 Cr. B. Ltd. Rs. 1,02,564 20,513 82,051 82,050

Total purchase consideration = (5,07,950 + 82,050) = Rs. 5,90,000 12.7 INTERNAL RECONSTRUCTION OR CAPITAL REDUCTION Reduction of Capital can be carried out by a Company in any of the following ways : i) By reducing the liabilities of the shareholders in respect of any unpaid amount on the share held by them. ii) By paying off surplus capital, if any, which is much in excess of needs of the company. This can be done with or without reducing the liability on the shares. 49

iii)

By cancelling the paid up share capital which has been lost in the course of the business and which is not represented by assets. This can also be done with or without reducing the liability on the shares. This is the most common method adopted by companies to write off their huge accumulated losses. Accounting Entries

i)

When the Liability of the shareholders in respect of the unpaid amount on the share held by them is reduced. Share Capital (Partly paid up) A/c Dr.

To Share Capital (Fully paid up) A/c (With the paid up amount of the shares) Note : In such a case, the paid up share capital of the company will remain unaffected. ii) When the surplus capital, if any, which is much in excess of the needs of the company is paid off : a) b) Share Capital A/c To Share holder A/c Share holders A/c To Bank A/c (with the amount refunded) Note : In such a case, the paid up capital of the company will be reduced by the amount paid office. iii) If the paid up share which has been lost in the course of business is cancelled :a) If the face value of shares is changed by the reduction of CapitalShare Capital (old) A/c To Share Capital (New) A/c To Capital Reduction A/c Or To Reconstruction A/c 50 Dr. (Which the paid up Value of the old share) (Which the paid up Value of the old share) (with the difference) Dr. Dr.

Or (a) If the face value of shares remains unchanged by the reduction of Capital Share Capital A/c To Capital Reduction A/c Or To Reconstruction A/c Dr. (with the amount of reduction)

Note : The net effect in both the above case will be same. b) If the debenture holders and Creditor also make some sacrifice towards the reconstructionDebentures A/c Sundry Creditors A/c To Capital Reduction A/c Or c) To Reconstruction A/c Dr. Dr. (With the amount of sacrifice)

If the value of any assets is appreciatedRespective Assets A/c Dr. (With the amount of appreciation)

To Capital Reduction A/c Or To Reconstruction A/c

Note : In case there is an appreciation in the value of any asset, the preparation of the Reconstruction A/c would be the most appropriate one. d) When the accumulated losses and fictitious assets are written off and over valuation of assets, is written down to their present valuesCapital Reduction A/c Or Reconstruction A/c Dr. Dr. (As the case may be) (With the total amount written off)

To Profit and Loss A/c To Goodwill A/c To Trade Mark A/c To Patents A/c To Plant & Machinery A/c

51

e)

If there is any surplus in Capital Reduction A/c or Reconstruction A/c, the same should be transferred to the Capital reserve A/cCapital Reduction A/c Or Reconstruction A/c To Capital reserve A/c Dr. Dr. (With the amount of surplus)

Note :- The amount to be written off can not exceed the amount available in the Capital Reduction A/c or Reconstruction A/c. But, if any reserve appears in the books of the Company, the same may be utilised in writing off the accumulated losses and fictitious assets. Balance Sheet :While preparing the Balance sheet of the company after

reconstruction is duly carried out, the following points should be taken into considerationi) The words And Reduced should be added to the name of the company, if the court so directs. ii) So far as fixed assets are concerned, the amount written off under a scheme of reconstruction must be shown for five years.

52

Illustration9: The Balance Sheet of B Ltd. as on 30th June 1998 is given below : Balance Sheet Liabilities Amount Rs. Authorised Capital 25,000 Equity Share of Rs.20 each 3,000, 6% Preference share of Rs.100 each 3,00,000 Debtors Bills Receivable 3,00,000 Stock Cash at Bank Issued & Subscribed Capital 15,000 Equity Shares of Rs.20 each, fully paid 1000, 5% Preference Share of Rs.100 each, Rs.80 per share paid up. 600, 7% Debentures of Rs.100 each Bills payable Sundry Creditors Outstanding Interest on Debentures 8,800 5,03,800 5,03,800 60,000 5,000 50,000 80,000 3,00,000 Profit & Loss A/c Preliminary Exp. 35,000 12,000 45,000 7,000 99,000 5,800 5,00,000 Plant Patents 2,00,000 1,00,000 Assets Amount Rs.

53

A special resolution was passed and confirmed by the court to the following effect : i) That 1000 6% Preference share of Rs.100 each, Rs. 80 per share called up, be reduced to 1000 6% Preference share of Rs.60 each, Rs. 40 per share paid up. ii) That 15,000 Equity Share of Rs.20 each fully paid up be reduced to the same number of fully paid up share of Rs. 10 each. iii) That 600 7% Debentures of Rs.100 each be reduced to 600 8% Debentures of Rs.90 each. iv) That the debenture holder to forego the accumulated debenture interest due to them. v) That the Sundry Creditor agreed to forego 20% of their dues in exchange for equity share of 80% of their dues. vi) a) That the sum thus rendered available be applied as follows : The balance to the debit of Profit and Loss account and Preliminary Expenses account be completely written off. b) c) The Plant and Patents be written down by 25% and 40% respectively. The balance left if any, to be, carried forward to Capital Reserve Account. You are required to show the necessary journal entries and to prepare the Balance Sheet of the company after the reconstruction is duly carried out.

54

Solution Journal of B Ltd. Dr. Rs. 1998 June 30 6% Preference Share Capital A/c Dr. To Capital Reduction A/c 40,000 40,000 Cr. Rs.

(Being reduction of 1000 6% Preference share of Rs.100 each, Rs. 80 per share paid up into 1000 6%. Preference share of Rs.60 each, Rs.40 per share paid up as per Capital resolution date____vide Courts order dated__________). June 30 Equity Share Capital (old) A/c Dr. 3,00,000 1,50,000 1,50,000

To Equity Share Capital (New) A/c To Capital Reduction A/c

(Being reduction of 1500 equity share of Rs.20 each, fully paid up into 1500 equity share of Rs.10 each fully paid up as per special resolution Courts order date____________). June 30 7% Debenture A/c To 8% Debenture A/c To Capital reduction A/c Dr. 60,000 54,000 6,000

(Reduction of 600 7% Debenture of Rs.100 each into 600 8% Debenture of Rs.90 each as per special resolution date______vide Courts order dated________) June 30 Outstanding Debenture Interest A/c To Capital Reduction A/c (Being cancellation of debenture invest under the scheme) Dr. 8,800 8,800

55

June 30

Sundry Creditors A/c To Equity Share Capital A/c To Capital Reduction

Dr.

50,000 40,000 10,000

(Being allotment of 4,000 equity shares of Rs.10 each fully paid upto creditors and transfer of the balance 20% of their dues foregone to Capital Reduction A/c as per Boards resolution dated__________) June 30 Capital Reduction A/c To Profit and Loss A/c To Preliminary Expenses A/c To Plant A/c To Patents A/c Dr. 1,94,800 99,000 5,800 50,000 40,000

(Being utilisation of the amount available in Capital Reduction A/c to write off the debit balance of Profit & Loss A/c, Preliminary Expenses A/c and to write down the value of Plant and Patent under the Scheme) June 30 Capital Reduction A/c To Capital Reserve A/c (Being transfer of surplus to Capital Reserve A/c) Dr. 20,000 20,000

56

Balance Sheet of B Ltd. as on 30th June 1998 Liabilities Amount Rs. Share Capital : 50,000 Equity Shares of each 5,00,000 Fixed Assets : Plants Patents 5,000 6% Preference Share of Rs. 60 each 3,00,000 Investments : Current Assets & Loans Advances : 8,00,000 Issued and Subscribed Capital : 19000 Equity Share of Rs.10 each fully paid 1000 6% Preference share of Rs.60 each, Rs.40 each paid up Reserve & Surplus : Capital Reserve Secured Loans : 600 8% Debentures of Rs.90 each, fully paid up Current Liabilities & Provisions. A. Current Liabilities Bills Payable B. Provisions : 5,000 3,09,000 3,09,000 54,000 20,000 40,000 1,90,000 A. Stock Debtors Bank Balance B. Loans and Advances : Bills Receivable Miscellaneous Exp. 12,000 Current Assets : 45,000 35,000 7,000 1,50,000 60,000 Assets Amount Rs.

