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Bureau’s Higher Secondary
ACCOUNTANCY CLASS- XII (For Commerce Students) (Prescribed by the Council of Higher Secondary Education, Odisha)
Written By Dr. Ajoy Mohanty Retd. Principal Sushilabati Govt. Women's College, Rourkela
Dr. Ram Chandra Jena Retd. Associate Prof. Of Commerce B.J.B. Junior College, Bhubaneswar
Dr. Uma Chand Lal Retd. Associate Prof. Of Commerce B.J.B. Autonomous College, Bhubaneswar
Dr. Prafulla Kumar Parida Associate Prof. Of Commerce S.C.S. Autonomous College, Puri
Reviewed by Prof. (Dr.) Gunanidhi Sahu Former Director, Higher Education, Odisha
Published by
Odisha State Bureau of Textbook Preparation and Production Pustak Bhavan, Bhubaneswar
Published by : The Odisha State Bureau of Textbook Preparation & Production, Pustak Bhavan, Bhubaneswar, Odisha, India First Edition : 2017/ 3000 copies Publication No. : 209 ISBN : 978 - 81 - 8005 - 404 - 4 © Reserved by The Odisha State Bureau of Text Book Preparation and Production, Bhubaneswar. No part of this publication may be reproduced in any form without the prior written permission of the publihser. Type Setting & Design : M/s Jagannath Process Pvt. Ltd., Cuttack Printed at : M/s Jagannath Process Pvt. Ltd., Cuttack Price : Rs. 160/– (Rupees One hundred sixty) only
FOREWORD The Odisha State Bureau of Textbook Preparation and Production, Bhubaneswar has made a pioneer attempt to publish text books for Commerce Stream with an excellent team of teachers in different subjects. The present book ‘‘Accountancy’’- Class-XII is meant for Higher Secondary Commerce Students. This book has been written by a team of learned academicians namely Dr. Ajoy Mohanty, Dr. Uma Chand Lal, Dr. Prafulla Kumar Parida and Dr. Ram Chandra Jena and reviewed by Prof. (Dr.) Gunanidhi Sahu. I would like to record my sincere gratitude to all them for accomplishing this venture in time. The main purpose of developing this text book is to provide a thorough exposure to the students of Commerce in this subject. The book prepared according to the new syllabus prescribed by the CHSE, Odisha shall cater to the needs of young students. I believe that the students and teachers of commerce stream shall welcome and appreciate the book. Constructive suggestions for further improvement of the book will be highly appreciated.
Sri Umakanta Tripathy Director The Odisha State Bureau of Textbook Preparation and Production, Pustak Bhavan, Bhubaneswar
(iii)
PREFACE The book on 'Accountancy' has been written for the Twelfth (XII) class students of Commerce Stream. It has been written according to the syllabus prescribed by the Council of Higher Secondary Education (CHSE), Odisha. Keeping in view the standard and requirements of the students, the book has been written in a very simple, lucid and comprehensive manner. We do not claim that the book is an original one. We have taken the help of publications by many renewed authors. We express our gratitude to all of them. Sufficient care has been taken to see that the students can be well-acquainted with the types of questions usually set by the CHSE, Odisha. Accordingly, large number of typical examples and illustrations have been given in each chapter. At the end of each chapter, varied type of questions such as : on multiple choice, one word, rectification of errors, filling up the blanks, one sentence, 30 words, 50 words, long questions and practical problems, have been incorporated. We are confident that the students will find this book quite useful. We have taken all possible care to see that the book is complete in every respect. Despite our best possible efforts, errors might have crept in inadvertently and there might have been some deficiencies as well. We shall highly appreciate the suggestions from the different quarters for imporvement of the book in the next edition. We are extremely thankful to the authorities of the CHSE, Odisha and the Odisha State Bureau of Text Book Preparation and Production, Bhubaneswar for entrusting this work to us. We also express our deep sense of gratitude to Prof. (Dr.) Gunanidhi Sahu, former Director of Higher Education, Odisha, who has taken pains to go through the entire manuscript throroughly and suggested imporvements to make the publication complete and perfect as far as possible. We express our sincere thanks to staff members of the Bureau, who have taken keen interest for bringing out the publication. We also express our thanks to the Jagannath Process Pvt.Ltd. but for whose efforts, the book could not have seen the light of the day. Board of Writers (iv)
SYLLABUS Objectives : To enable the students to understand and analyze the financial Statements of Profit & Non-Profit Making Organizations. To help the students in understanding the concepts and applications of depreciation. To develop and understanding about Accounting from Incomplete Records and its application. To help the students in learning the process of accounting for reconstitution and dissolution of partnership firms, and To help students understand the concept of accounting for companies specially about issue of shares and debentures : Course Inputs : Unit-I Financial Statements of Sole Trade and Not for Profit Organizations : Sole Trade form of Organizations Meaning, objectives and importance of preparing Trading, Profit and Loss Account and Balance sheet. Preparation of Trading, Profit and Loss Account and Balance Sheet of sole trader without and with adjustments relating to closing stock, outstanding expenses, prepaid expenses, accrued income, income received in advance, depreciation and bad debts, provision for doubtful debts, provision for discount on debtor/creditor, manager's commission, goods distributed as free samples and goods taken by the owner for personal use, abnormal loss, interest on capital and drawings. Not for profit organizations Meaning, objectives, necessity treatment of some important items such as legacy, donations, entrance fees, life membership fees, sale of assets, sale of old news paper, subscriptions, endowment fund, honorarium, expenses relating to a specific fund. Receipts and Payments Accounts-meaning, features, differences between Receipts and Payments Account and Cash Book. Income and Expenditure Accounts-meaning, features, difference between Income and Expenditure Account and Profit and Loss Account Preparation of Income and Expenditure Account and Closing Balance Sheet. Unit-II Accounting for Depreciation and from Incomplete Records (Single Entry System) Depreciation : Meaning, need, causes, objectives and characteristics of depreciation. Methods of Charging Depreciation- Simple depreciation, method and provision for depreciation method. Method of calculating depreciation Straight Line and Written down Value method. (v)
Accounting from Incomplete Records (Single Entry System) Meaning, charateristics and limitations of single entry system. Difference between single entry and double entry system. Difference between balance sheet and statement of affairs. Ascertainment of profit and loss by the statement of affairs method only. Unit-III Accounting for Partnership Firm : Meaning, Features, Partnership Deed and Provisions of Partnership Act, 1932 in the absence of partnership deed. Fixed vs Fluctuating Capital Accounts, preparation of Profit and Loss Appropriation A/c. Goodwill- Meaning, nature and Factors affecting Goodwill. Methods of Valuation of Goodwill (Average profit, super profit method and capitalization method). Reconstitution of partnership firm - Meaning, Circumstances Leading to Reconstitution : Change in Profit Sharing Ratio, Sacrificing Ratio, Gaining Ratio. Accounting for revaluation of assets and liabilities and distribution of reserves and accmulated profits and loss. Admission of a Partner - Simple Problems without Adjustment of Capital Unit-IV Accounting for Companies : Accounting for Share Capital : Shares and share capital : Nature and types as per Companies Act 2013. Issue of Shares at Par, Premium and Discount, Calls in Advance, Calls in Arrear, over subscription and under subscription of shares. Accounting for Forfeiture of shares and re-issue of shares. Disclosure of share capital in companies balance sheet (Vertical Format). Accounting for Debenture : Issue of debentures at par, at premium and at discount and issue of debentures for consideration other than cash. Unit-V Project Work with Viva : Suggested Areas for Project Work : Collections of source documents preparation of Vouchers, recording of transactions will the help of vouchers. Preparation of Bank Reconciliation Statement with the given cash book and the pass book with ten to fifteen transactions. Comprehensive project starting with journal entries regarding any sole proprietorship business, posting them to the ledger and preparation of Trial balance. The students will then prepare Trading and Profit and Loss Account and Balance Sheet on the basis of the prepared trial balance Expenses, incomes and profit (loss), assets and liabilities are to be depicted using pie chart / bar diagram. -o(vi)
CONTENTS CHAPTER
TITLE
PAGE
1
FINANCIAL STATEMENTS OF SOLE TRADING ORGANISATIONS
2
FINANCIAL STATEMENTS OF ‘NOT FOR PROFIT’ ORGANISATIONS
123-195
3
DEPRECIATION
196-241
4
ACCOUNTING FROM INCOMPLETE RECORDS
242-281
5
ACCOUNTING FOR PARTNERSHIP FIRM
282-328
6
ACCOUNTING FOR PARTNERSHIP FIRM (GOOD WILL)
329-345
7
RECONSTITUTION OF PARTNERSHIP FIRM
346-378
8
ADMISSION OF A PARTNER
379-418
9
ACCOUNTING FOR COMPANIES : ACCOUNTING FOR SHARE CAPITAL
419-578
10
ACCOUNTING FOR COMPANIES : ACCOUNTING FOR DEBENTURES
579-632
(vii)
1-122
(viii)
CHAPTER-1
FINANCIAL STATEMENTS OF SOLE TRADING ORGANISATIONS STRUCTURE
1.0 Meaning of Final Accounts 1.1 Objectives of Financial Statements 1.2 Importance of Financial Statements 1.3 Distinction Between Capital and Revenue 1.3.1
Capital Expenditure
1.3.2
Revenue Expenditure
1.3.3
Deferred Revenue Expenditure
1.3.4
Distinction between Capital and Revenue Expenditure
1.3.5
Capital Receipts and Revenue Receipts
1.3.6
Capital Profits and Revenue Profits
1.3.7
Capital Loss and Revenue Loss
1.4 Preparation of Financial Statements without adjustment 1.4.1
Preparation of Trading Account
1.4.2
Preparation of Profit and Loss Account
1.4.3
Preparation of Balance Sheet
1.5 Preparation of Financial Statements with Adjustments 1.6 Questions
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Chapter-1 Financial Statements of Sole Trading Organisations 1.0 MEANING OF FINAL ACCOUNTS The accounts and/or statements prepared at the end of the year (accounting period) are called final accounts. The final accounts are prepared from the Trial balance. Trial balance is the last step of Book-keeping and preparation of final accounts is the first step of Accounting. Final accounts are also interchangeably called the financial statements. Final accounts are usually prepared at the end of the accounting period to convey, the stakeholders/users, the financial health and operating efficiency of the business. Finacial statements are the summary of the accounts showing the result of operations and financial position of a business enterprise. These are the reports of incomes and expenditures of a business at the end of the year. Traditional concept of financial statements include the Income Statement (Trading account and Profit and Loss account) and the Balance Sheet/Position Statement. The modern concept of financial statements includes Cash Flow Statement and Value Added Statement in addition to the above two traditional statements. Our study, in this chapter, is limited to only the traditional concept of financial statements, i.e., the Trading and Profit and Loss Account and Balance Sheet. 1.1. OBJECTIVES OF FINANCIAL STATEMENTS The basic objectives of preparing financial statements are : (a)
to present a true and fair view of the operational efficiency of the business in financial terms;
(b)
to present a true and fair view of the financial position of the business. Besides the above, the other objectives are:
(i)
to help in the comparison of financial performance of the current year with that of the previous years,
Financial Statements of Sole Trading Organisations
3
(ii) to help in ascertaing the financial ratios for controlling the expenses and maximising/optimising revenues, (iii) to monitor the use of debts and capital in acquisition of assets, etc. 1.2 IMPORTANCE OF FINANCIAL STATEMENTS Financial statements are regarded as the financial barometers of a business enterprise. It measures the financial health, efficiency, soundness of the business. The various accounts are fed into the final accounts at the end of the year to make the business operations meaningful. The objective of a business is to earn profit besides the other social and cultural objectives. The importance of final accounts is to ascertain the profit, profitability and financial soundness of the business. The business enterprises are bound to prepare the final accounts annually, otherwise they will remain in dark. Final accounts are the summary of all accounts at the end of the accounting period. These are the means to communicate information to various stakeholders in the business so that they can take proper decisions. The stakeholders have diverse requirements of financial information from the business. They get better insight into the financial strengths and weaknesses of a business. The financial statements are most important for the informational needs of investors and providers of risk capital. 1.3 DISTINCTION BETWEEN CAPITAL AND REVENUE It is essential to distinguish between capital and revenue items in order to prepare the final accounts. The revenue items form part of the Trading and Profit and Loss Account; while the capital items go to the Balance Sheet. The Going Concern Concept and Accounting Period Concept prompt the accountant to draw the distinction between capital receipts and revenue receipts; and payments as capital expenditure, revenue expenditure and deferred revenue expenditure. A failure or negligence to distinguish between the two items will falsify the entire results of accounting. 1.3.1 Capital Expenditure It is an expenditure incurred to acquire fixed assets. Capital expenditure increases the earning capacity of business. It is necessary for the operations of any business. It
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4
normally yields benefits for more than one accounting period. A particular capital expenditure is debited to the specific asset account. For example, acquisition of land and building, plant and machinery, furniture and fixtures are all capital expenditures. Assets acquired through capital expenditures are not meant for resale and are supposed to remain in the business for a long period (more than one year) with the help of which the business is carried on. These are subject to depreciation. Depreciation is charged to Profit and Loss Account every year and is shown as a deduction from the value of the concerned asset (Capital expenditure) in the Balance Sheet. An expenditure can be treated as capital expenditure in the following situations: 1. When an expenditure results in the acquisition of an asset, for example, purchasing land and building, plant and machinery, furniture and fixtures, etc. 2. When an expenditure is incurred whose benefits will last for a long time, for example, preliminary expenses, cost of research and development, cost of acquisition of patents, trade mark, development expenditure on plantations, etc. 3. When an expenditure is incurred to put a newly purchased asset in the working condition, for example, cost of transportation, installation, registration, etc. 4. When an expenditure results in creation of extra capacity, for example, extension or addition of new rooms to an existing building. 5. When an expenditure reduces the cost of production, for example, replacement of petrol engine by a diesel engine of a passenger car, etc. 1.3.2
Revenue Expenditure
This expenditure is incurred for the the day-to-day conduct of the business. If helps in maintaining the earning capacityof the business. Revenue expenditure is recurring in nature and gives benefit to the business for a maximum period of one year. For example, manufacturing expenses, office and administrative expenses, selling
Financial Statements of Sole Trading Organisations
5
and distribution expenses- all these are charged/debited to Trading and Profit and Loss Account of the year during which these are incurred. An expenditure is treated as revenue expenditure in the following situations: 1.
Expenditure incurred to purchase raw materials, or finished products, for example, carriage inward, octroi duty, customs duty, etc.
2.
Expenditure whose benefit will expire during the same accounting year for example, salary, rent, postage, printing and stationery, etc.
3.
Expenditure for maintaing the capacity of a fixed asset, for example, repairs and maintenance, renewals, etc.
4.
Expenditure incurred to defend one's right to an asset or product in the interest of the business, for example, renewal of licence.
5.
All types of losses, i.e., whether stock-in-trade or any current or fixed asset, for example, loss of stock by theft or fire, loss of any asset by accident, etc.
1.3.3
Deferred Revenue Expenditure
Sometimes it is difficult to correctly demarcate between capital expenditure and revenue expenditure. Deferred Revenue Expenditure is one which is normally treated as revenue expenditure but it gives benefits to the business for more than one accounting period. For example, a heavy expenditure on advertising for launching a new product or opening a new brand, preliminary expenses, etc. are likely to give benefit for more than one accounting period. The impact of advertisement on consumers will remain for more than one accounting year. Deferred revenue expenditure is of non-recurring and special in nature and a heavy amount is spent on it. So, it may be spread over a number of years during which the benefit is received by the business. A proportionate amount of expenditure is charged to the Profit and Loss Account every year. The balance is carried forward to the subsequent years as deferred revenue expenditure and is shown on the asset side of the Balance Sheet, till it is fully written off.
6
Accountancy
1.3.4 Distinction between Capital and Revenue Expenditure The following are the distinctions between capital and revenue expenditure : (a) (b) (c) (d) (e)
(f) (g)
Capital expenditure improves the earning capacity of the business but revenue expenditure is incurred to maintain the earning capacity. Capital expenditure is incurred to acquire fixed assets for operation of business but revenue expenditure is incurred for day-to-day conduct of the business. Capital expenditure is non-recurring in nature but revenue expenditure is recurring in nature. Capital expenditure gives benefit for more than one accounting year but revenue expenditure normally benefits one accounting year. Capital expenditure represents unexpired cost and its benefits are taken to the future. But revenue expenditure represents expired cost and its benefits are exhausted within the year of expenditure. Capital expenditure is subject to depreciation while revenue expendure is subject to adjustment for outstanding and prepaid amounts. Capital expenditure is shown on the asset side of Balance Sheet but revenue expenditure is closed by transfer to the debit side of Trading or Profit and Loss Account.
1.3.5 Capital Receipts and Revenue Receipts. Receipts of a business enterprise comprise of capital receipts and revenue receipts. When the receipts of a business imply an obligation to return the money, these are capital receipts. For example, capital invested in the business, long-term loans and sale proceeds of fixed assets are capital receipts. But when a receipt does not imply an obligation to return the money or is not in the form of a sale of fixed asset, it is treated as revenue receipts. For example, money received from sale of goods/merchandises, interest, commission, discount, interest on drawings, income from other sources are revenue receipts. Capital receipts are reflected in the Balance Sheet whereas the revenue receipts are transferred to Profit and Loss account.
Financial Statements of Sole Trading Organisations
7
1.3.6 Capital Profits and Revenue Profits The profits earned by selling or revalution of old fixed assets, profits earned at the time of procuring share capital at premium on issue of shares or debentures, profit made on the reissue of forfeited shares or profits made prior to the incorporation of a company are called capital profits. Capital profits are usually shown as capital reserve on the liability side of Balance Sheet but in practice, capital profit like profit on sale of fixed assets is credited to Profit and Loss Account. For example, a machinery purchased for `1,00,000 is sold at `85,000 after two years of use at a depreciation rate of 10% on straight line method, the excess of `5,000 over the book value of `80,000 is capital profit. Capital profits are non-recurring in nature. The profits earned during the normal course of day to day business is called revenue profits. The net result of the Trading Account and Profit and Loss Account is revenue profit. It is the profit earned by selling goods and merchandises of the business. In other words, the excess of net sales over the cost of goods sold plus indirect expenses is called revenue profit. Both gross profit and net profit come under the purview of revenue profit. Revenue profits are recurring in nature. 1.3.7 Capital Loss and Revenue Loss The losses incurred by selling old fixed assets, revaluation of fixed assets, loss/ discount on issue of share or debentures, premium on redemption of preference shares or debentures are called capital losses. Capital losses are non recurring in nature i.e. do not occur in the ordinary course of the business. Capital losses may be treated as deferred revenue expenditure or fictitious assets which may be written off during a few years. Revenue losses occur in the normal course of the business. These losses are incidental to the day to day business operations. Revenue losses are the excess of revenue expenditure over the revenue incomes. Loss of stock by fire, pilferage, bad debts, misappropriation of goods and embezzlement of cash are treated as revenue losses.
8
Accountancy
Illustration 1 1.
State with reasons whether the following are Capital or Revenue items : (a) Freight and insurance on new machinery. (b) Wages paid for erection of a new machinery. (c) `2,000 paid on repairing a second hand machine purchased newly. (d) `8,000 paid as compensation to employees who are retrenched. (e) `5,000 spent on repainting the factory. (f) Discount allowed to debtors `200. (g) Discount allowed by creditors `300. (h) Legal expenses paid `3,000 to purchase a building. (i) Carriage paid on goods purchased. (j) A building costing `1,00,000 sold for `1,20,000. (k) Plant costing `60,000 is sold for `58,000. (l) Dividend received on shares `5,000. (m) Raised a Loan of `5,00,000 from IDBI. (n) Additional capital invested in the business `1,00,000. (o) Misappropriation of cash by cashier `7,000. (p) Bad debts written off. (q) Bad debts previously written off now recovered.
Solution: (a) Capital expenditure as it is incurred to make the machinery ready for use. (b) Capital expenditure since it makes the machinery fit for use. (c) Capital expenditure as it makes the second hand machinery ready for use. (d) Revenue expenditure since it is neither giving extra benefit nor increasing the value of any asset.
Financial Statements of Sole Trading Organisations
9
(e) Revenue expenditure as it is incurred to maintain the asset (factory) in working order. (f) Revenue expenditure as it is incurred in the ordinary course of the business. (g) Revenue receipts since it is earned in the ordinary course of the business. (h) Capital expenditure as it is spent to acquire a fixed asset which is a capital expenditure. (i) Revenue expenditure because it is incurred in connection with the purchase of goods which is revenue expenditure. (j) Building sold at `1,20,000 is a capital receipt. Profit on sale of building `20,000 is a capital profit. (k) Plant sold at `58,000 is a capital receipt. Loss on sale of plant `2,000 is capital loss. (l) Revenue receipt since it is received regularly on investment in shares. (m) Capital receipt as the loan is raised from the bank which increases the liability of the business. (n) Capital receipt as it increases the liability of the business to the proprietor. (o) Revenue loss because it is incidental to the business. (p) Revenue loss as it is incidental to the business. (q) Revenue receipt since bad debts written off was treated as a revenue loss. 1.4
PREPARATION OF FINANCIAL STATEMENTS WITHOUT ADJUSTMENT Financial statements are the summaries of information about the operating result and financial position of a business enterprise. Traditionally the term 'Financial Statements' is used to denote mainly two statements :
(i)
Income Statement (Trading and Profit and Loss Account) which shows the financial performance of an enterprise during an accounting period;
10
(ii)
Accountancy
Position Statement (Balance Sheet) which shows the financial position of the business at a particular point of time. Now a days as per the International Financial Reporting Standard (IFRS) two more financial statements are to be prepared by the business enterprises, i.e., (a) Cash Flow Statement and (b) Value Added Statement. The traditional financial statements are to be prepared on the basis of trial balance and additional information, if any. Financial statements are the means of conveying to management, present and potential investors, lenders, short term creditors, employees, customers, government and their various agencies, a concise picture of earning capacity and financial soundness of the business.
1.4.1 Preparation Trading Account (without adjustment) Trading account is one of the financial statements prepared on the basis of trial balance to show the results of buying and selling of goods and services during an accounting period. It is prepared to ascertain the Gross Profit/Gross Loss by matching the net sales with the cost of goods sold or services rendered, as the case may be. Gross Profit = Net Sales – Cost of goods sold Net Sales = Gross Sales – Sales Return. Cost of Goods Sold = Net Purchases + Stock at the begining + Direct expenses on purchases – Stock at the end. A Trading Account is prepared by passing of entries to transfer the balances of revenues and expenses accounts to it. These transferring entries so made to close the concerned nominal accounts are called "Closing Entries". A closing entry may be either simple or compound closing entry. A simple closing entry only affects two accounts, i.e., one account is debited and another account is credited with an equal amount. A compound closing entry involves several accounts which are either debited or credited to Trading account.
Financial Statements of Sole Trading Organisations
11
Relevant Items in Trading Account The relevant items of revenue and expense appearing in the trading account are explained below: Items on the debit side : (i)
Opening Stock - This is the amount of goods in hand at the begining of the accounting period. It has been carried forward from the closing stock of the previous year. It remains unchanged during the year and appears on the debit side of the trial balance. It appears on the debit side because it forms a part of the cost of goods sold during the current year. There is no opening stock for a new business. Opening stock consists of raw materials, work-in process and finished goods in case of a manufacturing concern while it is only one item of goods traded by the business, in case of a trading concern.
(ii)
Net Purchase- It includes both cash and credit purchases of goods meant for resale or further processing or production, as the case may be, less purchase returns, if any.
(iii) Direct expenses- These expenses are incurred in order to make goods ready and fit for sale. The various direct expenses are : (a)
Wages (or wages and salaries) : When wages have been incurred on manufacturing the goods or making the goods better saleable, they become direct expenses and are debited to Trading account.
(b)
Carriage/Cartage/Freight- inward : These expenses are incurred to carry the goods from the godown of the supplier to the godwon of the purchaser. If such expenes are incurred in carrying the fixed assets from supplier to purchaser, carriage/cartage should be capitalised and debited to relevant asset account.
(c)
Import duty and Dockdues : When goods are imported from abroad import duty, customs duty and dock charges, etc. have to be paid. These direct expenses are debited to Trading Account.
(d)
Octroi : Sometimes goods are purchased outside the municipal area (local selfgovernment area) which are to be sold within the area of municipality. Octroi
12
Accountancy
duty is to be paid on such goods by the purchaser at the octroi gate. This expense is shown on the debit side of the Trading Account. (e)
Motive Power, Coal, Gas and Water : These direct expenses are shown on the debit side of the Trading Account if Manufacturing Account is not prepared. otherwise these expenses are normally debited to the Manufacturing Account.
(f)
Manufacturing expenses : Expenses incurred in manufacturing the goods in the factory such as factory rent, insurance, depreciation, lighting, are debited to Trading Account if no Manufacturing Account is prepared.
(g)
Consumable stores : Expenses incurred to keep the machineries in ready working conditions are called consumable stores. It includes grease, engine oil, soap, rags, etc., are debited to Trading Account if Manufacturing Account is not prepared.
(h)
Royalty : Royalty is the expense incurred for using patent right, copyright or ownership right of land to their owners. If royalty is paid on the basis of production, it is direct expense and debited to Trading Account when Manufacturing Account is not prepared. When royalty is paid on the basis of sales, it is debited to Profit and Loss Account, being an indirect expense.
(i)
Packaging : Ordinary or primary packaging is one which forms part of the manufacturing expenses. It is a direct expense and debited to Trading Account, when Manufacturing Account is not prepared.
Items on the credit side : (i)
Sales : Sales mean the sale of goods purchased for resale. Sales account on the credit side of Trial Balance shows gross total sales made during the year. It includes both cash and credit sales. Goods returned by customers are called sales return or return inwards and are shown as a deduction from total sales. Gross total sales less return inwards is the net sales. Sale of fixed assets, goods sold on consignment or on hire-purchase or on saleor-return basis, if included in sales, are to excluded and shown separately.
(ii)
Closing stock : It is the unsold goods at the end of the current accounting period. Closing stock is shown usually under adjustment outside the trial balance,
Financial Statements of Sole Trading Organisations
13
it will be credited to the Trading Account and shown on the asset side of Balance Sheet. But when purchases are adjusted (adjusted purchases) through opening and closing stock, it will be shown on the debit column of trial balance. When closing stock is given outside the trial balance, it will be credited to the Trading Account and shown on the asset side of Balance Sheet. But when it is under the debit column of trial balance, it will appear as an asset on Balance Sheet only. Value of the closing stock is always shown at cost or market price which ever is less. Closing Entries Trading Account is prepared by transferring the balances of opening stock, purchases, sales, returns, direct expenses and closing stock to it through a journal entry. The journal entry made to transfer the balances of such accounts to Trading Account is called 'closing entry' The closing entry closes the balances of such accounts in the particular accounting year. The closing entries passed to give effect to such transfers are cited below: (a)
For transferring opening stock, purchases, sales return, wages, carriage inwards and all other direct expenses to Trading Account : Trading Account
Dr.
To Opening Stock A/c To Purchases A/c To Sales Return A/c To Wages A/c To Cariage Inward A/c To All other direct expenses A/c (b)
For transferring sales, purchases returns, closing stock to Trading Account : Sales A/c
Dr.
Purchases Returns A/c
Dr.
Closing Stock A/c
Dr.
To Trading A/c
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14
Sales Returns and Purchases returns A/c are respectively credited and debited in the closing entries in order to close these accounts in the ledger. But in actual practice, sales return is shown as deduction from sales on the credit side of the Trading A/c to arrive at the net sales. Similarly purchases return is shown as deduction from purchases in order to arrive at the net purchases. (i)
For transferring Gross Profit : Trading Account
Dr.
To Profit and Loss Account (ii)
For tranferring gross loss : Profit and Loss Account
Dr.
To Trading Account Typical Proforma of a Trading Account.
Dr.
Trading Account of M/s XYZ for the year ending...... Particulars
To Opening Stock To Purchases : Cash Purchases XXX Credit Purchases XXX Total Purchases Less : Purchase Retruns Abnormal Loss Goods for Personal use Goods as free sample (-) To Wages To Carriage Inward To Other Direct expenses To Gross Profit c/d to P&L A/c
` XXX
XXX XXX XXX XXX XXX XXX
Particulars
Cr. `
By Sales : Cash Sales XXX Credit Sales XXX Total Sales XXX Less : Sales Returns XXX By Closing Stock By Gross Loss c/d to Profit & Loss Account
XXX XXX XXX
XXX XXX XXX XXX
XXX XXX
XXX
Financial Statements of Sole Trading Organisations
15
Illustration 2 From the following balances, prepare the Trading Account for the year ending on 31.12.2016: Opening stock `80,000, cash sales `2,00,000, credit sales `5,00,000, returns outward `6,000, wages and salaries `8,000, carriage inwards `3,000 cartage inward `1,000, cash purchases `1,00,000 credit purchases `2,50,000, returns inward `5,000, closing stock `86,000 whose market value `82,000. Solution : TRADING ACCOUNT for the year ending 31st December, 2016 Dr.
Particulars
` 80,000
To Opening Stock To Purchases : (`) Cash Purchases 1,00,000 Credit Purchase 2,50,000 Total Purchase 3,50,000 Less Returns Outward 6,000 3,44,000 To wages and Salaries 8,000 To Cariage Inwards 3,000 To Cartage Inward 1,000 To Gross profit transferred to P&L A/c 3,41,000 7,77,000
Particulars
`
Cr.
By Sales : ` Cash Sales 2,00,000 Credit Sales 5,00,000 Total Sales 7,00,000 Less Returns Inward 5,000 6,95,000 By Closing Stock 82,000
7,77,000
N.B.:Here gross profit will be transferred to the credit side of Profit and Loss Account, closing stock is to be shown on the asset side of the Balance Sheet. Illustration 3 From the following information, prepare the Trading Account for the year ending 30th June 2016 : Adjusted purchases `10,26,000, Sales `13,95,000, closing stock `87,000, freight and cartage inwards `7,000, wages `3,000, Freight outwards `4,000, octroi `1,000, clearing charges `8,000, Coal, gas and water `11,000, motive power `10,000.
Accountancy
16
Solution: Trading Account for the year ending 30th June 2016 Dr.
Cr. Particulars
To Adjusted Purchase To Freight & Cartage Inward To Wages To Clearing charges To Coal, gas and water To Motive power To Octroi To Gross Profit transferred to P & L A/c
Particulars
` 10,26,000 7,000 3,000 8,000 11,000 10,000 1,000 3,29,000
By Sales
13,95,000
` 13,95,000
13,95,000
Note : (i)
Adjusted Purchases = Net purchases + Opening Stock – Closing stock
(ii)
Opening and closing stock are not shown in the Trading Account separetely as opening stock has been already added to purchases and closing stock has been deducted from purchases for computing adjusted purchases.
(iii) Freight outwards are indirect expenses, hence excluded from being debited to Trading Account. Illustration 4 From the following particulars, you are required to prepare Trading Account for the year ending 30th September 2016: Cost of goods sold
`7,70,000
Sales
`11,28,000
Closing stock
`75,000
Financial Statements of Sole Trading Organisations
17
Solution : Trading Account for the year ending 30th September 2016 Dr.
Cr. Particulars
To Cost Goods sold To Gross Profit transferred to Profit and Loss Account
` 7,70,000
Particulars By Sales
` 11,28,000
3,58,000
11,28,000
11,28,000
1.4.2 Preparation of Profit and Loss Account. (Without adjustment) Profit and Loss Account is one of the income statements showing the financial performance of a business during an accounting period. The aim of preparing Profit and Loss Account is to ascertain the net profit/loss of a business for the year. There are certain items of revenues, expenses and losses of the business to be taken into consideration for preparing profit and loss account. All revenues, both operating and non-operating and all indirect expenses are taken for calculating net profit/loss. Indirect expenses are those expenses which relate to the whole business and are incurred for the purpose of making the goods available to the customers. Broadly, these expenses may be management expenses, legal expenses, financial expenses, selling and distribution expenses, extraordinary expenses, losses, etc. Profit and Loss Account is prepared by taking all the (indirect expenses and losses) nominal accounts from the trial balance. Relevant items in Profit and Loss Account (i)
Gross profit/Loss : Gross profit or Gross Loss is the first item of the Profit and Loss Account which is brought down from Trading Account.
18
(ii)
Accountancy
Salaries : Salaries paid to employees of office, sales and advertising department is an indirect expense and debited to Profit and Loss Account. When net salary is paid after deduction of income tax, employees contribution to provident fund, the gross salary is charged to Profit and Loss Account. Even the employers’ contribution to provident fund is added to salary of the employees. Both employees’ own contribution and contribution of employer to provident fund will be payable to the employees at the time of their retirement. So, these two items of provident fund contribution are to be shown on the liability side of Balance Sheet.
(iii) 'Salaries and wages' / ‘wages and salaries’ : As salary is an indirect expense and wages are included in salary account, such wages are treated as indirect expenses. Hence, ‘salaries and wages’ are debited to Profit and Loss Account and 'wages and salaries' are direct expenses and debited to Trading Account. (iv) Interest : Interest may be received or paid. Interest received being income is credited to Profit and Loss Account and interest paid being an expense is debited to Profit and Loss Account. (v)
Commission : Commission paid to effect sales is an indirect expense and debited to Profit and Loss Account. Commission received from agency services are income of the business and credited to Profit and Loss Account. When commission is paid on purchase of goods being a direct expense is debited to Trading Account.
(vi) Discount : Discount may be either credit or debit. Discount allowed is debit and discount received is credit. Discount allowed on cash sales or on collections from sundry debtors being an indirect expense is debited to Profit and Loss Account. Discount received from sundry creditors at time of early payment to them is credited to Profit and Loss Account. (vii) Apprenticeship premium : It is the fee received from trainees on various trades by the business for providing them skill enhancement and practical oriented training facilities. This, being an income of the business, is credited to Profit and Loss Account.
Financial Statements of Sole Trading Organisations
19
(viii) Printing and stationery: Printing and stationery expenses include ink, pen, pencils, files, registers, bills, vouchers, invoices, letter pads, threads, gums, carbon papers, etc. and are debited to Profit and Loss Account. (ix) Insurance premium : Insurance premium paid on the assets of the office, godown and warehouse, showroom are debited to Profit and Loss Account. But when insurance premium is paid on the assets of factory and production department, it is debited to Trading Account, being a direct expense. (x)
Sales Tax/Goods and Services Tax : Sales tax/Goods and services tax are paid on goods and services sold. It may appear in the trial balance either with a debit balance or with a credit balance. When it shows a debit balance, it is debited to Profit and Loss account. But when it shows a credit balance, it means that Sales Tax/Goods and Services Tax is not paid and remains outstanding. It is to be shown as a current liability in the Balance Sheet.