57

12.8 SUMMARY Amalgamation refers to combining of business of two or more existing companies of business of two or more existing companies. For accounting purposes, it is assumed that all liabilities are taken over by the transferee company and then liabilities actually not taken over are discharged by making direct payment to the parties. The purchase consideration may be determined by lump sum method, net assets method and net payment method. Amalgamation of a company involves realisation of assets and settlement of claims of various stakeholders. For this purpose, Realisation Account is opened which shows the net result of realisation of assets and settlement of claims of various stakeholders excluding equity shareholders. Inter-company owings represented by common debtors and or bills of exchange are cancelled by passing an additional entry in the books of the transferee company. 12.9 KEYWORDS Amalgamation: It is used when two or more existing companies go into liquidation and a new company is formed to take over their business. Absorption: It is used when one or more existing company (or companies) goes into liquidation and some existing company takes-over its business. External Reconstruction: It is used when one existing company goes into liquidation and a new company is formed to take over its business. Inter-company Owings: If any amount is owed by the purchasing company to the vendor company or vice-versa at the time of amalgamation or absorption of companies, it is inter-company owings. 12.10 SELF ASSESSMENT QUESTIONS 1. Define amalgamation and external reconstruction. What entries are passed by a

company to close its books when it is purchased by another company?

58

2.

What entries should be passed in the books of a company that goes into

liquidation for the purpose of amalgamation? 3. Define purchase consideration. Explain the different methods of determining

purchase consideration. 4. D Ltd. and A Ltd. carrying on similar business agree to amalgamated by

transferring their undertaking to a new Company A D Ltd. The balances sheet of the two companies as on the date of transfer were as follows : Liabilities D Ltd. Rs. Share Capital Equity Share Capital of Rs.100 each 6% Preference Share of Rs.100 each 5% Debentures General Reserve Profit & Loss A/c 1,15,000 55,000 35,000 7,50,000 13,90,000 7,50,000 2,00,000 70,000 5,00,000 2,50,000 40,000 5,00,000 3,00,000 A Ltd. Rs. Land & Building Plant & Machinery Furniture & Fittings Stock 79,000 81,500 34,000 52,000 24,600 22,500 3,900 5,60,000 3,58,000 4,65,000 2,55,000 Assets D. Ltd. Rs. A Ltd. Rs.

Sundry Debtors 56,000 Cash at Bank Cash in Hand Preliminary Expenses 55,100 87,000 6,400

Sundry Creditors 75,000 13,90,000

59

The term of agreement were as follows : a) The purchase consideration consisted of i) ii) The assumption of liabilities of both the Companies The discharge of the debentures in A Ltd. at a premium of 5% by the issue of 7% debentures in A D Ltd. iii) The issue of 10 equity shares of Rs.10 each at a premium of Rs. 2 per share for each preference share held in both the Companies. iv) The share of 10 equity shares of Rs.10 each equity share of D Ltd. and 5 equity share of Rs.10 each at a premium of Rs.2 per share and Rs. 80 in cash for every equity share in A Ltd. b) All the assets and liabilities of the two companies were taken over at their book value except a provision @ 5% to be raised on debtors. c) In order to raise working capital and to pay the purchase consideration A D Ltd. decide to issue 30,000 equity share of Rs.10 each at a premium of Rs.3 per share. You are required to pass the journal entries in the books of D Ltd. to close its accounts, and show the opening balance sheet of A D Ltd. 5. The Balance Sheet of A Ltd. on 31st Dec. 1998 was as follows : Rs. Assets Land & Buildings Plant & Machinery 4,00,000 50,000 Furniture Stock Sundry Debtors = 1,00,000 Less Provision 30,000 for Doubtful Debts = 5,000 95,000 Rs. 2,30,000 1,80,000 20,000 90,000

Liabilities Share Capital : 8000 Equity Shares of Rs.50 each fully paid up General Reserve Workmens Accident Compensation fund (Outstanding Liabilities Rs.8000)

1000, 7% Debentures of Rs. 50 each 50,000

60

Sundry Creditors Bank Overdraft Staff Provident Fund

40,000 10,000 40,000 6,20,000

Cash Discount on issue of Debentures

2,000

3,000 6,20,000

The business of the company is taken by B Ltd. on that date. The purchase consideration is to be discharged as follows : a) b) A payment of Rs.10 for every share in A Ltd. A further pay in cash Rs.10 for every debenture in A Ltd. in full discharge of the debentures. c) An exchange of 5 shares in B Ltd. of Rs.10 each at the Market Value of Rs.15 per share, for every 2 share in A Ltd. d) The expenses of liquidation Rs.5000 were borne by A Ltd. show the Realisation A/c, cash and pass the journal entries. 6. A Ltd. and B Ltd. are two companies carrying on business in the same line. Their balance sheet as on 31.12.1998 are given below : Balance Sheet Liabilities A Ltd. Rs. Full paid up Equity Share Of Rs.10 each General Reserve Secured Loan Current Liabilities 6,00,000 22,00,000 4,00,000 9,00,000 4,00,000 6,00,000 2,00,000 1,00,000 6,00,000 2,00,000 B. Ltd. Rs. Land and Building Plant & Machinery Investments Stock Debtors Cash at Bank 7,00,000 1,00,000 9,00,000 3,00,000 1,00,000 22,00,000 3,00,000 4,00,000 1,00,000 1,00,000 9,00,000 1,00,000 Assets A Ltd. Rs. B. Ltd. Rs.

61

The two companies decide to amalgamate into A B Ltd. The following further information is given : a) b) A Ltd. holds 8000 share in B Ltd. @ Rs.12.50 each. All assets and liabilities of two companies, except investment are taken over by A B Ltd. c) Each share in B Ltd. is valued @ Rs.25 for the purpose of the amalgamation. d) Shareholder in A Ltd. and B Ltd. are paid off by issuing to them sufficient number of equity shares of Rs.10 each in A B Ltd. as fully paid up at par. e) Each share in A Ltd. is valued @ Rs.15 for the purpose of amalgamation.

Show journal entries to close the books of both the companies and balance sheet of A B Ltd. 7. Given below is the Balance Sheet of H Ltd. as at March 31, 1998. Balance Sheet Liabilities 40,000 share of Rs.10 each fully paid. Creditors 4,00,000 3,00,000 Rs. Assets Land & Building Plant & Machinery Stock Debtors Cash Preliminary Expenses Profit & Loss A/c 7,00,000 The following scheme of reconstruction was arranged : i) The company to go into liquidation and a new company with an authorised capital of Rs.8,00,000 to be formed to take over the assets and liabilities. Rs. 3,20,000 1,30,000 70,000 1,20,000 500 5,000 54,000 7,00,000

62

ii)

Preferential Creditor of Rs.10,000 included in the above Balance Sheet are to be paid in full.

iii)

Unsecured Creditors to receive either (a) 50% of their claim in cash or (b) 6% debenture in the new company equivalent to their claim, at par.

iv)

Shareholder of H Ltd. to be allotted one share in the new company of Rs.10 each, Rs. 5 paid for every existing share held by them.

v)

Reconstruction costs amounting to Rs.6000 to be paid by H Ltd. from cash made available by the new company. Half of the unsecured creditor in value of opted out for immediate cash payment

for which purpose necessary cash was made by the new company which made a call of Rs.5 each on the partly paid share allotted as aforesaid. The new company value all assets/except Land & Building taken over from H Ltd. at par. Prepare the Balance sheet of new company after the above transaction are concluded. 8. The following is the Balance Sheet of P Ltd. as on 31-12-1998. Rs. Assets Loan & Building Plant & Machinery 8,00,000 5,00,000 25,000 2,85,000 16,10,000 16,10,000 Stock Cash Profit & Loss A/c Rs. 2,50,000 6,00,000 2,35,000 26,000 2,50,000

Liabilities Authorised & Issued Capital 80,000 Equity share of Rs.10 each fully paid 5% Debentures Accrued Interest Sundry Creditors

The debentures are held by G Ltd. who also hold 20,000 shares acquired during the past two year at a total cost of Rs. 1,45,000.

63

Negotiation between the two companies resulted in an agreement for the absorption of P Ltd. by G Ltd. upon the following terms : a) That G Ltd. takes over the assets and liabilities of P Ltd. as on 31-12-1999 at their book value, subject to the revaluation of the Plant and Machinery at Rs.4,50,000. b) That the amount due in respect of debenture be set off against the purchase consideration and that they be cancelled on the completion of the transaction. c) That the outside shareholder in P Ltd. be given Rs.10 share issued at par by G Ltd. on the basis of such shares being worth Rs.15 each and in P Ltd. being worth Rs.5 each. The arrangement was approved by the necessary resolution of the shareholder in P Ltd. Show journal entries required to close the books of P Ltd. and to record the transactions in the books of G Ltd. including the transfer required to close accounts therein relating to the share and debentures in P Ltd. 12.11 SUGGESTED READINGS 1. 2. 3. 4. 5. 6. Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi.

64

LESSON : 13
CO-OPERATIVE ACCOUNTING
STRUCTURE 13.0 13.1 13.2 13.3 13.4 13.5 13.6 13.7 13.8 13.9 Objective Introduction Feature of Co-operative Society Types of Co-operative Society Importance of Book-keeping in Co-operative Societies Cooperative System of Accounting Accounting Procedure in Co-operatives Summary Keywords Self Assessment Questions

13.10 Suggested Readings 13.0 OBJECTIVE After reading this lesson, you should be able to (a) (b) (c) 13.1 Define a co-operative society and explain its features. Discuss the co-operative system of accounting. Explain the accounting procedure in a co-operative society. INTRODUCTION

Co-operation is the basis of domestic social life. It imbues the spirit of self help and man to man assistance to generate economic wealth and advancement of social transformation.

The Co-operative organisation is a form of organisation for the economic upliftment of weaker section of society. Under this form of organisation, a large number of people set up and run any economic activity for their own benefit and for the benefit of other people like them. The Co-operative movement in India started in 1904 to protect weaker section of society from exploitation of rich people (capitalist). The primary objective of this movement is how to protect economically weaker section of society from oppression of economically strong segment of society? The objective of Co-operative organisation is totally different from other form of business organisations. These forms are not set up for profit but for protecting and upliftment of its members and also other weaker people of the society. Co-operative societies are voluntary associations started with the aim of service to its members. In simple words The Co-operative societies are the voluntary associations of a large number of economically weak people for the protection of their interest with their combined efforts and combined resources. The India Co-operative Societies Act. 1912 defines Cooperative in Section 4 as a society which has its objectives of promotion of economic interest of its members in accordance with Co-operative principle. 13.2 FEATURES OF CO-OPERATIVE SOCIETY

A Co-operative society will have the following broad features :1. Voluntary membership

The members in any co-operative can enter or leave the society any time on their choice. No member can force any individual to enter or leave the society. There are a few rules and regulation in the co-operative which have to be abides by the its member. Voluntary membership is a most important principle of any co-operative and this is the main principle behind the success of co-operative movement. 2. Democrative Management

The democrative procedure is followed by co-operatives for their management. The management or body to control the day to day activity of co-operative is elected by its member. The members are owner of the co-operative and from time to time they give instructions to the management for better control of operation of society. 3. One man, One Vote

The another important principle of these societies is equity of its member. All members have right to cast one vote in the matters of co-operative irrespective of their investment size.

In joint stock company, the member has voting right according to share held by him, But here votes are just given upon membership and one member has one vote only. 4. Service Motive

The main motive of co-operative is service. The society is always set up for betterment of society and its member. All other forms of business organisation like Partnership, Joint stock company, Sole proprietor etc. are set up for making profit for their owner. But societies are for providing services. Even if the co-operatives earn profit that is just for the betterment of its member, the main motive always remains service. 5. Equity in distribution of surplus

Like the voting right the members of Co-operative also enjoy equity in participation of profit. The surplus of co-operative is not distributed like Joint stock company on the basis of investment. In co-operative the profit or surplus is distributed either on their service basis or sometimes equally to all members. The Indian Co-operative Society Act has given guidelines for the distribution of the surplus. Under the act a certain percent of profit is paid in form of interest or dividend on capital and certain percent is kept as Reserves and rest spent on welfare to members. 6. Compulsory Resignation

The registration of the Co-operative society is must. After making a voluntary association of a minimum person required, the registration has to be taken before starting the functions of co-operative. In India minimum ten members are required for getting registration of any cooperative under the India Co-operative Act 1912. The registration are made by State level offices which functions under State Government. 7. Control of State Government

The Co-operative societies are to follow certain rules and regulations formed by state government. In India, as said earlier the co-operatives are registered in state level office under Indian Co-operative Act-1912. 8. Cash Trading

All the transactions of the co-operative society will be on cash basis. Co-operative Society can only flourish on cash trading principle basis. The chances of bad debts and losses due to delayed payment are eliminated with cash trading in co-operative societies. The society can provide for exemptions with approval of all its members.

13.3

TYPES OF CO-OPERATIVE SOCIETIES

Different types of Co-operatives are working with a single motive of protection and betterment of weaker section. But the ways and areas of operation are different. Some important types of co-operative are : 1. Consumer co-operatives

These co-operative societies are started to help lower and middle class people by providing them necessary goods at reasonable rates. The member of these Co-operatives contribute capital and elect some executive and management members to look after the day to day working of the society. The societies purchase the goods in bulk quantity directly from the producers and sell it to its members and common people after charging a very reasonable small profit. So the people get the goods at lower price. In India, all co-operative store selling basic commodities are running under this type of co-operative forms. 2. Producers Co-operatives

The Co-operatives are set up to protect the small and cottage producers from big and multinational industrialist. These co-operatives are divided into following two types : a) Producers Co-operatives : The various small producers or handicraft producers are the members of such societies. The society is set up at a common place where all members can come. The members can work as an employees in the society and are paid wages for there services. All the raw material required by the member is supplied by the society. The society collects the output of its member, sell it in the market and earn profit. This profit is distributed in members again after keeping some reserves. b) Industrial Service Co-operatives : These Co-operatives are for small and cottage industries. The members are again small producers. The co-operative society purchase raw material in bulk quantity and supply it to members. The society also supply the required machines. Members makes the products which are collected by the society and sold in market to earn profit. Profit is distributed in the members. 3. Marketing Co-operative

This type of Co-operative provide market to the cottage producers. This type of society protect its members from the exploitation of the middleman. The society take the production of various members and pool it together. The society than arrange the various services like grading, warehousing, transportation, insurance and financing etc. The goods are sold directly by the society in the market without any middleman. So members get better price for their products. Society also provide market information to its members.

4.

Housing Co-operatives

These Co-operative are set up for providing houses to low and middle income group people. These societies purchase land and construct houses for these members. Societies also arrange loans for its members from financial institution and government agencies. Sometimes societies purchase land in bulk and distribute plots to the members. In conclusion the purpose of all these societies is to help their member in purchasing land and constructing houses. 5. Credit Co-operatives

These Co-operatives societies are set up for providing financial assistance to the farmers and other weaker section. The main motive of these co-operatives are to protect the weaker section people and farmers from the exploitation of money lender, who charge exorbitant interest rate on the loan. The Rural co-operatives get loans from State Co-operative Bank or Regional Rural Bank where as in urban areas it is provided by Urban banks. 13.4 IMPORTANCE OF BOOK KEEPING IN CO-OPERATIVE SOCIETIES

We know a Co-operative organisation is a business as well as a welfare institution. Equitable economic benefit to members is its prime goal. In the first place, a business cannot be run in a go-as-you-like style. Well planned operations are must and recorded accounts can only supply required information for the purpose. Secondly, equitable distribution of the gains of business (supply of scare/seasoned items and net surplus earned) is made possible when you keep records of purchases and sales and so on. In fact, accounting is the language of business. No business expression is possible without it. 13.5 CO-OPERATIVE SYSTEM OF ACCOUNTING

Co-operative system of accounting is one in which both receipt and payment effect of a particular transaction is recorded in a book of original entry and posted accordingly. In case of interest both amount received and paid are taken separately and not the balance (either debit/credit). It basically follows double entry system. It is a simplified indigenous system. But some small co-operatives also follows Single Entry System in their accounting. a) Double Entry System : Any business involves transaction i.e. action resulting in transfer of money from one party to another or transfer of goods or services of money value. In business money is the common denominator and any transaction is carried out in term of money or money value paid/payable or received/receivable. Thus any transaction involves receiving and giving goods or services or money. The system under which both the aspects of

a transaction is recorded, is called double-entry system of book-keeping. Thus Double entry system of book-keeping means a system whereby twofold aspects of each transactions are recorded in the books of accounts. One aspect (giver) is credited and the other (receiver) is debited. From this we get a formula that every debit has a corresponding credit of equal amount of money value and vice-versa. Total Debit = Total Credit Double-entry system can better be defined as a system under which both the credit as well as debit aspects are entered in the books of accounts. b) Single Entry System : Single entry system as the name goes, does not record both the aspects and as such amounts to incomplete recording of transaction. There are variation in such incomplete recording. But usually personal aspects and cash aspects are recorded. For example, cash received entered in the Cash Book is posted to the Credit of the concerned personal account(s). But items of receipts like cash sales, interest etc. are not posted. This is a fragmented approach. Difference between Single Entry System and Double Entry System S.No. Norms 1 Testing Accuracy of accounts Single Entry System Since double aspects of each transaction are not recorded, arithmetical accuracy is not these 2 Calculation of business results As no nominal account is recorded business result (Profit & Loss) cannot be ascertained easily. 3 Financial position (Balance Sheet) In absence of records of real accounts, books fail to provide details of assets and liabilities and no balance sheet can be prepared. With complete records, accounts to ascertain surplus or deficity can be readily prepared. With ready availability of property accounts, a statement of affair or balance sheet can be prepared. Double Entry System Recording credit and debit aspects of transactions makes the test a sure fire.