(xi) Income Tax : Income tax is paid to the Central Government on the profit and gains of a business. It is a personal expense of the proprietor and not debited to Profit and Loss Account. If it appears in the trial balance, it is to be deducted from capital as a drawing of the proprietor in the Balance Sheet. (xii) Depreciation : Depreciation of fixed asset is charged to Profit and Loss account as an indirect notional expense. (xiii) Advertisements : Advertisement charges are debited to Profit and Loss Account. When a lump sum amount is paid to an advertising agency for providing benefits for more than one year, a proportionate amount is charged to Profit and Loss Account for the current accounting period and the balance is to be transferred to Balance Sheet as an asset under the head 'Deferrded Revenue Expenditure'. (xiv) Samples : Free samples are distributed by the business for the purpose of advertisement, hence, debited to Profit and Loss Account. (xv) Stable Expense : Expenses incurred on rearing horses in the stable are treated as indirect expenses, hence debited to Profit and Loss Account.
20
Accountancy
(xvi) Abnormal losses : Loss on sale of fixed assets, misappropriation of cash, goods destroyed by fire not covered under insurance are treated as abnormal losses, hence, debited to Profit and Loss Account. (xviii)Rent, Rates and Taxes : Rent may be paid either for office or for factory or for warehouse. Rates are the cess or taxes paid to the local authority. When rent, rates and taxes are paid for the factory, those are debited to Trading Account. But when such expenses are paid for the office or warehouse, these are to be debited to Profit and Loss Account. Sometimes rent is received on subletting of the building, which is an income of the business and credited to Profit and Loss Account. (xix) Bad debts : The debtors remain uncollected for a long period are to be treated as bad as it is unrecoverable. Hence, it is an indirect expense and debited to Profit and Loss Account. (xx) Life insurance premium :Life insurance premium is a personal expense of the proprietor. If it is paid out of the business cash, it is not to be debited to Profit and Loss Account. It is to be debited to drawings account and deducted from capital in the Balance Sheet. (xxi) Private expenses : Any private expenses of the proprietor, if paid out of business cash, is debited to drawings account and deducted from capital in the Balance Sheet. (xxii)Interest on capital and on drawings : Interest on capital being an expense for the business is charged at a normal rate and debited to profit and loss account. Interest on drawing is charged by the firm to the proprietor. Interest on drawing is a gain to the business and credited to Profit and Loss Account. Interest on capital is added to capital in the Balance Sheet and interest on drawings is added to drawings and shown as a deduction from capital in the Balance Sheet. Closing Entries The entries required to bring down the net profit/loss by transferring the indirect expenses and incomes to Profit and Loss Account, are called closing entries.
Financial Statements of Sole Trading Organisations
21
The purpose of passing closing entry is to close the indirect and direct expenses (nominal accounts) at the end of the accounting period. For a sole trade organisation, Profit and Loss Account is closed by transferring the net profit/ loss to capital account. The closing entries for indirect expenses/incomes are : (a)
To close the accounts of indirect expenses and lossesProfit and Loss Account
Dr.
To various Items of Expenses and Losses Account (individually) (b)
To close the accounts of indirect incomes and gains (other than those shown on the credit side of Trading account)Various Items of Gains and Incomes Account. (Individually)
Dr.
To Profit and Loss Account (c)
To Close the Profit and Loss Account (i) For net profit Profit and Loss Account
Dr.
To Capital Account (ii) For net Loss Capital Account To Profit and Loss Account.
Dr.
22
Accountancy
Typical Proforma of Profit and Loss Account Profit And Loss Account of (M/s ABC Traders) for the year ending on (31st March 2017).... Dr. Particulars Amount Particulars To Gross Loss b/d XXX By Gross Profit b/d To Salaries and Wages XXX By Interest received To Rent, Rate and Taxes XXX By Commission received To Fire Insurance Premium XXX By Rent from subletting To Repairs and Maintenance XXX By Discount received To Depreciation XXX By Apprenticeship Premium To Audit Fees XXX By Dividend received To Bank Charges XXX By Recovery of bad debts To Legal Charges XXX By Sale of old news papers To Cariage, freight outward XXX By Profit on sale of fixed assets To Commission XXX By Interest on drawings To Discount XXX By Profit on sale of short-term To Trade Expenses XXX marketable shares To Advertisements XXX By Sundry receipts To Packaging Expenses (secondary) XXX By Net loss transferred To Bad debts XXX to Capital Account To Printings and Stationeries XXX To Postage and telephone XXX To Bonus to Staff XXX To Office heating, cooling and lighting XXX To Rent of showroom XXX To Free samples XXX To Interest on Loan XXX To Charity, Donations XXX To Loss on sale of fixed assets XXX To Loss of goods by fire/theft XXX To Employees State Insurance (ESI) XXX To Employer's Contribution to Provident fund XXX To Loss by pilferage XXX To Net profit transfered to Capital A/c XXX XXX
Cr. Amount XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
XXX
Financial Statements of Sole Trading Organisations
23
Illustration-4 From the following particulars, prepare Profit and Loss Account for the year ending 31st March 2017 : (`) Gross Profit 1,13,000 Discount allowed 2,000 Discount received 3,000 Salaries and wages 7,000 Wages and salaries 5,000 Carriage inward 2,000 Carriage outward 4,000 Commission allowed 6,000 Commission received 3,000 Interest on loan paid 2,000 Interest received 5,000 Rent paid 10,000 Rent received 8,000 General Expenses 1,000 Freight outward 9,000 Profit on Sale of fixed assets 7,000 Loss by Fire 6,000 Income from Investment 2,000 Miscellaneous expenses 1,000 Trade Expenses 3,000 Bad debts 7,000 Sales promotion expenses 5,000 Loss on sale of fixed assets 2,000 Brokerage allowed 6,000 Repairs and maintenance 1,000 Travelling expenses 3,000 Office heating, cooling and lighting 5,000 Postages and Telephone 3,000 Packaging expenses (Primary) 2,000 Packaging expenses (secondary) 6,000
Bank charges Legal charges Audit fees Entertainment expenses Depreciation on office furniture Depreciation on office machinery Loss by Embezzlement of cash Sundry incomes Apprenticeship premium Sales of old newspapers Fire insurance premium
(`) 2,000 9,000 11,000 7,000 3,000 10,000 1,000 2,000 11,000 1,000 8,000
Accountancy
24
Solution : Profit and Loss Account for the year ending 31st March 2017 Dr. (`) To Discount allowed 2,000 To Salaries and wages 7,000 To Carriage outward 4,000 To Commission Allowed 6,000 To Interest on Loan paid 2,000 To Rent Paid 10,000 To General Expenses 1,000 To Freight Outward 9,000 To Loss by fire 6,000 To Loss by Embezzlement of cash 1,000 To Loss on sale of fixed asset 2,000 To Miscellaneous expenses 1,000 To Trade Expenses 3,000 To Bad debts 7,000 To Sales Promotion Expenses 5,000 To Brokerage allowed 6,000 To Repairs and maintenance 1,000 To Travelling Expenses 3,000 To Office heating, cooling and lighting 5,000 To Postage and Telephone 3,000 To Packaging (secondary) 6,000 To Bank Charges 2,000 To Legal Charges 9,000 To Audit Fees 11,000 To Entertainment Expenses 7,000 To Depreciation : Office Furniture 3,000 Office Machinery 10,000 13,000 To Fire Insurance 8,000 To Net Profit transferred to Capital A/c 16,000 1,56,000
Cr. By Gross Profit b/d By Apprenticeship premium By Income from Investments By Profit on sale of fixed assets By Interest received By Sundry incomes By Sale of old newspapers By Rent received By Discount Received By Commission Received
(` 1,13,000 11,000 2,000 7,000 5,000 3,000 1,000 8,000 3,000 3,000
1,56,000
Financial Statements of Sole Trading Organisations
25
1.4.3 Preparation of Balance Sheet (Without adjustments) Balance Sheet is prepared after the preparation of Profit and Loss Account. It is a statement of financial position of the business on a particular date. It shows assets, external liabilities, capital, reserves and surplus. Balance Sheet is also called the "Position Statement" of a business. It is a statement of the balances of ledger accounts which are carried forward to the next year. The nominal accounts are closed by transferring to Trading Account and Profit and Loss Account. But the personal accounts and real accounts including fictitious assets accounts, not yet written off, are never closed on the last day of the accounting period. These three types of accounts are shown as a statement called Balance Sheet. A Balance Sheet is also called a statement showing the sources and applications of funds. Features of Balance Sheet : The features of a balance sheet are stated as under (a)
Balance Sheet is a ‘statement’, not an ‘account’. It has two sides, i.e., assets and liabilities. It has neither debit side nor credit side, as it is not an account.
(b)
Balance Sheet is prepared and presented on a particular point of time or on a particular date but not over a period of time.
(c)
It is a summary of balances of those ledger accounts which have not been closed by transfer to either Trading Account or Profit and Loss Account.
(d)
Balance Sheet shows the assets and liabilities in a classified manner such as current and fixed assets and liabilities on a particular point of time.
Purpose of Preparing a Balance Sheet : The purpose of preparing a balance sheet is to (i)
ascertain the nature and value of assets of a business on a particular date,
(ii)
ascertain the nature and extent of liabilities of a business on the same date, and
(iii) ascertain the financial solvency of the business. If assets exceed the liabilities,
Accountancy
26
the enterprise is financially sound and solvent. It can pay off the external liabilities on due date. On the other hand, if the liabilities exceed the assets, it is a situation of insolvency and the business cannot pay off the external liabilities fully. Relevant items shown in a Balance Sheet : Following items are generally shown in a balance sheet : (i)
Assets side - The debit balances of personal, real and fictitious assets accounts are not closed after the preparation of Trading Account and Profit and Loss, Accounts. These are to be shown as assets on ‘Assets’ side of the Balance Sheet. Classification of various assets shown in a Balance Sheet is given below: Assets Fixed Assets Current Assets
Tangible Assets : Intangible Assets: Fictitions Assets: Land, Building, Plant, Goodwill, Preliminary Machinery, Furniture, Copyright, Expenses, Fixtures, Wasting assets Patent, Heavy Advertising like mines, quarries etc. Trademark, Expenditure, Profit and Licence etc. Loss Account (Debit Balance), etc. Cash, Bank, Debtors, Stock, Bills receivable, Prepaid Expenses, Income Receivables, etc. Different kinds of assets are described below: a) Fixed assets : The assets are acquired and held permanently with a view to carrying on the business. Such assets are land, building, plant, machinery, furniture, fixtures, mines, quarries, timber yards, etc. Fixed assets collectively are also known as “Block”.
Financial Statements of Sole Trading Organisations
27
b)
Current assets : Current assets are the assets which are likely to be converted into cash within a maximum period of one accounting year. These assets are held in the business in the form of cash or cash equivalents such as bank balances, bills receivable, debtors, stock, etc. Current assets can be realised to discharge the short term liabilities within one accounting period. Adequate current assets prove the short-term solvency of an organisation.
c)
Intangible fixed assets : The assets which can neither be seen nor touched without having physical substance, are called intangible assets. The intangible assets held for use in production or supply of goods and services of a business enterprise for a long period of time, are called intangible fixed assets. Such assets are goodwill, copyright, patent, trademark, licence, etc.
d)
Wasting assets : The fixed assets whose value are gradually reduced or which are physically depleted or exhausted in the course of regular use are called wasting assets. These assets are finally exhausted completely. Mines, quarries, oil wells, etc. come under this category of assets.
e)
Investments : These are assets held by a business for earning income in the form of dividends, interests, rentals, capital appreciation etc. Investments may be made in Shares, Debentures, Bonds, Immovable Properties, etc. When investments are held for a short period, it is a short-term investment and treated as current asset. But when investment is held for a long period with a profit motive, it is a long term investment and treated as fixed asset.
f)
Contingent assets : These assets are not in the immediate possession of the business and hence, not shown in the Balance Sheet. These assets may be acquired and possessed on the happening of an uncertain event in future. For example, claim for damages from the supplier for which the matter is subjudice in the court of law. If the judgement of the court goes in favour of the business enterprise, the claim for damages will be received in the form of a compensation in future. Such assets are shown as footnotes under the Balance Sheet.
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g)
Fictitious assets : Some assets are fictitious in nature and these assets are not virtual assets. These may be past accumulated losses or expenses incurred once in the life time of a business, etc. These losses and expenses are capitalised for the time being. Such assets are profit and loss account debit balance, preliminary expenses, heavy advertising expenditure, etc.
(ii) Liability Side The credit balance of ledger accounts, i.e., personal accounts which are not closed after preparation of Trading Account and Profit and Loss Account, are called liabilities. These are shown in the ‘liabilities’ side of Balance Sheet. A classification of various liabilities shown in a Balance Sheet is given below: Liabilities
Fixed liabilities
Longterm labilities
Current Labilities
Capital
Long Term Loans, Debentures, etc.
Sundry creditors, out standing expenses, Income received in advance, Bills payable, short-term loans, Bank overdrafts, etc.
Liabilities are the claims of owners and outsiders on the assets of a business. The liabilities of a business are to be paid legally as and when they become due. The various liabilities are : a)
Fixed liabilities : The liability of the business is to pay the owner on the closure of the business. The capital invested by him may increase by the amount of profit earned or may decrease by the amount of loss suffered and the amount of drawing either in cash or in kind or in both. The liability of the business to the owner is called ‘capital’ which is payable only after the winding up of the business. This is why it is termed as fixed liability.
Financial Statements of Sole Trading Organisations
29
b)
Long-term liabilities : A long term liability is one which is not payable within one accounting period. It is payable after more than 12 months from the date of a Balance Sheet. Long-term loan from financial institutions, debentures, etc are examples of long-term liability of a business. A long-term liability is also called non-current liability.
c)
Current liabilities : A liability expected to be paid within one accounting period by the business, is called a current liability. Current liabilities are to be settled normally within 12 months from the date of Balance Sheet.Such liabilities are sundry creditors, bills payable, outstanding expenses, bank overdraft, income received in advance, etc.
d)
Contingent Liability : The liability which may or may not arise in future, the occurrence of which depends on the happening of an uncertain event in future, is called a contingent liability. If the uncertain event occurs, the contingent liability becomes a liability, otherwise it is not a liability. As the contingent liability is not a real liability, it is not shown in the Balance Sheet. But it is shown as a footnote under the Balance Sheet.
Marshalling and Grouping of Assets and Liabilities The presentation of groups of assets and liabilities in a Balance Sheet in an orderly manner is called ‘marshalling and grouping’ of assets and liabilities. The assets and liabilities are arranged either in order of liquidity or in order of permanence. Liquidity refers to the early convertibility of a current asset into cash and the urgency of payment of a current liability in cash or near cash. If order of liquidity is followed, Current assets are shown first followed by fixed assets and current liabilities are shown on the top of the Balance Sheet, the long-term liabilities being shown thereafter.
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An example of the balance sheet arranged in order of liquidity, is given below: Balance Sheet of .... as on..... Amount Amount Liabilities Assets Outstanding Expenses Bills Payable Sundry Creditors Bank Overdraft Longterm Loan Capital : Opening Balance XXX Add / Less : Profit/Loss XXX Less : Drawings XXX XXX Total
XXX XXX XXX XXX XXX
Prepaid Expenses Cash in Hand Bills Receivable Debtors Stock Furniture Plant & Machinery Landand Building Goodwill
XXX XXX Total
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
In an order of permanence, the arrangement is reversed. The least liquid assets are shown at the top and the most liquid asset is shown at the bottom of the Balance Sheet. Goodwill is shown at the top, followed by land and buildings, plant and machinery etc, and cash is at the bottom of the Balance Sheet on the assets side. So also the least urgent liabilities for payment remain at the top of the Balance Sheet on the liability side.Capital (Owner’s equity/liability) being least urgent for payment is shown at the top and current liability, outstanding expenses being most urgent for payment are shown at the bottom of the Balance Sheet on the liabilities side. Proforma of Balance Sheet A Balance Sheet may be presented either horizontally or vertically. The horizontal presentation of Balance Sheet is in the form of an ‘account’ In a soletrading and partnership business, the Balance Sheet is presented horizontally or in the “T” shape. It has two sides, i.e., left hand side known as liabilities side and the right hand side known as assets side. Horizontal form of presentation of Balance Sheet is shown as above in page 30.
Financial Statements of Sole Trading Organisations
31
The vertical presentationof a Balance Sheet is in the form of a ‘report’. Under this method of presentation, the items are presented in a “single column statement” in a meaningful sequence. The vertical presentation of Balance Sheet has been made compulsory for the company form of business under the Companies Act 2013. A model vertical form of Balance Sheet is shown below. Vertical Form Balance Sheet............... A.
B.
Particulars Sources of Funds : (a) Proprietor’s Funds Capital in the beginning Add : Net Profit Less : Drawings Less : Income Tax (b) Longterm Loan Application of Funds : (a) Networking Capital (i) Current Assets : Cash in Hand Cash at Bank Bills Receivable Sundry Debtors Stock Prepaid Expenses Income Receivable Less: Current Liabilities Accured Expenses Income received in advance Bank overdraft Sundry Creditors Bills Payable (b) Investments
(` )
(`)
XXX XXX
XXX
XXX XXX XXX XXX
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
XXX
XXX XXX
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(c) Fixed Assets : Goodwill Land and Building Plant and Machinery Patents and Trademark Furniture & Fittings
XXX XXX XXX XXX XXX XXX
Distinction between Trial Balance and Balance Sheet Followings are the points of distinction between Trial Balance and Balance Sheet : Sl No. Basis of Distinction Trial Balance 1.
Format
2.
Contents
3.
Objective
4.
Compulsion
5.
Opening stock
6.
Closing stock
7.
Net Profit/Loss
8.
Use by outsiders
9.
Order of presentation
It has two columns for recording debit and credit balances. It contains real, personal and nominal accounts. Its objective is to check the arithmetical accuracy of the recorded transactions. It is not compulsory to prepare. Opening stock is shown in Trial Balance. Generally, closing stock is not shown in Trial Balance except at the time of ‘adjusted purchase’. It does not give information on net profit/loss. It is of no use to outsiders.
There is no order in the presentation of items in the Trial Balance.
Balance Sheet It has two columns for recording assets and liabilities. It contains only personal and real accounts. Its objective is to ascertain the financial position of the business on a particular date. It is compulsory to prepare. Opening stock is not shown in Balance sheet. Closing stock is always shown on the asset side of Balance Sheet. It gives information on net profit/loss. It is of utmost use to creditors, bankers, tax authorities, etc. There must be an order in the presentationof items in Balance Sheet.
Financial Statements of Sole Trading Organisations
33 Distinction between Trading Account, Profit and Loss Account and Balance Sheet
Trading Profit and Loss Account and Balance Sheet are different from each other on the following points : Sl. Basis Trading, Profit and Balance Sheet No. Loss Account 1. Nature It is an account. It is a statement. 2. Objective It is prepared to It is prepared to ascertain the financial ascertain the financial position performance (gross profit / on a particular date. gross loss and net profit / net loss during an accounting period. 3. Contents All nominal accounts are All personal and real recorded in this account. accounts are recorded in Balance sheet. 4. Period It is prepared for a particular This is prepared on a accounting period. particular date. 5. Balancing It is balanced to show either Balance sheet does not show profit or loss. any balance. Its two sides are tallied. 6. Sides It has two sides, i.e., debit It has also two sides i.e., and credit. assets and liabilities. 7. Manner of All expenses are recorded All real and personal recording on debit side and all incomes accounts with debit balance and revenues are recorded are recorded on the assets on credit side, prefixed by side and only personal “To” and “By” respectively. accounts with credit balances are recorded on the liabilities side without any prefix “To” and “By”. Illustrations 13 From the following Trial Balance, prepare the Trading and Profit and Loss Account of Messrs. Jaga Balia Garments for the year ending 31.03.2017 and Balance Sheet as on that date : (Dr.) (Cr.) ` Particulars ( ) ( `) Opening stock 55,000 -Purchases 3,50,000 --
34
Sales Purchases Return Sales Return Capital Commission Sundry Creditors Bank Overdraft Cash in hand Sundry Debtors Furniture Machinery Carriage on Purchases Wages Rent Bad debts Drawings Stationery Travelling Expenses Insurance Discount Office Expenses
Accountancy
-- 4,26,000 -2,000 2,000 --- 3,00,000 -4,000 -- 1,00,000 -28,000 32,000 -1,40,000 -1,28,000 -60,000 -12,000 -7,000 -10,000 -16,000 -18,000 -6,000 -8,000 -10,000 -3,000 2,000 5,000 -Total 8,62,000 8,62,000 Closing stock as on 31st March 2017 was valued at `64,000. Solution : Trading, Profit and Loss Account of Messers Jaga Balia Garments for the year ending 31st March 2017 Dr. Cr. (`) (`) Particulars Particulars (`) By Sales 4,26,000 To Opening Stock 55,000 Less To Purchases 3,50,000 Sales Return 2,000 4,24,000 Less By Closing Stock 64,000 Purchase return 2,000 3,48,000 To Carriage on Purchases 12,000 To Wages 7,000 To Gross Profit c/d 66,000 4,88,000 4,88,000 66,000 To Rent 10,000 By Gross Profit b/d To Bad debts 16,000 By Commission 4,000
Financial Statements of Sole Trading Organisations
35
To Stationery To Travelling Expenses To Insurance To Discount To Office Expenses To Net Profit transferred to Capital A/c
6,000 By Discount 8,000 10,000 3,000 5,000 14,000 72,000
2,000
72,000
Balance Sheet of Messrs Jaga Balia Garments as on 31 March 2017 Amount Liabilities Assets Current Liabilities : Current Assets : Bank Overdraft 28,000 Cash in Hand Sundry Creditors 1,00,000 Debtors Capital : Closing Stock Opening Balance 3,00,000 Fixed Assets : Add : Funiture Net Profit 14,000 Machinery 3,14,000 Less : Drawings 18,000 2,96,000 4,24,000
Amount
32,000 1,40,000 64,000 1,28,000 60,000
4,24,000
Illustrations 14 From the following Trial Balance of Mr Jayant, Prepare the Trading, Profit and Loss Account for the year ending 31st December 2016 and Balance Sheet as on that date : (Dr.) (Cr.) Particulars (` ( `) Bills Payable -6,600 Sundry Creditors -99,000 Sales -- 6,32,000 Purchases 5,27,000 --
Accountancy
36 Loan from Bank Capital Returns outward Discount Bad debts Recovered Bad debts Fixed Assets Opening stock Sundry Debtors Bills Receivale Investments Cash in Hand Returns Inward Carriage Drawings Duty on Purchases Primary Packing Charges Rent Insurance Office Expenses Interest Bank Loan Delivery Van Expenses Income Tax Goods and Service Tax (GST) Loose Tools Apprentice Premium
Total
-50,000 -- 5,54,000 -5,000 3,000 2,000 -4,500 4,000 -4,50,000 -80,000 -1,50,000 -10,000 -60,000 -5,000 -10,000 -2,000 -19,000 -1,600 -2,000 -3,000 -3,400 -15,200 -2,400 -7,000 -3,000 --5,500 4,000 --3,000 13,61,600 13,61,600
Closing stock was `90,000. Note: (a) Goods and services Tax : Goods Services Tax (GST) is replacing the Value Added Tax (VAT) and Central and State Sales Tax Excise Duty from the Financial year 2017-18. If Goods and Services Tax is collected and paid to the Central and State Government, it is to be shown under the debit column of Trial Balance and will be debited to Profit and Loss Account as an expenses. But when GST is collected and not paid to the Government, it is a liability of the business and shown under the credit column of the Trial Balance and will be shown in the Balance Sheet as a liability. (b) Income Tax - It is a personal expenditure of the proprietor levied by the Central Govt on his personal income. If it is shown in the debit column of Trial Balance, it is treated as drawings of the proprietor and debited to his capital Account, i.e; to be deducted from his capital in the Balance Sheet.
Financial Statements of Sole Trading Organisations
37
Trading, Profit and Loss Account of Mr. Jayant for the year ending 31st December 2016 Amount Liabilities Assets To Opening Stock To Purchases 5,27,000 Less : Returns Outward 5,000 To Duty on Purchases To Carriage To Primary Packing Charges To Gross Profit c/d To Bad debts To Rent To Insurance To Office Expenses To Discount to Interest on Bank Loan To Delivery Van Expenses To Net Profit transferred to Capital A/c
Amount
80,000 By Sales 6,32,000 Less : Returns 5,22,000 Inward 10,000 6,22,000 1,600 By Closing Stock 90,000 2,000 2,000 1,04,400 7,12,000 4,000 3,000 3,400 15,200 3,000 2,400 7,000
By Gross Profit b/d By Discount By Bad debts Recovered By Apprentice Premium
75,900 1,13,900
7,12,000 1,04,400 2,000 4,500 3,000
1,13,900
Balance Sheet of Mr. Jayant as on 31st December 2016 Liabilities Capital : Opening Balance 5,54,000 Add : Net Profit 75,900 Less : Drawings 19,000 Less : Income Tax 3,000 Loans : Loan from Bank Current Liabilities : Bills payable Sundry Creditors Goods and Services Tax
Assets Fixed Assets : Investments : Current Assets : Cash in Hand 6,07,900 Sundry Debtors Bills Receivable 50,000 Loose Tools 6,600 Closing Stock 99,000 5,500 7,69,000 Amount
Amount
4,50,000 60,000 5,000 1,50,000 10,000 4,000 90,000
7,69,000
38
Accountancy
Illustrations 15 From the following Trial Balance of Ruma Textiles, as on 30th September 2016, prepare Trading and Profit and Loss Account for the year ending 30th September 2016 and Balance Sheet as on that date : Particulars Capital Opening Stock Purchases Carriage Inwards Sales Salaries Commission Wages Interest on Investments Creditors Bills Payable Rent and Taxes Repairs Telephone Charges Legal Expenses Cash in Hand Sundry Debtors Machinery Investments Drawings Bank overdraft Miscellaneous Incomes
Dr. (`) -20,000 1,78,000 2,500 -20,000 -8,000 ---3,800 4,000 2,400 2,300 12,000 30,000 50,000 40,000 18,000 --3,91,000
Cr. (`) 1,00,000 ---2,28,000 -13,000 -7,000 28,000 2,300 ---------10,000 2,700 3,91,000
Financial Statements of Sole Trading Organisations
39
Closing stock was valued at `30,000. Solution : Trading and Profit and Loss Account of Ruma Textiles for the year ending 30th September 2016 Dr. Amount(`) Particulars Particulars To Opening Stock 20,000 By Sales To Purchases 1,78,000 By Closing Stock To Carriage Inwards 2,500 To wages 8,000 To Gross Profit c/d 49,500 2,58,000
To Salaries To Rent and Taxes To Repairs To Telephone Charges To Legal Expenses To Net Profit transferred to Capital A/c
20,000 3,800 4,000 2,400 2,300
By Gross Profit b/d By Commission By Interest on Investment By Miscelloneous Incomes
39,700 72,200
Cr. Amount (`) 2,28,000 30,000
2,58,000 49,500 13,000 7,000 2,700
72,200
Balance sheet of Ruma Textiles as on 30th September 2016 Dr. Liabilities Amount Bills Payable 2,300 Creditors 28,000 Bank Overdraft 10,000 Capital : Opening balance 1,00,000 Add : Net Profit 39,700 Less : 1,39,700 Drawings 18,000 1,21,700 1,62,000
Cr. Assets Cash in Hand Sundry Debtors Closing Stock Investments Machinery
Amount 12,000 30,000 30,000 40,000 50,000
1,62,000
40
Accountancy
1.5 PREPARATION OF FINANCIAL STATEMENTS WITH ADJUSTMENTS In the previous section, we learnt about the preparation of simple final accounts without any adjustments. In the absence of any business complexities, simple final accounts can be prepared. But in fact, during the normal business operations, one will come across the complexities as the preparation of final account is based on accrual basis of accounting It is necessary to consider all the incomes and expenses relating to the year for ascertaining true profit or loss and financial position of a business. Revenue recognition concept requirs that the revenue should be recognised in the period in which the sale is deemed to have taken place. Again matching concept requires that expenses should be recognised in the same period in relation to the revenues. Expenses recognition is linked to revenue recognition during a particular accounting period. According to accrual concept of accounting the final accounts are to be prepared by taking into account the incomes earned, not the incomes received in cash and the expenses incurred, not the expenses paid in cash. Adjustments are made in final accounts for all those items which have not been included in the trial balance. It implies that certain expenses of the current period are to be recorded which are incurred but not yet paid; and certain incomes of the current period are to be recorded which are earned but not yet received. The rationale of adjustment in final accounts is that some receipts of incomes and payments of expenses in cash during the current year may partially relate to the previous year or to the next year. Also there may be some revenues and expenses relating to the current year which are still to be brought into the books of account. For example, outstanding expenses (expenses incurred but not paid), accrued incomes (incomes earned but not received), prepaid expenses (expenses paid but partially relate to next year), incomes received in advance (income received in the current year but partially relate to next year), non-cash items like depreciation on fixed assets, interest
Financial Statements of Sole Trading Organisations
41
on capital, interest on drawings), anticipated losses (like provision for bad debts, provision for discount on debtors), anticipated gains (like reserve for discount on creditors), need adjustment in the final account to ascertain true profit/loss and the correct financial position. 1.5.1 Important Adjustments The various adjustments made in final accounts by means of journal entries at the end of the trading period called adjustment entries. The items, which need adjustments, are : (a) Closing Stock (b) Outstanding expenses (c) Prepaid expenses (d) Accrued Income (e) Income received in advance/Unearned income (f) Depreciation (g) Opening stock (h) Interest on Capital (i) Interest on drawings (j) Interest on loan (k) Bad detbts (l) Provision for Bad and Doubtful debts (m) Provision for Discount on Debtors (n) Reserve for Discount on Creditors (o) Loss by accident (Abnormal Loss) (p) Charity in the form of goods
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(q) Distribution of goods as free sample (r) Goods taken by the owner for personal use. (s) Manager’s commission (t) Deferred revenue expenditure (a)
Closing Stock :
Closing stock is the stock which remains unsold at the end of the current accounting period and is carried forward to the next accounting period as opening stock. Closing stock is valued at cost or market price which ever is lower as per the principle of prudence and conservatism concept. In case of manufacturing organisations, closing stock consists of finished products, work-in-progress and raw materials. While, in case of trading organisations, it is only of one type, i.e. the products that is traded in. It is ascertained only at the end of the accounting period and therefore, it is not included in trial balance and shown as an additional information below the trial balance. The following adjustment entry is passed for closing stock : Closing Stock A/c.... Dr. To Trading A/c (Being closing stock transferred to Trading Account) Closing stock is shown on credit side of Trading Account and on the asset side of the Balance Sheet as a current asset. If closing stock is given in the trial balance, no adjusting entry is required to be passed, as it has already been taken into account for computing the amount of Adjusted purchase or cost of goods sold. Closing stock will be shown as a current asset in the Balance Sheet only and not in the Trading Account. Illustration 16 Closing stock on 31st December 2016 amounting `15,000 was shown outside the Trial Balance. Pass an Adjustment entry and show how this will appear in final accounts if accounts are closed on 31st December every year.
Financial Statements of Sole Trading Organisations
43
Solution : Adjustment Entry Particulars
Closing Stock A/c
Dr
To Trading A/c
Dr.
Cr.
`
`
15,000 15,000
(Being closing transferred to Trading A/c) Trading Account for the Year ending 31.12.2016 Dr.
Cr. `
Particulars
Particulars By Closing Stock
` `15,000
Balance Sheet as on 31.12.2016 Liabilities
Amount
Assets
`
Amount `
Current Assets : Closing Stock
15,000
(b) Outstanding Expenses : Outstanding expenses refer to those expenses which are incurred but not paid during the accounting period. The benefit of those expenses have already been derived by the business during the current accounting period. Such expenses must be taken
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44
into the books of account in order to find out the true profit/loss and show the true financial position of the business. Outstanding expenses are normally incurred for salaries, wages, rent and utility expenses like water, electricity, cess, ctc. The following adjustment entry is passed for recording outstanding expenses : (Relevant) Expenses A/c
Dr.
To Outstanding Expenses A/c (Being outstanding expenses brought into books) Accounting Treatment (i)
Treatment in Trading A/c
Added to the relevant expenses i.e. suppose
(If it is a direct expense)
wages on the debit side.
(ii) Treatment in P & L A/c (If it is an indirect expense) (iii) Treatment in Balance Sheet.
Added to the relevant expenses like salary on the debit side. Shown on the liabilities side as a current liabilities.
If any item of outstanding expenses already appears in the Trial Balance, then adjustment entry is not required to be passed. Because these expenses have already been taken into account for recording the amounts. Such outstanding expenses will be shown on the liability side of the Balance Sheet as a current liability and it will never be shown in either Trading Account or Profit and Loss Account (Income Statement). Illustraion 17 Rent paid for 10 months @A5,000 during the year 2016-17. Pass an adjustment entry and show how this will appear in final accounts if books are closed on 31st March every year. Solution : Adjustment Entry Particulars Dr. Cr. ( ` )) ( ` )) Rent A/c Dr 10,000 To Outstanding Rent A/c 10,000 (Being rent not paid for two months)
Financial Statements of Sole Trading Organisations
45
Profit and Loss Account for the year ending 31.03.2017 Dr.
Cr. Particulars To Rent A/c (Paid) 50,000 Add : Outstanding 10,000
(`)
Particulars
(`)
60,000
Balance Sheet as on 31st March 2017 Liabilities Current Liabilities : Outstanding Rent
( `))
Assets
(`)
10,000
(c) Prepaid Expenses : Prepaid expenses refer to those expenses which have been paid in advance but the benefits are not received during the period. These are the expenses paid in advance in the current accounting period, but their benefit will be realised in the next accounting period. The unexpired (prepaid) part of these expenses will be taken over to the next accounting year in order to get the correct amount of profit of the current year and true financial position of the business. The adjustment entry to be passed for recording the prepaid expenses is as follows : Prepaid Expenses A/c Dr To (Relevant) Expenses A/c (Being prepaid expenses brought into books) Accounting Treatment (i) Treatment in Trading A/c Deducted from the relevant Expense (If it is a direct expense) say wages on the debit side. (ii) Treatment in P & L A/c Deducted from relevant expense, i.e., (If it is an indirect expense) Insurance on the debit side. (iii) Treatment in Balance Sheet Shown on the assets side as a current asset.
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46
If any item of prepaid expenses already appears in the Trial Balance then adjustment entry is not required to be passed. Because this expense has already been excluded from the relevant expense. Such prepaid expense will be shown as a current asset in the Balance sheet only and not in the Income Statement. Illustration 18 Salary paid in advance for one month @ A10,000 per month in the year ending 31.12.2016. Pass an adjustment entry and show how this will appear in final accounts. Solution : Adjustment Entry Particulars Prepaid Salary A/c To Salary A/c
Dr. 10,000
Dr.
Cr. 10,000
Profit and Loss Account for the year ending 31st December 2016 Dr.
Cr. Particulars To Salary
(A)
Particulars
(A)
1,30,000
(Paid) Less: Prepaid 10,000
1,20,000
Balance Sheet as on 31st December 2016 Liabilities
(A)
Assets
(A)
Current Assets : Prepaid Salary
10,000
(d) Accrued Income : The income which has been earned during the current year and is due, but has not been received in the current accounting period, is called accrued income. Income like interest on investment, rent receivable, commission, etc. are normally earned, due in a year but received in the following year. Such incomes require adjustment to get a true picture of the financial statements. The treatment of such
Financial Statements of Sole Trading Organisations
47
incomes in accounting is based on the accrual concept. The adjustment entry to be passed for recording the accrued income is as follows : Accrued Income A/c
Dr.