Information flow

Incomplete records and hence no information is reliable

By and large information can be relied upon

Fraud and Errors

Provides almost free ground for frauds and errors. It is difficult to detect a misappropriation.

There is always a check on fraud errors and misappropriation.

Use Value

Very low, if at all. It is rather confusing.

It is highly revealing and as highly facilitating.

Finally, single entry system is a crude and incomplete system and cannot stand the test in comparison to a complete and workable thing like double entry system. Rules of Double Entry System Accounts record the facts relating to business transactions. A transaction cannot take place unless there are two parties. A transaction involves giving and receiving of benefits in the shape of moneys worth (goods or services). It has to be remembered that :a) There are a number of other cooperatives, individuals or firms with which a cooperative has to deal. b) The Co-operative enterprise must also have some fixed assets like furniture, land and building, plant and machinery, equipments, etc. c) A Co-operative Society in course of its business shall have to incur expenses like, wages, salary, rent, postage and obviously earns income and may incur losses. All these type of transactions are divided into three basic nature of accounts, under double entry system. viz. a) b) c) Personal account Real account and Nominal account

Accounts

Personal A/C Real

1.

Impersonal Nominal

Personal Account : This accounts involves all the persons in any transaction. The person includes all human beings called real persons and artificial persons, who are created by law e.g. Capital (Owners Accounts). Ram account, Debtors, Creditors, Bank, Business house, Sonitpur Agriculture Co-operative Society. NEFED etc. Rule : Debit the receiver, Credit the payer or supplier. e.g. Ram sold goods to Sham on credit. Ram and Sham both are human beings, therefore belongs to personal a/c Sham is receiver, therefore debit him. Ram is supplier, therefore credit him. 2. Real account :- All the real things are included in this accounts. In terms of account this account includes all the assets e.g. Building, Machinery, Furniture, Goodwill, Cash, Stock etc. Rule : Debit what comes in and credit what goes out. e.g. Purchase Machinery for Cash. Cash and Machinery are real things, so are part of real a/c Machinery purchase means comes in, therefore, debit it. Cash is paid means going out, therefore credit it. 3. Nominal account : This account involves incomes, losses, and expenses, e.g. salaries, rent, depreciation, commission, wages and carriage etc. Rule : Debt all incomes and gains, Credit all loss and expenses. e.g. Received Commission in cash. Cash is a real thing, therefore is a part of real account and comes in so Debit it. Commission received is an income, therefore, is a part of nominal account. Incomes are to be credited according to rule of nominal account, so credit it.

S.No. Transaction

Two a/cs involved Cash Capital Real a/c Personal a/c Dr. what comes in Cr. The payer /supplier Dr. What comes in Cr. Supplier Furniture comes in Naresh supplied furniture Salaries Paid Cash paid out Naresh received cash paid out Cash comes in the business Proprietor paid money Cash 50000

Nature of the a/c

Rule of Debit and Credit

Explanation

Dr. Account

Cr. Account Capital 50000

1.

Started business with Rs. 50,000

2.

Purchase furniture of Rs. Furniture 10000 from Naresh Naresh

Real a/c Personal a/c

Furniture 10000

Naresh 10000

9
Salaries Cash Personal a/c Real a/c Nominal a/c Real a/c Dr. Expenses Cr. What goes out Dr the receiver Cr. What goes out Salaries 5000 Naresh 5000 Cash 4000 Cash 5000 Cash 5000 Commission 4000 Cash Real a/c Commission Nominal a/c Dr.What comes in All Cash comes in incomes are to be commission is credited an income

Paid Salaries Rs. 5,000

Paid Rs. 5000 to Naresh Naresh Cash

5.

Commission received Rs. 4000

13.6

ACCOUNTING PROCEDURE IN CO-OPERATIVES The accounting procedure in cooperatives is as follows:

1. Journal :

Like the accounting procedure of any business house, in the Co-operative also the first step is to write financial transactions in Journal. All the financial transactions are recorded in Journal. Journal Date Particular L.F. Amount Dr. Amount Cr.

2. Book of Accounts: Different books may be used in different types of Co-operative societies according to their nature of work. The following books are generally used by these Co-operative Societies. i) Day Book:- This book is again prepared every day. All the transaction from the journal are recorded in this book, but cash items are not recorded in this book, because the same are recorded in Cash book.

10

Day Book Debit

Credit
Particular Amount Total Amount General L.F. Personal L.F. Particulars Amount Total Amount

General L.F. Personal L.F.

11

ii) General Ledger :- This is also called control Ledger. All accounts Capital and Revenue. (Expenses, Incomes, Assets and Liabilities) are opened in this book on separate pages. The transaction are passed in this book from Day book daily in the evening. The various accounts in this book are closed on a particular day or at the end of each year. The procedure to close the accounts is called Balancing. The most important function of this book is to control the personal Ledger. The proforma of the book is similar to the Ledger.

General Ledger Date Particulars Day Book Folio Debit Amount Credit Dr/Cr Amount Balance Amount

iii) Personal Ledger :- These are the simple ledger accounts prepared from the Day book. The difference between Personal Ledger and General Ledger is only that in General Ledger all the accounts are recorded in one book on different page, where as in Personal Ledger one account is recorded in one book. The proforma of the Personal Ledger is same as General Ledger. These Personal Ledgers are also closed on the day on which General Ledger are closed. iv) Trial Balance :On the day of the closing of the book we find the balance amount in each ledger account. The statement of the balances of the ledgers is called Trial Balance. The statement is to be prepared to find out mathematical accuracy in our accounting system and to prepare final accounts (Trading, Profit & Loss account and Balance Sheet). In trial balance all assets and expenses are shown in Debit side, where as all incomes, Liabilities and Capital are shown in credit side. Trial Balance Of _____________________ Co-operative As on __________________________ Name of a/c L.F. Debit balance Credit Balance

12

V)

Trading, Profit & Loss account This is a one statement of the Final account. This statement is prepared to find out the profit/loss of the society. All the income and expenses are included in this statement. In the Trading account opening stock purchases and direct expenses are taken in Debit side where as the sale and closing stock are taken in credit side, the difference in the account is called Gross profit it is in debit side and Gross loss if it is in debit side and Gross loss if it is in credit side. Profit and loss account is a statement of all the income and expenses of the year. All the expenses are shown Debit side and incomes are shown in credit side. The difference, if in Debit side is called Net profit and, if in credit side Net loss. Trading and Profit and Loss A/c Of ________________ Co-operative Dr. Particulars For the year ended Amount Particular Amount Cr.

vi) Balance Sheet :This is the last statement in the accounting procedure. The statement is prepared to know the financial position or financial soundness of any Co-operative Society. All the capital items of the society i.e. various assets own by it and its liabilities are included in this statement. The statement gives a comparative position of assets and liabilities of the Co-operative on a particular day. Balance Sheet Of ________________ Co-operative as on __________________________ Liabilities Amount Assets Amount

13

Illustration and Exercise

i) ii)

iii) iv) v)

The Sampla Thrift & Credit Co-operative Society bought one share No. 1 of Rs. 100/ - and paid Rs. 2/- as admission fee. Raikot Agricultural Service Co-operative Society was admitted as member. Two shares numbering 2 & 3 of Rs. 100/- each were allotted to it. The society also paid Rs. 2.00 for admission fee. Sh. Ram Lal opened a Saving Bank deposit a/c with Rs. 900/- and Cheque Book No. 1 containing cheques numbering 1 to 15 was issued to him. The Society purchased stationery articles worth Rs. 104/- in cash from M/S Narula Stationary Mart Panipat. Postage and Stamps worth Rs. 12/- were purchased by the bank for its daily use. (Cash in hand 1088)

2nd Jan 98 i) ii) S. Kartar Singh opened a Saving Bank A/c with Rs. 1700/- and cheque Book No. 2 containing cheques numbering 16 to 30 was issued to him. The Panipat Handloom Weavers Co-operative Society was enrolled as member of the bank. The society purchased 3 shares numbering 4 to 6 of Rs. 100/- each and deposited Rs. 2/- as admission fee. Current a/cs were opened by Sh. Paras Ram with Rs. 840/- and Sansar Chand with Rs. 480/- Current a/c Cheque Book No. 1 & 2 having cheques numbering CA/0001 to CA0020 and CA/0021 to CA0040 respectively were issued to them. The Nilo Kheri M.P. Co-operative Society deposited Rs. 4000/- as fixed deposit for one year @ 3% and fixed deposit receipt No. p-Co-op/0001 was issued to him. The Bank opened a current a/c with the State Bank of India (Panipat) with Rs. 2500/-. The State Bank issued cheque Book containing cheques numbering 30001 to 30050 to the Bank. Furniture worth Rs. 150/- was purchased for use in the bank. (Cash balance Rs. 5760/-) 3rd Jan 98 i) The Babar Pur Service Co-operative Society became member of the bank by purchasing

iii)

iv) v)

vi)

14

ii) iii) iv) v) vi)

one share No. 7 of Rs. 100/- and paying Rs. 2/- as admission fee. S. Kartar Singh opened a S.B. a/c with Rs. 440/- and cheque Book containing cheques numbering 31 to 45 was given to him. S. Mohinder Singh deposited Rs. 375/- in his newly opened current a/c. The Bank issued him cheque Book No. 3 containing cheque CA0041 to CA0060. Sh. Kailash Chand Jain opened a Fixed Deposit a/c with Rs. 2000/- for six months @ 2% and fixed Deposit Receipt No. P-Co-op/0002 was issued to him. The Bank purchased N.S. Certificates worth Rs. 5000/- in cash. One Iron Safe was purchased for Rs. 400/- from M/s Reliance Traders, Delhi. The bill is still outstanding. (Cash in hand Rs. 3677)

4th Jan 98. i) Third Five Year Plan Bonds of the face value of Rs. 2000/- were purchased in cash at 98. The brokers Commission @ 50 p. percent amounted to Rs. 10/ii) The Sampla Thrift & Credit Co-op Society was advanced a loan of Rs. 500/- vide promote No. P.Co-op-L/10001 through Shri Ram Das Cashier. iii) Sh. Ram Lal withdrew Rs. 240/- from his S.B. a/c per cheque NO. 1 of 3rd Jan., 98. iv) S. Karnail Singh deposited Rs. 240/- in his newly opened current a/c The Bank issued Ch. Book No. 4 having Cheques numbering CA/0061 to CA/0080. v) The Bank purchased one share No. HB 3116 Hr. State Co-op of the Bank Ltd, Chandigarh of Rs. 100/- and paid Rs. 5/- as admission fee. vi) The Nurpur Co-operative Store become member of the Bank. Share NO. 3 & 9 Rs. 100/- each were allotted to it. The store paid Rs. 2/- as admission fee. 6th Jan. 98 i) ii) iii) iv) S. Karnail Singh issued cheque No. 16 for Rs. 350/- on his saving Bank a/c in favour of Shri Mangal Sain which was duly paid. The Panipat Handloom Weavers Co-operative Society was advanced a clean loan of Rs. 1000/- per pronote NO. P.Co-L/0021 through Shri Ram Ditta Mal member. The Bank with drew Rs. 250/- from its current a/c with the State Bank of India per cheque No. 30001 dated 6.1.98 through its cashier. Shri Virender Kumar open a saving Bank a/c with Rs. 210/- Cheque Book containing cheques numbering 56 to 60 was issued to him.

15

7th January, 1998 i) ii) iii) iv) Preet Nagar Agricultural Service Society was admitted member. Share No. 10 of Rs. 100/- was allotted to the society. The society also paid Rs. 2/- a admission fee. A loan of Rs. 750/- was given to Rai Koot Agricultural Service Social Vide Pronote No. P-Co-op.L/10041 through Shri Inderjit V. President. Sh. Paras Ram withdrew Rs. 240/- from his current a/c vide cheque No. CA/0001 dated 6.1.98 per self. Rs. 1000/- were withdrawn from the current a/c with State Bank of India vide cheque No. 30002 dated 6.1.98. (Cash Balance Rs. 516) 8th Jan. i) ii) iii) iv) v) vi) Shri Ved Parkash opened a S.B. a/c with the Bank (Panipat Urban Bank) with Rs. 325/- cheque No. 61 to 75 were given to him for withdrawing money from the Bank. Shahpur Labour and Construction Co-op. Society became member. The society purchased three shares 11 to 13 of Rs. 100/- each and paid Rs. 2/- as admission fee. The Sampla Thrift & Credit Co-op. Society repaid its loan amounting to Rs. 250/through its cashier Shri Ram Dass. Shri Sansar Chand deposited Rs. 240/- in his current a/c Shri Ram Saran Singh deposited Rs. 1500/- in fixed a/c for months at 2% vide F.D.R. No. P.Co-op F/0003. Rs. 3000/- were deposited in the current a/c with State Bank of India. (Balance Rs. 133/-) 9th Jan 98 i) ii) iii) iv) Shri Ram Lal deposited Rs. 165/- in his S.B. a/c. Gannaur Industrial Co-operative Society Ltd. purchased five shares numbering 14 to 8 of Rs. 100/- each and paid Rs.2/- as admission fee. Babar Pur Service Co-operative Society was advanced a loan of Rs.400/- per pronote No. P-Co-op./10061 dated 6th Jan 1998 through Shri Jagdish Chander member. Mohinder Singh deposited Rs. 225/- in his current a/c. (Cash Balance Rs. 625)

16

10th Jan 98 i) ii) iii) iv) v) Rs. 270/- were given to Nurpur Co-operative. Store as loans Pronote No. P-Co-op. L/0041 was obtained from the store. The Panipat Handloom weavers Co-operative Society deposited Rs. 400/- towards its loan a/c. Gurmit Singh deposited Rs. 115/- in his newly opened S.B. a/c Saving Bank withdrawal cheques No. 76 to 90 were supplied to him. Kartan Singh withdrew Rs. 240/- from his S.B. a/c per cheque No. 31 dated 10.1.98 favouring Ajit Singh. S. Karnail Singh deposited Rs. 160/- in his current a/c. (Cash Balance Rs. 790/-)

11th Jan 98 i) Shri Virender Kumar withdrew Rs. 120/- from his S.B. a/c per cheque No. 16 dated 11.1.98. ii) Preet Nagar Agricultural Service Society borrowed Rs. 800/- per pronote No.P-Coop.L/0051 dated 10th Jan. through Shri Ram Sarup. 15th Jan 98 i) ii) iii) Gian Singh opened S.B a/c with Rs. 460/- cheques numbering 91 to 105 were supplied to him. Karam Singh deposited Rs. 150/- in his S.B. a/c Shahpur Labour and Construction Co-op. Society borrowed Rs. 6000/- on the security of pronote No. P-Co-op. Society borrowed Rs. 6000/- on the security of pronote No. P-Co-op.L/0061 through Duni Chand President. iv) v) vi) Raikot Agricultural Service Co-operative Society returned its loan Rs. 405/Kartar Singh deposited Rs. 135/- in his S.B. a/c. Mohinder Singh withdrew Rs. 400/- from his Current a/c vide cheque No. C.A.00411-98. 16th Jan 98. i) ii) Shri Ved Parkash issued Cheque No. 61 on his S.B. a/c for Rs. 185/- favour of Shri Moti Ram. The payment was duly made by the Bank. The Gannaur Industrial Co-operative Society was given a loan of Rs. 950/- per p.L/

17

iii) iv) v)

0071. Nurpur Co-operative Society borrowed Rs. 330/- from vide pronote No.p-Co-op.L/ 0042 dated 15.1.59 through Shri Ram Dass. Sh. Sansar Chand withdrew Rs. 320/- from his current a/c per cheque No. C.A. 0021 dated 16.1.98. S. Bhagwan Singh deposited Rs. 1520/- in his fixed Deposit a/c for one year @ 2%. (Cash Balance Rs. 75/-)

18th Jan 98 i) ii) iii) iv) v) S. Balbir Singh deposited Rs. 640/- in his newly opened S.B. a/c Cheque Book having cheques from 106 to 120 was supplied to him. Sh. Ram Lal issued Ch. No. 2 for Rs. 340/- in favour of Sh. Sulekh Chand on his S.B. a/c. The amount is paid. Babar Pur Co-op Society returned its loan Rs. 180/-. Paras Ram withdrew Rs. 400/- from his current a/c vide cheque no. CA 0002 dated 17.1.98, per Kartar Chand. S. Karnail Singh deposited Rs. 340/- in his S.B. a/c (Balance Rs. 355/-)

19th Jan.98 i) ii) iii) S. Gurmit Singh withdrew Rs. 55/- from his S.B. a/c per cheque No. 76, Sh. Virender Kumar deposited Rs. 335/- in his S.B. a/c The Panipat Handloom weavers Co-op Society returned Rs. 209 towards its loan a/c. 22th Jan.98 i) ii) iii) iv) v) Sh. Gian Singh issued cheque No. 91 for Rs. 243/- on his S.B. a/c in favour of M/s Punjab Traders, Panipat. The amount was paid by the Bank. Preet Nagar Agricultural Service Society repaid its loan Rs. 240/- through Ram Sarup. S. Kartar Singh withdrew Rs. 165/- from his S.B. a/c per cheque No. 32 dated 22.1.98 per Avtar Singh. Nurpur Co-operative Society repaid its loan Rs. 200/-. S. Mohinder Singh withdrew Rs. 180/- from his current a/c per cheque No. CA 0042 dated 22.1.98.