To (Relevant) Income A/c (Being income earned, due but not received yet) Accounting Treatment (i) Treatment in P & L A/c
Accrued Income is added to the relevant income on the credit side.
(ii) Treatment in Balance Sheet
Shown on the assets side as a current asset.
If accrued income appears in the trial balance, then adjustment entry is not required to be passed as these incomes have already been taken into account while recording such income. Such accrued income will be shown as a current asset in Balance sheet and not to be shown in the Income Statement. Illustration 19 An amount of A20,000 received on account rent for the year ending 31st December 2016 @ A2,000 p.m. Pass an adjusting entry and show it in the final accounts. Solution : Adjustment Entry Dr. (A)
Particulars Accrued Rent A/c To Rent receivable A/c (Being rent earned, due but not received yet)
Dr.
Cr. (A)
4,000 4,000
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48
Profit and Loss Account for the year ending 31.12.2016 Dr.
Cr. Particulars
(A)
Particulars (A) By Rent (Received) 20,000 Add : Accrued 4,000 24,000
Balance Sheet as on 31.12.2016 Liabilities (A) Assets Current Assets : Accrued Rent (Receivable)
(e)
(A) 4,000
Income received in Advance/Unearned Income : The income received in advance or unearned income is one which is received but not earned during the current accounting period. It is that part of the Income which has been received before the sale of goods or services rendered. The unearned income relates to the next year or any future year but has been received during the current year. The adjustment entry to be passed for recording the unearned income is: Relevant Income A/c Dr. To Income received in Advance A/c or To Unearned Income A/c (Being Income received in advance recorded) Accounting Treatment (i) Treatment in P& L A/c Deducted from the relevant Income on the credit side. (ii) Treatment in Balance Sheet Shown on the liabilities side as a current liability If unearned income already appears in the Trial Balance, no adjustment entry is required as it has already been deducted from the relevant income. Such accrued income will be shown as a current liability in the Balance Sheet only and not to be shown in the Income Statement.
Financial Statements of Sole Trading Organisations
49
Illustration 20 X & Co. received a rent of A13,000 from his tenant during the year ending 31st March 2017 out of which A1000 belongs to the next year. Pass the necessary adjustment entry and show it in the Income Statement and Balance Sheet. Solution : Adjustment Entry Particulars Dr. (A) Cr. (A) Rent A/c Dr. 1,000 To Unearned Rent A/c 1,000 (Being unearned rent recorded) Profits Loss Account for the year ending 31st March 2017
Dr. Particulars
(A)
Cr.
Particulars
(A)
By Rent Received 13,000 Less : Unearned
1,000
12,000
Balance Sheet as on 31st March 2017 Liabilities
(A)
Assets
(A)
Current Liabilities : Unearned Rent
1,000
(OR Rent Received in Advance) (f) Depreciation : Depreciation is the charge against profit for the use of fixed assets in the business. The value of fixed assets decreases due to wear and tear, passage of time, obsolescence etc. Depreciation is treated as a business expense for income generation like other expenses. The adjustment entry for recording depreciation is : Depreciation A/c To Fixed Assets A/c or To Provision for Depreciation A/c (Being depreciation provided on fixed asset)
Dr.
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50
According Treatment (i) Treatment in P& L A/c
Shown on the debit side like any other expenses.
(ii) Treatment in the Balance Sheet
Shown on the asset side by deduction from the value of relevant fixed asset.
If depreciation already appears in the trial balance, then no adjustment entry is required to be passed as it has already been recorded and deducted from the relevant fixed asset. Only such depreciation will be shown in debit side of the Income Statement and not in the Balance sheet. When fixed assets are to be shown at their original cost in the Balance Sheet, depreciation will not be deducted from the relevant fixed asset. Provision for Depreciation Account will be opened and shown in the liability side of the Balance sheet. Illustration 21 On 1.7.2016 a machinery was purchased at a cost of A1,00,000. Depreciation is to be charged @10% per annum. The books are closed on 31st December 2016. Pass necessary adjustment entry and show in the final accounts. Solution : Adjustment Entry Particulars Dr. Cr. A A Depreciation A/c Dr 5,000 To Machinery A/c 5,000 (Being depreciation provided on machinery) Profit and Loss Account for the year ending 31st December 2016 Dr. Particulars To Depreciation
(A) 5,000
Particulars
Cr. (A)
Financial Statements of Sole Trading Organisations
51
Balance sheet as on 31st December 2016 Liabilities (A) Assets Fixed Assets : Machinery Less : Depreciation
(A) (A)
1,00,000 5,000 95,000
(g) Opening Stock : Opening stock normally appears in trial balance and is debited to Trading Account. In some cases, opening stock appears outside the trial balance as an information and closing stock and Adjusted Purchases account appear in the trial balance simultaneously. It is implied from the situations that the opening stock is added to and closing stock is deducted from the net purchases in order to arrive at the Adjusted Purchases Account. As such opening stock appearing outside trial balance will not be taken for adjustment and it is given for the sake of information. (h) Interest on Capital : The proprietor should charge the interest on capital to profit at a normal rate in order to arrive at the real profit. As a man of prudence, the proprietor should consider the interest on the capital invested by him in the business. Interest on capital of the proprietor is a notional expense and should be charged to profit. The adjustment entry is as follows : Interest on Capital A/c
Dr.
To Capital A/c (Being interest on capital allowed) Accounting Treatment (i)
Treatment in Profit and Loss
Debited to Profit and Loss
Account
Account as an expense of the business.
(ii) Treatment in Balance Sheet
Added to Capital as a gain to the proprietor on the liabilities side.
(i) Interest on Drawings : Sometimes the proprietor withdraws cash or goods from the business for his personal use. Such withdrawals by the proprietor is called
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52
drawings and interest on drawings is charged on the proprietor. It is treated as a notional income of the firm. The adjustment entry is as given below : Drawings A/c
Dr.
To Interest on Drawings A/c Accounting Treatment (i)
Treatment in Profit and Loss Account. Credited to Profit and Loss Account as an income of the firm.
(ii) Treatment in Balance Sheet.
Added to Drawings and deducted from Capital in the liabilities side of Balance Sheet.
Interest on drawings is calculated at a fixed rate from the date of drawings to the end of the accounting period. But practically, all the drawings are made on different dates as and when the proprietor requires money or goods for personal use. That is why, interest is calculated by taking the individual date of drawings by applying the product method. But when the date of drawings are not available for each drawings, interest on total drawings is calculated for 6 months. (j) Interest on Loan : The proprietor borrows money for the purpose of expansion for a long period from outside persons, banks and financial institutions. Loan is a liability of the firm and the interest on such loan is an expense. Normally the interest on such loan remains unpaid at the end of the accounting period, so interest on loan remains outstanding. Sometimes, the firm advances loans to emplolyees and other outside persons. The loan, in these cases, is an asset of the firm and any interest on such loan is treated income of the firm. The adjustment entry for interest on loan (as liability) is as follows : Interest on Loan A/c
Dr.
To Loan A/c (Being interest on loan provided for) The reverse adjustment entry is passed when the firm advances loan as an asset.
Financial Statements of Sole Trading Organisations
53
Accounting Treatment (i)
Treatment in P & L A/c
(ii) Treatment in the Balance sheet
Shown on the debit side of P &L A/c (as an expense) Shown on the credit it side of P&L A/c (as an income) (a) Shown in liabilities side of Balance Sheet as current liability. (b) Shown in the assets side of Balance Sheet as current asset.
Illustration 22 The proprietor S. Das charges interest @6% on his capital of A2,00,000 for the accounting year ending 31.03.2017. Make necessary accounting treatment in the books of S. Das. Adjustment Entry Particulars Dr. Cr. A A Interest on Capital A/c Dr. 12,000 To Capital A/c 12,000 (Being interest on capital provided)
Dr.
Profit and Loss Account for the year ending 31.03.2017 Particulars (A) To Interest on capital A/c 12,000
Particulars
Balance Sheet as on 31st March 2017 Liabilities (A) Assets (A) Capital 2,00,000 Add : Interest on Capital 12,000 2,12,000
Cr. (A)
(A)
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54
Illustration 23 The capital and drawings of a soletrader Mr. A given in his trial balance are A2,00,000 and A10,000 respectively as on 31.12.2016. He decided to charge interest on drawings A600 for the accounting period ending 31.12.2017. Pass necessary adjustment entry, show them in Final Accounts. Solution : Adjustment entry Particulars Drawing A/c To Interest n Drawings A/c (Being Interest charged on drawings)
Dr. A 600
Dr.
Cr. A 600
Profit and Loss Account of Mr. A for the year ending 31.12.2016
Dr. Particulars
(A)
Particulars
Cr. (A)
By Interest on Drawings A/c
600
Balance Sheet of Mr. A as on 31.12.2017 Liabilities
(A)
Assets (A)
(A) Capital
2,00,000
Less : Drawings 10,000 Add: Interest
600 10,600
1,89,400
Illustration 24 A borrowed from his wife A1,00,000 @71/2% interest per annum at the begining of the year ending on 30th June 2017 Show the adjustment entry for the interest on drawing and treatment in final accounts.
Financial Statements of Sole Trading Organisations
55
Solution : Adjustment entry Particulars Interest on Loan A/c To Mrs. A’s Loan A/c (Being Interest on loan provided)
Dr.
Dr. A 7,500
Cr. A 7,500
Profit and Loss Account for the year ending 30.06.2017 Dr.
Cr. Particulars
To Interest on Loan
(A)
Particulars
(A)
7,500 Balance Sheet as on 30.06.2017
Liabilities Mrs. A’s Loan : Add : Interest on Loan
(A)
Assets
(A)
1,00,000 7,500 1,07,500
Illustration 25 From the trial balance of Mr. X, a sole trader as on 30.06.2017, prepare Trading, Profit and Loss Account for the yer ending 30.06.2017 and the Balance sheet as on that date : Trial Balance as on 30.06.2017 Particulars Dr. Cr. A A Opening Stock 70,000 -Capital -- 2,00,000 Drawings 20,000 -Fixed Assets 4,00,000 -Purchases and sales 7,00,000 13,00,000
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Sales Return Purchases Return Carriage Wages Salaries Rent Insurance Audit Fee Debtors and creditors Bills Receivable and Bills Payable Printing & Stationary Commission Cash in Hand Cash at Bank Bank Loan Interest on Bank Loan
15,000 --10,000 28,000 -50,000 -30,000 --20,000 3,000 -1,500 -80,000 1,00,000 60,000 40,000 3,000 --1,000 20,000 -3,38,000 --- 1,50,000 2,500 -18,21,000 18,21,000
Additional Information : 1) Closing stock was A90,000 2) Rent received in advance A2,000 3) Commission due A200. 4) Depreciation to be provided @10% on fixed assets. 5) Interest on Bank Loan outstanding A500 6) Allow 8% interest on capital 7) Charge A2,000 as interest on drawings 8) Wages outstanding A2,000 Solution : Trading and Profit and Loss Account of Mr. X for the year ending 30.06.2016 Dr. Particulars
Amount (A) 70,000
To Opening Stock To Purchases 7,00,000 Less: Purchases Return 10,000 6,90,000
Particulars
By Sales
Cr. Amount (A)
13,00,000
Less: Sales Return
15,000 12,85,000
Financial Statements of Sole Trading Organisations
57 By Closing Stock To Carriage To Wages Add : Wages outstanding To Gross Profit c/d
90,000
28,000 50,000 2,000
52,000 5,35,000 13,75,000 13,75,000 30,000 By Gross Profit b/d 5,35,000 3,000 By Commission 1,000 1,500 Add: Accrued Commission 200 1,200
To Salaries To Insurance To Audit fee To Interest Bank on Loan2,500 Add : Outstanding Interest 500 3,000 By Rent 20,000 To Printing and Stationary 3,000 Less : To Depreciation fixed assets 40,000 Rent received in Advance 2,000 To Interest on Capital 16,000 By Interest on Drawings To Net Profit transferred to Capital A/c 4,59,900 5,56,200 Balance Sheet of Mr. X as on 30.06.2017 Liabilities Amount Assets (A) Capital 2,00,000 Fixed Assets 4,00,000 Less : Add : Interest 16,000 40,000 Depreciation Net Profit 4,59,700 Closing Stock Less : 6,75,700 Accrued Commission Drawings 20,000 Bills Receivable 6,55,700 Debtors Interest on drawings 2,000 6,53,700 Cash at Bank Bank Loan 1,50,000 Cash in Hand Add : Interest outstanding 500 1,50,500
18,000 2,000
5,56,200 Amount (A) 3,60,000 90,000 200 60,000 80,000 3,38,000 20,000
Accountancy
58 Rent Received in Advance Creditors Bills Payable Wages outstanding
2,000
2,000 1,00,000 40,000 2,000 9,48,200
9,48,200
(k) Bad Debts : Finished goods are sold to the customers both in cash and on credit. The customers to whom the goods sold on credit are called debtors. Sometimes the amount due from the customers could not be recovered/realised and becomes bad. The reasons of debts being bad may be death or insolvency of the customers or any other reasons. As such, bad debt is the amount of unrealised debt due from the customers. The adjustment entry for bad debts is as follows : Particulars Dr. Cr. A A Bad debts A/c Dr. 7,500 To Debtors A/c 7,500 (Being bad debts provided for)
Accounting Treatment (i)
Treatment in P & L A/c
(ii) Treatment in the Balance Sheet
Shown on the debit side as a loss Shown on the asset side of the Balance Sheet by way of deduction if bad debt is given outside the Trial Balance. If baddebt is given inside the Trial Balance, it should not be taken to Balance Sheet.
Illustration 26 Out of A50,000 total debtors, A2,000 became bad because of the insolvency of one of the debtors. Pass an adjustment entry and show how this will be treated in final accounts.
Financial Statements of Sole Trading Organisations
59
Solution : Adjustment Entry Dr. A 2,000
Particulars Bad debts A/c To Sundry Debtors A/c (Being bad debts provided for)
Dr.
Cr. A 2,000
P & L A/c for the year ending 31.12.20..... Dr. Particulars To Bad Debts
Amount (A)
Cr. Amount (A)
Particulars
2,000
Balance Sheet as 31.12.20.... Liabilities
Amount (A)
Assets Sundry Debtors Less : Bad Debts
Amount (A) 50,000 2,000
48,000
When bad debts appear in the trial balance, these should not be deducted from sundry debtors in the Balance Sheet. In these cases, bad debts will be debited to Profit and Loss A/c. But when bad debts are given as additional information, then only the bad debt is treated as additional/further bad debt and deducted from sundry debtors in the Balance Sheet and shown in the debit side of Profit and Loss Account. (l) Provision for Bad and Doubtful Debts : Normally, the debtors of the trader are divided into three groups, i.e., good, doubtful and bad. A part of total debtors are good and there is certainty of their realisation, and some debtors are doubtful of their realisation and some other debtors are bad which cannot be realised. After deducting the bad debts from the total debtors, the remaing debtors could not be taken as good debtors. Therefore, a provision for bad and doubtful debts should be made on these
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debtors by means of a predetermined percentage/rate on the net debtors. If some of the net debtors (Total Debtors less bad debts) do not pay the dues in future, then the loss can be recovered from this provision. The adjustment entry for provision for bad and doubtful debt is as follows :
Profit and Loss A/c
Dr.
To Provision for Bad Doubtful Debts A/c (Being provision for bad and doubtful debts created) Accounting Treatment (i)
Treatment in P & L A/c
(ii) Treatment in Balance sheet
Shown on the debit side as a separate item like any other expense/loss. Shown on the Asset side by way of deduction from net debtors.
Illustration 27 An extract of a Trial Balance as on 31.03.2015, show sundry debtors at A52,000 and bad debts at A1,000. Besides it is revealed that after preparation of Trial Balance, a debtor owing A2,000 died and nothing could be recovered from him. It is also decided to create a provision of 5% on debtors for doubtful debts. Pass the necessary journal entries and show the relevant ledger accounts along with final accounts. Solution : Particulars Bad Debts A/c To Sundry Debtors A/c (Being the amount bad now written off)
L.F. Dr.
Dr. A 2,000
Cr. A 2,000
Financial Statements of Sole Trading Organisations
61
Profit an Loss A/c Dr. To Bad Debts A/c (Being transfer of bad debts to P&L A/c) Profit & Loss A/c Dr. To Provision for Bad and doubtful debts A/c (Being the provision created for doubtful debts on {(52,000-2000)×5%} Sundry Debtors A/c
3,000 3,000 2,500
Dr. Particulars
Amount Particulars (A) To Balance b/d 1,000 By profit and loss A/c To Sundry Debtors A/c 2,000 (transferred) 3,000 Provision for Bad and Doubtful Debts Account Dr. Particulars Amount Particulars (A) To Balance c/d 2,500 By profit and loss A/c 2,500 By Balance b/d Dr. Particulars To Bad Debts 1,000 Add: Further Bad Debts 2,000 To Provision for Bad and Doubtful Debt A/c
Profit and Loss Account for the year ending 31.12.2015 Amount Particulars (A)
3,000 2,500
2,500
Cr. Amount (A) 3,000 3,000 Cr. Amount (A) 2,500 2,500 2,500 Cr. Amount (A)
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Liabilities
Balance Sheet as on 31.12.2015 Amount Assets (A) Current Assets : Sundry Debtors 52,000 Less : Further Bad Debts 2,000 Less : 50,000 Provision created 2,500
Amount (A)
47,500 Illustration 28 Following balances have been extracted from the Trial Balance as on 31.12.2016 : Particulars Debit Credit A A Sundry Debtors 52,000 Bad Debts 1,000 Provision for Bad and Doubtful Debts 1,500 Additional Information : (i)
Additional Bad Debts A2,000
(ii) Create a provision for doubtful debts @5% on debtors. Pass the necessary jourbal entries and prepare relevant ledger accounts and show them in final accounts. Solution : Journal Particulars Bad Debts A/c Dr. To Sundry Debtors A/c (Being the additional bad debts written off)
L.F.
Dr. A 2,000
Cr. A 2,000
Financial Statements of Sole Trading Organisations
63
Provision for Bad and Doubtful Debts A/c Dr. To Bad Debts A/c (Being the bad debts transfered to provision for Bad an Dobtful Debts A/c) Profit and Loss A/c Dr. To Provision for Bad and Doubtful Debts A/c (Being the provision for Bad debts credited and charged to P&L A/c)
3,000
4,000
Sundry Debtors A/c
Dr. Particulars To Balance b/d
Amount (A) 52,000
To Balance b/d
52,000 50,000
Particulars To Balance b/d To Sundry Debtors A/c
Dr.
3,000
Particulars By Bad Debts A/c By Balance c/d
Bad Debts A/c Amount Particulars (A) 1,000 By Provision for Bad 2,000 and Doubtful Debts A/c (transferred) 3,000
Provision for Bad and Doubtful Debts Account Particulars
To Bad Debts A/c To Balance c/d 5 {(52,000-2000)× 100 }
Amount (A) 3,000 2,500
Particulars By Balance b/d By Profit and Loss A/c
5,500 By Balance b/d
4,000
Cr. Amount (A) 2,000 50,000 52,000
Amount (A) 3,000 3,000 Cr. Amount (A) 1,500 4,000 5,500 2,500
Accountancy
64
Profit and Loss Account for the year ending 31.12.2016 Dr. Particulars
(A)
Cr. (A)
Particulars
To Provisional for Bad Debts A/c:
Bad Debts Add : Additional Bad debts New provision required
1,000 2,000 2,500
5 } {(5200-2000)× 100
5,500 Less : Existing provision
Liabilities
1,500 4,000 Balance Sheet as on 31.12.2016 (A) Assets
(A)
Current Assets : Sundry Debtors 52,000 Less : Additional Bad Debts 2,000 Less : 50,000 New Provision Required 2,500
(A)
47,500
(m) Provision for Discount on Debtors : Traders usually allow cash discount to those customers who make prompt payment. At the end of a financial year, there may be some credit customers who may make payment in the next financial year. They may be allowed cash discount. Such discount should be treated as a loss for the trader only for the financial year in which sale was effected. Hence, at the end of the year, a provision for discount on debtors account wills be created. Such provision is made only on good debtors only. The adjustment entry is given as below :
Financial Statements of Sole Trading Organisations
65
Profit and Loss A/c Dr To Provision for Discount on Debtors A/c (Being provision for Discount on Debtors created) Accounting Treatment (i) Treatment in P & L A/c Shown on the debit side as a separate item. (ii) Treatment in the Balance Sheet
Shown on the Assets side by way of deduction from Sundry Debtors after deduction of further bad debt and new provision created.
Illustration 29 From the extracts of a Trial Balance as on 31.03.2016 as given below, you are required to pass the necessary journal entries and show the treatment in relevant accounts and in the final accounts : Particulars Dr. Cr. A A Sundry Debtors 1,06,500 Bad Debts 2,000 Discount 1,000 Provision for Bad and Doubtful Debts A/c 1,500 Additional Information: (a)
Create a provision for bad and doubtful debts @5% on debtors
(b)
A further bad debt of A6,500 to be written off.
(c)
Create a provision on for Discount on Debtors @2% on debtors.
Solution: Journal Particulars Bad Debts A/c To Sundry Debtors A/c (Being further bad debts written off)
L.F. Dr.
Dr. A 6,500
Cr. A 6,500
Accountancy
66
Provision for Bad and Doubtful Debts A/c
. Dr.
8,500
To Bad Debts A/c
8,500
(Being bad debts transferred to provision for Bad and doubtful debts A/c) Profit and Loss A/c
Dr.
12,000
To Provision for Bad and Doubtful Debts A/c
12,000
(Being the provision for Bad and Doubtful Debts created) Profit and Loss A/c Dr. To Provision for Discount on Debtors A/c (Being the Provision for Discount on Debtors created) i,e., 95,000×2%=1900
1,900 1,900
Sundry Debtors A/c
Dr. Particulars To balance b/d
To balance b/d
Dr. Particulars To Balance b/d To Sundry Debtors
(A) 1,06,500
Cr.
Particulars By Bad debts A/c By Balance c/d
1,06,500 1,00,000
8,500
6,500 1,00,000 1,06,500
Bad Debts A/c (A) 2,000 6,500
(A)
Cr. Particulars
By Provision for Bad Debts A/c
(A) 8,500
8,500
Financial Statements of Sole Trading Organisations
67
Provision for Bad and Doubtful Debts A/c Dr.
Cr. Particulars
(A)
To Bad Debts A/c To Balance c/d (1,00,000×5%)
8,500 5,000
Particulars By Balance b/d By Profit and Loos A/c
13,500
(A) 1,500 12,000
13,500
Discount (Allowed) A/c Dr.
Cr. Particulars
(A)
To Balance b/d
1,000
Particulars By Profit and Loss A/c
1,000
(A) 1,000
1,000
Provision for Discount on Debtors A/c Dr.
Cr. Particulars
(A)
To Balance c/d {(1,06,500 – 6,500–5,000)×
1,900
Particulars By Profit and Loss A/c
1,900
By Balance b/d
1,900 1,900
2 } 100
1,900
Dr.
(A)
Profit and Loss Account for the year ending 31.03.2016 Particulars
(A)
To Provision for Bad and Doubtful Debts A/c Bad Debts 2,000 Add : Further Bad Debts 6,500 New Provision required 5,000 Less 13,500 Old Provision 1,500 12,000
Particulars
Cr. (A)
Accountancy
68
Profit & Loss A/c (continued) Dr.
Cr. Particulars
To Discount To Provision for Discount on Debtors A/c
(A)
Particulars
(A)
1,000 1,900
Balance Sheet as on 31.03.2016 Dr.
Cr. Liabilities
(A)
Assets Current Assets : Sundry Debtors 1,06,500 Less : Further Bad Debt 6,500 1,00,000 Less Provision for Bad Debts @5% 5,000 on 1,00,000. 95,000 Less : Provision for Discount 1,900 on Debtors (@2% onA95,000)
(A)
93,100
(n) Reserve for Discount on Creditors : A trader also expects to receive discount from his creditors by making early payment. So he creates a provision/reserve for discount on creditors. If he pays off the creditors before the agreed date, he may receive some discount which is an income for him. The Provision for Discount on Creditors is popularly named as Reserve for Discount on Creditors as it is an income of the business. The adjustment enty is as given below : Reserve for Discount on Creditors A/c To Profit and Loss A/c (Being a reserve created on Sundry Creditors)
Dr.
Financial Statements of Sole Trading Organisations
69
Accounting Treatment (i)
Treatment in P & L A/c
(ii) Treatment in Balance Sheet
Shown on the credit side as a separate item of income. Shown on the Liabilities side as a deduction from Sundry Creditors.
Illustration 30 On 01.01.2013, a provision for Doubtful Debts showed a credit balance of A7,200. During the year, the bad debts amounted to A5,600. The debtors on 31.12.2013 amounted to A1,92,000 and a provision of 5% for Doubtful Debts was to be maintained. In 2014, the bad debts amounted to A2,400 and the debtors at the end of the year amounted to A80,000 on which a provision of 5% for Doubtful Debts was to to be maintained. Make journal entries and prepare the provision for Doubtful Debts Account. Also show the items in Profit and Loss Account and Balance Sheet for the periods. Solution : Journal Entries Particulars 2013 Bad Debts A/c Dr. Dec,31 To Sundry Debtors A/c (Being the additional bad debts written off) Provision for Doubtful Debt A/c Dr. To Bad Debts A/c (Being the transferd of Bad Debts to Provision for Doubtful Debt A/c) Profit and Loss A/c Dr. To Provision for Doubtful Debts A/c (Being the provision created and charged to P&L A/c)
L.F.
Dr. A 5,600
Cr. A 5,600
5,600 5,600
8,000 8,000
Accountancy
70
2014 Bad Debts A/c Dec,31 To Sundry Debtors (Being debts written off) Provision for Doubtful Debts A/c To Bad Debts A/c (Being Bad debts transferred to Provision for Doubtful Debts A/c) Provision for Doubtful Debts A/c To Profit and Loss A/c (Being excess provision credited to P&L A/c)
Dr.
2,400 2,400
Dr.
2,400 2,400
Dr.
3,200 3,200
Provision for Doubtful Debts A/c Dr. Date
Particulars
31.12.2013 To Bad Debts A/c To Balance c/d (1,92,000×5%)
(A) 5,600
9,600 15,200 31.12.2014 To Bad Debts A/c 2,400 To Profit and Loss A/c 3,200 (Balancing figure) To Balance c/d (80,000×5%) 4,000 9,600
Date
Particulars
1.1.2013 By Balance b/d 31.12.2013 By Profit and Loss A/c (Balancing figure) 1.1.14
By Balance b/d
Cr (A) 7,200 8,000 15,200 9,600
9,600
Profit and Loss A/c for the year ended 31.12.13 and 31.12.14 Dr. Particulars 2013 : To Provision for Doubtful Debts A/c : Bad Debts
(A)
5,600
Particulars
Cr. (A)
Financial Statements of Sole Trading Organisations
71
And New provision required Less Old Provision
9,600 15,200 8,000 7,200 2014 By Provision for Doubtful Debts A/c
Old Provision Less Bad Debts Less New Provision required
9,600 2,400 7,200 4,000 3,200
Balance Sheet as on 31.12.2013 and 31.12.2014 Dr.
Cr. Liabilities
(A)
Assets
(A)
2013 Sund Debtors 1,92,000 Less Provision for Doubtful Debts 9,600 1,82,400 2014 Sundry Debtors 80,000 Less Provision for Doubtful Debts 4,000 76,000 Illustration 31 Mr. A maintained reserve for Discount @4% on creditors which on 1st January 2013 was A4,000. His balances on 31.12.2013 and 2014 were as given below :
Discount Received Sundry Creditors
31.12.2013
31.12.2014
(A)
(A)
3,000
300
50,000
40,000
Show the necessary ledger accounts and show how the items would appear in the final accounts of 2013 and 2014.
Accountancy
72
Solution : Dr. Date
Discount (Received) A/c Particulars
(A)
Date
31.12.2013 To Reserve for 31.12.2013 Discount on Creditors A/c 3,000 3,000 31.12.2014 To Reserve for Discount 31.12.2014 on Creditors A/c 500
Dr.
Particulars
Cr. (A)
By Sundry Creditors A/c
3,000
By Sundry Creditors A/c
3,000 300
Reserve for Discount on Creditors A/c (A)
Cr. (A)
31.12.2013 To Balance b/d 4,000 31.12.2013 By Discount Received A/c 3,000 To Profit and Loss A/c 1,000 By Balance c/d 2,000 (Balancing figure) 5,000 (50,000×4%) 5,000 31.12.2014 To Balance b/d
2,000 31.12.2014
2,000
By Discount Received A/c 300 By Profit and Loss A/c 100 (Balancing figure) By Balance c/d 1,600 (40,000×4%) 2,000
(o) Abnormal Loss (Accidental Loss) : Losses of goods and assets may occur due to accident, natural calamity, fire, theft, pilferage, leakage, spoilage, etc. The cost of such stock or asset lost is abnormal loss. The abnormal loss of stock or asset is an avoidable loss. The adjustment entries for abnormal loss of stock is as follows : (i)
When goods are lost due to accident Loss by Accident A/c To Trading A/c (Being goods destroyed in accident)
Dr.
Financial Statements of Sole Trading Organisations
73
(ii) If goods are not insured Profit and Loss A/c Dr. To Loss by Accident A/c (Being loss of goods charged to P&L A/c (iii) If goods are fully insured Insurance claim A/c Dr. To Loss by Accident A/c (Being amount due from Insurer) (iv) When goods are partially insured Profit and Loss A/c Dr. Insurance Claim A/c Dr. To Loss by Accident A/c (Being claim received from insurer and balance transferred P&L A/c as a loss) Accounting Treatment (i)
Treatment in Trading A/c
The value of abnormal loss is credited
(ii) Treatment in Profit & Loss A/c
The cost of goods if not insured, all or partially uncovered is debited
(iii) Treatment in Balance Sheet
If goods are insured fully or partly, the claim amount received from the insurer is shown as Insurance claim. When some fixed asset is lost in accident, this abnormal loss is reflected only in Profit and Loss Account and Balance Sheet. The Adjustment entries for such loss is : Loss by Accident A/c Dr. To Fixed Asset A/c (Being the asset lost in accident)
Accountancy
74
Accounting Treatment (i) Treatment in P&L A/c The amount of abnormal loss for the fixed asset is debited. (ii) Treatment in Balance sheet The amount of such abnormal loss is deducted from the fixed asset. Illustration 32 Goods lost in transit during the year ending 31.12.2016 of M/s T Krishna Patra & Sons worth A2,00,000. Give the adjustment entries and accounting treatment in final accounts (a) If goods were not insured. (b) If the goods were fully insured. (c) If the goods were partially insured (70%). Solution : (a) If goods were not insured Adjustment Entry Date Particulars L.F. Dr.(A) Cr. (A) 31.12.2016 Loss in Transit A/c Dr. 2,00,000 To Trading A/c 2,00,000 (Being goods lost in transit) Trading Account of M/s. T. Krishna Patro & Sons for the year ending 31.12.2016 Dr. Cr. Particulars (A) (A) By Loss in Transit A/c
Dr.
Profit and Loss A/c of M/s T. Krishna Patro & Sons for the year ending 31.12.2016 Particulars (A) Particulars
To Loss in Transit A/c
2,00,000
2,00,000
Cr. (A)
Financial Statements of Sole Trading Organisations
75
(b) If goods were fully insured. Adjustment Entry Date Particulars Loss in Transit A/c Dr. To Trading A/c (Being goods lost in transit) Insurance Claim A/c To Loss in Transit A/c (Being claim accepted fully by Insuer)
L.F.
Dr.(A) 2,00,000
2,00,000 2,00,000 2,00,000
Balance sheet of M/S T. Krishna Patra & Sons as on 31.12.2016 Liabilities (A) Assets Insurance Claim (c) If goods were Partially (70%) Insured : Adjustment Entry Date Particulars 31.12.16 Loss in Transit A/c Dr. To Trading A/c (Being goods lost in transit) Insurance Claim A/c Dr. To Loss in Transit A/c (Being 70% of loss claimed was accepted) Dr.
L.F.
Dr. (A) 2,00,000
1,40,000
Profit & Loss Account of M/s T. Krishna Patro for the year ending 31.12.2016 Particulars (A) Particulars 60,000
Cr. (A)
1,40,000
Trading Account of M/s. T. Krishna Patro & Sons for the year ending 31.12.2016 Particulars (A)
To Loss in Transit A/c (2,00,000-1,40,000)
(A) 2,00,000
2,00,000
By Loss in Transit A/c
Dr.
Cr. (A)
Cr. (A) 2,00,000
Cr. (A)
Accountancy
76
Balance Sheet of M/s T. Krishna Patro & Sons as on 31.12.2016 Liabilities (A) Assets Insurance Claim (70% of 2,00,000)
(A) 1,40,000
(p) Charity (in the form of Goods) : Sometimes, the businessman gives some goods as charity from his stock. It is taken as an expense of the business. The adjustment entry is as follows: Charity A/c
Dr.
To Purchases A/c (Being goods issued as charity) Accounting Treatment (i)
Treatment in Trading A/c
(ii) Treatment Profit and Loss A/c
Shown as a deduction from total purchases Shown as an expense on the debit side
(q) Distribution of goods as free samples : The trader distributes goods as free sample for the sake of advertisement. The free samples are taken as a business expense. It reduces the stock position of the trader. The adjustment entry for distributing goods as free sample is as follows : Advertisement A/c
Dr.
or Free samples A/c
Dr.
To Purchases A/c (Being the goods distribuded as free sample for advertisement) Accounting Treatment (i)
Treatment in Trading A/c
(ii) Treatment Profit and Loss A/c
Shown as a deduction from total purchases Shown as an expense on the debit side
Financial Statements of Sole Trading Organisations
77
(r)
Goods taken by the owner for personal use :
Sometimes the trader takes away goods from the business for personal use. It is called drawing of goods by the owner / trader. The adjutment entry for this is given below Drawings A/c Dr. To Purchases A/c (Being goods withdrawn for personal use) Accounting Treatment (i) Treatment in Trading Account Shown as a deduction from total purchases. (ii) Treatment in Balance sheet Deducted from Capital Account as Drawings for Goods. Further sometimes cash is withdrawn by the trader for paying off personal expenses. The adjustment entries for withdrawing cash for private use is as follows : Adjustment Entry (i) Drawings A/c Dr. To Cash/Bank A/c (Being drawings made in cash) (ii) Capital A/c Dr. To Drawings A/c (Being drawings adjusted in Capital) Accounting Treatment (i) Treatment in Balance Sheet Deducted (i) from relevant Cash/Bank A/c and also (ii) from Capital Account. If Income Tax or Life Insurance Premium is paid out of the business cash, the adjustment entries are : Adjustment Entry (i) Income Tax/Life Insuracne Premium A/c Dr. To Cash/Bank A/c (Being Income Tax/Life Insurance Premium Paid)
Accountancy
78
(ii) Drawings A/c To Income Tax/Life Insurance Premium A/c (Being income tax / life insurance premium transfered to Drawings A/c) (iii) Drawings A/c
Dr.
Dr.