18

24th Jan. 98 i) S. Balbir Singh withdrew Rs. 187/- from his S.B. a/c per cheque No. 106 (Balance Rs. 687/-) Sh. Ram Lal deposited Rs. 134/- in his S.B. a/c. Sh. Ved Parkash deposited Rs. 345/- in his S.B. a/c through Sh. Ishwar Chand. Shahpur Labour Construction Co-op. Society paid Rs. 300/- towards its loan a/c per Sh. Duni Chand president. Sh. Sansar Chand withdrew Rs. 150/- from his current a/c per cheque No. CA/0022 dated 24/1/98 per self. (Cash Balance Rs. 1129/-)

ii) iii) iv) v)

25th Jan. 98 i) ii) iii) iv) i) ii) i) ii) Sh. Karam Singh withdrew Rs. 215/- from his S.B. a/c per cheque No.17 per Sh. Naresh Kumar. Sh. Virender Kumar withdrew Rs. 245/- from his S.B. a/c per cheque No.47 per Sh. Vijay Singh. The Gannaur Industrial Co-op. Society repaid its loan amounting to Rs.90/-. Babarpur Co-op. Society was advanced a loan of Rs.180/- Vide pronote No. L/ 0032 dated 24/1/98. Through Inder Singh member. Karnail Singh withdrew Rs.500/- from his current a/c vide cheque No. AC/0061 dated 25/1/98. 27th Jan. 98 Sh. Gurmit Singh deposited Rs.47/- in his S.B. A/c through Rajinder Singh. S. Balbir Singh issued Ch.No.107 on his Saving Bank a/c for Rs.450/- in favour of Sh. Mohan Lal. iii) The Sampla Thrift & Credit Co-op. Society repaid its loan amounting to Rs. 150/through Sh. Ram Dass. iv) The Panipat Handloom wavers Co-op. Society was advanced a loan of Rs.500/- vide P.No.L/00112 dated 26-1-98. v) Preet Nagar Agricultural Serving Society borrowed Rs.440/- vide pronote No. L/ 0052 dated 26-1-98.

19

vi)

Parash Ram withdrew Rs.300/- from his current a/c vide cheque No. CA/0003 dated 27-1-98. Per self.

vii)

Rs.1000/- were withdrew from the current a/c with State Bank. (Balance Rs. 86/-)

29th Jan 98 i) Sh. Ved Parkash withdrawn Rs.195/- from his S.B. a/c per ch. No.62 through S. Narayan Singh. ii) iii) iv) Gian Singh deposit Rs.108/- in his S.B. a/c. Raikot Agricultural Service Society returned Rs.175/- towards its loan a/c. Nurpur Co-op. Society repaid its loan amounting to Rs.250/-. (Balance Rs.424/-) 31st Jan 98 i) Sh. Karam Singh withdrew Rs.425/- from his S.B. a/c per cheque No.18 dated 301-98 per self. ii) Sampla Thrift & Credit Co-op. Society was given a loan of Rs.400/- vide Pronote No. P-Co-op.L/0002 dated 29-1-98 through Ram Murti member. iii) iv) The Gannaur Industrial Co-op. Society repaid its loan amounting Rs.160/-. Babarpur Co-op. Society was advanced a loan of Rs.250/- vide pronote No. L/0033 of 30-1-98 through Inder Singh member. v) vi) Preet Nagar Co-op. Society repaid its loan amounting to Rs.300/-. Shahpur L/C Co-op. Society was advanced a loan of Rs.400/- vide pronote No.11/ 0062 dated 29-1-98. vii) viii) ix) Sh. Sansar Chand withdrew Rs.75/- from his current a/c per cheque No. CA/00233. Mohinder Singh deposited Rs.140/- in his current a/c. Rs.600/- were withdrawn from the Bank (State Bank). (Balance Rs. 74/-)

20

Day Book 1st. January, 1998 The Panipat Urban Co-operative Bank Ltd. Panipat Debit Amount Total Rs. P. Amount Rs. P. Gener Perso Particulars al nal L.F. L.F. Stationery a/c Amount Total Rs. P. Amount Rs. P.

Credit

General Pero Particulars L.F. nal

L.F.

Share Capital a/c By Cost of one share No.1 to Sampla 100.00 Trift & Credit C.S.

300.00

To Cost of Stationary Purchased 104.00 104.00

21
200.00 4.00 2.00 900.00 1204.00 Nil 1204.00

By Amount from Rai Kot Agricultural Service C.S. Share No. 2 & 3

Postage To cost of postage stamp 12.00 purchased

12.00

Admission Fee a/c By Amount from Sampla Thrift and 2.00 Credit Co-op. Society.

By Raikot Agri. Service Co-op Society

Saving Bank a/c By amount deposited by Sh. Sham Lal 900.00 Total

Total Cash in Hand Crand Total

116.00 1088.00 1204.00

Opening Balance

Grand Total

Day Book 2nd. January, 1998 The Panipat Urban Co-operative Bank Ltd. Panipat

General Pero Particulars L.F. nal

L.F.

Amount Total Rs. P. Amount Rs. P.

Share Capital a/c By amount from the Panipat Handloom Weaver's Co-op. Society 300.00 300.00

Amount Total Gener Perso Particulars Rs. P. Amount al nal Rs. P. L.F. L.F. Current a/c With State Bank of India To amount deposited in the bank 2500.00 2500.00 Furniture a/c
To cost of furniture purchased 150.00 150.00 as per detail on Voucher

Saving Bank a/c By amount from Sh. Karam Singh 1700.00 1700.00

22
2.00 7322.00 1088.00 8410.00

Current a/c By amount from Sh. Paras Ram 840.00 1320.00 By amount from Sh. Sansar Chand 480.00

Fixed Deposit a/c By amount from Nilo Kheri M/P Coop. Society. 4000.00 4000.00

Admission fee a/c By amount from Panipat H. Weaver's Co-op. Society 2.00

(Cash-Rs. Five thousand seven hundered and Sixty only)

Total Cash in hand G. Total 2650.00 5760.00 8410.00

Total

Opening Balance

G. Total

General Ledger Share Capital Account

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. 00 Cr. Balance

Rs. 1.1.1998 By amount from Day Book By amount from Day Book 1

P.

Rs. 300

Rs. 300

P. 00

2.1.1998

600

00

Cr.

300

00

Admission Fee Account

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. 00 Cr. Balance

Rs. 1.1.1998 By amount from Day Book By amount from Day Book 1

P.

Rs. 4

Rs. 4

P. 00

2.1.1998

00

Cr.

00

Saving Bank Account

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. 00 Cr. Balance

Rs. 1.1.1998 By amount from Day Book By amount from Day Book 1

P.

Rs. 900

Rs. 900

P. 00

2.1.1998

1700 00

Cr.

2600

00

23

Fixed Deposit Account

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. 00 Cr. Balance

Rs. 2.1.1998 By amount from Day Book 1

P.

Rs. 4000

Rs. 4000

P. 00

Current Deposit Account

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. 00 Cr. Balance

Rs. 2.1.1998 By amount from Day Book 2

P.

Rs. 1320

Rs. 1320

P. 00

Loan to Members Account

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. Dr. 4 1000 00 Dr. 1500 00 Balance

Rs. 4.1.1998 To amount from To amount 3 500

P. 00

Rs.

Rs. 500

P. 00

5.1.1998

24

Current Account with State Bank of India (Panipat)

Date Particular Day Book Folio Debit Credit Dr. or Cr. P. Dr. Balance

Rs. 2.1.1998 By amount from Day Book 2 2500

P. 00

Rs.

Rs. 2500

P. 00

Furniture Account
Date Particular Debit Credit Dr. or Cr. Balance

Rs. 2.1.1998 To amount of furniture as per Day Book ...2 150

P. 00

Rs.

P. Dr.

Rs. 150

P. 00

25

Stationary Account
Date Particular Debit Credit Dr. or Cr. Balance

Rs. 1.1.1998 To cost of Stationary per Day Book....1 104

P. 00

Rs.

P. Dr.

Rs. 104

P. 00

Postage Account
Date Particular Debit Credit Dr. or Cr. Balance

Rs. 1.1.1998 To cost of postage as per Day Book....1 12

P. 00

Rs.