To Capital A/c (Being Capital A/c is reduced by Drawings amount) The accounting treatment of income tax / life insurance premium paid out of the business cash is like that of the withdrawings of cash by the trader to pay off his personal expenses. Illustration 33 From the following extracts from Trial Balance of M/s X & Co. as on 31.03.2017, you are required to give adjustment entries and also show the treatment in final accounts : Dr. A 2,00,000 10,000 1,500
Purchases Advertisement Charity
Cr. A ----
Adjustments (i) Goods worth A2,000 distributed as free samples; (ii) Goods worth A800 were given as charity. Solution : Date Advertisement A/c Charity A/c
Particulars
L.F. Dr.(A) Dr. Dr.
To Purchases A/c (Being goods issued as free samples and charity)
Cr. (A)
2,000 800 2,800
Financial Statements of Sole Trading Organisations
79
Trading Account of M/s X & Co. Dr.
for the year ending 31.03.2017 Particulars
(A)
Particulars
Cr. (A)
To Purchases 2,00,000 Less : Free Samples - 2,000 Charity -
800 2,800 1,97,200 Profit and Loss Account of M/s X & Co.
Dr.
for the year ending 31.03.2017 Particulars
To Advertisement
(A) 10,000
Add : Free Samples To Charity
2,000
12,000
1,500
Add : Charity of goods 800 2,300
Particular
Cr. (A)
Accountancy
80
(s)
Manager’s Commission :
Sometimes, the manager is allowed commission on profits earned by the trader. The commission is allowed on the basis of the service conditions and job profile. The commission is calculated as a percentage of profit either before charging such commission or after charging such commission. If commission is payable at fixed percentage on net profit before charging such commission, then : Manager’s Commission % of commission Net profit before charging such commission 100
If commission is payable on net profit after charging such commission, then Manager’s Commission
% of commission Net profit before charging such commission (100 + % Commission)
The adjustment entry for Manager’s Commission is as follows : Manager’s Commission A/c Dr. To Outstanding Commission A/c (Being Manger’s commission remains outstanding) Accounting Treatment (i)
Treatment in P&L A/c
(ii) Treatment in the Balance Sheet (t)
Shown on the debit side as a separate item of expense. Shown on the liabilities side as a current liability.
Deferred Revenue Expenditure :
There are some expenditures of a trader which is revenue in nature but gives benefit to the business for a long period. For example, a heavy expenditure incurred in launching a new product will give benefit to the trader for more than one year. Such a revenue expenditure is partially revenue and partially capital in nature. This revenue expenditure is of specialised in nature and called Deferred Revenue Expenditure. The adjustment entry for deferred revenue expenditure is :
Financial Statements of Sole Trading Organisations
81
Profit and Loss Account
Dr
To Relevant Expense A/c (Being a part of the relevant expense written off) Accounting Treatment (i)
Treatment in P&L A/c
A part of the relevant expenses say ( 18 th) is written off and shown on the debit side as a revenue expense. Remaining part of the relevant expenses, (say 1- 18 th) 78 th is shown as an asset under the heading Deferred Revenue Expenditure.
(ii) Treatment in the Balance Sheet
Illustration 34 On 31st December 2015, goods costing A5,000 were taken by the proprietor for his private use for which no record was made. Purchases were A1,00,000 and capital A2,00,000. Pass the adjusting entry and show the accounting treatment for drawings in final accounts for the year ending 31.12.2015. Solution : Adjustment Entry Particulars Dr.
Drawings A/c To Purchases A/c (Being the goods withdrawn for private use)
Dr.
L.F. Dr.( A) 5,000
5,000
Trading Account for the year ending 31.12.2015 Particulars To Purchases 1,00,000
(A)
Less : Goods taken for private use 5,000
95,000
Cr. (A)
Particulars
Cr. (A)
Accountancy
82
Liabilities
Balance Sheet as on 31.12.2015 ( `) Assets
(`)
Capital : Opening Balance 2,00,000 Less : Drawings for goods 5,000 1,95,000 Illustration 35 The net profits of M/s AB & Co. for the year ending 31.03.2017 are `2,10,000 before charging any commission. The manager is allowed a commission of 5% on the net profits (i) before/ (ii) after charging such commission. Calculate the commission payable to the manager and also show it in Final Accounts of the year. Solution : (i) Manager’s commission before charging such commisson. Commission = Net profit × = `2,10,000 ×
Rate of Commission 100
5 100
= `10,500 (ii) Manager’s commission after charging such commission. Commission = Net profit × = `2,10,000 ×
Rate of Commission 100 + Rate of Commission
5 = A10,000 105
Financial Statements of Sole Trading Organisations
83
(i) Profit and Loss Account Dr. for the year ending 31.03.2017 Particulars ( `) Particulars To Manager’s Commission 10,500
Balance Sheet as on 31.03.2017 ( `) Assets
(`)
Liabilities Current Liabilities : Manager’s Commission Due 10,500 (ii)
Cr. ( `)
Profit and Loss Account for the year ending 31.03.2017
Dr. Particulars To Manager’s Commission
( `) 10,000
Particulars
Balance Sheet as on 31.03.2017 ( `) Assets
Cr. ( `)
(`)
Liabilities Current Liabilities : Manager’s Commission Due 10,000 Illustration 36
From the “following trial balance of Ajay as on 31.12.2016, prepare the final accounts : Particulars Cash in Hand
Dr.
Cr.
(`) 3,200
(`) --
Accountancy
84
Cash at Bank Purchases Purchases Return General Expenses Insurance Capital Debtors and creditors Sales Sales return Wages Fuel and Power Cariage on sales Cariage Inwards Stock on 01.01.2016 Building and Land Machinery Salaries Trademark
10,600 -2,62,500 --2,000 10,000 -3,600 --- 3,50,000 60,000 48,000 -- 5,00,500 4,500 -45,200 -5,700 -5,100 -2,600 -40,000 -3,00,000 -1,00,000 -12,500 -35,000 -9,00,500 9,00,500
Adjustments : (a) Closing stock amounted to `85,000. (b) Salaries Outstanding `2,500. (c) Insurance prepaid for the next years `1,200. (d) Depreciate Building & Land by 5% and Machinery by 10%. Solution : Trading A/c, Profit & Loss A/c of Ajay for the year ending 21.12.2016 Dr Particulars ( `) Particulars To Opening Stock To Purchases 2,62,500 Less : Returns 2,000 To wages
40,000 2,60,500 45,200
Cr. ( `)
By Sales 5,00,500 Less : Sales Return 4,500 4,96,000 By Closing Stock 85,000
Financial Statements of Sole Trading Organisations
85
To Fuel and Power To Carriage Inwards To Gross Profit c/d To General Expenses To Insurance 3,600 Less : Prepaid 1,200 To Carriage on Sales To Salaries 12,500 Add : Outstanding 2,500 To Depreciation :
5,700 2,600 2,27,000 5,81,000 10,000
By Gross Profit b/d
5,81,000 2,27,000
2,400 5,100
15,000
On Building and Land 15,000
On Machinery 10,000 25,000 To Net profit transferred to Capital A/c 1,69,500 2,27,000
2,27,000
Balance Sheet of Ajay as on 31.02.2016 Assets ( `) Liabilities ( `) Outstanding Salaries 2,500 Cash in Hand 3,200 Creditors 48,000 Cash at Bank 10,600 Capital : Debtors 60,000 Opening Balance 3,50,000 Closing Stock 85,000 Add : Prepaid Insurance 1,200 Net Profit 1,69,500 Machinery 1,00,000 5,19,500 Less : Depreciation 10,000 90,000 Building & Land 3,00,000 Less : Depreciation 15,000 2,85,000 Trademark 35,000 5,70,000 5,70,000
86
Accountancy
Illustration 37 From the following trial balance of M/s Raj Traders, prepare Trading and Profit and Loss Account for the year ending 31.03.2017 and the Balance Sheet as on that date : Name of Accounts Dr. Cr. Opening Stock 30,000 Purchases 2,70,000 Sales Return 7,000 Cariage Inward 2,000 Plant and Machinery 1,00,000 Furniture & Fixturess 60,000 Freehold Property 50,000 Cash in Hand 6,000 Carriage Outwards 1,000 Wages 33,000 Salaries 20,000 Lighting-factory 2,000 Sundry Debtors 30,000 Travelling Expenses 2,500 Rent & Taxes 5,000 Drawings 6,000 Insurance 2,000 Capital 1,50,000 Sales 4,00,000 Purchases Return 6,500 Sundry Creditors 40,000 Bills payble 20,000 Commission 10,000 6,26,500 6,26,500 Adjustments : (a)
Stock on 31.03.2017 was valued at `40,00,000 (market price `35,000)
(b)
Wages `2,000 were outstanding.
(c)
Commission received in advance `3,000.
Financial Statements of Sole Trading Organisations
87
(d) Provide depreciation on plant and machinery at 5% and on furniture and fixtures at 10%. Solution : Trading and Profit and Loss Account of M/s Raj Traders for the year ending 31.03.2017 Dr
Cr. ( `)
Particulars To Opening Stock To Purchases Less : Returns
30,000 2,70,000 6,500
( `)
Particulars By Sales Less : Returns By Closing stock
4,00,000 7,000 3,93,000 35,000
2,63,500 To Wages Add : Outstanding Wages To Carriage Inward To Factory Lighting To Gross Profit c/d
33,000 2,000
To Salaries 20,000 To Travelling Expenses To Carriage Outwords To Rent & Taxes To Insurance To Depreciation : Plant and Machinery 5,000 Furntiture and Fixture 6,000 To Net profit transferrred to Capital A/c
35,000 2,000 2,000 95,500 4,28,000 2,500 1,000 5,000 2,000
By Gross profit b/d By Commission Less : Received in Advance
4,28,000 95,500 10,000 3,000
7,000
11,000 61,000 1,02,500
1,02,500
Accountancy
88
Balance Sheet of M/S Raj Traders as on 31.03.2017 ( `)
Liabilities Outstanding wages
( `)
Assets
2,000 Cash in Hand
6,000
Bills Payable
20,000 Sundry Debtors
30,000
Sundry Creditors
40,000 Closing Stock
35,000
Commission Received in Advance
3,000 Furnitures Fixture
Capital :
60,000
Less:Depreciation 6,000
Opening Balance1,50,000
Plant and Machinery 1,00,000
Add : Net Profit 61,000
Less:
2,11,000
Depreciation
Less : Drawings
54,000
Freehold Property
5,000
95,000 50,000
6,000 2,05,000 2,70,000
2,70,000
Illustration 38 From the following Trial balance of Sri Ganpati Ram, prepare the final accounts for the year ending 31.12.2016 and the Balance Sheet on that date : Trial Balance Ledger Accounts Dr. (`) Cr.(`) Capital -5,00,000 Drawing 35,000 -Plant and Machinery 2,50,000 -Land and Building 3,00,000 -Patents 1,50,000 -Purchases & Sales 7,50,000 13,00,000 Return Inward/Outward 15,000 14,000 Carriage 28,000 -Wages 60,000 -Salaries 40,000 -Rent received -35,000 Insurance 2,500 --
Financial Statements of Sole Trading Organisations
89
Audit Fees Debtors and Creditors Printing and Stationery Opening Stock Cash in Hand
6,000 80,000 9,000 1,50,000 13,500 18,89,000
-40,000
18,89,000
Adjustments : 1. Closing stock was `95,000. 2. Accrued Rent `7,500 3. Insurance paid in advance `500 4. Allow 10% interest on capital and charge `2,000 on drawings. 5. Provide 5% depreciation on plant and machinery and 10% on patents. Solution : Trading and Profit and Loss Account of Sri Ganpati Ram for the year ending 31.12.2016. Dr. Particulars ( `) Particulars To Opening Stock To Purchases Less : Returns
7,50,000 14,000
To Carriage To Wages To Gross profit c/d To Salaries To Insurance 2,500 Less : Prepaid 500 To Audit fees To Printing and Stationery To Interest on Capital
Cr. ( `)
1,50,000 By Sales 13,00,000 Less: Returns Inward 15,000 12,85,000 By Closing stock 95,000 7,36,000 28,000 60,000 4,06,000 13,80,000 13,80,000 40,000 By Gross profit b/d 4,06,000 By Rent Received 35,000 2,000 Add : 6,000 Accrued Rent 7,500 42,500 9,000 By Interest on Drawings 2,000 50,000
Accountancy
90
To Depreciation : Plants machinery 12,500 Patents 15,000 To Net profit transferred to Capital A/c
27,500 3,16,000 4,50,500
4,50,500
Balance Sheet of Sri Ganpati Ram as on 31.12.2016 Liabilities
( `)
Capital 5,00,000 Add : Interest on Capital 50,000 Net profit 3,16,000 8,66,000 Less : Drawings 35,000 8,31,000 Less : Interest on Drawings 2,000 8,29,000 Creditors 40,000 8,69,000
Assets
( `)
Land and Building 3,00,000 Plant and Machinery 2,50,000 Less:Depreciation 12,500 2,37,500 Patents 1,50,000 Less : Depreciation 15,000 1,35,000 Closing stock 95,000 Debtors 80,000 Cash in Hand 13,500 Accrued Rent 7,500 Prepaid Insurance 500 8,69,000
Illustration 39 From the following Trial balance of Mr. Bohidar on 31.03.2015, prepare Trading, Profit and Loss Account for the year ending 31.03.2015 and the Balance Sheet as on that date. Debit Balances Opening Stock Purchases Cash in Hand Bank Balances
( `) 50,000 1,80,000 300 10,000
Credit Balances Purchases Return Bank Loan Creditors Capital
( `) 2,000 20,000 70,000 1,68,000
Financial Statements of Sole Trading Organisations
91
Plant and Machinery Manufacturing wages Freight Inward Freight Outward Salaries Furniture Insurance & Taxes General Expenses Debtors Bad debts Discount Sales Return Stable Expenses Live Stock Fuel & Power Building
50,000 10,000 2,500 3,000 15,000 30,000 7,000 8,000 90,000 2,700 1,300 4,000 3,000 15,000 2,000 1,00,000 5,83,800
Provision for bad debts Sales
1,000 3,22,800
5,83,800
Adjustments : (a) Closing stock was `40,000. (b) Maintain a provision for bad debts @5% on Debtors (c) Create a reserve for discount @2% on creditors. (d) Depreciate Plant and Machinery by 10%, Furniture by 5% and Live Stock by `2,000. (e) Prepaid insurance `800 (f) Commission to factory manager allowed @10% on net profit before charging such commission. Solution : Trading and Profit and Loss Account of Mr. Bohidar for the year ending 31.03.2015 Dr. Cr. Particulars ( `) Particulars ( `) To Opening Stock
50,000
By Sales
3,22,800
Accountancy
92
To Purchases 1,80,000 Less: Purchases Returns 2,000 1,78,000 To Manufacturing wages 10,000 To Fuel and Power 2,000 To Freight Inward 2,500 To Gross Profit c/d 1,16,300 3,58,800 To Freight Outward 3,000 To Salaries 15,000 To Insurance & Taxes 7,000 Less : Prepaid Insurance 800 To General Expenses To Discount To Stable Expenses To Depreciation : Plants & Machinery 5,000 Furniture 1,500 Live stock 2,000 To Provision for Bad debts : Bad debts 2,700 Add : New Provision Required 4,500 7,200 Less: Existing Provision 1,000 To Balance c/d (Profit before charging manager’s commission)
Less : Sales Return By Closing stock
4,000 3,18,800 40,000
By Gross Profit b/d By Reserve for Discount on creditors
3,58,800 1,16,300 1,400
6,200 8,000 1,300 3,000
8,500
6,200 66,500
1,17,700 To Factory Manager’s Commission 6,650 To Net profit transferred to capital A/c 59,850 66,500
By Balance b/d (Net profit before charging such commission)
1,17,700 66,500
65,100
Financial Statements of Sole Trading Organisations
93
Balance Sheet of Mr. Bohidar as on 31.03.2015 ( `)
Liabilities Bank Loan Creditors Less :
70,000
( `)
Assets
20,000 Cash in Hand Bank Balances Debtors
300 10,000 90,000
Reserve for discount
1,400 68,600 Factory Manager’s Commission outstanding 6,650 Capital : Opening Balance 1,68,000 Add : Net Profit 59,850 2,27,850 on creditors
Less : Provision Provision for bad debts Closing stock Prepaid Insurance Furniture Less : Depreciation Live stock Less : Depreciation Plant and Machinery Less : Depreciation Building
3,23,100
4,500
30,000 1,500 15,000 2,000 50,000 5,000
85,500 40,000 800 28,500
13,000 45,000 1,00,000 3,23,100
Illustration 40 From the Trial Balance of M/s Purohit & Sons, prepare the final accounts for the year ending 31.03.2017 and the Balance Sheet as on that date. Trial Balance as on 31.03.2017 Dr. Balances
( `)
Opening Stock Purchases Plant and Machinery Sundry Debtor Furniture Customs duty Life Insurance Premium
25,000 2,55,000 1,30,000 60,000 15,000 5,000 3,000
Cr. Balances Capital Return Outwards Sundry Creditors Sales Rent Received Loan from Bank @10%
( `) 1,60,000 4,000 20,900 3,41,000 4,000 29,000
Accountancy
94 Carriage Inward Carriage Outward Trade Expenses Return Inward Discount allowed Bank Interest Office Expenses Cash in Hand Salaries
1,500 1,700 2,000 3,500 3,000 500 3,000 5,700 45,000 5,58,900
5,58,900
Adjustments : (i) Closing stock was `35,000 (ii) Stock of `5,000 was burnt by fire. It was fully insured and the insurance company admitted the claim in full. (iii) Goods worth `3,000 were distributed as free samples and goods worth `1,000 were taken by the proprietor for personal use. (iv) Maintain a reserve of 2% on sundry creditors. (v) Provide a depreciation @10% on Plant and machinery. Solution : Trading and Profit and Loss Account of M/s Purohit and Sons for the year ending 31.03.2017 Particulars ( `) Particulars To Opening Stock To Purchases Less: Return outward Less: Lost by fire Less: Free samples
2,55,000 4,000 2,51,000 5,000 2,46,000 3,000 2,43,000
25,000 By Sales Less : Return Inward By Closing Stock
( `)
3,41,000
3,500
3,37,500 35,000
Financial Statements of Sole Trading Organisations
95 Less: Drawings in goods To Customs duty To Carriage Inward To Gross Profit c/d
1,000 2,42,000 5,000 1,500 99,000 3,72,500 3,72,500 1,700 By Gross Profit b/d 99,000 2,000 By Rent Received 4,000 3,000 By Reserve for Discount 500 on Creditors 418
To Carriage Outward To Trade Expenses To Discount allowed To Bank Interest Add : Outstanding interest 2,400 (29,000×10% – 500) To Free Samples (or Advertisements) To Office expenses To Salaries To Depreciation on Plant and Machinery To Net Profit transferred to Capital A/c
2,900 3,000 3,000 45,000 13,000 29,818 1,03,418
1,03,418
Balance Sheet of M/s Purohit and Sons as on 31.03.2017 Liabilities Sundry Creditors 20,900 Less : Reserve for Discount on creditors 418 10% Bank Loan 29,000 Add : Outstanding Interest 2,400 Capital : Opening Balance 1,60,000 Add : Net Profit 29,818 1,89,818
( `)
Assets
Cash in Hand Sundry Debtors Closing Stock 20,482 Insurance Claim Admitted Furniture Plant and Machinery 1,30,000 31,400 Less : Depreciation 13,000
( `) 5,700 60,000 35,000 5,000 15,000
1,17,000
Accountancy
96 Less : Drawings for Life insurance Premium Less : Drawings for Goods
3,000 1,86,818 1,000 1,85,818 2,37,700
2,37,700
Illustration 41 Prepare final accounts from the following Trial Balance for the year ending 31.12.2016 : Dr. Balances ( `) Cr. Balances ( `) Drawings 20,000 Provision for bad debts 8,000 Carriage Inwards 8,000 Purchases Return 4,500 Wages 7,500 Sundry Creditors 70,000 Power 2,700 Capital 2,00,000 Advertisement 25,000 Sales 3,95,500 Plant and Machinery 70,000 Opening Stock 28,000 Purchases 3,80,000 Return Inward 3,500 Cash in Hand 17,000 Cash at Bank 15,000 Salaries 12,500 Prepaid Insurance 1,200 Rent and Insurance 20,000 Goods services Tax 6,700 Bad debts 900 Sundry Debtors 60,000 6,78,000 6,78,000 Adjustments : (i)
Closing stock was `1,00,700
(ii) Depreciate machinery by 10%. (iii) Write off advertisement by 20%.
Financial Statements of Sole Trading Organisations
97
(iv) Further bad debts `2,000 and make provision for bad debts by 5%. (v) Charge 10% manager’s commission on net profit after charging such commission. Solution : Trading and Profit and Loss Account for the year ending 31.12.2016 Dr. Cr. Particulars ( `) Particulars (`) To opening stock 28,000 To Purchases 3,80,000 Less : Purchases Return 4,500 3,75,500 To Carriage Inward 8,000 To Wages 7,500 To Power 2,700 To Gross Profit c/d 71,000 4,92,700 To Advertisement written off 5,000 To Depreciation on Machinery 7,000 To Salaries 12,500 To Rent and Insurance 20,000 To Goods Services Tax 6,700 To Balance c/d 22,000 (Profit before charging Manager’s Commission)
By Sales Less : Return Inward By Closing stock
3,95,500 3,500 3,92,000 1,00,700
By Gross Profit b/d By Provision for Bad debts : Existing Provision 8,000 Less : Bad debts 900 Further Bad debts 2,000 New Provision {(60,000-2,000)×5%}2,900
5,800 To Manager’s Commission 10 (22000× 110 ) To Net Profit transferred to Capital A/c
4,92,700 71,000
73,200 2,000 By Balances b/d
2,200 73,200 22,000
20,000 22,000
22,000
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98
Balance Sheet as on 31,12.2016 Liabilities Sundry Creditors Capital : Opening Balance 2,00,000 Add : Net Profit 20,000 2,20,000 Less : Drawings 20,000 Manager’s Commission
( `)
Assets
( `)
70,000 Cash in Hand 17,000 Cash at Bank 15,000 Closing Stock 1,00,700 Prepaid Insurance 1,200 Plants and Machinery 70,000 Less : Depreciation 7,000 63,000 2,00,000 Advertisements 25,000 20,000 2,000 Less : Written off 5,000 Sundry Debtors 60,000 Less: Further bad debts 2,000 58,000 Less : Provision Required 2,900 55,100 2,72,000 2,72,000
Illustration 42 From the following Trial Balance of M/s Prabhu Traders prepare final accounts for the year ending 31.03.2017. Dr. Balances ( `) Cr. Balances ( `) Opening Stock Purchases Manufacturing Wages Fuel & Power Salaries Income Tax Loan to Ambika @10% p.a. Furniture Plants and Machinery Debtors Cash Rent
30,000 1,50,000 9,000 3,000 10,000 2,500 20,000 8,000 85,000 32,400 3,700 6,400 3,60,000
Discount Apprentice Premium Creditors Interest on Loan Capital Sales
3,700 6,000 25,000 1,500 1,00,000 2,23,800
3,60,000
Financial Statements of Sole Trading Organisations
99
Adjustments : 1. Closing stock was `38,000 2. Depreciate plant and machinery by 10% and furniture by 5%. 3. Create a reserve for discount on creditors by 5% and provision for discount on debtors by 5%. 4. Sundry debtors include `400 due from a customer who became insolvent. 5. Goods worth `3,000 were destroyed by fire and the insurance company admitted claim for `1,800. 6. Outstanding salaries were `2,000. Solution : Trading and Profit and Loss Account of M/s Prabhu Traders for the year ending 31.03.2017 Dr. Cr. Particulars ( `) To Opening stock 30,000 To Purchases 1,50,000 Less: Goods lost by fire 3,000 1,47,000 To Manufacturing wages 9,000 To Fuel and Power 3,000 To Gross Profit c/d 72,800 2,61,800 To Salaries 10,000 Add : Outstanding Salaries 2,000 12,000 To Depreciation : Plant & Machinery 8,500 Furniture 400 8,900 To Bad debt 400 To Provision for discount on debtors {(32,400–400)×5%)} 1,600 To Loss by fire (A3000–A1,800) 1,200 To Rent 6,400 To Net Profit transferred to Capital A/c 55,250 85,750
Particulars By Sales
( `) 2,23,800
By Closing Stock
38,000
By Gorss profit b/d By Reserve for discount on creditors. By Apprentice Premium By Interest on Loan 1,500 Add : Accured Interest 500 By Discount
2,61,800 72,800 1,250 6,000 2,000 3,700
85,750
Accountancy
100
Liabilities
Balance Sheet of M/s Prabhu Traders as on 31,03.2017 Assets ( `)
Creditors 25,000 Less : Reserve for discount on creditors 1,250
Cash Debtors 32,400 Less : 23,750 Bad debts 400 Provsion for Discount 1,600 2,000 Salaries Outstanding 2,000 Capital : Closing Stock Opening balance 1,00,000 Loan to Ambika Less : Drawings Interest on Loan Accrued (for income tax) 2,500 Furniture 8,000 97,500 Less : Depreciation 400 Add : Plant & Machinery 85,000 Net Profit 55,250 1,52,750 Less : Depreciation 8,500 Insurance claim admitted 1,78,500
Illustration 43 Following is the Trial balance of PJ Brothers on 31.12.2016 Dr. Balances ( `) Cr. Balances Purchases (adjusted) 3,49,600 Capital Salaries 2,100 Bills Payable Lighting 150 Loan Carriage on Sales 250 Sales Building 13,500 Commission Carriage on Purchases 200 Sundry Creditors Rates & Taxes 200 Sundry Debtors 4,000 Furniture 3,000 Cash in Hand 125 Bills Receivable 750 Closing stock 30,625 Bank balance 750 4,05,250
( `) 3,700
30,400 38,000 20,000 500 7,600 76,500 1,800 1,78,500
( `) 20,000 5,000 10,000 3,60,000 250 10,000
4,05,250
Financial Statements of Sole Trading Organisations
101
Adjustments : (i) Rates have been prepaid `60 (ii) During year, bad debt amounted to `250. (iii) A provision of 10% is to be made on debtors. (iv) Buildings have to be depreciated by 2% and furniture by 1%. Prepare the final accounts for the year. Solution : Trading and Profit and Loss Account of P.J. Brothers for the year ending 31.12.2016 Dr. Cr. Particulars ( `) Particulars ( `) To Adjusted Purchases 3,49,600 By Sales 3,60,000 To Carriage on purchases To Gross Profit c/d To Salaries To Lightining To Carriage on sales To Rates & Taxes 200 Less : Prepaid Rates 60 To Bad debt To Provision for bad debts {(4,000-250)×10% To Depreciation : Building 270 Furnitures 30 To Net profit transfered to Capital A/c
200 10,200 3,60,000 2,100 By Gross Profit b/d 150 By Commission 250
3,60,000 10,200 250
140 250 375
300 6,885 10,450
10,450
Accountancy
102
Balance of PJ Brothers as on 31,12.2016 Assets Liabilities ( `) Sundry Creditors Bills Payable Loan Capital : Net Profit
20,000 6,885
10,000 Cash in Hand 5,000 Bank balance 10,000 Bills Receivable Sundry Debtors 26,885 Less : Bad debts
( `) 125 750 750 4,000 250 3,750
Less : Provision for doubtful debt 375 Closing Stock Prepaid Rates Furniture 3,000 Less : Depreciation 30 Buildings 13,500 Less: Depreciation 270 51,885
3,375 30,625 060 2,970 13,230 51,885
1.6 Questions 1. From the alternatives given below, write the correct answer along with its serial number against each bit : (i)
Revenue expenditure is one which gives benefits for : (a) Current year
(c) Future year
(b) Previous year
(d) First two years
(ii) Capital expenditure is one which gives benefits for : (a) Current year only
(c) Future years
(b) Previous year only
(d) Less than one year
(iii) Heavy amount spent on advertisement of new product is : (a) Capital expenditure
(c) Revenue loss
(b) Revenue expenditure
(d) Deferred revenue expenditure
Financial Statements of Sole Trading Organisations
103
(iv) Wages spent for installation of machinery is a :
(v)
(a) Capital expenditure
(c) Deferred revenue expenditure
(b) Revenue expenditure
(d) Capital loss
Expenditure incurred in manufacturing goods is : (a) Capital expenditure
(c) Revenue expenditure
(b) Capital loss
(d) Revenue loss
(vi) Trading Accounts reveals : (a) Gross profit/Loss
(c) Financial position
(b) Net profit /loss
(d) Appropriation of profits
(vii) Profit and Loss Account reveals : (a) Gross profit/loss
(c) Appropriation of profits
(b) Net profit/loss
(d) Financial position
(viii) Balance Sheet of a trader reveals : (a) Balances of all ledger accounts
(c) Balance of Net profit
(b) Balance of Gross profit
(d) Financial Position
(ix) Closing stock appearing in the Trial Balance is transferred to :
(x)
(a) Trading Account only
(c) Trading Account and Balance sheet
(b) Balance sheet only
(d) Trading Account and Profit and Loss Account
Income tax paid by a sole trader is shown in : (a) Debit side of Trading A/c
(c) Asset side of Balance Sheet
(b) Debit side of Profit and Loss A/c (d) Deducted from capital on the liability side of Balance Sheet (xi) An example of intangible asset is : (a) Machinery
(c) Prepaid Expenditure
Accountancy
104
(b) Mines
(d) Copyrights
(xii) Marshalling of Balance Sheet means : (a) the arranging assets and liabilities (b) the arranging assets only (c) the arranging liabilities only (d) the totalling assets and liabilities (xiii) Direct expenses are shown in : (a) Balance Sheet
(c) Trading Account
(b) Profit and Loss Account
(d) Trading Account and Balance sheet
(xiv) Indirect expenses are shown in : (a) Balance sheet
(c) Trading Account
(b) Profit and Loss Account
(d) Profit and Loss A/c and Balance Sheet
(xv) One of the following, which is not shown in the Balance Sheet is : (a) Current Liability
(c) Current Asset
(b) Non-current liability
(d) Contingent liability
(xvi) One of the following, which is not deducted from capital, is : (a) Net Loss
(c) Income Tax
(b) Drawings
(d) Loan
(xvii)Accrued Income is a/an : (a) Asset
(c) Income
(b) Liability
(d) Expense
(xviii) Income received in advance is a/an : (a) Asset
(c) Income
(b) Liability
(d) Expenditure
Financial Statements of Sole Trading Organisations
105
(xix) Prepaid expense is an example of : (a) Current Asset
(c) Intangible asset
(b) Fixed Asset
(d) Fictitious asset
(xx) Prepaid Insurance appearing in the Trial balance is shown in : (a) Profit and Loss A/c only
(c) Balance Sheet only
(b) Balance Sheet & Profit and Loss A/c (d) Balance Sheet and Trading A/c (xxi) A manager’s commission of 10% on net profit of `2,20,000 after charging such commission is : (a) `22,000
(c) `20,200
(b) `20,000
(d) `22,020
(xxii) A manager’s commission of 5% on net profit A2,10,000 before charging such commission is : (a) `10,500
(c) 10,050
(b) `10,000
(d) 10,505
(xxiii) Closing stock is shown in final accounts at : (a) cost price
(c) cost or market price which ever is more
(b) market price
(d) cost or market price which ever is less
[Answers : (i) a, (ii) c, (iii) d, (iv) a, (v) c, (vi) a, (vii) b, (viii) d, (ix) b, (x) d, (xi) d, (xii) a, (xiii) c, (xiv) b, (xv) d, (xvi) d, (xvii) a, (xviii) b, (xix) d, (xx) c, (xxi) b, (xxii) a, (xxiii) d.] 2.
Answer the following questions in one word / term each : (a) Where will you show in final accounts the prepaid Insurance if appearing in the Trial balance ?
106
Accountancy
(b) Where will you show the income received in advance in the Balance sheet ? (c) Where will show in final accounts if the closing stock appears in Trial Balance ? (d) Which item is an expense to the firm but income to the proprietor ? (e) Which item is an income to the firm but expense to the proprietor ? (f) What is the term used for income earned but not received during the current accounting period ? (g) How do you term the expense which has been paid during the current accounting period but benefit will accrue in the sabsequent account period ? (h) Where will you show in final accounts, if depreciation appears in the Trial Balance ? (i) What is that amount which is due from a customer but cannot be recovered ? Ans : (a) Balance Sheet (b) Liability side (c) Balalnce Sheet (d) Interest on capital (e) Interest on drawings (f) Accrued income (g) Prepaid expense (h) Income Statement (i) Bad debts. 3.
Rectify the underlined portions of the following sentences : (a) An expenditure, the benefit of which is consumed in the current year is capital expenditure. (b) An expenditure, the benefit of which is consumed in more than one accounting period is revenue expenditure. (c) Provision for discount on debtors sometimes shows a credit balance. (d) Depreciation appearing in Trial balance will appear in Balance Sheet. (e) Prepaid expenses appearing in Trial balance is shown on the liabilities side of the Balance sheet. (f) Outstanding salary, if appears in Trial balance will be shown in the Profits Loss A/c.
Financial Statements of Sole Trading Organisations
107
(g) The manager’s commission is an income for the business firm. (h) Closing stock is always recorded at cost or market price whichever is higher. (i) Depreciation is charged on fictitious assets only. (j) Interest on capital is considered as an expense of the proprietor. (k) Interest on capital is considered as an income of the business. (l) Interest on drawing is considered as an income of the proprietor. (m) Interest on drawing is considered as an income of the proprietor. (n) For goods withdrawn by proprietor for personal use, purchase account is debited. (o) For goods distributed as free samples /charity purchase account is debited. (p) For abnormal loss of stock, insurance claim admitted by insurer is treated in Profit and Loss Account. (q) All direct expenses are charged to Profit and Loss A/c. (r) Income Statement depicts the financial position of the business at the end of the year. (s) Income Statement is also known as the Position Statement of a business. [Ans. : (a) Revenue (b) Capital (c) Always (d) P&L A/c (e) asset (f) Balance Sheet (g) expense (h) lower (i) fixed (j) income (k) proprietor (l) expense (m) business (n) credited (o) credited (p) Balance Sheet (q) Trading (r) Balance Sheet (s) Balance Sheet.] 4.
Fill up the blanks. (a) Bad debts is a ______ . (b) Discount received from creditors is an ______ . (c) An expenditure incurred in achieving economy in operation is a ______ expenditure. (d) An amount spent on white washing a new factory is a ______ expenditure.
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Accountancy
(e) Royalties paid on sales is charged to ______ A/c. (f) Royalities paid on production is charged to ______ A/c. (g) Bad debts recovered are transferred to ______ side of Profit and Loss A/c. (h) All indirect expenses are taken to ______ A/c. (i) All direct expenses are taken to ______ A/c. (j) Depreciation is charged on ______ assets. (k) If prepaid expenses are shown in the Trial Balance, it will be shown onlyin the ______ . (l) Income received in advance is a ______ for the business firm. (m) Manager’s commission payable is shown on the ______ side of Balance Sheet. (n) Accrued Income is an ______ for the business. [Answer: (a) loss (b) income (c) capital (d) capital (e) Profit and Loss (f) Manufacturing (g) credit (h) Profit and Loss (i) Trading (j) Fixed (k) Balance Sheet (l) liability (m) liability (n) asset.] 5.
Answer the following questions in one sentence each : (a) What do you mean by capital expenditure ? (b) What do you mean by revenue expenditure ? (c) What is meant by deferred revenue expenditure ? (d) To which account will the item ‘salaries and wages’ be transferred ? (e) What is meant by marshalling of Balance Sheet ? (f) Why is Balance Sheet also called Position Statement ? (g) Why is the Trading and Profit and Loss Account called Income Statement ? (h) What do you mean by adjusted purchase ? (i) Under which circumstances closing stock is given in Trial Balance ? (j) What do you mean by doubtful debts ?
Financial Statements of Sole Trading Organisations
109
6.
Answer the following questions within thirty words each : (a) Distinguish between revenue expenditure and capital expenditure. (b) What is cost of goods sold ? (c) Differentiate between Balance Sheet and Tril Balance. (d) What are the direct expenses ? (e) What are the two ways of arranging the items of Balance Sheet ? (f) Differentiate between current asset and fixed asset. (g) Distinguish between gross profit and net profit. (h) Name five items appearing in Profit and Loss Account. (i) Name five items appearing in Trading Account. (j) Give two examples of fictitious asset. (k) Give two examples of deferred revenue expenditure.
7.
Answer the following questions in fifty words each : (a) Why is it necessary to distinguish between capital expenditure and revenue expenditure ? (b) Explain the difference between capital expenditure and capitalised expenditure. (c) Distinguish between deferred revenue expenditure and prepaid expenditure. (d) How will you treat ‘Outstanding expenses’ and ‘Prepaid expenses’ appearing in the Trial balance ? (e) How is managers commission on net profit calculated while preparing final account ? (f) How is abnormal loss treated in final accounts if : (i) stocks are not insured (ii) fully insured and (iii) partly insured, on the presumption that insurance claim is admitted.
Accountancy
110
8. 9. 10.
11. 12. 13.
(g) How are accrued income and unearned income treated in final accounts if they appear is the Trial Balance ? (h) Give adjustment entries for provision for discount on debtors. (i) Give adjustment entry for provision for bad and doubtful debts. (j) Define closing entries. (k) Define adjustment entries. Explain the accounting treatment of outstanding expenses, prepaid expenses, accrued income and unearned income in final accounts with imaginary figures. Give the accounting treatment of goods destroyed by fire under different situations with suitable examples. Show the treatment of goods used for personal use of proprietor, goods distributed as free samples and also for charity in final accounts with suitable examples. What is meant by provision for doubtful debts ? How are the relevant accounts prepared and what journal entries are passed in final accounts ? Is it necessary to pass two entries for every adjustment ? Explain with suitable examples. Calculate gross profit from the extract of Trial Balance of Mohan for the year ending 30.09.2016 : `
`
Opening stock 15,000 Purchase return 5,000 Closing stock 25,000 Purchases 20,000 Net Sales 40,000 Direct expenses 8,000 (Ans. Gross profit `27,000) 14. From the ledger balances given below, prepare the Trading Account for the year ending 31.12.2015 : `
Opening stock 7,000 Purchases 21,000 Sales 90,000 Returns inward 2,000 (Ans. Gross profit `60,300)
`
Returns outward Carriage Inwards Freight & Customs duty Stock on 31.12.2015
2,400 3,500 4,600 10,000
Financial Statements of Sole Trading Organisations
111
15. From the following Trial Balance, prepare Trading and Profit and Loss Account and Balance Sheet as on 31.12.2016 : Dr. Balances Plant & Machinery Sundry Debtors Drawings Purchases Wages Sundry Expenses Rent and Taxes Carriage Inwards Bank Opening stock
(`) 27,000 21,600 2,700 59,000 14,500 600 1,350 450 4,500 6,000 1,37,700
Cr. Balances Capital Bills Payable Sundry Creditors Sales
( `) 60,000 1,400 2,800 73,500
1,37,700
Closing stock as on 31.12.2016 was `22,400 (Ans. Gross profit `15,950 Net profit 14,000 B/s Total 75,500) 16. From the following Trial Balances of M/s Chahar on 31.03.2017, you are required to prepare Trading and Profit and Loss Account and Balance Sheet as on that date : Name of the Accounts Opening stock Purchases and sales Returns Productive wages Dock and clearing charges Donation and charity Delivery van expenses Lighting Goods and Services Tax
Dr. Bal.(`) 12,000 38,000 900 6,000 4,000 600 6,000 500 800
Cr. Bal (`) 80,000 600
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112
Bad debts Miscellaneous incomes Rent from Tenants Royalty Capital Drawings Debtors and Creditors Cash Investment Patents Machinery
600 6,000 2,000 3,200 40,000 2,000 6,000 8,000 3,000 6,000 4,000 43,000 1,36,600 1,36,600
Closing stock 15,000 (Ans. Gross profit 31,500, Net profit 31,000 B/s Total 77,000) 17. From the following balances, prepare Trading and Profit and Loss Account for the year ended on 31st March 2016 and Balance Sheet as on that date : Dr. Balances Insurance Bad debts Book debts Plant & Machinery General expenses Drawings Cash at Bank Bills Receivable Buildings Furniture Discount Bank Charges Salaries Purchases Opening stock Sales Return
( `) 750 1,250 82,740 31,640 3,630 6,300 13,870 2,860 41,580 5,130 3,960 100 6,420 1,99,080 60,220 1,870
Cr. Balances Capital Discount Loans Sales Provision for bad and doubtful debts
( `) 1,52,000 2,980 15,000 2,81,500 4,650
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Carriage Rent and Taxes
5,170 7,680 4,74,250
4,74,250
Adjustments : (a) Closing stock was `70,000. (b) Create a provision for bad and doubtful debts @10% on debtors. (c) Insurance prepaid `50. (d) Rent outstanding `150. (e) Interest on Loan is due @6% p.a. (Ans. Gross Profit 86,610; Net Profit `61,176; B/S Total `2,39,596.) 18. The following balances have been extracted from the Trial balance of Bijoy. You are required to prepare Trading, Profit and Loss Account for the year ending 30th September 2016 and the Balance Sheet on that date from the given data : Dr. Balances Drawings Bad debts Sundry Debtors Printing and Stationery Freight Inwards Trade Expenses Returns Inward Opening stock Purchases Rent, Rates and Taxes Furniture & Fixtures Plant and Machinery Bills Receivable Wages Cash Discount Investment Land and Buildings
Amount (`) 20,000 1,000 80,000 2,000 4,000 2,400 7,000 25,000 1,80,000 5,000 20,000 1,00,000 14,000 10,000 6,000 2,000 40,000 51,000 5,69,400
Cr. Balances Sales Returns outward Capital Bank Overdraft Provision for bad debts Sundry Creditors Bills Payable
Amount ( `) 2,76,000 2,000 2,50,000 12,000 4,000 20,000 5,400
5,69,400
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Adjustments : (1) Closing stock was `45,000. (2) Provision for doubtful debts is to be made @5% on debtors. (3) Depreciation charged on Furniture and Fixtures @5% p.a., Plant and Machinery @6% p.a., and on Land and Buildings @10% p.a. (Ans.Gross profit `97,000; Net profit `72,500; Balance sheet Total `3,39,900.) 19. Prepare Trading, Profit and Loss Account of Mr Sujit for the year ending 31.12.2016 from the following trial balance : Dr. Balances Investment Bed debts Discount Lighting and Heating Machinery Cash Debtors Insurance General Expenses Packing (Primary) Rent & Rates Wages Salary Postage Returns Inward Purchases Opening Stock
Amount (`) 23,100 3,500 3,500 5,000 70,000 10,000 50,000 4,000 400 500 1,000 3,000 12,300 600 5,000 1,45,000 35,000 3,71,900
Cr. Balances Sales Returns Outward Creditors Bills Payable Discount Provision for Bad Debts Capital Interest Received
Amount ( `) 2,50,000 6,000 10,000 20,000 1,000 4,500 75,000 5,400
3,71,900
Adjustments : (1) Closing stock was `25,000. (2) Wages Outstanding `1000. (3) Insurance Prepaid `400 (4) Provide for doubtful debt @5% on debtors subject to further bad debts of `1,000.
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(5) Depreciation on machinery 10% p.a. (Ans. G.P. `86,500, N.P. `62,050, B/S Total `1,68,050) 20. From the following extracts of a Trial balance of Mr. Sajjan Kumar, prepare Trading, Profit and Loss Account for the year ending 30.06.2017 and the Balance sheet as on that date : Dr. Balances Opening Stock Building Furniture Purchases Carriage Inward Returns Inward Plant Cash Carriage Outward Wages Salaries Lighting-factory Sundry Debtors Travelling Expenses Rent & Taxes Drawings General Expenses Insurance
Amount ( `) 20,000 50,000 6,000 90,000 2,000 7,000 50,000 6,000 500 33,000 20,000 1,000 30,000 1,500 5,000 6,000 2,000 12,500 3,42,500
Cr. Balances Capital Sales Returns Outward Discount Sundry Creditors Bills Payable
Amount ( `) 1,06,000 2,20,000 2,000 500 10,000 4,000
3,42,500
Adjustments: 1. Provide depreciation on plant @5% and on furniture @ 10% p.a. 2.
Wages outstanding `2,000 and Salaries outstanding `1,800.
3.
Prepaid Insurance `2,00.
4.
Stock on 31.06.2017 `28,000, its market value is `25,000. (Ans. Gross Profit `92,000; Net Profit `46,300; B/S Total `1,64,100.)
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21. Prepare Trading Account, Profit and loss Account for the year ending 31.12.2016 and the Balance Sheet on that date from the Trial Balance of Suraj given below : Dr. Balances Amount Cr. Balances Amount ( `) (`) Rent 1,000 Capital 46,000 Plant and Machinery 40,000 Creditors 30,000 Horses & Carts 34,000 Sales 20,000 Debtors 10,000 Bills Payable 9,250 Cash in hand 2,600 Purchases 8,000 Wages 1,000 Salaries 1,000 Repairs 950 Stock 2,400 Coal, gas and water 600 Bad debt 200 Carriage 300 Octroi 200 Drawings 3,000 1,05,250 1,05,250 Adjustment: 1. Rent paid in advances `120. 2. Wages due `300. 3. Depreciate plant and machinery @10% and horses and carts @15% p.a. 4. Interest on capital is charged @10% p.a. 5. Closing stock `4,100. (Ans. Gross Profit `11,300; Net Loss `5,430; Balance sheet Total `81,720) 22. From the trial balance given below, prepare Trading and Profit and Loss Account for the year ending 31.03.2017 and the Balance Sheet as on that date : Dr. Balances Amount Cr. Balances Amount (`) ( `) Opening Stock 2,000 Capital 10,000 Machinery 4,000 Creditors 1,000 Debtors 2,400 Bills Payable 700
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Drawings Purchases Returns Inward Wages Manufacturing expenses Bank Rent Carriage Bad debt
1,000 11,500 300 4,800 1,000 1,000 450 250 900 29,600
Returns Outward Sales
500 17,400
29,600
Adjustments : 1. Closing stock was valued at `2,450. 2. Depreciate machinery by 8% p.a. 3. Allow interest on Capital @5% p.a. 4. Rent outstanding `50. (Ans. Gross Profit `500; Net Loss `1,720; Balance sheet Total `9530)
23. From the following Trial balance of Rajat Traders, prepare Trading, Profit and Loss Account for the year ending 31.03.2017 and the Balance Sheet as on that date : Dr. Balances Amount Cr. Balances Amount ( `) (`) Adjusted Purchases 3,80,000 Sales 5,40,000 Sundry Debtors 1,40,000 Sundry Creditors 1,00,000 Returns Inward 3,600 Returns Outward 6,400 Trade Expenses 2,000 Capital 2,00,000 Production expenses 6,000 Commission 16,500 Plant and Machinery 40,000 Bills Payable 2,900 Rates and Taxes 10,000 Loan 30,000 Productive wages 44,000 Repairs and Maintenance 14,400 Land and Building 70,000 Cash 19,000 Power 14,000 Office Salaries 11,000 Bad debts 2,800
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Drawings Carriage Inward Carriage Outward Bills Receivable Sundry Expenses Closing Stock
12,000 4,600 2,400 15,200 4,800 1,00,000 8,95,800
8,95,800
Adjustments : 1.
Salaries outstanding `1,000
2.
Commission accrued but not received `3,500
3.
Provide depreciation on plant & machinery @10% p.a. (Ans. Gross Profit `94,200; Net Profit `61,800; B/s Total `3,83,700.
24. Prepare Trading, Profit and Loss Account for the year ending 30.09.2016 from the extracts of a trial balance given below : Dr. Balances Purchases Opening Stock Returns Inward Carriage Inward Wages Coal, gas and water Production expenses Debtors General Expenses Bad debt Salaries Rent, Rates & Taxes Cash Drawings
Amount (`) 3,33,950 27,400 2,005 7,715 59,840 40,860 6,840 67,900 3,890 1,000 3,305 2,910 4,805 3,000 5,65,420
Cr. Balances Sales Returns Outward Creditors Discount Capital
Amount ( `) 4,52,160 1,150 12,000 110 1,00,000
5,65,420
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Adjustments : 1. Closing stock `45,820 2. Salaries outstanding `695. 3. Rent, Rates & Taxes paid in advance `910. (Ans. Gross Profit `20,520; Net Profit `9,740; B/S `1,19,435.) 25. From the following Trial balance of Mr Amit, prepare Trading, Profit and Loss Account for the year ending 30th June 2017 and the Balance Sheet as on that date : Dr. Balances Amount Cr. Balances Amount ` ( ) ( `) Opening stock 8,000 Sales 37,000 Purchases 20,000 Returns Outward 1,455 Returns Inward 1,350 Capital 30,000 Wages 1,000 Sundry Creditors 20,000 Carriage 500 Salaries 1,700 Printing and stationery 800 Drawings 3,000 Machinery 32,000 Cash 105 Sundry Debtors 20,000 88,455 88,455 Adjustments : 1. Wages outstanding `300 2. Goods destroyed by fire `2,000; Insurance claim was not admitted for the loss. 3. Depreciate machinery by 5% p.a. 4. Closing stock `18,000. (Ans. Gross profit `27,305; Net profit `21,205; Balance sheet `68,505.) 26. From the following trial balance of Kamlesh, prepare final accounts for the year ending 31.03.2017 : Dr. Balances Amount Cr. Balances Amount (`) ( `) Plant and Machinery 52,000 Capital 75,000 Furniture 8,000 Sales 1,27,500 Sundry Debtors 10,000 Sundry Creditors 12,000
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Trade Expenses Depreciation Cash at Bank Wages and Salaries Opening stock Purchases Discount Drawings Bills Receivable Bad debts
1,000 2,000 7,500 6,000 23,500 90,800 1,200 17,000 4,000 700 2,23,700
Purchases Return Rent Bills Payable Interest
1,000 3,200 4,000 1,000
2,23,700
Adjustments : 1. Closing stock `35,000 2. Wages due `2,000 3. Create a reserve for discount @ 5% on creditors. (Ans. Gross Profit `41,200; Net Profit `41,100; Balance sheet Total `1,16,500.) 27. From the following trial balance taken from the books of Bimal Kumar, prepare Trading, Profit and Loss Account for the year ending 31.12.2016 and a Balance Sheet as on that date : Dr. Balances Amount Cr. Balances Amount (`) ( `) Opening stock 9,700 Bank overdraft 7,000 Purchases 30,250 Creditors 15,000 Bank charges 050 Capital 60,000 Freehold Premises 10,000 Sales 50,920 Fixed Deposit 3,000 Bills Payable 18,000 Furniture 4,000 Legal Charges 200 Insurance 600 General Expenses 2,900 Telephone 600 Wages 6,300 Factory Fuel 2,900
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Bills Receivable Drawings Rent and Taxes Office Expenses Sundry Debtors
5,320 5,000 3,500 600 66,000 1,59,920
1,50,920
Additional Information : 1. Closing stock was A15,750 2. Prepaid insurance A300 3. Wages due A700 4. Interest accrued on Fixed Deposits @10% p.a. [Ans. Gross Profit A16,820; Net Profit A8,970; Balance sheet Total A1,04,670.) 28. From the following Trial balance extracted from the books of Pooja Stores, prepare the final accounts for the year ending 31.03.2017 : Dr. Balances Amount Cr. Balances Amount (A) ( `) Cash in hand 10,500 Sales 4,30,000 Plant & Machinery 1,20,000 Capital 2,50,000 Furniture 20,000 Bills Payable 5,000 Bad debts 2,000 Discount Received 4,000 Printing 2,500 Sundry Creditors 40,000 Patents 20,000 Income Tax 5,000 Debtors 45,000 Stock as on 01.04.2016 22,000 Salary Paid 45,000 Wages 15,000 Carriage Inward 10,000 Carriage Outward 9,000 Land and Building 1,00,000 Commission 23,000 Purchases 2,80,000 7,29,000 7,29,000
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Adjustments : 1. Closing stock was `35,000 2. Goods worth `15,000 were destroyed by fire but insurance company accepted a claim of `10,000 only. 3. Depreciate Plant and Machinery by 10%, Patents by 5% and Buildings by 7 1/2%. 4.Wages due ` 3,000 (Ans. Gross Profit `1,50,000; Net Profit `47,000; Balance sheet total `3,40,000.)
CHAPTER-2
FINANCIAL STATEMENTS OF ‘NOT FOR PROFIT’ ORGANISATIONS STRUCTURE
2.0 2.1 2.2 2.3 2.4 2.5
2.6
2.7 2.8 2.9
INTRODUCTION MEANING OBJECTIVES NECESSITY OF PREPARING FINANCIAL STATEMENTS BOOKS OF ACCOUNTS AND ACCOUNTING PROCEDURE RECEIPTS AND PAYMENTS ACCOUNT 2.5.1 Meaning of Receipts and Payments Account 2.5.2 Features of Receipts and Payments Account 2.5.3 Format of Receipts and Payments Account 2.5.4 Difference between Receipts and Payments Account and Cash Book INCOME AND EXPENDITURE ACCOUNT 2.6.1 Meaning of Income and Expenditure Account 2.6.2 Features of Income and Expenditure Account 2.6.3 Difference between Receipts and Payments Account and Income and Expenditure Account 2.6.4 Difference between Income and Expenditure Account and Profit and Loss Account 2.6.5 Format of Income and Expenditure Account TREATMENT OF SOME IMPORTANT ITEMS PREPARATION OF INCOME AND EXPENDITURE ACCOUNT AND BALANCE SHEET QUESTIONS
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2.0 INTRODUCTION Some organisations are set up with an objective either for making profit or for providing service to the society. Thus, from the point of view of objectives of any legal and accounting entity, one can divide the organisations into two categories such as : (a) Trading/Manufacturing or Profit making organisations, and (b) Non-trading or ‘Not for Profit’ making organisations. The trading organisations are the common business organisations such as sole trading units, partnership firms and corporate houses like Reliance Industries Ltd., Tata Iron and Steel Company Ltd., National Alumunium Company Ltd., Parle Agro Private Ltd., etc. The main objective of commercial organisations is to earn profit. On the other hand, non-trading or ‘not for profit’ making organisations primarily provide services to the society at large and also to its meambers without any objective of making profit. These organisations are mainly set up for social, religious, cultural, scientific, charitable, recreation and entertainment purposes. Social organisations are non-governmental organisations like clubs, societies and associations. The charitable organisations are like hospitals, religious organisations like temples, mosques, churches, educational and cultural organisations like schools, colleges, universities, libraries, etc. These organisations mainly render services to the society and also to its members. They carry on their activities for promoting their objectives of raising the standard of living and other socio-cultural and economic conditions of the society. 2.1 MEANING ‘Not for profit’ organisations are those organisations whose main objective is not to earn profit but to render services to its members and to the society at large. These organisations help in promoting art, science, culture, religion, charity, recreation, entertainment, etc. Their intention is to spend their earnings in promoting their organisational objectives. They restrict on distributing dividend to its members. The examples of some organisations are, Board of Cricket Control of India, Cricket Associations of different states, Institute of Chartered Accountants of India, Federation of Indian Chambers of Commerce and Industries, charitable educational institutions like DAV group of educational institutions, etc.
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2.2 OBJECTIVES The primary objective of ‘not for profit’ organisations is to render valuable services to its members and to the society. They carry out their activities without an intention to make profit. The main objectives of such organisations are : (a) to render valuable services to its members and to the society; (b) to work without any motive to earn profit; (c) to promote art, culture, religion, etc; (d) to create awareness on social evils like untouchability, child marriage, animal sacrifice, etc; (e) to promote health and education in remote, hilly and mountaineous regions; (f) to promote and protect socio-economic status of its members and the society; (g) to provide entertainment facility and charity. 2.3
NECESSITY OF PREPARING FINANCIAL STATEMENTS The ‘not for profit’ organisations do not exist for earning profit. They simply render services to the public. The primary sources of income of such organisations are by way of fees, donations, subscriptions, grants, etc. These incomes do not belong to any person in particular. There are chances of fraud and mismanagement of cash and other valuable assets of such organisations. An Executive Committee or Governing Body or Trust is formed by taking a group of persons as members to organise and manage the activities and funds of the organisation. An individual works as the Chairman or Director or CEO (Chief Executive Officer) or Trustee of the organisation. It becomes essential to record and maintain the books of accounts regularly and periodically. Accounting for ‘not for profit’ organisations is a particular accounting system. This accounting system accumulates, communicates and interpretes the historical data useful for the purpose of ascertaining the financial position and operating results of such an organisation.Accumulating of data refers to
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collection, recording and summarising the historical data and finding out the operating results and financial position of the organisation, communicating the accumulated data to the stakeholders of the organisations like members, society, government, donors by preparing Income and Expenditure Account and Balance Sheet. 2.4 BOOKS OF ACCOUNTS AND ACCOUNTING PROCEDURE As most of the transactions of ‘not for profit’ organisations are in cash, they normally maintain a book to record the receipts and payments of cash. It is known as Receipts and Payments Account. Besides this book, they maintain other books, such as : (a)
Members’ Register: It is a record of all the members of ‘not for profit’ organisations. This register contains the name, address and date of admission as member in the organisation. It also records, whether a member is a Life member or Annual member.
(b)
Personal Ledger : It consists of : (i) Collection Register : It records the collection of fees, subscriptions from members, etc. (ii) Donors’ Register : It shows the amount paid by the donors - how much is received and how much is outstanding and for which purpose the amount is donated, i.e., whether it is a general donation or a specific donation.
(c)
Stock Register : It keeps the record of all properties purchased, i.e., purchase of land and buildings, machineries, furniture, investments, books, consumable stores, sports materials, etc.
(d)
Minutes Book : It is a record of the proceedings of the meetings of Executive Committee or Governing Body or any other body as may be named. At the end of each accounting period, the ‘not for profit’ organisations prepare : (i) Receipts and Payments Account;
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(ii) Income and Expenditure Account; and (iii) Balance Sheet 2.5
RECEIPTS AND PAYMENTS ACCOUNT Usually, the ‘not for profit’ organisations prepare a Receipts and Payments Account at the end of each accounting period. It is simply a summary of Cash Book. This account is prepared on the basis of transactions recorded in the Cash Book. Each item of receipt and payment recorded chronologically in the Cash Book is summerised and totalled. The total amount of an item is recorded in the Receipts and Payments Account. For example, salary paid to the employees are recorded in the cash book on different dates of different months. Then individual salary item is totalled for the year and recorded in the payment side of the Receipts and Payments Account. Similarly, subscriptions and fees collected from members on different dates of different months are recorded in the Cash Book. The fees/suscriptions received for the year is totalled and recorded on the receipt side of Receipts and Payments Account.
2.5.1 Meaning of Receipts and Payments Account A Receipts and Payments Account is a Real Account. It records the classified summary of transactions of a Cash Book alongwith cash and bank balances in the beginning and end of an accounting period. All receipts are recorded on the debit (receipts) side and all payments are recorded on the credit (payments) side of this account. According to William Pickles “Receipts and Payments Account is nothing more than a summary of cash book (cash and bank transactions) over a certain period, analysed and classfied under suitable headings. It is the form of account most commonly adopted by the treasurers of societies, clubs, associations, etc. when preparing the results of the year’s working.” 2.5.2. Features of Receipts and Payments Account The main features of Receipts and Payments Account are as follows :
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(i)
It is a Real Account and is based on the golden principle of double-entry system of book-keeping, i.e., debit what comes in and credit what goes out.
(ii)
It starts with an opening balance of cash in hand and cash at bank at the beginning of the accounting period.
(iii) It ends with a closing balance of cash in hand and cash at bank at the end of the accounting period. (iv) It is a summary of Cash Book. It represents the totals of all transactions of Cash Book under different heads. (v)
It ignores the time period of cash transactions. The receipts and payments made in the current year may relate to the previous year, current year or the next year.
(vi) The transactions are recorded in this account without any date. (vii) All receipts are recorded on the debit side and all payments are recorded on the credit side. (viii) It ignores the cash or bank status by summing up both cash and bank transactions as similar transactions. Contra entries are not passed for a cash and bank transaction. (ix) It does not record non-cash items like depreciation, outstanding expenses or accuced incomes. (x)
It ignores the nature of the transactions while recording. It records all receipts and payments whether they are of revenue or capital in nature.
2.5.3. Format of Receipts and Payments Account Receipts and Payments Account of... Dr.
for the year ending 31.12.20.... Receipts
To Balance b/d Cash Bank To Subscriptions :
(A) ............. .............
Payments By Balance b/d (in case of Bank overdraft) By Rent, Rates and Taxes
Cr. (A)
............. .............
Financial Statements of ‘Not for Profit’ Organisations
Previous year Current year Next year To Dividend received To Interest received To General donations To Govt. grants To Lockers rent To Rent of club To Rent of Hall To Rent of playground To Sale of old newspaper and periodicals To Proceeds from charity show To Tuition fees To Sale of Assets To Bar takings receipts To Legacies To Entrance fees To Lifemembership fee To Specific Donations To Endowment Fund receipts To Prize Fund To Sports Fund To Scholarship Fund To Bank Loan To Sundry Receipts To Restaurant takings To Tournament proceeds
............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............
By Salaries By Printing and Stationery By Postage and Telephone By Purchase of News Papers/periodicals By Electricity and Water
129
............. ............. .............
............. ............. By Travelling and Conveyance ............. By Repairs and Maintenance ............. By Upkeep of Lawn ............. By Charity Show expenses ............. By Advertisement ............. By Honorarium to Secretary/coach/doctors ............. By Bar Payments ............. By Catering payments ............. By Restaurant Expenses ............. By Entertainment ............. By Tournament Expenses ............. By Office Expenses ............. By Library Books ............. By Purchase of Land and Building, flat machinery, and furniture By Payment of Bank Loan ............. By Billiard Table ............. By Mowing Machine ............. By Balance c/d Cash ............. ............. Bank ............. .............
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2.5.4 Difference between Receipts and Payments Account and Cash Book
1.
Basis of difference Nature
Receipt and Payments A/c It is a ledger account.
2.
Prepared by
It is prepared by ‘not for profit’ organisations.
3.
4.
Manner of recording Transactions of similar nature are recorded in summarised form and put under one head. Contra Entries It ignores contra entries.
5.
Side
6.
Columns
Cash Book It is a journal as well as ledger account It is prepared by trading and manufacturing organisations with profit motive. Transactions are recorded chronologically as and when they occur.
It records contra entries for a transaction in cash and bank Left side is Receipt and Left side is debit and right right side is Payment. side is credit. There is only one column There is separate column for recording both cash for recording cash, bank and bank transactions. and discount transactions.
2.6 INCOME AND EXPENDITURE ACCOUNT The ‘not for profit’ organisations are interested to know the financial performance of their activities at the end of each year, like the trading organisations. While the trading organisations prepare Trading Account, Profit and Loss Account, ‘not for profit organisations’ prepare Income and Expenditure Account, at the end of each accounting period. They are interested to know whether their incomes are sufficient to meet the expenditures or not. 2.6.1 Meaning of Income and Expenditure Account Income and Expenditure Account is a Nominal Account, It is a summary of revenue incomes and revenue expenditures of a ‘not for profit’ organisation in
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an accounting period. All expenses and losses of revenue nature are recorded on the debit side and all incomes and gains are recorded on the credit side. If the credit side of the account is more than its debit side, it is known as surplus or excess of income over expenditure. But if the debit total of this account is more than its credit total, it is known as deficit or excess of expenditure over income. Income and Expenditure Account is prepared on accrual basis and not on cash basis.That is why all the incomes earned during an accounting period are recorded in this account. The incomes earned both received and accrued are taken into account. The incomes received in advance is deducted from the total of incomes received in cash during the accounting period. Similarly, all expenses incurred in the relevant period, whether paid or not, are taken into consideration. Any prepaid expenditure is deducted from the total expenditure paid during an accounting period. The excess of income over expenditure or the excess of expenditure over income is transferred to Capital Fund, shown in the Balance Sheet. 2.6.2. Features of Income and Expenditure Account 1. 2. 3. 4. 5. 6. 7. 8. 9.
It is a nominal account. It is debited with all expenses and losses of revenue nature. It is credited with all incomes and gains of revenue nature. It is prepared on accrual basis. If records only income and expenditures of the current accouting period. It takes into account all outstanding expenses and accrued incomes. It records both cash and non-cash items like depreciation, bad debt, expenses payable and incomes receivable for the current accounting period. Its balance at the end of the accounting period is either surplus, i.e., excess of incomes over expenditures or deficit, i.e., excess of expenditures over incomes. The balance either surplus or deficit is transferred to Capital Fund in the Balance Sheet.
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2.6.3 Difference between Income and Expenditure Account and Receipts and Payments Account Basis of differences
Receipts and Payments Account
Income and Expenditure Account
1. Types of Account
It is a Real account
2. Objective
Its objective is to provide a summary Its objective is to ascertain the cash receipts and payments of similar surplus or deficit of its financial transactions during an accounting operations. period.
3. Form
It is a summarised form of cash book.
It is in the form of an Income statement, i.e., profit and loss account.
4. Opening Balance
It starts with opening balances of cash in hand cash and at bank.
It does not start with any opening balance.
5. Closing Balance
It ends with closing balances of cash It ends with a closing balance of in hand and cash at bank. surplus i.e. excess of income over expenditure or deficit, i.e., excess of expenditure over income. All receipts of cash-both revenue and All revenue expenses/ losses are capital are debited. debited. All payments of cash are credited. All revenue incomes and gains are credited. It ignores non-cash items It records non-cash items If records both revenue and capital It records only revenue items. items. Closing balance is transfered to next Closing balance is transferred to year. capital fund.
6. Debit 7. Credit 8. Cash items 9. Revenue/Capital 10. Transfer
It is a Nominal account.
2.6.4 Difference between Income and Expenditure Accoutnt and Profit and Loss Account Both the accounts one prepared for the purpose of ascertaining the results of financial operations. Both record only the revenue items. Adjustment entries are passed in both the accounts for transactions not taken care of.
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Inspite of such similaries between the two, there are some differences which are discussed below : Basis of differences 1. Organisation 2. Basis
3. Objective
Income and Expenditure Accoutnt
Profit and Loss Account
It is prepared by ‘not for profit’ It is prepared by trading and commercial organisations. organisation. It is prepared on the basis of data from Receipts and Payments Account. Its objective is to ascertain the excess of income over expenditure or excess of expenditure over income.
It is prepared on the basis of data from the Trial balance. Its objective is to ascertain the net profit or net loss.
4. Opening balance It does not have any opening It starts with gross profit/loss as opening balance. balance. 5. Transfer of Closing balance is transferred to Closing balance is transferred to Capital fund. Capital Account. closing balance
2.6.5 Format of Income and Expenditure Account The typical proforma of Income and Expenditure Account is given below : Income and Expenditure Account of ...... Dr.
for the year ending 31st....... 20...... Expenditure
To Salaries To Wages To Rent, Rates and Taxes To Purchase of news papers, magazines To Repairs and maintenance To Charity To Expenses on Lectures To Upkeep of lawn
(A)
Income
Cr. (A)
............. By Subscriptions ............. By Entrance Fees ............. By Donations
............. ............. .............
............. ............. ............. ............. .............
............. ............. .............
To Dividend and Interest By Proceeds from Lectures By Income from charity show By Profit on sale of fixed Assets
.............
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To General Body Expenses To Land Revenue To Entertainment Expenses To Tournament Expenses To Printing and Stationery To Ground Rent To Honorarium to CEO/ Coach / Doctors To Purchase of Bars To Cost of Refreshments To Annual function Expenses To Audit Fees To Help to Poor Students To Conveyance and Travelling To Electricity and Water To Bank Charges To Grass seeds To Surgery and Dispensary To Loss from Annual Dinner To Loss from sale of Fixed Assets To Loss on sale of sports Equipment / materials To Miscellaneous Expenses To Insurance Premium To Depreciation on Fixed Assets To Surplus transferred to Capital Fund
............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............
............. ............. ............. ............. .............
By Profit on sale of sports equipment / materials By Sales of Periodicals and Journal By Visiting Fees (Received by doctors) By Sale of Grass By Fees from Non-members By Locker Rent By Income from Restaurants By Receipts from Annual Function By Bar Takings (Collections) By Income from Billiard Rooms By Grants from Governments and Local Authority By Souvenir Advertisement By Deficit transferred to Capital Fund
............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. ............. .............