P. Dr.

Rs. 12

P. 00

26

Loan Ledger

Name The Sampla Th. & Credit Co-op Society P.O. M.C.L Classification No. And Date of Pronote Registrars order Sampla, Tehsil Rohtak District Rohtak No. Date Cheque Bonds Issued Date : 4.1.98 Account

Principal
Particulars Credit Balance 500 00 4 2000 No. of Prod Days ucts 500 00 Debit

Interest
Date Particulars Debit 31.1. To interest 3 up to 31.1.98 98 @ 6% (say..) 40 Credit Balance 3 40

Date

No. of Pronote

4.1.98

27
By amount received By amount 150 400 00 500 00 00 100 00 4 1 250 00 250 00 19 4650 400 500 To amount advanced through Sh. Ram Murti Member 28 7550

To amount P-Coop. L/1000 advanced through Sh. Ram Dass Cashier

8.1.98

18.2. By amount received 98

40

Nill

27.1.98

31.1.98 10002

Illustration 2 The following is the list of balances of the Gohana Marketing Coop. Society Ltd., as on 31.12.98. Prepare a Trial Balance as on that date Rs P.
Share Capital Stock at Commencement Salaries of the staff Admission Fee Interest Received Rent of office Building Purchases Interest on Deposits Paid Salaries payable Interest (Cr.) Furniture & fixture Stationary and printing Loans advanced to Members Audit Fee payable Sundry Creditor Cash in hand Deposit in C.B. Branch 17220.00 12000.00 2850.00 175.00 1153.00 940.00 54,380.00 618.00 140.00 230.00 1750.00 437.75 18,242.25 840.00 6000.00 632.00 6540.00 Postage Spent Reserve Fund Commission Earned T.A. to Directors Sales Account Shares held Interest Recoverable Carriage on goods purchased Returns outwards Discount allowed by Creditors Return inwards Undistributed Profits Security Deposit with D.W.S. Discount allowed

Rs. P.
183.18 2450.00 2640.00 334.62 70,915.56 1800.00 430.00 680.00 572.34 850.50 725.00 795.00 1200.00 238.00

28

Solution The Gohana Marketing Coop Society Ltd. Trial Balance as on 31.12.1998 Debit Balance Amount Rs. Stock at Commencement Salaries of the staff Rent of office Building Purchases Interest on Deposits Furniture & fixture Stationary and printing P. Credit Balance Share Capital a/c Admission Fee Interest Received Salaries payable Interest payable Audit Fee Payable Sundry Creditors Reserve Fund Commission Earned Sales a/c Returns outwards Discounts allowed by Creditors Profit (undistributed) Amount Rs. P. 17220.00 175.00 1153.00 140.00 230.00 840.00 6,000.00 2450.00 2640.00 70,915.56 572.34 850.50 795.00

12000.00 2850.00 940.00 54380.00 618.00 1750.00 437.75

Loans advanced to Members 18,242.25 Cash in hand Deposit in C.B. Branch Postage spent T.A. to Directors Share held Interest Recoverable Carriage on goods purchased Returns inwards Security Deposits with D.W.S. Discount allowed Total 632.00 6540.00 183.18 334.62 1800.00 430.00 680.00 725.00 1200.00 238.60 1,03,981.40

Total

1,03,981.40

29

Illustration 3 From the following Trial Balance of the Bhiwani Marketing Co-operative Society for the year ending 31.12.1998. Prepare Trading a/c, Profit & Loss a/c and Balance Sheet as on that date Dr. Balance Stock of goods (Opening) Purchases Freight & Carriage Octroi & Terminal Taxes Wages to Coolies T.A. of Staff Salaries a/c Building Stationary & Printing Postage & Telephone Saving Bank a/c with C.B. Bhiwani Cash in hand Sundry Debtors Depriciation Interest paid Furniture Return from Debtors Total 214 7244 150 237 1250 348 51624 Total 51624 6800 17580 1840 234 425 164 2654 5760 159 45 6520 Cr. Balance Share Capital a/c Funds Sales Interest received Sundry Creditors Salaries Payable Return outwards Deposits 18655 3240 21437 348 6475 280 189 1000

Note : Stock in hand on 31.12.1998 was valued at Rs. 3560/-

30

Solution : The Bhiwani Marketing Co-operative Society Ltd. Trading Account Dr. Particulars Amount Particulars Cr. Amount

To opening Stock

6800

By Sales

21347

To purchase 17580 Less Returns 189 17391

Less Return 348

21089

By closing stock To Freight & Carriage 1840 By Gross Loss transferred to P/L a/c

3560 2041

To Octroi & Terminal taxes To wages

234 425 26690

Profit and Loss Account

26690

Dr. Particulars To Gross loss from Trading a/c To salaries a/c Amount 2041 2654 Particulars

Cr. Amount 348 5102

By Interest Received By Net Loss to Balance Sheet

To T.A. to Staff To Stationary & Printing Postage & Telegrams To Depriciation To Interest Paid Total

164 159 45 150 237 5450 Total 5450

31

Balance Sheet as on 31.12.98 LIABILITIES Share Capital Funds Deposits Sundry Creditors Salaries Payable AMOUNT 18655 3240 1000 6475 280 ASSETS Cash in hand Saving Bank a/c with C.B. Bhiwani Building Sundry Debtors Furniture Stock a/c Net Loss as per P/L a/c Total Illustration 4 The following is the Trial Balance of the Gurgaon Transport Co-operative Society as on 31.4.99. Prepare a Profit & Loss a/c and Balance Sheet as on that date. Dr. Balance Rs. Pay of Drivers 46822 Pay of Conductors 22134 Cash in hand 3461 Police Vouchers Recoverable 984 Vehicle insurance Paid 18236 Fleet of Vehicles 556789 Petrol Consumed 23456 Pay & allowances of office Staff 34567 Printing & Stationary 9876 Stock of Stationary 2104 Stock of Spare Parts 6789 Stock of Petrol in Lorries 1235 Adda Fees Paid 6824 Cr. Balance Rs. Share Capital a/c 150875 Reserve Fund 87519 Lorry Income 245678 Clean Loan from Central 75642 Members Deposits 34680 Contract Bookings 28247 Interest on Loans Payable 3456 Loan from Punjab Motor 112500 Petrol Bills Payable 13482 Carriage of Mails 8679 Profit & Loss a/c Balance 11234 Miscellaneous income 650 29,650 Total AMOUNT 214 6520 5760 7244 1250 3560 5102 29,650

32

Painting Charges Furniture Shares of C.B. Purchased Entertainment to Visitors Income tax Refundable Saving Bank a/c with C.B. Repairs to Lorries Loose Tools Stock General Charges Total Adjustments :(i) (ii) (iii) (iv) (v)

3651 4262 2150 846 3567 1486 9732 10523 3148 772642

Total

772642

Fleet of vehicles is to be depreciated @ 10%. Insurance amounting to Rs. 2468/- is unexpired. Petrol Bills of Rs. 784/- Painting Bills, Rs. 416/- were outstanding. Rs. 650/- were received and included in contract Booking a/c but the service was yet to be performed. Interest of Rs. 1125/- on Loans was payable.

Solution The Gurgaon Transport Co-operative Society Ltd. Profit & Loss account for the year ending 31.4.99

Particulars To Pay of Driver To Pay of Conductors

Amount 46822 22134

Particulars By Lorry Income By Contract Booking 28247

Amount 245678

To Pay & allowance of Staff To Vehicle Insurance Paid 18236 Less unexpired

34567

Less received in 650 advance By carriage of mails By miscellaneous income

27597 8679 650

2468 15768

33

To Petrol

23456 24240 9876 6824 4067 9732 3148 1125 55678 47777 2,82,604 Total 2,82,604

Petrol Bills Payable 784 To Printing & Stationary To Adda fees paid To Painting Bills Paid 3651 To Painting Bills 416 payable To Repairs to Lories To General Charges To Interest on Loans To Depriciation on Lorries @10% To Net Profit carried to Balance Sheet Total

Balance Sheet as on 31.4.99

LIABILITIES Share Capital Reserve Fund Member deposits Clean Loan from C.B. Loan from Punjab Motor Finance Payable item Interest as per

AMOUNT 150875 87519 34680 75642 112500

ASSETS Cash in hand S.B. deposit with C.B. Fleet of Vehicles 556789

AMOUNT 3461 1486

Less depreciation 55678 @ 10% C.B. Share purchased Furniture Printing & Stationary Stock

501111 2150 4262 2104

34

Trial Balance Interest as per Adjustment

3456 1125 4581

Spare Parts Stock Petrol Stock Loose Tools stock Police voucher recoverable Income Tax refundable Insurance Paid in Advance

6789 1235 10523 984 3567 2468

Petrol Bills payable 13482 Petrol Bills payable 784 14266 Painting Bills Payable 416 Contract Booking received 650 in advance Profit & Loss a/c Last Balance 11234 59011 5,40,140

Profit as per P/L a/c 47777 Total

Total

5,40,140

13.7

SUMMARY

Co-operative societies are voluntary associations of persons started with the aim of service to its members. Different types of co-operatives are working with a single motive of protection and betterment of weaker sections of the society with different ways and area of operations. Co-operative system of accounting is one in which both receipt and payment effect of a particular transaction is recorded in a book of original entry and posted accordingly. Different books may be used in different types of co-operative societies accordingly to their nature of work. 13.8 KEYWORDS

Co-operative Society: It is a society which has its objectives of promotion of economic interest of its members in accordance with co-operative principles. Co-operative System of Accounting: It is a system in which both receipts and payments effect fo a particular transaction are recorded in a book of original entry and posted accordingly.