Financial Statements of ‘Not for Profit’ Organisations
2.7
135
TREATMENT OF SOME IMPORTANT ITEMS
1. Legacy : Legacy is the amount received from property of a deceased person as per his ‘will’ prior to his death. It is a type of donation received by the ‘not for profit’ organisations under a ‘will’ on the death of the donor. It appears on the receipt side of the Receipts and Payments Account. If the amount of the legacy is very small and not for any specific purpose, it is treated as ‘revenue’ receipt and credited to Income and Expenditure Account. On the other hand, if the amount of legacy is significantly large and for a specific purpose, it is a ‘capital’ receipt and credited to Capital Fund in the Balance sheet. 2. Donations : Donation is an amount received by the ‘not for profit’ organisations from a donor. The donor may be a member of the organisation or an outsider. The purpose of the donation may be either general or specific. If the amount of ‘General’ donation is small, it is treated as a ‘revenue’ receipt and credited to Income and Expenditure Account. On the other hand, if the amount of general donation is significantly large, it is treated as a ‘capital’ receipt and credited to Capital Fund in the Balance Sheet, Whether the general donation is small or large, it depends on the nature and size of the organisation. If the question is silent on the nature of donation, it is treated as a general donation and the students should specify it under foot note. Any donation received for a specific purpose is treated as a ‘capital’ receipt and is credited to that specific fund and shown on the liabilities side of the Balance Sheet. The specific funds are like Building Fund, Prize Fund, Tournament Fund, etc. Any income from the specific fund is credited to that fund and any expenditure of revenue in nature is deducted from the specific fund. Sometimes a part of the specific fund is transferred to Capital Fund in the Balance Sheet. When the amount of the specific fund is invested outside the business, a Specific Fund Investment Account is opened and shown on the assets side of the Balance Sheet. Illustration 1 From the extracts of the Receipts and Payments Account of an Orphanage, treat the amount of donations :
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Receipts and Payments Account (extracted) for the year ending 31.03.2017 Dr. Receipts
(A)
To Balance b/d
Payments
Cr. (A)
-----------
To Donations for Building Fund
1,00,000
To Donations
7,000
To Legacy
70,000
Additional Information : (1) An amount of A9,000 is spent on building (2) Capital Fund stood at A2,00,000. Solution : Income and Expenditure Account for the year ending 31.03.2017 Dr. Expenditure
(A)
Income By Donations
Cr. (A) 7,000
Balance Sheet as on 31.03.2017 Liabilities Capital Fund : Add Legacy Building Fund
(A)
2,00,000 70,000
2,70,000
1,00,000
Less : Building Expenses 9,000
91,000
Assets
(A)
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137
3. Entrance Fees : Entrance fee is received from the new members only at the time of admission into the organisation. The entrance fee received is non-recurring in nature. So it is treated as a Capital receipt and shown on the liability side of the Balance Sheet. Some accountants are of the view that entrance fees are received regularly from the members and hence, it is recurring in nature and treated as revenue receipt and credited to Income and Expenditure Account. In the absence of any specific information, the students are advised to justify the accounting treatment by giving a foot note. 4. Life membership fees : It is a lump sum amount received once only from the members for their permanent/life membership. It is non-recurring in nature. It is a capital receipt and should be shown on the liability side of Balance Sheet either as an independent item or added to Capital Fund on the liability side of Balance Sheet. 5. Sale of Assets : Sale of old and obsolete assets like equipment, sports materials, waste papers is treated as revenue receipts and credited to Income and Expenditure Accounts. Normally the sale of old current assets are revenue in nature and credited to Income and Expenditure Account. The sale proceeds of the fixed assets are credited to the relevant Fixed Asset Account as a capital receipt. But the profit/loss on sale of the fixed asset is credited/ debited to Income and Expenditure Account. The profit or loss sale of fixed asset is the difference between the sales proceeds and its written down value. 6. Sale of old news papers : The sale proceeds of old news papers and periodicals are treated as revenue receipts. It is a recurring source of revenue. It is credited to Income and Expenditure Account. 7. Sale of consumble stores : The ‘not for proft’ organisations have some consumbale items for sale during their normal course of operations. These are : sale of eatable refresments, medicines, stationeries, etc. These are treated as revenue receipts and credited to Income and Expenditure Account. 8. Subscription : Subscription is a periodical contribution of specific amount by the members to a ‘not for profit’ organisation. It is a regular/recurring income of
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the club or society. The subscriptions may be collected from the members monthly, quarterly, half-yearly or annually. It is a revenue receipt and is credited to Income and Expenditure Account. 9. Endowment Fund : Endowment Fund is a permanent fund created by the ‘not for profit’ organisations from receipts in the form of gifts, bequests, etc. It is a capital receipt and shown on the liability side of the Balance Sheet. It represents a permanent source of income to a ‘not for profit’ organisation. Any interest received from the Endowment Fund Investments is credited to Income and Expenditure Account. 10. Specific Fund : ‘Not for profit’ organisations create some specific funds like Tournament Fund, Prize Fund, Building Fund, Entertainment Fund, etc. Any receipt from this type of fund invested in various securities, is credited to the specific fund account while the expenses on those specific funds are debited to the fund account and the balance is shown on the liabilities side of the Balance Sheet. When the expenses of the specific fund are more than the balance of the fund account, the difference is debited to the Income and Expenditure Account. As and when the purpose of the specific fund is fulfilled, the balance in the specific fund is transferred to Capital Fund. 11. Honorarium : An amount paid to the invitees, guest lecturers, doctors, artists, singers for their voluntary services is called honorarium. This amount is paid to them in their honour for visiting the ‘not for profit’ organisation and providing service to the public. It is a revenue expenditure and is debited to Income and Expenditure Account. 12. Capital Fund : The excess of assets over the total outside liabilities is called Capital Fund of a ‘not for profit’ organisation. It is shown on the liabilities side of the Balance Sheet. Capital Fund is also called the General Fund. Capital Fund is increased by addition of surplus and decreased by deduction of deficit. Sometimes, the amount of special funds are transferred to this fund and some receipts are capitalised. Capital Fund is the major source of funds of every ‘not for profit’ organisation. It accumulates year after year. The capital fund at the end of the year becomes the
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139
opening Capital Fund for the following year. The increase/decrease in Capital Fund is shown as below : Opening Capital Fund at the beginning of the year XXX Add : Surplus (excess of income over expenditure) XXX Capitalised portion of Entrance Fees/Life membership Fees XXX Amount transferred from special fund, if any XXX XXX Less : Deficit (Excess of expenditure over income) XXX Closing Capital Fund XXX 13. Government Grant : Grant from the Government is an important source of revenue for a ‘not for profit’ organisation. Grants from the Governemnts are received for (i) maintenance and for (ii) development. The grants for maintenance is meant for day-to-day expenses of the organisation. It is treated as a revenue income and credited to Income and Expenditure Account. The grants for development are meant for acquiring any fixed asset. The grants for development are non-recurring and are capital receipts. So it is shown on the liabilities side of the Balance Sheet as an independent item. 2.8
PREPARATIN OF INCOME AND EXPENDITURE ACCOUNT AND BALANCE SHEET
(A) The preparation of Income and Expenditure Account is followed by the preparation of Balance Sheet of a ‘not for profit’ organisation. The Income and Expenditure Account is prepared on the lines of Profit and Loss Account prepared by the profit-making organisations. The revenue expenses are debited and revenue incomes are credited to this account on the basis of the information from the Receipts and Payments Account. The steps in the preparation of Income and Expenditure Account are : 1.
Ignore the opening balance of cash and bank.
2.
Ignore all capital receipts and all capital expenditures.
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3.
Ascertain the revenue incomes of the current accounting period and credit them to Income and Expenditure Account. The revenue income of the current accounting period is to be calculated as follows : Calculation of Revenue Income
Revenue receipts as per Receipts and Payments A/c Add : Accrued Income at the end of curent year Income received in Advance in the previous year
XXX XXX XXX XXX XXX
Less : Accured Income in the Previous year
XXX
Income received in Advance at the end of the current year XXX XXX Revenue Income for the current accounting period 4.
XXX
Ascertain the revenue expenses of the current year and debit them to Income and Expenditure Account. The revenue expense of the current year is to be calculated as follows : Calculation of Revenue Expenses
Revenue payments as per Receipts and Payments Account Add: Outstanding expenses at the end of the current year Prepaid expenses at the end of the previous year
XXX XXX XXX XXX XXX
Less Outstanding expenses at the beginning of the previous year XXX Prepaid expenses at the end of the current year Revenue Expense of the current accounting year
XXX XXX XXX
5.
Ascertain the non-cash expenses such as depreciation or loss on sale of fixed assets. These non-cash expenses are to be debited to Income and Expenditure Account.
6.
Ascertain profit or loss from the trading activities such as Restaurant Bar, Canteen, etc. separetely. Show them on the credit side (if profit) or on the debit
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141
side (if loss) of Income and Expenditure Account. A Separate trading account is to be prepared for each trading activity. Debtors Account and Creditors Account are to be prepared for credit sales and credit purchases repectively. 7.
Ascertain the difference between the total of credit side and total of debit side of the Income and Expenditure Account. (a) If the total of the credit side is more than the total of the debit side, it is surplus. The surplus is transferred and credited to ‘Capital Fund’. (b) If the total of the debit side is more than the total of the credit side, it is deficit. The deficit is transferred and debited to ‘Capital Fund’.
Illustration 2 Calculate the subscription income and show it in Income and Expenditure Account and in Balance Sheet from the data given below : Subscription received during 2016
A25,000 01.01.2016 31.12.2016
Subscription Accrued
A5,000
A3,000
Subscription Received in Advance
A3,000
A2,000
Solution : Income and Expenditure Account for the year ending 31.12.2016 Dr. Expenditure
(A)
Cr. (A)
Income By Subscription Add : Accrued 31.12.16 Advance on 01.01.16
25,000 3,000 3,000 31,000
Less: Accrued on 1.1.16 (-) 5,000 Advance on 31.12.16 (-) 2,000 24,000
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Balance Sheet as on 31.12.2016 Liabilities Subscription received in Advance (Closing)
(A) 2,000
Assets Subscription Accrued (Closing)
(A) 3,000
Illustration 3 Ascertain the Rent expenses and show it in Income and Expenditure Account and in Balance Sheet from the information given below : (A) Rent paid during the year ending 31.12.15 22,000 Rent outstanding as on 31.12.2015 5,000 Rent outstanding as on 01.01.2015 3,000 Rent prepaid as on 31.12.2015 4,000 Rent prepaid as on 01.01.2015 2,000 Solution : Dr.
Income and Expenditure Account for the year ending 31.12.2016 Expenditure (A) Income (A)
To Rent Add : Outstanding (on 31.12.15) Prepaid (on 01.01.15)
22,000 5,000 2,000 29,000
Less : Prepaid on 31.12.15 (-) 4,000 Outstanding on 01.01.15 (-) 3,000
22,000
Cr. (A)
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143
Balance Sheet as on 31.12.2015 Liabilities Rent outstanding (31.12.15)
(A) Assets 5,000 Rent prepaid (31.12.15)
(A) 4,000
Illustration 4 From the following Receipts and Payments Account, prepare Income and Expenditure Account for the year ending 31st December 2016 : Dr. Cr. Receipts (A) Payments (A) (A) To Balance b/d Cash in Hand Cash at Bank To Subscriptions 2015 2016 2017 To Entrance Fees To Sale of old New papers
1,000 9,000 4,000 30,000 6,000
To Locker Rent To Hire of Ground To Sale of Annual Drama Tickets To Interest on Investments
10,000
By Salary By Insurance Premium By Printing and Stationery
40,000 4,800 300
By Electricity By Furniture By Mowing Machine By Annual Drama Expenses By Subscription to Journals By Investments
2,900 2,000 10,000 500 70,500
By Balance c/d Cash in Hand Cash at Bank
(A) 800 2,200
8,000 2,000 1,000 1,500 12,000 18,000 7,000 3,000 15,000
3,000 70,500
144 Solution :
Dr.
Accountancy
Income and Expenditure Account for the year ending 31.12.2016 Expenditure (A) Income
To Salary
8,000
By Subscriptions
To Insurance Premium To Printing and Stationery To Electricity To Subscription to Journal To Excess of Income over Expenditure
2,000 1,000 1,500 3,000
By Entrances Fees By Sale old news papers By Locker Rent By Hire of Ground
25,000
By Interest on on Investment By Profit from Annual Drama : (A) Sale of Tickets 10,000 Less : Expenses 7,000
40,500
Cr. (A) 30,000 4,800 300 2,900 2,000 500
3,000 40,500
(B) After preparation of Income and Expenditure Account, a Balance Sheet has to be prepared by the ‘not for profit’ organisations. The Balance Sheet of these organisations is prepared on the lines of preparation of Balance Sheet of any Trading and profit-making organisations. The excess of assets over liabilities is treated as ‘Capital Fund’ or ‘General Fund’. No members contribute to the Capital Fund of the ‘not for profit’ organisations. Capital Fund. is increased with capital receipts, receipts which are capitalised and surplus of the Income and Expenditure Account. If Capital Fund is not given in the beginning, it is to be ascertained by preparing the opening Balance Sheet. Balance Sheet is prepared from the items remaining in the Receipts and Payments Account after transfer of all revenue incomes and expenses to the Income and Expenditure Account. The Balance Sheet contains only the capital items, i.e., capital expenditures and capital receipts, liabilities and Capital Fund. Assets and liabilities are to be arranged either on the basis of ‘permanence’ or on the basis of ‘liquidity’.
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145
The following points should be taken into consideration at the time of preparing the Balance Sheet : (i) Recording of Fixed Assets : The fixed assets in the opening balance sheet are to be adjusted for assets purchased, sold and depreciation charged during the year. The new fixed assets purchased shown on the credit (payment) side of Receipts and Payments Account is to be added to the balance of fixed assets of opening Balance Sheet while preparing the new balance sheet. If only asset is sold, its book value/written down value is to be deducted from the relevant asset of the previous year. The amount of depreciation is to be charged after adjustment of purchase and sale of fixed assets. (ii) Recording of Prepaid Expenses and Accrued Incomes : The prepaid expenses and accrued incomes at the end of the accounting period are to be shown on the assets side of the closing Balance Sheet. Similarly, the prepaid expenses and accrued incomes of the previous year are taken to the assets side of the opening Balance Sheet. (iii) Recording of Balances of cash in hand and cash at bank : The opening balance of cash in hand and cash at bank shown in the receipts and payments account, are to be transferred to the assets side of the opening Balance Sheet. Similarly, the closing balnaces of cash in hand and cash at bank shown in the receipt and payments account are transferred to the assets side of the closing Balance Sheet. (iv) Balance of consumable items: The balances of consumable items like stationeries, sports materials, medicines, stock of bars, refreshments at the end of the accounting period are to be shown on the assets side of the closing Balance Sheet. (v) Recording of Capital Fund : The capital fund of the opening Balance Sheet is adjusted with curent year’s surplus/deficit and transfer from Special Fund Account, Capitalised portion of Entrance Fees and Life Membership Fees in the closing Balance Sheet. (vi) Recording of Loans : The loan appearing on the liability side of the opening Balance Sheet is to be taken to the closing Balance Sheet. Any repayment of
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loan shown on the credit side of the Receipts and Payments Account is taken for deduction in the closing Balance Sheet. Similarly, if some additional loan is raised from the banks or other financial institutions, are added to the loan account in the closing balance sheet. The fresh loan taken during the current year is found on the credit side of Receipts and Payments Account. (vii) Recording of Capital Receipts : The capital receipts like donations for specific purpose are shown on the liabilities side of the Balance Sheet. Similarly, Special Funds and Endowment Funds will be shown on the liabilities side of the Balance Sheet. (viii) Recording of Entrance fees, Legacies and Life Membership Fees : When it is decided to capitalise these receipts, these are transferred to the liabilities side of the Balane Sheet. (ix) Outstanding expenses and incomes received in advance at the end of the accounting period are shown on the liability side of the closing Balance Sheet. Similalry, prepaid expenses and accrued incomes at the end of the accounting period, are shown on the assets side of the Balance Sheet. FORMAT OF BALANCE SHEET BALANCE SHEET AS ON ...... Liabilities (A) Assets (A) Capital Fund : Opening Balance Add : Surplus Entrance Fees (Capitalised portion) Life membership fee (Capitalised portion) Amount Transferred from Speecial Fund
XXX XXX XXX XXX
XXX XXX XXX
Less : Deficit Special Fund : Prize Fund XXX Add: Income from Prize Fund XXX
Land and Building Less Depreciation Ground and Pavillion Sports Equipment Mowing Machine Furniture and Fixtures Billiards Table Liabrary Books Motor Vehicles Crockery and Cutlery XXX Investments : Share Debentures National Savings Certificates
XXX XXX
XXX XXX XXX
XXX XXX XXX XXX XXX XXX XXX XXX XXX
Financial Statements of ‘Not for Profit’ Organisations
XXX XXX
Less : Prize Awarded Building Fund Tournament Fund Scholarship Fund Endowment Fund Loans Life Membership Fees Entrance Fees (if capitalsed) Legacy Government Grants : For Development For Books For Computers For Pavillion Current Liabilities : Bank overdraft Creditors Outstanding Expenses Subscriptions received in advance
XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
Prize Fund Investment XXX Building Fund Investment XXX Endowment Fund Investment Scholarship Fund Investment Fixed Deposits Current Assets : Sports Materials Stock of Refreshments Bar Stock Stock of medicines Prepaid Expenses Accrued Incomes Cash in Hand Cash at Bank
XXX XXX XXX XXX XXX
147 XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX XXX
XXX
Illustration 5 From the following Receipts and Payments Account of Sambulpur Club for the year ending 31.12.2016, prepare Income and Expenditure Account for the year and the Balance Sheet as on that date : Receipts and Payments Account for the year ending 31.12.2016. Dr. Cr. Liabilities (A) Assets (A) To Balance b/d : (A) Cash in Hand Cash at Bank To Subscriptions :
4,800 5,000
9,800
By Salaries By Printing and Stationeries By Office Expenses
15,000 3,000 8,500
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148 (A) 12,500 34,500 5,400
For 2015 For 2016 For 2017 To Rent of Hall To Entrance Fees To Sale of Old News Papers
52,400 12,000 5,000 1,000 1,000 80,200
By Books By Newpapers By Rent By Balance c/d : Cash in Hand : Cash at Bank
10,000 6,000 4,500 18,000 15,200 33,200
80,200
Additional Information: (i) On 01.01.2016, the club owned Building valued A2,00,000 and Furniture A50,000. Solution : Income and Expenditure Account of Sambalpur Club for the year ending 31.12.2016 Dr. Cr. Expenditures (A) Incomes (A) To Salaries 15,000 To Printing and Stationeries 3,000 To Office Expenses 8,500 To Newspapers 6,000 To Rent 4,500 To Exces of Income over Expenditure (surplus transferred to Capital Fund) 15,500 52,500
Liabilities
By Subscriptions By Rent of Hall By Entrance Fees By Sale of old Newspapers
52,500
Balance Sheet of Sambalpur Clus as on 31st December, 2016 (A) Assets
Subscriptions received in advance 5,400 Capital Fund : Opening balance 2,72,300 Add surplus 15,500 2,87,800 2,93,200
34,500 12,000 5,000 1,000
Cash in hand Cash at bank Building Furniture Library books
(A) 18,000 15,200 2,00,000 50,000 10,000 2,93,200
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149
Working Note : Liabilities
Balance Sheet as on 31.12.2015 (A) Assets
Capital Fund (Balancing figure)
2,72,300
Cash in Hand Cash at Bank Subscription outstanding Furniture Building
2,72,300
(A) 4,800 5,000 12,500 50,000 2,00,000 2,72,300
Illustration 6 From the following Receipts and Payments Account and additional information, prepare the Income and Expenditure Account and Balance Sheet of DAV Educational Society : Receipts and Payments Account for the year ending 31.12.2016 Dr. Cr. Receipts (A) Payments (A) To Balance b/d To Subscriptions For 2015 2,200 For 2016 27,500 For 2017 2,500 To Lockers Rent To Sale of old Newspapers To Sale of Old Furniture (Book Value A6,000) To Interest on Investment To Grants from Government
20,550
32,200 3,000 250 4,200 450 20,000 80,650
By General Expenses By Newspapers
4,200 2,850
By Salaries By Electricity By Investments (@10% per annum) By Rent By Printing and Stationery
4,600 3,000 30,000
By Furniture By Balance c/d
20,000 7,200
5,500 3,300
80,650
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Additional Information : (i) Subscription outstanding on 31.12.2016 A2,000 (ii) Salary outstanding on 31.12.2016 A1,400 (iii) Rent A700 has been paid in advance. (iv) On 01.01.2016, the society had furniture worth A15,000. Solution : DAV Educational Society Income and Expenditure Account for the year ending 31.12.2016 Dr. Expenditures (A) Incomes To General Expenses To Newspaper To Salaries Add : Outstanding To Electricity To Rent
4,600 1,400 5,500
Less : Prepaid
700
To Printing and Stationery To Loss on sale of old furniture To Surplus (Excess of Income over Expenditure)
Liabilities
Cr. (A)
4,200 By Subscriptions 27,500 2,850 Add : Accrued 2,000 29,500 By Lockers Rent 3,000 6,000 By Sale of Old Newspapers 250 3,000 By Interest on Investment 450 Add : Accrued Interest 2,550 3,000 4,800
{(30,000×
10 ) – 450} 100
3,300 By Grants from Government
20,000
1,800 29,800 55,750
55,750
Balance Sheet as on 31.12.2016 (A) Assets
Outstanding Salaries 1,400 Subscription Received in Advance 2,500 Capital Fund 37,750 Add Surplus 29,800 67,550
71,450
Furniture 10% Investment Accrued Interest on Investment Subrscription outstanding Prepaid rent Cash
(A) 29,000 30,000 2,550 2,000 700 7,200 71,450
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151
Working Notes : 1. Balance Sheet as on 01.01.2016 (Opening) Liabilities (A) Assets Capital Fund (Balancing figure)
2. Dr.
37,750 Cash Subscription due Furniture
20,500 2,200 15,000
37,750
37,750
Furniture A/c Particulars
(A)
To Balance b/d To Bank (Purchases)
(A)
Particulars
Cr. (A)
15,000 By Bank (Sale of Furniture) 20,000 By Loss on Sale of Furniture By Balance c/d
4,200 1,800 29,000
35,500
35,000
Illustration 7 From the information of Sunshine Club Joyepre ascertain the amount of sports materials consumed during the year ending 31.12.2016 and show it in their final accounts. Receipts and Payments Account for the year ending 31.12.2016 Dr. Cr. Receipts (A) Payment (A)
Liabilities
By Sports Materials
3,500
Balance Sheet as on 01.01.2016 (A) Assets
(A)
Creditor of on sports materials
150 Sports Materials
200
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Illustration 6 From the following information of Sunshine Club, Jeypore, ascertain the amount of sports materials consumed during the year ending 31.12.2016 and show it in their final accounts : Receipts and Payments Account for the year ending 31.12.2016 Dr. Cr. Receipts (A) Payments (A) By Sports Materials
Liabilities
Balance Sheet as on 01.01.2016 (A) Assets
Creditors for Sports Materials
150 Sports Materials
Additional information : (a) Sports materials on hand as on 31.12.2016 was valued at A550. Solution : Income and Expenditure Account for the year ending 31.12.2016 Dr. Expenditure (A) Income To Consumption of sports materials : Opening stock 200 Purchased in 2016 3,500 Less 3,700 Creditors paid for previous year 150 Less Closing Stock (as on 31.12.2016) 550
Liabilities
(A) 200
Cr. (A)
3,000
Balance Sheet as on 31.12.2016
Dr.
3,500
(A)
Assets Sports Materials
Cr. (A) 550
Illustration 7 A Club has 50 members each contributing an annual subscription of A250. For the year 2016, the extract of the Receipts and Payments Account of the club was as follows :
Financial Statements of ‘Not for Profit’ Organisations
153
Subscriptions: For 2015 A850 For 2016 A10,000 For 2017 A900 Calculate the amount of subscriptions to be credited to the Income and Expenditure Account.
Solution : Dr.
Income and Expenditure Account Expenditure (A) Income
Cr. (A)
By Subscriptions : Received for 2016 A10,000 Add Outstanding A2,500 A12,500 {(250×50) – actually received 10,000}
Illustration 8 The Receipts and Payments Account of a ‘Not for Profit’ organisation shows A44,000 as subscriptions received during the year 2016. Taking into consideration the following additional information, calculate the income from subscriptions for 2016: (A) (i) Subscriptions outstanding as on 31.12.2015 1,350 (ii) Subscriptions outstanding as on 31.12.2016 3,200 (iii) Subscriptions received in advance as on 31.12.2015 950 (iv) Subscriptions received in advance as on 31.12.2016 1,250 Solution : Income and Expenditure Account for the year ending on 31.12.2016 Dr. Cr. Expenditure (A) Income (A) By Subscriptions : (A ) Received in 2016 44,000 Add : Outstanding in 2016 3,200 Received in advance for 2015 950 48,150 Less : Outstanding for 2015 1,350 Received in advance 46,800 for 2017 1,250 45,550
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Illustration 9 From the following extract of Receipts and Payments Account and additional information given below, calculate the amount of subscription and show how they would appear in the Income and Expenditure Account for the year ending 31.12.2016 and in the Balance Sheet as on that date : Receipts and Payments Account for the year ending on 31.12.2016 Dr. Cr. Receipts
(A)
Payments
(A)
To Subscriptions For 2015 For 2016 For 2017
(A) 750 25,000 1,000
26,850
Additional information : (i) Subscriptions outstanding as on 31.12.2015 A1,200. (ii) Subscriptions outstanding as on 31.12.2016 A4,000. (iii) Subscriptions received in advance as on 31.12.2015 A1,000. Solution : Income and Expenditure Account for the year ending on 31.12.2016 Dr. Expenditure
(A)
Income
Cr. (A)
By Subscriptions : (A) Received in 2016 25,000 Add : Outstanding for 2016 3,550 Received in Advance in 2015 for 2016 1,000 29,550
Balance Sheet as on 31.12.2016
Dr. Liabilities
Subscriptions Received in Advance
(A)
Assets
Cr. (A)
1,100 Subscriptions outstanding : For 2015 (A1,200-received A750) 550 For 2016 (Total outstanding 3,550 A4,000 – outstanding for 2015 A450)
Financial Statements of ‘Not for Profit’ Organisations
155
Illustration 10 Srikrishna Dance Society has 120 members. The annual subscription for each member is A300. During the year ending 31.12.2016, 85 members have paid their subscriptions. Of these, 25 members have paid their annual subscriptions for 2017 in advance. You are required to show the Income from subscriptions as it would appear in the Income and Expenditure Account. Also, show the required information in the Balance Sheet of the society. Solution : Income and Expenditure Account of Srikrishna Dance society for the year ending 31.12.2016 Dr. Cr. Expenditure (A) Income (A) By Subscriptions : (A) Received (85×A300) 25,500 Add : Outstanding {(120×A300) –A25,500} 10,500 36,000
Balance Sheet as on 31.12.2016
Dr. Liabilities
Subscriptions Received in Advance (25×A300)
(A)
Assets
7,500 Subscriptions outstanding
Cr. (A) 10,500
Illustration 11 Kishore Club, Bhubaneswar had the following assets and liabilities on 01.03.2017. (A) Cash in Hand 350 Outstanding Subscriptions 800 Books 3,000 Furniture 4,000 Bat and Balls 2,500 Prepaid rent 600 Salary Outstanding 950 Creditors for stationery 750 Calculate Capital Fund on 01.03.2017.
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Solution : Liabilities
Balance Sheet of Kishore Club as on 01.03.2017 (A) Assets
Salary Outstanding Creditors for stationery Capital Fund (Balancing Figure)
950 Cash in Hand 750 Outstanding Subscriptions 9,550 Prepaid Rent Books Bat and Ball Furniture 11,250
(A) 350 800 600 3,000 2,500 4,000 11,250
Illustration 12 Receipts and Payments Account of Lions Club, Cuttack showed that A80,000 were received by way of subscriptions for the year ending 31.03.2017. The additional information were as follows : (A) (i) Subscriptions outstanding as on 31.03.2016 4,200 (ii) Subscriptions outstanding as on 31.03.2017 3,800 (iii) Subscriptions received in advance as on 31.03.2016 3,500 (iv) Subscriptions received in advance as on 31.03.2017 2,700 Show the above information in the Income and Expenditure Account and Balance Sheet of the Club for the year ending on 31.03.2017. Solution : Income and Expenditure Account of Lions Club, Cuttack for the year ending 31.03.2017 Dr. Cr. Expenditure (A) Income (A) By Subscriptions : (A) Received during the year ending 31.03.17 80,000 Add : Outstanding as on 31.3.17 3,800 Received in advance as on 31.03.2016: 3,500 Less : 87,300 Outstanding as on 31.3.16 4,200 Received in advance 83,100 as on 31.03.2017 2,700 80,400
Financial Statements of ‘Not for Profit’ Organisations
Dr. Liabilities
Balance Sheet of Lions Club, Cuttack as on 31.03.2017 (A) Assets
Subscriptions Received in Advance
2,700 Subscriptions Outstanding
157
Cr. (A) 3,800
Illustration 13 Receipts and Payments Account shows payment of salary A5,600 for the year ending 31.12.2016. The additional information are : Salary paid include A550 for 2015 and A600 for 2017. Salary due but not paid on 31.12.2016 amounts to A750. Salary paid in advance as on 31.12.2015 was A700. Show the information in the Final Accounts for the year ending 31.12.2016. Solution : Income and Expenditure Account for the year ending 31.12.2016 Dr. Cr. Expenditure (A) Income (A) (A) To Salary 5,600 Add : Outstanding on 31.12.2016 750 Prepaid on 31.12.2015 700 7,050 Less : Outstanding on 31.12.2015 550 6,500 Prepaid as on 31.12.2016 600 5,900
Liabilities Salary Outstanding
Balance Sheet as on 31.12.2016 (A) Assets 750 Salary Prepaid
(A) 600
Accountancy
158
Illustration 14 Following is the extract of a Receipts and Payments Accounts of Vijay Club for the year ending 31.12.2016 : Receipts and Payments Account for the year ending 31.12.2016 Dr. Cr. Receipts
(A)
Payments By Salary Paid For 2015 For 2016 For 2017
(A) 800 6,500 300 7,600
Calculate the expenses on salary for 2016 and show it in the Income and Expenditure Account and Balance Sheet after taking into consideration the following additional information : (a) Salary outstanding as on 31.12.2015 A1,000 (b) Salary outstanding as on 31.12.2016 A500 (c) Salary paid in advance as on 31.12.2015 A400 (d) Salary paid in advance as on 31.12.2016 A300 Solution : Income and Expenditure Account for the year ending 31.12.2016
Dr. Expenditure
(A)
To Salary Paid for 2016 6,500 Add : Outstanding for 2016 300 Prepaid in 2015 for 2016 400 7,200
Income
Cr. (A)
Financial Statements of ‘Not for Profit’ Organisations
Liabilities Salary outstanding : For 2015 (A1,000 – A800) For 2016
Balance Sheet as on 31.12.2016 (A) Assets Salary prepaid (for 2017) 200 300
159
(A) 300
500
(Total outstanding A500 less outstanding for 2015 A200)
Illustration 15 From the following extracts of Receipts and Payments Account and additional information for the year ending 31.12.2016, show the treatment of subscriptions in the final accounts : Receipts and Payments Account for the year ending 31.12.2016 Dr. Cr. Receipts (A) Payments (A) To Subscriptions (A) For 2015 5,600 For 2016 38,700 52,800 For 2017 8,500 Additional Information : (i) Subscriptions outstanding on 31.12.2016 A4,400 (ii) Subscriptions outstanding on 31.12.2015 A6,900 (iii) Subscriptions received in advance on 31.12.2015 A2,400 Solution : Income and Expenditure Account Dr. Cr. for the year ending on 31.12.2016 Expenditure (A) Income (A) (A) By Subscriptions : Received in 2016 : 38,700 Add : Outstanding for 2016 {4,400-(6,900-5,600)} 3,100 Received in advance in 2015 for 2016 2,400
44,200
Accountancy
160
Liabilities
Balance Sheet as on 31.12.2016 (A) Assets
Subscriptions Received in Advance (In 2016 for 2017)
Subscriptions outstanding 8,500 For 2015 (6,900-5,600) For 2016 (4,400-1,300)
(A) 1,300 3,100 4,400
Illustration 16 From the following Receipts and Payments Account, prepare Income and Expenditure Account : Receipts (A) Payments (A) To Balance b/d By Salaries 4,600 Cash in Hand 800 By Rent 1,800 Cash at Bank 1,000 By Postage and Telephones 700 To Subscriptions 9,000 By Printing and Stationery 1,200 To Sale of old newspapers 350 By Fixed Deposit 3,000 To Sale of old furniture 800 By Balance c/d Cash in Hand 500 (Book value A1,000) To Donations 300 Cash at Bank 450 12,250 12,250 Solution : Income and Expenditure Accounts Dr. Expenditure (A) Income To Salaries 4,600 By Subscriptions To Rent 1,800 By Sale of old Newspapers To Postage and Telephones 700 To Printing and Stationery 1,200 To Loss on sale of Furniture 200 To Excess of Income over Expenditure (Surplus) 850 9,350 Note : Donations assumed to have been capitalised.
Cr. (A) 9,000 350
9,350
Financial Statements of ‘Not for Profit’ Organisations
161
Illustration 17 From the following information, calculate the amount of subscriptions to be credited to the Income and Expenditure Account of Current Year : Subscriptions received during the current year A 9,500 Subscriptions outstanding at the end of the previous year A 1,000 Subscriptions outstanding at the end of the current year A 750 Subscriptions received in advance at the end of the previous year A 800 Subscriptions received in advance at the end of the current year A 650 Solution : Income and Expenditure Account Dr. Cr. Expenditure (A) Income (A) By Subscriptions (A) Received during the year Add : Outstanding at the end of the current year Received in Advance at the end of the previous year Less : Outstanding at the end of the previous year Received in Advance at the end of the current year
9,500
750 800 11,050
1000 10,050 650
9,400
Illustration 18 The Receipts and Payments Account shows the payment of salary A14,500 for the year ending 31.12.2016. The additional information below the Receipts and Payments Account are : Salary paid includes A4,500 for 2015 and A7,000 for 2017. Salary outstanding on 31.12.2016 amounts to A6,000 and salary paid in advance as on 31.12.2015 was A5,000. Show the salary account in the Income and Expenditure Account of 2016.
Accountancy
162
Solution : Dr. Expenditure
Income and Expenditure Account for the year ending 31.12.2016 (A) Income (A)
Cr. (A)
To Salary 14,500 Add : Outstanding as on 31.12.2016 6,000 Prepaid on 31.12.15 5,000 25,500 Less : Outstanding as on 31.12.15 4,500 21,000 Prepaid on 31.12.16 7,000 14,000
Illustration 19 From the following Receipts and Payments Account of Adishakti Club for the year ending 31.12.2015, prepare Income and Expenditure Account : Dr. Receipts To Balance b/d Cash in Hand 21,070 Cash at Bank 12,650 To Donations To Subscriptions To Interest on Securities To Sale of old Newspaper To Entrance Fees To Locker Rent To Receipts from cricket match
(A)
33,720 18,000 14,500 3,400 300 2,450 2,900 7,800
83,070
Cr. (A) 3,000 750 3,000 11,000 1,800 30,000 6,000 1,800 650 12,000
Payments By Charity By Rates and Taxes By Match Expenses By Salaries By General Expenses By Investment By Furniture By Insurance Premium By Newspapers By Books Purchased By Balance c/d Cash in Hand 6,700 Cash at Bank 6,370 13,070 83,070
Financial Statements of ‘Not for Profit’ Organisations
163
Additional Information : (i) Salary unpaid for 2015 A1,000 (2) Half of the donation is to be capitalised (3) Insurance premium paid in advance A300. Solution : Income and Expenditure Account for the year ending 31.12.2015 Dr. Cr. Expenditure To Charity To Rates and Taxes To Salaries Add Unpaid To General Expenses
(A)
11,000 1,000
Income
3,000 By Donations 750 Less Capitalised By Subscriptions 12,000 By Interest on securities
(A) 18,000 9,000
9,000 14,500 3,400
1,800 By Sale of old Newspapers 300 To Insurance Premium 1,800 By Entrance Fees 2,450 Less Prepaid 300 1,500 By Locker Rent 2,900 To Newspapers 650 By Profit from cricket match : To Excess of Income over Receipts 7,800 Expenditure (surplus) 17,650 Less Expenses 3,000 4,800 37,350 37,350 Illustration 20 From the Receipts and Payments Account of Ganjam Club, Berhampur, prepare the Income and Expenditure Account for the year ending 31st December 2014 and the Balance Sheet as on that date : Receipts and Payments Account for the year ending 31.12.2014 Dr. Cr. Receipts (A) Payments (A) To Balance b/d By Salaries Cash in Hand 3,600 For 2013 500 Cash at Bank 17,000 For 2014 6,000 6,500 To Subscriptions 26,900 By Miscellaneous Expenses 1,500 To Entrance Fees 2,400 By Books 10,000 To Restaurants taking 3,800 By Restaurant Expenses 2,650 To Rent of Ground 800 By 9% Fixed Deposit 15,000 To Sale of old Newspapers 200 (on 01.01.2014)
164
To Interest on Fixed Deposits
Accountancy
600 By Honorarium to Coach By Periodicals and Newspapers By Balance c/d Cash in Hand Cash at Bank 55,300
2,500 1,100 4,050 12,000 55,300
Additional Information : (1) The club has 50 members and each paying an annual subscription of A600 per annum. Subscriptions received include A900 for 2013 and A1,200 for 2015. (2) Salaries outstanding on 31.12.2014 A1,000. (3) On 01.01.2014, the club owned Land and Building worth A1,00,000, Furniture worth A10,000 and Machinery worth A20,000. (4) Provide a depreciation of 5% on all fixed assets except on books. Solution : Income and Expenditure Account of Ganjam Club for the year ending 31.12.2014 Expenditure (A) Income (A) (A) By Subscriptions : (A) To Salaries 6,000 Received during 2014 26,900 Add : Outstanding Less : Received for 2013 900 for 2014 1,000 7,000 26,000 To Miscellaneous Expenses 1,500 Received for 2015 1,200 To Honorarium to coach 2,500 24,800 To Periodicals and Newspapers 1,100 Add To Depreciation : (A) outstanding for 2014 5,200 On Land and Buildings 5,000 {(50×600) – 24,800} 30,000 On Furniture 500 By Entrance Fees 2,400 By Profit from Restaurants On Machinery 1,000 Takings 3,800 To Excess of Income over 6,500 Less Expenses 2,650 1,150 Expenditure (surplus) 17,300 By Rent of Ground 800 By Sale of old Newspapers 200 By Interest on Fixed Deposit Received 600 Add Accrued 750 1,350 9 {(A15,000× 100 ) –A600) 35,900 35,900
Financial Statements of ‘Not for Profit’ Organisations
Liabilities
Balance Sheet as on 31.12.2014 (A) Assets
Salaries outstanding Subscriptions received in Advance Capital Fund : Opening Balance 1,51,000 Add Surplus 17,300
165
(A)
1,000 Cash in Hand 4,050 1,200 Cash at Bank 12,000 Subscription outstanding 5,200 Interest on FD Accrued 750 9% Fixed Deposit 15,000 1,68,300 Books 10,000 Land and Buildings 1,00,000 Less Depreciation 5,000 95,000 Machinery 20,000 Less Depreciation 1,000 19,000 Furniture 10,000 Less Depreciation 500 9,500 1,70,500 1,70,500
Working Note : Liabilities Salaries outstanding Capital Fund (Balancing figure)
Balance Sheet as on 31.12.2013 (A) Assets 500 Land and Buildings 1,51,000 Machinery Furniture Subscriptions Outstanding Cash in Hand Cash at Bank 1,51,500
(A) 1,00,000 20,000 10,000 900 3,600 17,000 1,51,500
Illustration 21 The following is the Receipts and Payments Account of Lions Club, Bhubaneswar for the year ending 31.12.2016 : Receipts and Payments Account for the year ending 31.12.2016 Receipts (A) Payments (A) To Balance b/d By Salaries 3,640 Cash 1970 By Charity 1,500 Bank 13,620 By Municipal Expenses 700 15,590 By Sundry Expenses 800
Accountancy
166
To Donations To Subscriptions To Interest on securities To Sale of sports materials To Entrance Fees To Locker Rent To Bar Takings
10,000 22,500 3,400 250 1,450 950 7,500
By Investment in Government security By Furniture By Insurance By Bar Expenses By Sports Equipment By Balance c/d Cash in Hand 2,000 Cash at Bank 10,000
61,640
20,000 8,000 1,000 6,000 8,000
12,000 61,640
Additional Information : (1) Salaries not paid for 2016 A1,360. (2) Insurance premium paid in advance A200. (3) Subscriptions received during 2016 include subscriptions of A1,500 for 2017. Prepare Income and Expenditure Account and Balance Sheet. Solution : Income and Expenditure Account of Ganjam Club for the year ending 31.12.2016 Expenditure
(A) (A)
To Salaries 3,640 Add Unpaid 1,360 5,000 To Charity 1,500 To Municipal Expenses 700 To Sundry Expenses 800 To Insurance 1,000 Less Prepaid 200 800 To Excess of Income over expenditure (surplus) 29,750 38,550
Income To Donations By Subscriptions Less Received in Advance
(A) 10,000 22,500 1,500
(for 2017) By Interest on securities By Sale of sports materials By Entrance Fees By Locker Rent By Profit from Bar : Takings 7,500 Less Expenses 6,000
21,000 3,400 250 1,450 950
1,500 38,550
Financial Statements of ‘Not for Profit’ Organisations
Liabilities
Balance Sheet as on 31.12.2016 (A) Assets
Salaries Unpaid Subscriptions Received in Advance Capital Fund : Opening Balance 15,590 Add Surplus 29,750
Working Note : (1) Liabilities
1,360 Cash in Hand 1,500 Cash at Bank Prepaid Insurance Investment in Government 45,340 Securities Sports Equipment Furniture 48,200
Balance Sheet as on 31.12.2015 (A) Assets
Capital Fund (Balancing Figure)
15,590
Cash Bank
15,590
167
(A) 2,000 10,000 200 20,000 8,000 8,000 48,200
(A) 1,970 13,620 15,590
Illustration 22 From the following Receipts and Payments Account and additional information, prepare Income and Expenditure Account for the year ending 31.12.2016 and the Balance sheet as on that date : Receipts and Payments Account for the year ending 31.12.2016 Dr. Cr. Receipts To Balance b/d To Subscriptions To Donations To Legacies To Interest on Investment To Dividend on shares To Sale of old Newspapers
(A) 11,500 20,000 2,700 15,000 2,600 800 200
52,800
Payments By Charities By Salaries By Printing By Postages By Telephones By Rate and Taxes By Furniture By Insurance By Investment By Balance c/d
(A) 7,500 3,500 500 300 700 1,300 10,000 1,000 20,000 8,000 52,800
Accountancy
168
Additional Information : (1) Donations are treated as revenue receipts. (2) Legacies 60% is treated as capital and 40% as revenue receipt. (3) Insurance prepaid during 2016 A100. Solution : Income and Expenditure Account for the year ending 31.12.2016 Dr. Income (A) Expenditure To Charities 7,500 By Subscriptions To Salaries 3,500 By Donations To Printing 500 To Postages 300 To Telephones 700 To Rate and Taxes 1,300 To Insurance 1,000 Less Prepaid 100 900 To Excess of Income over Expenditure (surplus) 17,600 32,300
Liabilities Legacies 15,000 Less (40% of A15,000) 6,000 Capital Fund : Opening Balance 11,500 Add Surplus 17,600
40 By Legacies ( 100 ×15,000) By Interest on Investment By Dividend on Shares By Sale of old Newspapers
Balance Sheet as on 31.12.2016 (A)
Cr. (A) 20,000 2,700 6,000 2,600 800 200
32,300
Assets
(A)
Cash and Bank 9,000 Prepaid Insurance Investment Furniture 29,100
8,000 100 20,000 10,000
38,100
38,100
Financial Statements of ‘Not for Profit’ Organisations
169
Working Note :
Liabilities Capital Fund (Balancing Figure)
Balance Sheet as on 31.12.2015 (A) Assets 11,500 11,500
Cash and Bank
(A) 11,500 11,500
Illustration 23 The following is the Receipts and Payments Account of Sambalpur Dance society for the year ending 31.03.2017. Prepare the Final Accounts of the Society for the year ending 31.03.2017. Receipts and Payments Account Dr. Cr. Receipts (A) Payments (A) To Balance b/d By Equipment and Machinery 17,000 Cash in Hand 4,700 By Stationery 3,500 Cash at Bank 5,300 By Insurance 4,500 To Subscriptions 40,000 By Repairs 2,000 To Sale of Old Furniture 800 By Salaries 23,000 (Book value A1,200) By Help to poor students 10,000 To Donations 10,000 By Audit fee 1,500 To Interest on Investments 2,800 By Advertisement 1,000 By Balance c/d 1,000 Cash in Hand 600 Cash at Bank 500 63,600 63,600 Additional Information : (1) Subscriptions for March 2017 is outstanding A7,000 and for March 2016, it was due A9,000. (2) Investments as on 31.03.2016 were A25,000 (Rate of Interest 12% p.a.) (3) Insurance prepaid was A500. (4) Depreciate Equipment and Machinery @10% p.a.
Accountancy
170
Solution : Dr.
Income and Expenditure Account of Sambalpur Dance Society for the year ending 31.03.2017 Expenditure
(A)
To Stationery To Insurance Less Prepaid
Income
3,500 (A) 4,500 500
To Repairs To Salaries To Help to poor students To Audit fee To Advertisement To Depreciation on Equipment and Machinery (A17,000×10%) To Loss on sale of old Furniture To Excess of Income over Expenditure (surplus)
By Subscriptions Add : Outstanding 4,000 for March 2017
(A) 40,000 7,000 47,000
2,000 Less Outstanding for March 2016 9,000 38,000 23,000 By Donations 10,000 10,000 By Interest on Investments 2,800 1,500 Add Accrued Interest 200 3,000 12 1,000 {(A25,000× 100 ) – A2,800} 1,700 400 3,900 51,000
Balance Sheet of Sambalpur Dance Society as on 31.03.2017 Liabilities (A) Assets Capital Fund : Opening Balance : Add Surplus
45,200 3,900
Cr. (A)
Cash in Hand Cash at Bank 49,100 Subscriptions Accrued Interest on Investment Accrued Prepaid Insurance 12% Investments Equipment and Machinery (A17,000 – A1,700) 49,100
51,000
(A) 600 1,500 7,000 200 500 25,000 15,300 49,100
Financial Statements of ‘Not for Profit’ Organisations
171
Working Note : Balance Sheet as on 31.03.2016 (A) Assets
Liabilities Capital Fund (Balancing Figure)
45,200
Cash in Hand Cash at Bank Subscriptions Accrued Furniture Investments
45,500
(A) 4,700 5,300 9,000 1,200 25,000 45,200
Illustration 24 The following is the Receipts and Payments Account of Star Club for the year ending 31.03.2016 : Dr.
Receipts and Payments Account
Receipts To Balance b/d To Subscriptions To Receipts from Canteen To Sundry Incomes To Rent of Hall To Interest on Investment
(A) 7,000 13,380 14,000 450 1,120 4,850
Payments By Salaries By Stationery By Rent and Taxes By Telephone Charges By Investments By Advertisements By Postage By General Expenses By Canteen Expenses By Balance c/d
40,800
Cr. (A) 12,450 3,600 2,400 600 7,500 1,250 800 3,500 5,000 3,700 40,800
Additional Information : 1. There are 50 members each paying A300 as annual subscription. 2. Stock of Stationery on 01.04.2015 was A700 and on 31.03.2016 A900. 3.
Land and Building A80,000, to be depreciated @7 21 %.
Accountancy
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You are required to prepare an Income and Expenditure Account for the year ending 31.03.2016 and the Balance Sheet as on that date. Dr. Solution :
Income and Expenditure Account of Star Club for the year ending 31.03.2016 Expenditure
(A)
To Salaries To Stationeries consumed : (A)
Opening Stock Add Purchases
700 3,600 4,300 900
Less Closing stock To Rent and Taxes To Telephone Charges To Advertisements To Postage To General Expenses To Depreciation on Land and Building 15 (A80,400× 200 ) To Excess of Income over Expenditure (surplus)
Liabilities
By Profit from Canteen By Sundry Incomes 3,400 By Rent of Hall 2,400 By Intereston Investments 600 1,250 800 3,500 6,000
Balance Sheet of Star Club as on 31.03.2016 (A) Assets
A87,700 A20
(A)
12,450 By Subscriptions A13,380 Add : Due for Current year (31.03.16) A1,620
20 30,420
(A)
Capital Fund : Opening Balance Add Surplus
Income
Cr.
15,000 9,000 450 1,120 4,850
30,420
(A)
Cash in Hand Subscriptions Accrued Stock of Stationery 87,720 Investments Land and Building : Opening Balance A80,000 Less Depreciation A 6,000
3,700 1,620 900 7,500
74,000
87,720
87,720
Financial Statements of ‘Not for Profit’ Organisations
173
Working Note :
Liabilities Capital Fund (Balancing Figure)
Balance Sheet of Star Club as on 31.03.2015 (A) Assets
(A)
87,700 Cash in Hand Stock of Stationery Land and Building
7,000 700 80,000
87,700
87,700
Illustration 25 From the following Receipts and Payments Account of Jogamaya Club and additional information supplied, prepare an Income and Expenditure Account for the year ending 31.12.2016 and a Balance Sheet on that date : Receipts and Payments Account for the year ended of 31st December, 2016 Dr. Cr. Receipts To Balance b/d Cash in Hand Cash in Bank To Subscriptions : 2015 A800 2016 A7,500 2017 A400 To Donations To Lockers Rent To Profit from entertainment To Sale of grass To Interest on Fixed Deposit
(A) 4,200 46,000
8,700 3,275 420 1,380 80 240 64,295
Payments
(A)
By Books By Salaries By General Expenses By Newspapers By 6% Fixed Deposit (on 1.7.16) By Hanorarium By Balance c/d Cash in Hand Cash at Bank
30,000 12,800 3,500 850 12,000 3,000 845 1,300
64,295
Additional Information : (a) The club has 100 members each paying an annual subscriptions of A120. Subscriptions outstanding on 31.12.2015 were A1,200. (b) Salaries paid include A800 for 2017 and salaries outstanding on 31.12.2016 A3,000. (c) On 01.01.2016, the club owned building A50,000 and furniture A8,000.
Accountancy
174
(d)
Provide depreciation on building and furniture @10% p.a.
Solution : Income and Expenditure Account of Jogamaya Club for the year ending 31.12.2016 Dr. Expenditure To Salaries Less Prepaid Add Unpaid To General Expenses To Newspapers To Honorarium To Depreciation : Building Furniture
(A)
A12,800 A800 A12,000 A3,000
15,000 3,500 850 3,000
A5,000 A800
5,800
Income
By Subscriptions A7,500 Add Outstanding (100×A1200-A7,500) A4,500 12,000 By Donations 3,275 By Lockers Rent 420 By Profit from entertainment 1,380 By Sale of grass 80 By Interest on Fixed DepositA240 Add Accrued A120 6 (A12,000× 100 × 21 -A240) By Excess of Expenditure over Income (Deficit)
28,150
Liabilities
Balance Sheet of Jogamaya Club as on 31.12.2016 (A) Assets
Subscriptions Received in Advance Salary unpaid Capital Fund : Opening Balance Less Deficit
Cr. (A)
10,635 28,150
(A)
400 Subscriptions outstanding (A) For 2015 (A1,200–A800) 400 3,000 For 2016 4,500 4,900 Prepaid Salary 800 A1,09,400 Cash in Hand 845 A10,635 98,765 Cash at Bank 1,300 Accrued Interest on Fixed Deposit 120 6% Fixed Deposit 12,000 Books 30,000 Building 50,000 Less Depreciation 5,000 45,000 Furniture 8,000 Less Depreciation 800 7,200 1,02,165 1,02,165
Financial Statements of ‘Not for Profit’ Organisations
175
Working Note : Liabilities
Opening Balance Sheet as on 31.12.2015 (A) Assets
Capital Fund (Balancing Figure)
1,09,400
Subscriptions Outstanding Cash in Hand Cash at Bank Furniture Building
1,09,400
(A) 1,200 4,200 46,000 8,000 50,000 1,09,400
Illustration 26 Following is the Receipts and Payments Account of Nandighosh Club, Bolgarh for the year ending 31.12.2016
Dr. Receipts
To Balance b/d To Subscriptions : 2015 A1,250 2016 A15,800 2017 A1,600 To Sale of old furniture (Book value A200) To Rent of Hall To Sale of old Newspapers
(A)
Payments
7,750 By Salaries By Books By Newspapers By Postages 18,650 By Furniture By Office Expenses 120 By Balance c/d 850 120 27,490
Cr. (A) 4,800 2,000 800 250 2,000 1,050 16,590
27,490
Additional Information : (a)
The club has 100 members. Annual subscription per member is A180. A300 are still outstanding for 2015.
(b)
Salaries outstanding for as on 31.12.2016 were A1,250 and salaries paid include A500 paid for 2015.
(c)
On 31.12.2015, the club owned the following assets : Building A80,000 and Furniture A18,000. You you are required to prepare Income and Expenditure Account for the year ending 31.12.2016, and a Balance Sheet as on that date.
Accountancy
176
Solution : Income and Expenditure Account of Nandighosh Club, Bolgarh for the year ending 31.12.2016 Expenditure To Salaries Less Paid for 2015
(A) A4,800 A500 A4,300
Add Outstanding
A1,250
To Newspapers To Loss on sale of furniture (A200 – A120) To Postages To Office Expenses To Excess of Income over Expenditure (surplus)
5,550 800
(A) Income By Subscriptions A15,800 Add Outstanding A2,200 (A180×100 –A15,800) 18,000 By Rent of Hall 850 By Sale of old Newspaper 120
80 250 1,050 11,240 18,970
18,970
Balance Sheet of Nandi Ghosh Club, Bolgarh as on 31.12.2016 Liabilities (A) Assets (A) Subscriptions Received Cash in Hand 16,590 in Advance 1,600 Salaries Outstanding 1,250 Subscriptions Outstanding : Capital Fund : For 2015 A300 For 2016 A2,200 2,500 Opening Balance A1,06,800 Add Surplus A11,240 1,18,040 Books 2,000 Furniture A18,000 Less Sold A200 A17,800 Add Purchased A2,000 19,800 Building 80,000 1,20,890 1,20,890
Financial Statements of ‘Not for Profit’ Organisations
177
Working Note : Opening Balance Sheet of Nandighosh Club, Bolgarh as on 31.12.2015 Liabilities (A) Assets (A ) Salaries Outstanding Capital Fund (Balancing Figure)
500 Subscriptions outstanding Received in 2016 A1,250 1,06,800 Still outstanding A300 Cash in Hand Furniture Building 1,07,300
1,550 7,750 18,000 80,000 1,07,300
Illustration 27 From the following information relating to Star Club, prepare Income and Expenditure Account for the year ending on 31.12.2016 and a Balance Sheet as on that date : Receipts and Payments Account of Star Club for the year ending 31.12.2016 Dr. Cr. Receipts To Balance b/d To Subscriptions To Entrance Fees To Donations To Life Membership Fees To Interest on Fixed Deposits
(A) 5,180 40,500 2,400 2,540 3,600 1,500
Payments By Salaries By Rent By Electricity Charges By Books By 12% Fixed Deposits (on 01.01.2016) By Office Expenses By Balance c/d
55,720 Liabilities Salaries Outstanding Capital Fund (balancing figure)
Balance Sheet of Star Club as 31.12.2015 (A) Assets 2,400 Cash in hand 22,580 Books Furniture Subscriptions outstanding 24,980
(A) 12,500 3,200 1,280 3,600 15,000 2,400 17,740 55,720 (A ) 5,180 12,000 5,000 2,800 24,980
Accountancy
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Additional Information : (a) Subscriptions outstanding as on 31.12.2016 A3,500. (b) Half of donations are to be taken as income. (c) Salaries outstanding A1,800. Solution : Income and Expenditure Account of Star Club for the year ending 31.12.2016 Dr. Expenditure (A) Income
Cr. (A)
To Salaries Add Outstanding
A12,500 By Subscriptions A40,500 A1,800 Less Received for 2015 A2,800 A14,300 A37,700 Less paid for 2015 A2,400 11,900 Add Outstanding To Rent 3,200 for 2016 A3,500 41,200 To Electricity charges 1,280 By Donation A2,540
To Office Expenses To Excess of Income over Expenditure (Surplus)
2,400
Less Capitalised (50% of A2,540) A1,270 27,890 By Entrance Fees By Interest on fixed Deposit A1,500 Add Accrued A300
1,270 2,400 1,800
12 {(A15,000× 100 –A1,500)}
46,670
Liabilities
Balance Sheet of Star Club as on 31.12.2016 (A) Assets
Salaries Outstanding Life membership Fees Capital Fund : Opening Balance A22,580 Add Donation Capitalised A1,270 Add surplus
A27,890
1,800 Subscriptions outstanding 3,600 Interest on Fixed Deposit Accrued Cash in hand 12% Fixed Deposit Books A12,000 Add Purchased A3,600 51,740 Furniture 57,140
46,670
(A ) 3,500 300 17,740 15,000 15,600 5,000 57,140
Financial Statements of ‘Not for Profit’ Organisations
179
Illustration 28 From the following Receipts and Payments Account of Sahara Club, Jaipur and additional information, prepare the Income and Expenditure Account for the year ending 31.12.2016 and a Balance Sheet as on that date : Receipts and Payments Account of Sahara Club, Jaipur for the year ending 31.12.2016
Dr. Receipts To Balance b/d
(A)
Cash A350 A8,400 Bank 8% Fixed Deposit A5,000 13,750 To Subscriptions 15,860 (including A950 for 2015) To Donations 3,000 To Entrance Fees 1,800 To Interest on Fixed Deposit 200 To Sale of old Newspapers 140 To Sale of Equipment 350 (Book Value A500) To Tournament Fund 2,000
Payments By Purchase of Equipment (on 01.07.2016) By Repairs By Match Expenses By Salaries By Honorarium By Upkeep of Lawn By Postage Stamp By Sundry Expenses By Investment By Tournament Expenses By Balance c/d Cash A800 Bank A10,240 8% Fixed Deposit A5,000
37,100 Additional Information : (a)
Provide depreciation on equipment @10%.
(b)
Stock of postage stamp on 31.12.2016 A80.
(c)
Subscriptions outstanding for 2016 A2,840.
(d)
Salaries outstanding for 2016 A1,350.
(e)
Donations are to be capitalised.
Cr. (A) 3,200 850 1,260 5,340 2,950 560 250 1,350 4,000 1,240
16,100 37,100
Accountancy
180
Solution : Dr.
Income and Expenditure Account of Sahara Club for the year ending 31.12.2016 Expenditure (A) Income
To Repairs To Match Expenses To Salaries Add Outstanding To Honorarium To Upkeep of Lawn To Postage
850 By Subscriptions 1,260 Loss Paid for 2015: A5,340 A1,350
250
Less Stock on 31.12.16
80
To Sundry Expenses To Depreciation on Equipment 10 × 126 ) (A3,200× 100 To Loss sale of Equipment (A500 – A350) To Excess of Income over Expenditure (Surplus)
Liabilities Salaries Outstanding Tournament Fund : Opening Balance Less Expenses Capital Fund : Opening Balance Add Surplus Add Donations
Cr. (A )
A15,860 A950 A14,910 Add Outstanding in 2016 A2,840 17,750
6,690 2,950 By Entrance Fees 560 By Interest on Fixed Deposit A200 Add Accured Interest 170
{(A5,000× 8 ) –A200} 100
A200
1,350 By Sale of old Newspapers 160
1,800
400 140
150
5,950 20,090
Balance Sheet of Sahara Club as on 31.12.2016 (A) Assets
A2,000 A1,240 A15,200 A5,950 A3,000
20,090
(A )
1,350 Subscriptions Outstanding Stock of Postage Interest on Fixed Deposit Accrued 760 Cash Bank 8% Fixed Deposit Investments 24,150 Equipment A3,200 Less Depreciation A160
2,840 80 200 860 10,240 5,000 4,000
26,260
26,260
3,040
Financial Statements of ‘Not for Profit’ Organisations
181
Working Note :
Liabilities
Opening Balance Sheet of Sahara Club as on 31.12.2015 (A) Assets
Capital Fund (Balancing Figure)
15,200 Subscriptions Outstanding Equipment Cash Bank 8% Fixed Deposit 15,200
(A ) 950 500 350 8,400 5,000 15,200
Illustration 29 The Master Club, Bolangir submits you its Receipts and Payments Account for the year ending 31.12.2016. You are required to prepare the Income and Expenditure Account and the Balance Sheet relating to the year. Receipts and Payments Account of Master Club, Bolangir for the year ending 31.12.2016 Dr. Cr. Receipts (A) Payments (A) To Opening Balance : Cash Bank To Subscriptions (including A750 for 2017) To Lockers Rent To Interest on 6% Bonds To Donations To Sale of Grass
250 20,550 21,250 1,250 1,000 10,000 50
By Rent (includes A400 for 2017) By Postage and Telephone By Upkeep of ground By Printing and Stationery By Travelling Expenses By Meeting Expenses By Salaries By Books By Donations By Closing Balance : Cash Bank
54,350
The Club gives also the following information : (a) The club holds 6% Government Bonds of A40,000 on 01.01.2016. (b) The Books Account stood at A20,000 on 01.01.2016. (c) Half of the donations received is to be capitalised. (d) Salaries A300 is still unpaid.
6,000 540 250 600 150 500 5,400 3,000 5,000 310 32,600 54,350
Accountancy
182
Solution : Dr.
Income and Expenditure Account of Master Club, Bolangir for the year ending 31.12.2016 Expenditure
To Rent
(A) A6,000
Less Paid for 2017 A400 To Postage and Telephone To Upkeep of ground
Income
By Subscriptions Less For 2017 5,600 By Lockers Rent 540 By Interest on Bonds 250 Add Accrued
Cr. (A )
A21,250 A750 20,500
1,250 A1,000
6 To Donations 5,000 (A40,000× 100 -A1,000) A1,400 2,400 To Printing and Stationery 600 By Donations A10,000 To Travelling Expenses 150 Less Capitalised A5,000 5,000 To Meeting Expenses 500 By Sale of grass 50 To Salaries A5,400 Add Unpaid A300 5,700 To Excess of Income over Expenditure (surplus) 10,860 1 29,200 2 29,200
Balance Sheet of Master Club, Bolangir as on 31.12.2016 Liabilities Subscriptions Received in Advance Salary Unpaid Capital Fund : Opening Balance A80,800 Add Surplus A10,860
(A) 750 300
Add 21 of Donations Capitalised A5,000 96,660
Assets Cash Bank 6% Government Bond A40,000 Add Accrued Interest A1,400 Books A20,000
310 32,600 41,400
Add Purchased during 2016 Prepaid Rent
97,710
(A )
A3,000
23,000 400 97,710
Financial Statements of ‘Not for Profit’ Organisations
183
Working Note :
Liabilities Capital Fund (Balancing Figure)
2.9 1. (a)
(b)
(c)
(d)
(e)
(f)
Opening Balance Sheet as on 01.01.2016 (A) Assets
(A )
80,800 Cash Bank 6% Government Bond Books
250 20,550 40,000 20,000
80,800
80,800
QUESTIONS From the Following alternatives given under each bit, write the correct answer along with its serial number, against each bit; One of the following which is a ‘not for profit’ organisation, is. (i) Tata Iron and Steel Company Limited. (ii) Birla Tyres Ltd. (iii) Ramakrishna Charitable Trust. (iv) Bharat Sanchar Nigam Limited. Receipts and Payments Account is a : (i) Personal Account (iii) Cash Account (ii) Real Account (iv) Nominal Account Receipts and Payments Account shows : (i) Capital Fund (iii) Receipts and Payments in cash (ii) Surplus/Deficit (iv) Balance of assets The Receipts and Payments Account reveals : (i) Net profit/loss (iii) Balances of Assets (ii) Surplus/Deficit (iv) Balance of Cash Income and Expenditure Account is prepared by (i) Manufacturing concerns (iii) ‘Not for profit’ concerns (iv) Trading concerns (v) Manufacturing and trading concerns Income and Expenditure Account is a : (i) Nominal Account (iii) Real Account (ii) Personal Account (iv) Representative Personal Account
184 (g)
(h)
(i)
(j)
(k)
(l)
(m)
(n)
(o)
(p)
(q)
(r)
Accountancy
Income and Expenditure Account shows : (i) Cash in Hand and at Bank (iii) Capital Fund (ii) Net Profit/Loss (iv) Surplus/deficit Subscription received in advance during an accounting year is : (i) An asset (iii) An income (ii) A liability (iv) An expense Subscription outstanding at the end of an accounting year is : (i) An asset (iii) A liability (ii) An income (iv) An expense Donation received for a specific purpose is a : (i) Capital Receipt (iii) Capital expenditure (ii) Revenue Receipt (iv) Revenue expenditure Life membership fee is a/an : (i) Capital receipt (iii) Capital expenditure (ii) Revenue receipt (iv) Revenue expenditure Legacy may be treated as : (i) Capital receipt (iii) Capital or revenue receipt (ii) Revenue receipt (iv) Revenue Income Sale of old newspaper is a/an (i) Capital receipt (iii) Capital expenditure (ii) Revenue receipt (iv) Revenue expenditure Receipts and Payments Account is prepared in lieu of : (i) Balance sheet (iii) Income and Expenditure Account (ii) Profit and Loss Account (iv) Cash Book Income and Expenditure Account is the equivalent name of : (i) Trading Account (iii) Revaluation Account (ii) Profit and Loss Appropriation A/c (iv) Profit and Loss Account The day to day cash transactions are recorded in (i) Receipts and Payments Account (iii) Income and Expenditure Account (ii) Cash Book (iv) Trial Balance When sports fund is created, sports expenses are transfered to : (i) Receipt and Payments Account (iii) Sports Fund Investment Account (ii) Income and Expenditure Account (iv) Sports Fund Account Special Fund usually appears in : (i) Income and Expenditure Account (iii) Balance Sheet (ii) Receipts and Payments Account (iv) Trial Balance
Financial Statements of ‘Not for Profit’ Organisations
(s)
(t)
(u)
2. (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) (m) (n)
185
The difference of assets and liabilities of opening Balance Sheet is : (i) Surplus (iii) Reserve Fund (ii) Capital Fund (iv) Deficit Income and Expenditure Account records only : (i) Revenue items (iii) Both Revenue and Capital items (ii) Capital items (iv) Only revenue receipts Receipts and Payments Account records : (i) Revenue items (iii) Both revenue and capital items (ii) Capital items (iv) Only revenue receipts [Ans.: (a) iii, (b) ii, (c) iii, (d) iv, (e) iii, (f) i, (g) iv, (h) ii, (i) i, (j) i, (k) i, (l) iii, (m) ii, (n) iv, (o) iv, (p) ii, (q) iv, (r) iii, (s) ii, (t) i, (u) iii.] Answer the following questions in one word / term each : Name the organisation rendering service to its members and the society without any profit motive. What type of organisations are the schools, colleges, universities, libraries, sports clubs, charitable hospitals, religious societies, etc. ? What does a ‘not for profit’ organisation provide ? What is the principal source of income of a ‘not for profit’ organisation ? To which Account is the surplus/deficit transferred ? Name the fee paid by the members at the time of their admission to a club for membership. What is the term used for the lump sum amount paid by the members/well-wishers of a ‘not for profit’ organisation ? What is the term used for the amount received by a ‘not for profit’ organisation as per the will of a deceased person ? Name a register which contains the names and addresses of all members. Name the book which contains the proceedings of all meetings of the Board and Committees. On which side of the Balance Sheet is the ‘outstanding subscription’ shown ? What is the term used for the remuneration paid to artists/dancers/doctors, etc for their performance and service ? On which side of the Balance Sheet is the subscription received in advance shown ? What is that fund which is not to be spent but provides a permanent source of income to the ‘not for profit’ organisation ? [Ans. (a) ‘Not for profit’, (b) ‘Not for profit’, (c) Service, (d) Membership fee/Subscription, (e) Capital Fund, (f) Entrance fee, (g) Donation, (h) Legacy, (i) Members register, (j) Minutes Book, (k) Asset, (l) Honorarium, (m) Liability, (n) Endowment.]
186 3.
Accountancy
Correct the underlined portions of the following sentences : (a) Receipts and Payments Account is a Personal account. (b) Income and Expenditure Account is a Real account. (c) Legacy is a revenue receipt. (d) Life membership fee is a revenue receipt. (e) Life membership fees is a recurring receipt. (f) Capitalised donations are recurring items. (g) Any amount paid to invitees like dancers, artists, singers, doctors, etc for their performance and service is called salary. (h) Honoraium is a capital expenditure. [Ans.: (a) Real (b) Nominal (c) Capital, (d) Capital, (e) non-recurring (f) non-recurring (g) Honorarium (h) revenue] 4. Fill up the blanks of the following sentences : (a) The opening balance of Receipts and Payments Accounts is _______. (b) Receipts and Payments accont records revenue and _______ items. (c) The difference between two sides of Income and Expenditure Account is ______. (d) The excess of assets over liabilities of a ‘not for profit’ organisation is _______. (e) Endowment fund yields _______ income. (f) Life membership fee is shown on the _______ side of Balance Sheet. (g) Payment of honorarium is treated as _______ expenditure. (h) Endoment Fund is shown on the _______ side of the Balance Sheet. (i) Subscriptions due but not received are shown on ______ side of Balance sheet. (j) Subscriptions received in advance is shown on the ______ side of Balance Sheet. (k) Income and Expenditure Account does not show any ______ balance. (l) Income and Expenditure Account is prepared on ______ basis. (m) Receipts and Payments Account is prepared on ______ basis. (n) Receipt of legacy is treated as a ______ receipt. (o) Building Fund Investment is shown on the ______ side of Balance Sheet. (p) Non-recurring entrance fee is treated as a ______ receipt. (q) Entrance fee collected from members every year is treated as _______ receipt. (r) Purchase and sale of fixed assets is ascertained from ______ Account. (s) Lump sum amount received from well-wishers is _______. (t) Amount received under the will of a person after his death is known as _______. [Ans.: (a) Cash in hand/at Bank, (b) Capital, (c) Surplus/deficit, (d) Capital Fund, (e) Regular, (f) Liabilities, (g) revenue, (h) Liability, (i) Assets, (j) Liabilities, (k) opening, (l) accrual, (m) cash, (vi) Capital, (o) Assets, (p) Capital, (q) revenue, (r) Receipts and Payments, (s) donations, (f) legacy]
Financial Statements of ‘Not for Profit’ Organisations
5.
187
Answer the following questions in one sentence each : (a) State the objective of a ‘not for profit’ organisation. (b) Which account gives information about cash in a ‘not for profit’ organisation ? (c) Which items are shown in Receipts and Payments Account ? (d) Which items are shown in Income and Expenditure Account ? (e) What are the sources of income of a ‘not for profit’ organisation ? (f) What is the basis of accounting in preparing Receipts and Payments Account ? (g) What is the basis of accounting in preparing Income and Expenditure Account ? (h) How is capital fund of a ‘not for profit’ organisation calculated ? (i)
How will you treat specifice Fund expenditure ?
(j) How will you treat general donation ? (k) How will you calculate Capital Fund if nothing is mentioned in question ? (l)
How would you treat suscriptions due at the beginning of the year ?
(m) How would you treat subscriptions received in advance in the current year ? 6.