35

Day Book: This is a book in which all the transactions from the journal are recorded in this except the cash items. Double Entry System: It is a system under which both the aspects of a transaction is recorded. 13.9 1. 2. 3. 4. SELF ASSESSMENT QUESTIONS Define a co-operative society. Discuss the features of a co-operative society. What are the different types of co-operative societies? Explain the accounting procedure in a co-operative society. Prepare the Trial Balance of Sampla Credit Co-operative Society from the following balances: Rs. P. Cash in hand Stationary and Printing Furniture a/c Paid up Share Capital Deposit by Non-members Share held of another Co-op. Reserve Fund Loan from Central Bank Rohtak Stock of Sugar Interest Payable Fertilizer stock Interest Recoverable Common Good Fund Contribution to Prov. Fund 1200.25 167.50 980.75 123.40 204.00 14.20 321.00 82.11 150.00 2235.00 960.00 800.00 820.00 4325.00 Postage Loan to members National Saving Certificate Deposit by members Rent a/c Salaries Buildings Profit & Loss a/c Cr. Rs. P. 37.89 4375.50 500.00 3450.00 180.00 240.00 5000.00 1843.60

36

5.

The following is the Trial Balance of the Bopa Rai Agricultural Service Society on 30.6.98. Prepare Profit & Loss Account and Balance Sheet.

Dr. Balance

Amount

Cr. Balance

Amount

Cash in hand S.B. Deposit with P.O. Salary of Staff Rent of Building Stationary & Printing Furniture Spray Pump

223 107 300 180 144 400 270

Shares Interest Received Admission Fee Members Deposits Non Members Deposit Dividend on shares Interest on National Saving Certificate

7345 4567 93 5678 3456 20 45

Stock of Fertilizer Shares of C.B. Jullundur Share of Bhogpur Sugar Mill Share of P.B. Jullundur National Saving Certificate Interest Paid & Payable On Loan to Members Profit & Loss Balance Total

540 150 400 100 800 1896 27983 184 33681

Reserve Fund Common Good Fund Interest Payable Central Bank Loan

785 165 216 11311

Total

33681

37

Adjustments i) Consider Rs. 311/- as bad out of amount due from members as loan. ii) Interest on Loans was recoverable Rs. 94/-.

iii) Depreciate Furniture @ 5%. iv) Stationary worth Rs. 36/- was purchased on credit but it could not be vouched. Note : This years Profit & Loss a/c discloses a Profit. Last years Profit and Loss a/c indicated Loss. Hence the balance i.e. resultant Profits will be shown on the liabilities side of the Balance Sheet. 6. From the following Ledger Balances of the Hansi Co-operative Agricultural Society Ltd. as on 30.6.98 Prepare Trading a/c, Profit & Loss a/c and Balance Sheet as on that date. Dr. Balances Previous Stock of Sugar Sugar Purchased Freight & Octroi Wages Agricultural Seed Purchased Salaries Audit Fee paid Interest Paid Stationary Consumed Office Rent Contribution to Co-op. Week Celebrations News Papers Subscriptions Loan to members National Savings Certificates Shares Purchased Building Advance with Execution Agent Furniture & Spray Pump Cash in hand Total 7. 500 2500 55 25 300 1200 225 400 20 60 50 50 132000 8000 500 500 50 400 1200 1,48,035 Cr. Balances Sale of Sugar Sale of Agricultural Seed Fertilizer Interest Received on Loans Admission Fee Members Share Capital a/c Government Share Capital a/c Member Deposit LoanfromCentralCo-op.Bank Non-members Deposits Reserve Fund Common Good Fund Building Fund Last years Profits 2600 325 100 3500 10 20000 5000 40000 30000 35000 6000 500 2000 3000

Total

1,48,035

The following is the Trial Balance of the Palwal Co-op Union Ltd ; as on 31.12.98. Prepare Profit & Loss Account and Balance Sheet.

38

Dr. Balances Interest Paid and Payable Establishment Dearness allowances Cash in hand Postage in hand Current a/c with C.B.Gurgaon Investments Security with Agr. Deptt. Fixed Deposit with State Co-op. Bank Contribution to Prov. Fund Postage Spent Library Books Furniture & Fittings Stationary & Printing 4316.13 1461.13 156.70 5514.25 7.13 843.62 48,500.00 200.00 75540.00 115.40 34.25 75.00 1.00 148.00

Cr. Balances Share Capital 103450.00 Reserve Fund 4544.00 Common Good Fund 1265.00 Bad & Doubtful Debt fund 1356.45 Current Deposits by Individuals 24345.00 S.B. Deposit by Societies 48418.72 Employees Prov. Fund 942.18 Govt. Audit Fee Deposits 1560.00 Interest on loans 4675.00 Interest on Investments 3412.48 Commission on sale 118.32 of Fertilizers Overdraft with State 7456.00 Bank of India Suspense Interest 4532.48 Interest Payable on 1435.83 Fixed Deposits Employees Securities deposits 764.14 Admission fee 26.00 Fixed Deposits 75276.00

Stock of Books for sale 546.37 Income Tax Recoverable 1275.30 Interest Recoverable 4532.43 Interest accured but not yet due 845.15 Profit & Loss a/c balance 4283.65 Travelling Expenses 238.35 General Charges 542.54 Depreciation on investments 460.00 Discount allowed 15.82 Sitting Fee 183.38 Loans advanced to Members 125450.00 Land and Building 7850.00 Audit Fee Paid 342.00 Shares held of C.B. 100 Rs. 283577.60

Rs.

283577.60

39

The following list of balances was taken from the general Ledger of the Moga Co-op Mortgage Bank as on 30.5.98. Prepare Profit & Loss a/c & balance sheet. Dr. Balances On Loan to Members Rent of Office Paid Printing & Stationary Postage Shares of S.L.M.B. Shares of Co-op. Bank Furniture Cash in hand General Charges Interest Recoverable Staff Salaries Rs. Amount 234568 1432 765 234 800 100 2345 189 321 1234 4567 246555 246555 Cr. Balances Share Capital Interest Earned Staff Security Deposit Loan from S.L.M.B. Admission Fee Deposits Amount 83700 6789 750 150780 4185 351

8.

The following is the Trial Balance of the Kaithal Multi Purpose Coop. Society on 31.12.1997. Prepared Profit & Loss a/c and Balance Sheet. Amount 176 2354 17875 3456 7654 352 743 468 38 Credit Balance Shares Interest Received Admission Fee Sundry Creditors Bill Payable Deposits Reserve Fund Investment Depreciation Fund Central Bank Loan Amount 6842 4567 25 9876 382 5430 4264 961 15600

Debit Balance Cash in Hand Stock of Sugar On Loan to Members Establishment Sundry Debtors Discount allowed Interest Paid Stationary & Printing Postage

40

Furniture Investment in Govt. Security Interest Recoverable Stock of fertilizer Building Audit Fee Paid General Charges Saving Bank a/c with C.B. Branch Rs. Adjustment :i) ii) iii) iv) v)

800 4560 346 740 9800 195 234 458 50249

Discount Received Profit & Loss a/c

145 2157

Rs.

50249

Stock of Sugar was valued at Rs. 2768/-. Stock of Fertilizer valued at Rs. 965/Interest on Loans to members to the extent of Rs. 880/- Could not be vouched before the close of the year. Govt. Securities are to be depreciated by Rs. 345/- out of Depreciation Fund. Depreciate furniture 5%

13.10 SUGGESTED READINGS 1. 2. 3. 4. 5. 6. 7. Fundamentals of Accounting by R.L. Gupta and V.K. Gupta, Sultan Chand and Sons, New Delhi. Advanced Accounting by R.L. Gupta and M. Radhaswamy, Sultan Chand and Sons, New Delhi. Advanced Accounting by Ashok Sehgal and Deepak Sehgal, Taxmann Allied Services Pvt. Ltd., New Delhi. Advanced Accounts by M.C. Shukla, T.S. Grewal and S.C. Gupta, S. Chand and Co. Ltd., New Delhi. Fundamentals of Advanced Accounting by R.S.N. Pillai and V. Bagavathi, S. Chand and Co. Ltd., New Delhi. Studies in Advanced Accounting by S.N. Maheshwari, Sultan Chand and Sons, New Delhi. Financial Accounting by Shashi K. Gupta, Nisha Aggarwal and Neeti Gupta, Kalyani Publishers, Ludhiana.

41