Answer the following questions within thirty words each : (a) What do you mean by ‘not for profit’ organisation ? (b) State the treatment of specific donation. (c) State the treatment of legacy in the final accounts of a ‘not for profit’ organisation. (d) What is an Endowment Fund ? (e) Give the accounting treatment of life membership fee. (f) Give any two important features of Receipts and Payments Account. (g) Give any two important features of Income and Expenditure Account. (h) What is Honorarium ? (i)
What do constitute the financial statements of a ‘not for profit’ organisation ?
(j) Give any two important features of a ‘not for profit’ organisation. (k) Give the treatment of sale of fixed assets at the time of preparing Income and Expenditure Account. (l)
State the treatment of subscription outstanding at the time of preparing Income and Expenditure Account.
Accountancy
188
(m) State the treatment of subscription received in advance at the time of preparing Income and Expenditure Account. (n) How does donation differ from subscription ? 7.
Answer the following questions within fifty words each : (a) Define Receipts and Payments Account. (b) Define Income and Expenditure Account. (c) State the features of a ‘not for profit’ organisation. (d) What is ‘legacy’ ? (e) How do you treat ‘specific donations’ ? (f) Give the steps in preparing Income and Expenditure Account. (g) How will you treat entrance fees in the final accounts of a ‘not for profit’ organisation ? (h) Why is Receipts and Payments Account prepared ? (i)
Distinguish between Cash Book and Receipts and Payments Account.
(j) Distinguish between Receipts and Payments Account and Income and Expenditure Account. (k) Distinguish between Income and Expenditure Account and Profit and Loss Account. (l)
Give any five items of Capital Receipt.
(m) Give any five items of Revenue Receipt. (n) How does donation differ from subscription ? 8.
Define ‘not for profit’ organisation with suitable examples. Distinguish between Receipts and Payments Account and Income and Expenditure Account.
9.
Define Receipts and Payments Account. State the procedure of preparing Income and Expenditure Account.
10.
What is ‘not for profit’ organisation ? Distinguish Receipts and Payments Account from Cash Book.
11.
What is Receipts and Payments Account ? How does it differ from Income and Expenditure Account ?
12.
Explain the treatment of the following items in preparing final accounts of ‘not for profit’ organisations : (a) Entrance Fees
(c) Subscription
(e) Life membership fee
(b) Capital Fund
(d) Legacy
(f) Donations
Financial Statements of ‘Not for Profit’ Organisations
189
13.
The following is the Receipts and Payments Account of Koshal Club, Bhawanipatna for the year ending 31st March 2017 :
Dr.
Cr. (A) 4,200 700 12,000 2,000 800 6,000
Receipts (A) To Balance b/d Cash in Hand A1,700 Cash at Bank A1,400 3,100 To Sale of old Newspapers 500 To Subscriptions 25,000
Payments By Salaries By Postages and Telephones By Investments By Rent By Printing and Stationery By Furniture By Balance c/d Cash in Hand A1300 Cash at Bank A1600 2,900 28,600 28,600
Additional Information : 1. Salaries Outstanding A300 2. Rent prepaid A500 3. Subscription due A1,000 4. Depreciate furniture by 10%. Prepare Income and Expenditure Account and Balance Sheet. (Answer : Surplus A18,400, Opening Capital Fund A3,100, Balance Sheet Total A21,800.) 14. From the following particulars of Kandhamal Legal Services Club, prepare the final accounts for the year ending 31.12.2016 : Receipts and Payments Account of Kandhamal Legal Service Club for the year ending 31.12.2016 Dr. Cr.
Receipts To Balance b/d To Subscriptions To Sale of Grass To Rent of Hall To Donation for prizes
(A) 11,000 25,000 1,000 1,700 10,000
48,700
Payments By Salaries By Legal Fees By Equipment By Travelling Expenses By Office Expenses By Balance c/d
(A) 4,000 2,000 20,000 1,400 1,300 20,000 48,700
Accountancy
190 Additional Information : 1.
Books as on 01.01.2016 were A17,000.
2.
Buildings as on 01.01.2016 stood at A63,000.
3.
Travelling expenses unpaid A600.
4.
Depreciate equipment by 71/2%.
5.
Subscription due at the end of the year A600.
6.
Subscription received in advance during the year A700. Hint - Capitalise donation as it is for a specific purpose. [Answers : Surplus A16,800, Opening Capital Fund A91,000 Balance Sheet Total A1,19,100.]
15.
The following is the Receipts and Payments Account of Mayurbhanja Cultural Society for the year ending 31.03.2017 : Receipts and Payments Account of Mayurbhanja Cultural Society for the year ending 31.03.2017
Dr.
Receipts To Balance b/d To Subscriptions To Govt. Grants To Rent of Hall To Entrance fees
(A) 18,000 30,000 12,000 1,000 7,000
68,000
1. 2. 3.
Payments By Salaries and wages By Office Expenses By Library Books By Telephone Charges By Repairs ByAddition to Building By Balance c/d
Cr. (A) 32,200 3,100 12,300 3,600 900 5,000 10,900 68,000
You are required to prepare an Income and Expenditure Account and Balance Sheet after considering the following additional information : Assets on 31.3.2016 were : Furniture 17,000, Building A50,000, Library Books A10,700. Subscriptions outstanding on 31.03.2017 were A1,000. Provide depreciation on all fixed assets @10%. [Ans. Surplus 1,700, Opening capital fund A95,700, Balance Sheet total A97,400.]
Financial Statements of ‘Not for Profit’ Organisations
16.
191 From the following particulars, prepare Income and Expenditure Account and Balance Sheet of Utkal Sangeet Parishad, Puri : Receipts and Payments Account of Utkal Sangeet Parishad, Puri for the year ending 31.03.2017
Receipts To Balance b/d To Subscriptions To Sale of old furniture (Book value A1,000) To Donations To Interest on Investments To Locker Rent
(A)
Payments
9,000 By Repairs 40,000 By Stationery 600 By Rent By Salaries 10,000 By Help to Poor 1,800 By Equipment 1,200 By Advertisement By Balance c/d 62,600
(A) 2,000 4,500 3,500 23,000 10,000 17,000 1,500 1,100 62,600
Additional Information : 1. Subscription on 31st March 2017 was due A7,000 and on 31st March 2016 was due A9,000. 2. Investments were A25,000 as on 31.03.2016. 3. Rent Prepaid A500. 4. Depreciate Equipment @20% p.a. [Answer : Deficit A6,800, opening capital Fund A44,000, Balance Sheet Total A47,200.] Hints - (1) Donation is Capitalised, (2) Furniture A1,000 and Investments A25,000 will appear on the Balance Sheet as on 31.03.2016. 17. From the following information of Neelachal Club, prepare Income and Expenditure Account and Balance Sheet for the year ending 31.12.2016 : Receipts and Payments Account of Neelachal Club Dr. Cr. for the year ending 31.12.2016
Receipts To Balance b/d To Subscriptions (including A825 for 2017) To Lockers Rent To Interest on Securities To Donations
(A)
Payments
22,800 By Salaries 23,375 (Including A440 for 2015) By Rent 1,375 By Establishment 1,150 By Telephone Charges 11,000 By Stationeries By Library Books By Donations By Balance c/d 59,700
(A) 6,600 5,940 1,100 275 825 3,300 5,500 36,160 59,700
Accountancy
192 Additional Information : 1.
On 1.1.2016, Library books was A40,000 and 8% Government Bonds A20,000.
2.
1/4 the of donations received is to be capitalised.
3.
Rent outstanding on 31.12.2017 A60. [Answer: Surplus A13,965, Opening Capital Fund A82,360. Balance Sheet Total A99,960.]
18.
From the following Receipts and Payments Account of Berhampur Music Club and other information given below, prepare Income and Expenditure Account for the year ending 31.12.2016 and the Balance Sheet as on that date : Receipts and Payments Account for the yer ending 31.12.2016 Receipts
Payments (A) To Balance b/d 23,000 By Salaries To Entrance fees 2,000 By Postage and Telephone To Subscriptions : By Rent 2015 A7,000 By Printing and Stationery 2016 A48,000 By Furniture (1.7.16) A2,000 57,000 By 12% Debentures (1.4.16) 2017 To Interest on Debentures 2,000 By Miscellaneous Expenses To Profit on Restaurants 12,000 By Balance c/d
96,000
(A) 18,000 2,500 4,000 3,500 20,000 30,000 5,000 13,000 96,000
Additional Information : 1. Depreciate furniture @10% p.a. 2. Rent unpaid A800. 3. Subscriptions outstanding A3.000. 4. The club had instruments worth A20,000 on 01.01.2016 on which depreciation to be charged @5% p.a. [Answer : Surplus A31,900. Opening Capital fund A50,000 Balance Sheet Total A84,700.] 19. From the following information, calculate the amount of subscription to be credited to Income and Expenditure Account for the year ending 31.03.2017 :
Financial Statements of ‘Not for Profit’ Organisations
193
Receipts and Payments Account
Dr.
Receipts
(A)
Subscriptions : For the year ending on 31.03.2016 For the year ending on 31.03.2017 For the year ending on 31.03.2018
Payments
Cr.
(A)
15,000 95,000 10,000
Additional Information : 1. Subscriptions outstanding on 31.03.2017 A18,000 2. Subscriptions outstanding on 31.03.2016 A15,000 3. Subscriptions received in advance on 31.03.2016 A5,000 [Answer : A1,18,000.] Hint : (A95,000 + A18,000 + A5,000) 20. From the following information, calculate the amount to be charged to Income and Expenditure Account for the year ending 31.03.2017 : (A) Salaries paid during the year 40,000 Salaries outstanding as on 31.03.2017 8,000 Salaries outstanding as on 31.03.2016 6,000 [Answer : A42,000 (A40,000+A8,000 – A6,000)] 21. During the year 31.03.2016, rent actually paid was A9,000. Find out the actual expenses on rent chargable to Income and Expenditure Account for the year ending 31.03.2016 from the information given below : (A) Prepaid Rent on 01.04.2015 1,200 Prepaid Rent on 31.03.2016 800 Outstanding Rent on 01.04.2015 700 Outstanding Rent on 31.03.2016 1,400 [Answer : A10,100. 22.
(A9,000+A1,200+A1,400 – A800 – A700)]
Show the consumption of stationery to be charged to Income and Expenditure Account from the following data for the year ending 31.03.2017 : Stock of Stationery : On 31.03.2016 A7,000 and on 31.03.2017 A8,000. Stationery purchased during the year ending on 31.03.2017 A22,000. [Answer : A21,000 (A22,000+A7,000 – A8,000)]
Accountancy
194 23.
Calculate the amount of stationery consumed during the year ending 31.03.2017 and to be charged to Income and Expenditure Account for the year from the information given below: (A) Amount paid for stationery during the year
3,700
Creditors for stationery on 01.04.2016
500
Creditors for stationery on 31.03.2017
650
Stock of stationery as on 01.04.2016
750
Stock of stationery as on 31.03.2017
800
[Ans.: (1) Purchase of Stationery during the year : (A3,850. (A3,700+A650–A500) (2) Amount to be charged to Income and Expenditure Account A3,800. (A3,850+A750–A800).] 24.
From the following Receipts and Paymetns Account of Santosh Club, Prepare the Income and Expenditure Account for the year ending 31.12.2016 and the Balance Sheet as on that date : Receipts and Payments Account of Santosh Club
Dr.
for the year ending 31.12.2016
Receipts To Balance b/d Cash in Hand Cash at bank To Entrance fee To Subscriptions To Donations To Life Member Fees To Interest on Deposits To Proceeds from Entertainment
(A) 600 2,500 490 18,000 1,650 2,500 240 2,320
28,300
Payments By Rent By Salary By Printing By Postage and Telephone By Electricity By Library Books By 8% National Savings Certificates (01.07.2016) By Balance c/d Cash in Hand Cash in Bank
Cr. (A) 2,400 1,600 1,200 2,400 2,100 4,000 12,000 500 2,100 28,300
Financial Statements of ‘Not for Profit’ Organisations
195
Additional Information : (a) On 31.12.2015, the club had books worth A20,000 and furniture worth A8,000. Provide depreciation on these assets @10% p.a. (b) Subscriptions outstanding at the beginning A500 and at the end A700. [Answer : Surplus A10,240. Opening Capital fund A31,600 Balance Sheet Total A44,340.] 24. Following is the Receipts and Payments Account of Peacock Club for the year ending 31.12.2016 : Dr. Cr.
Receipts To Balance b/d To Subscriptions
(A) Payments (A) 1,000 By Salaries 2,300 10,000 By Rent 1,100 By Printing 500 By Furniture (purchased on 1.7.2016) 6,000 By Balance c/d Cash in Hand 100 Cash at Bank 1,000 11,000 11,000
Additional Information : (i)
Salary outstanding A200
(ii) Rent Prepaid A100 (iii) Subscriptions outstanding A400. (iv) Depreciation on Furniture 10% p.a. (v) On 31.12.2015, the Building stood at A20,000 and Investments were A40,000. Prepare Income and Expenditure Account for the year ending 31.12.2016 and Balance Sheet as on that date. [Answer : Surplus A6,100, Opening Capital Fund A61,000, Balance Sheet total A67,300)]
CHAPTER-3
DEPRECIATION STRUCTURE
3.1 Meaning 3.2 Causes of depreciation 3.3 Objectives / Needs for providing depreciation 3.4 Characteristics 3.5 Factors for determination of depreciation 3.6 Methods of charging depreciation 3.6.1
Simple depreciation method
3.6.2
Provision for Deprecation method
3.7 Methods of calculating depreciation 3.7.1
Straight line method
3.7.2
Written Down Value method
3.8 Questions
Depreciation
197
After going through this chapter, you will be able to know meaning, need, causes, objectives and characteristics of depreciation. You will also be able to know different methods of charging depreciation. It is derived from latin word depretium which means decline in price. The word depreciation is related to the concept of business income. The long term assets are used in the business to generate revenue. In the process of use, the long term assets consume their economic potential. After certain period of time the assets become useless and discarded. The assets are replaced for new long term assets. The economic potential so consumed is the expired cost of the assets. Such expired cost must be recovered from the revenue of the business. Such recovery of the expired cost determines the actual profit earned by business. 3.1 MEANING The concept of depreciation refers to allocation of the cost of fixed assets over their expected period of useful life. The main purpose of depreciation is to charge it as an expense in order to find out the cost of production. As a result, true profit/loss earned/suffered by the business can be ascertained. The following definitions will give a clear understanding of the term depreciation : “The measure of the exhaustion of the effective life of an asset from any cause during a period.” Spicer and peggler “A measure of the wearing out, consumption or other loss of the value of depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. Depreciation includes amortisation of assets whose useful life is predetermined.” The Institute of Chartered Accountants of India. “Depreciation is the allocation of the depreciable amount of an asset over the estimated useful life. Depreciation for the accounting period is charged to the income either directly or indirectly” International Accounting Standard Committee. “Depreciation accounting is a system of accounting which aims to distribute the cost of tangible capital assets, less salvage value, if any over the estimated useful
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life of the assets in a systematic and rational manner. It is the process of allocation, not of valuation. Depreciation for the year is a portion of the total charge under such a system that is allocated to the year.” Analysis of the above definitions reveals : (i) Depreciation is a gradual decrease in the value of the assets. (ii) Depreciation accounting is concerned with allocation of amount to be depreciated (cost less scrap value) over the estimated useful life period of the asset. (iii) Such depreciation amount is charged to profit and loss account. (iv) Depreciation is a process of allocation, not valuation of fixed assets. Depreciable asset means : (i) Life period of the asset is more than one accounting period. (ii) Life of the asset is limited. (iii) Asset is used in the business. 3.2 CAUSES OF DEPRECIATION The following are the causes of depreciation (i) Wear and tear : Assets get worn out because of constant use, passage of time. Such thing happens with fixed assets like plant and machinery, furniture and fixtures, building, etc. (ii) Passage of time : The value of the most of the fixed assets fall because of the passage of time, irrespective of the use. Some assets have fixed legal life like lease, patent, copyright, etc. (iii) Exhaustion : Some assets get exhausted in the process of use. Examples are : mines, oil wells, stone quarries, etc. These assets are known as wasting assets. The value reduces with extraction or exploitation. (iv) Obsolescence : Obsolescence is a process of becoming obsolete or out of date. Some assets are discarded though they are in existence and working condition.
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For example, a new asset has hit the market with more efficiency, low running and maintenance cost, etc. Use of the old asset becomes uneconomic. Running and maintend cost will be increased. So the old asset is discarded and it is replaced by a new asset. (v) Accident : Sometimes the value of an asset reduces to zero or very negligible amount after it meets an accident. 3.3 OBJECTIVES / NEEDS FOR PROVIDING DEPRECIATION The following are the objectives of or need for providing depreciation. (i) To ascertain true profit : When we are purchasing an asset, we are paying in advance for the future expenses. For example we have purchased plant & machinery for A5,00,000 for business use. As a result we are saving the hiring charge or the rent of the plant & machinery until it exists and used in the business. But this will be useless after some period of time. So the cost of the plant is nothing but the advance rent or hiring charges for the entire period for which the plant is useful. This rent or hiring charges would have been charged to profit and loss account. So the cost of the plant is to be charged to the profit and loss account over the useful life period of the plant and machinery. So we are charging the depreciation as an expense to know the true profit or loss. This is an invisible expense for the subsequent years of purchase of the asset during which period no cash is paid, as it has been paid in lump sum when it was purchased. (ii) True financial position The balance sheet must reveal true and fair view of the financial position of the business. The asset loses its value because of depreciation for various reasons. Value of the assets will be overstated, if shown in the balance sheet without charging depreciation. So depreciation must be deducted from the asset to show true financial position of the business. (iii) For replacement of asset : All fixed assets become commercially unviable after a fixed period of time.
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But as per going concern concept, the business continues for a long period of time. So the old discarded assets are to be replaced by new ones in order to keep the business going. The depreciation so charged is accumulated over its useful life. This amount can be used to purchase a new asset. (iv) Computation of tax liability Depreciation is to be charged at a specific rate prescribled by the Income Tax authorities depending upon the nature and type of assets. Profit or loss can be calculated only after changing depreciation, so that the tax can be appropriataly levied. (v) Determination of cost of production Depreciation is an important componet of the cost of products though it is not paid in cash every year. So calculation of depreciation is important to find out the real cost of production. 3.4 CHARACTERISTICS (i)
Depreciation is a non-cash or non-monetary expense. The businessman need not pay anything in cash for depreciation.
(ii) The term depreciation is applicable to only fixed assets. (iii) Depreciation is a charge against profit. This implies that true profit or loss of a business cannot be accurately ascertained without charging depreciation. (iv) Depreciation is charged on the asset whether it is used for full year or part of the year. (v)
The total amount of depreciation cannot exceed the depreciable value of the fixed asset (i.e. cost price–scrap value)
(vi) Depreciation is a process of allocation of cost. (vii) Calculation of exact depreciation is almost impossible. It is always calculated on estimated basis. (viii) Depreciation is continuous fall in the value of the asset till the entire cost is exhausted.
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201
(ix) Depreciation has no link with market price of the asset. It is always charged as a percentage of the cost price of the fixed asset. (x)
Depreciation is different from maintenance. Maintenance expenses are incurred to keep the asset in usable condition.
3.5 FACTORS FOR DETERMINATION OF DEPRECIATION Calculation of depreciation usually depends upon the three factors, such as acquisition or historical cost, expected residual value or salvage or scrap value and estimated useful life of the asset. Each one of these factors is discussed below : 1.
Historical cost of the asset implies cost incurred on acquisition of the asset and other cost incurred to put the asset in useful condition. The other cost includes all expenses incurred till the asset is installed or put to use. These expenses include transportation charges, transit insurance charge, installation expenses, registration charges, commission paid on purchase of asset and any other expenses. Depreciation is calculated on cost of acquisition including all the above expenses. For example, a machinery is purchased at a cost of A2,00,000, transportation cost incurred is A10,000 and installation cost is A20,000. For the purpose of depreciation, the cost of the asset is A2,30,000.
2.
Estimated useful life of the depreciable asset implies either the number of years over which the asset is expected to be used or number of units expected to be produced or number of working hours of the asset during its life period or total kilometer to run during its useful life; depending upon the nature of the asset.
3.
Number of years : Usually the life of an asset is expressed in terms of number of calender years for which the asset can be used effectively. Methods of depreciation under this category are :
-
Fixed instalment method
-
Diministing balance method
-
Annuity method
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-
Depreciation fund method
-
Insurance policy method
-
Revaluation method
4.
Number of units : Total number of units to be produced during the life time of the asset is taken as its life. Depreciation is calculated basing upon number of units produced during an accountng year. The method used is production unit method or depletion method. For example, the cost of the machine is five lakh rupees. Total number of units to be produced during its life time is estimated at 10,000 units. In a particular year, 500 units are produced. Depreciation will be calculated as follows : Cost of the asset ___________________ x No. of units to be produced during life time
5.
Number of units produced during the year.
5,00,000 500 25,000 rupees 10,000
No. of working hours : Total number of hours for which asset is available for use during its life period is treated as its life. Depreciation is calculated basing upon number of hours for which asset is put to use during the year. Proceduer to calculate such depreciation is machine hour rate method or working hour method. For example, the cost of the machinery is A5,00,000, total number of working hour during its life is estimated to be 1,00,000 hours. During a year the machine is used for 10,000 hours. The amount of deprection during the year is : 5,00,000
A 1,00,000 10,000 A50,000. 6.
Expected residual value or salvage of depreciable asset implies estimated realisable value of the asset at the end of its useful life. It is also called scrap
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203
value or salvage. Difference between cost of the asset and its estimated scrap value is termed as depreciable cost of the asset. Such depreciable cost is allocated and recovered during the life period of the asset. Total depreciation charged during its life time must be equal to depreciable cost. 3.6 METHODS OF CHARGING DEPRECIATION There are two methods of charging depreciation. Those are : (i) Simple Depreciation Method or by charging depreciation to Asset Account, (ii) Provision for Depreciation Method or by creating provision or accumulated depreciation account. These methods are discussed below : 3.6.1 Simple Depreciation Method or Recording of Depreciation by charging to Asset Account Under this method, the amount of depreciation is debited to Depreciation Account and credited to Asset Account every year. The Asset Account appears in the Balance sheet at written down value (i.e. original cost less depreciation till date). The Depreciation Account is closed by transferring to Profit and Loss Account like any other items of expenses. The various journal entries which are passed under this method are summarised below: 1.
To record purchase of asset
2.
To provide depreciation
3.
To transfer depreciation to Profit and Loss Account
Asset A/c Dr. To Bank A/c (Being the asset purchased) Depreciation A/c Dr. To Asset A/c (Being the depreciation provided for) Profit and Loss Account Dr. To Depreciation A/c (Being transfer of depreciation account to P.L. A/c)
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4.
When additional asset is purchased Asset A/c
Dr.
To Bank A/c (Being the asset purchased) 5.
To record sale of asset
6.(a) To transfer profit on sale of asset
Bank A/c Loss on sale of asset A/c To Asset A/c (Being loss on sale of asset) or Bank A/c To Asset A/c To Profit on sale of asset A/c. (Being profit on sale of asset) Profit on sale of asset A/c
Dr. Dr.
Dr.
Dr.
To Profit and Loss A/c (Being transfer of profit on sale of asset). (b)
To transfer loss on sale of asset
Profit and loss A/c
Dr.
To Loss on sale of asset A/c (Being transfer of loss on sale of asset to P/L A/c).
1.
Tutorial Notes Book value on the date of sale = Original cost of asset – Total depreciation provided till the date of sale.
2.
Profit = Sale price of asset - Book value on the date of sale.
3.
Loss = Book value of asset on the date of sale – selling price of the asset.
4.
In case of exchange of asset, the amount at which the vendor agrees to acquire the asset is the sales price.
5.
In case of destruction or damage of an asset which is insured, claim admitted by insurance company is treated as sale price.
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205
3.6.2 Provision for Depreciation Method or Recording depreciation when a provision for Depreciation Account is maintained Under this method, the amount of depreciation to be charged in a particular year is debited to Profit and Loss Account and credited to Provision for Depreciation Account. The asset account appears on the asset side of the Balance Sheet at its original cost throughout its life; and the Provision for Depreciation Account appears on the liabilities side of the Balance Sheet. In case of sale of asset the provison for depreciation Account (relating to the asset sold) is transferred to Asset Account. Any amount realised on sale of asset is also transferred to Asset Account. The balance, if any, in the Asset Account (either profit or loss) is transfered to Profit and Loss Account. The following journal entries are passed under this method : 1.
For providing deprecration :
Depreciation A/c
Dr.
To Provision for Deprecation A/c 2.
For transferring depreciation A/c to Profit and Loss A/c
3.
For transferring
Profit and Loss A/c To Depreciation A/c Provision for Depreciation A/c
accumulated depreciation
Dr. Dr.
To Asset A/c
on asset sold. 4.
In case of profit on sale of asset
Bank A/c
Dr/
To Asset A/c To Profit and Loss A/c 5.
In case of loss on sale of Asset
Bank A/c
Dr.
Profit and Loss A/c
Dr.
To Asset A/c Distinction between Depreciation Account and Provision for Depreciation Account Depreciation is a gradual reduction in the value of a fixed asset. Depreciation account is opened to record such reduction in the value of the fixed assets.
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Depreciation account is a direct charge against the asset. It means every year the depreciation account is debited and concerned asset account is credited. At the end of the year the depreciation account is closed by transferring to Profit and Loss account. However, when the provision for depreciation account is opened, depreciation is not a direct charge against the asset. The provision for depreciation account is not closed each year and it is closed by transferring to asset account at the time of sale of the asset. Throughout the life time of the asset, the asset is shown on the asset side of the balance sheet at its original cost and provision for depreciation is shown on the liabilities side of the balance sheet. Depreciation Account
Provision for Depreciation Account
This account is a Nominal account.
This account is a provision account, always showing a credit balance till the disposal of the asset.
At the time of charging depreciation, depreciation account is debited and asset account is credited.
At the time of charging depreciation,
At the end of the accounting year, depreciation account is closed by transferring to profit and loss account.
Provision for depreciation account has no place in profit and loss account. It is shown on the liabilities side of the balance sheet and is closed by transferring to the particular asset account, when the asset is sold.
This account shows debit balance.
This account shows credit balance.
Asset is shown at written down value in the balance sheet.
Asset is shown at original cost in the balance sheet.
Depreciation account does not appear in the balance sheet.
Provision for depreciation account is shown on the liabilities side of the balance sheet.
depreciation account is debited and provision for depreciation account is credited.
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3.7 METHODS OF CALCULATING DEPRECIATION There are several methods of allocating depreciation over the useful life of the asset. There are various methods to recover the depreciable cost of the asset over its useful life. However, we will discuss only Straight Line method and Written Down value method. 3.7.1 Straight line method Under this method, a fixed percentage of the original cost of the asset is written off during each accounting period over the useful life of the asset. The rate of depreciation is calculated as under : Depreciation =
Cost of the asset Residual Value Estimated life
For example, the cost of an asset is A1,10,000. Its residual value after its 10 years estimated life is A10,000. Amount of depreciation is : A1,10,000 A10,000 A10,000 per annum. 10
A10,000 is charged as depreciation per annum for a period of 10 years. At the end of 10 years, the cost of the asset reduces to its residual value or scrap value. It is called straight line method as the amount of depreciation remains fixed or same in each year. Under this method, depreciation is generally calculated as a fixed percentage on the original cost of the asset. Advantages : The main advantages of straight line method of depreciation are as follows : (i)
This method is very simple to calculate and easy to apply.
(ii) The same depreciation amount is charged every year. So comparison of income of different years is easy. (iii) The value of the asset will be reduced to zero or scrap value at the end of its life time. (iv) This method is very suitable, particularly for those assets, which have a fixed life like leasehold property, patent right, etc.
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Disadvantages : If suffers from the following disadvantages : (i) It is based on the assumption that the asset has the same utility in different accounting periods. But the efficiency of the asset reduces with the passage of time. (ii) The repair and maintance cost of the asset increases as the asset gets older. Depreciation amount remains the same. So total charge (i.e., depreciation plus repair and maintenance cost) to profit and loss account increases year after year as the asset grows older and older. (iii) It does not consider loss of interest on the amount invested in the business. (iv) If does not provide liquid fund for replacement of asset on expiry of its useful life. (v) It is difficult to calculate depreciation on subsequent addition of the asset. (vi) This method is not recognised by the income tax department. 3.7.2 Written down value method This is otherwise known as diminising balance method or reducing instalment method. Under this method, depreciation is calculated at a fixed percentage on written down value of the asset.This method assumes that the efficiency of the asset goes on reducing as the asset grows older. So the amont of depreciation to be charged in different accounting periods also decreases with the passage of time. For example, the cost of an asset is A1,00,000 and the rate of depreciation is 10% per annum. Under written down value method, the depreciation is calculated as under : A Cost of the asset 1,00,000 less : Depreciation for 1st Year (10% of A1,00,000) 10,000 Written down value in the beginning of 2nd year 90,000 less : Depreciation for 2nd year (10% of A90,000) 9,000 Written down value in the beginning of 3rd year 81,000 less : Depreciation for 3rd year (10% of A81,000) 8,100 Written down value in the beginning of 4th year 72,900
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209
As the amount of depreciation is calculated on written down value of the asset, it is known as written down value method. Formula for calculating depreciation is as follows :
L M N
Residual Value
Rate of Depreciation = 1 n Cost of asset
O 100 P Q
Where n = number of year For example cost of the asset is A10,00,000, residual value is A64,000 and life period is 3 years.
L M N
64,000
O P Q
The rate of Depreciation = 1 3 10,00,000 100 = 60% Advantages This method has the following advantages : (i)
The total charge (i.e., depreciation plus repair and maintenance) remains almost the same year after year. The reason is amount of depreciation is more in the initial period. It goes on reducing as the asset grows older. The repair and maintenance is less in the initial period. It goes on increasing as the asset gets older. So total charge to profit and loss remains almost uniform.
(ii) This method is logical as the asset grows older, deprciation goes on reducing. (iii) This method is recognised by the Income Tax department. (iv) Fresh calculation of dereciation is not required when addition is made. (v)
A major portion of the asset is recovered in its earlier life. Replacement of the asset due to technological change will not create more problem.
Disadvantages It suffers from the following disadvantages : (i)
As the depreciation is calculated at a fixed percentage on written down value of the asset, the value of the asset cannot be zero.
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(ii) It does not take into consideration the loss of interest due to investment in asset. (iii) It does not provide liquid fund for replacement of asset at the end of its useful life. (iv) It is very difficult to calculate the amount of depreciation. (v) It takes a long time to write off the asset. Distinction between straight line method and written down value method Straight line method
Written down value method
The rate and amount of depreciation remain the same year after year throughout the life period.
The rate of depreciation remains the same, but the amount of depreciation goes on reducing year after year.
Depreciation is calcualted as a percentage on the original cost of the asset.
Depreciation is calculated as a percentage on the written down value or reducing balance or book value of the asset.
The book value of the asset becomes zero at the end of the life of the asset.
The value of the asset never comes down to zero.
As the asset grows older, the amount of repair increases. But the amount of depreciation remains the same. Hence, the total amount of repair and depreciation increases year after year. It reduces the annual profit gradually.
As the asset grows older, the amount of repair increases. But the amount of depreciation decreases. Hence, the total amount of depreciation and repair remains almost the same each year. It does not affect the profit of the subsequent years substantially.
It is suitable for the assets whose repair charges are less and possibility of obsolescence is less.
It is suitable for assets which are affected by change in technology and which require more repair with the passage of time.
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211
Illustration 1 (Calculation of Rate of Depreciation under straight line method.) Calculate the cost of the asset, the amount of depreciation per annum and the rate of depreciation in the following cases under straight line method : Case
Purchase Price A 55,000 45,000 63,000 2,00,000
Expenses to be capitalised (A) 15,000 27,000 27,000 30,000
Estimated Scrap value 10,000 12,000 9,000 20,000
Expected Life 6 years 5 years 9 years 15 years
1. 2. 3. 4. Solution : Calculation of total cost of the asset : Total cost of an asset = purchase price + Expenses to be capitalised Case-1 A55,000 + A15,000 = A70,000 Case-2
A45,000 + A27,000 = A72,000
Case-3
A63,000 + A27,000 = A90,000
Case-4
A2,00,000 + A30,000 = A2,30,000
Calculation of amount of depreciation per year : Amount of depreciation =
Total cost of asset Estimated scrap value Expected life in years
Case-1
A70,000 A10, 000 A10, 000 6
Case-2
A72,000 A12, 000 A12, 000 5
Case-3
A90, 000 A9, 000 A9, 000 9
Case-4
A2,30, 000 A20, 000 A14, 000 15
Calculation of rate of depreciation under straight line method :
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Rate of depreciation under straight line method=
Annual depreciation 100 Total cost of asset
A10, 000
Case-1 A70, 000 100 14.29% A12, 000
Case-2 A72, 000 100 16.67% A9, 000
Case-3 A90, 000 100 10% A14, 000
Case-4 A2, 30, 000 100 6.09% Illustration 2 (Calculation of depreciation for the 1st year of purchase, when rate of depreciation is not given.) A machine costing A1,80,000 was purchased. Installation expense is A20,000. Expected life period is 7 years. Expected residual value at the end of useful life is A25,000. Calculate the amount of depreciation for the year ending 31st March 2017, if the machine is purchased on : (i) 1st April, 2016 (ii) 1st July 2016 (iii) 30th September 2016 (iv) 1st January 2017 Solution : Cost of the machinery = Purchase price + Installation expense = A1,80,000 + A20,000 = A2,00,000 Amount of depreciation per year :
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213
Total cost of machine Estimated scrap value Expected useful life
=
A2,00,000 A25,000 A25,000 per annum. 7
Amount of depreciation for the first year of purchase : Case-(i) Asset is purchased on 01.04.2016 Amount of depreciation for 12 months = A25,000 Case-(ii) Asset is purchased on 1st July, 2016 Amount of depreciation for 9 months A25,000× Case-(iii)
Asset is purchased on 30th September 2016 Amount of depreciation for 6 months A25, 000
Case-(iv)
9 =A18,750 12
6 A12,500 12
Asset is purchased on 1st January 2017 Amount of depreciation for 3 months A25, 000
3 A6, 250 12
Illustration 3 (Calculation of depreciation for the first year of purchase when rate is given) A machine costing A80,000 was purchased. Installation expense is A20,000. Rate of depreciation under straight line method is 10% p.a. Calculate depreciation for the first year ending 31st March 2017, if the machine is purchased on : (i) 1st April 2016 (ii) 1st July 2016 (iii) 1st October 2016 (iv) 1st January 2017
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Solution : Total cost of the machine A80,000 + A20,000 = A1,00,000 Amount of Depreciation = Period from date of purchase to date of closing
Cost of the machine
Rate 100
the accounts 12
Case-(i) When date of purchase is 1st April 2016 : Amount of depreciation for 12 months A1, 00, 000
10 12 A10, 000 100 12
Case-(ii) When the date of purchase is 1st July 2016 : Amount of depreciation for 9 months A1, 00, 000
10 9 A7,500 100 12
Case-(iii) When date of purchase is 1st October 2016 : Amount of depreciation for 6 months A1, 00, 000 10 6 A5, 000 100 12
Case-(iv) When date of purchase is 1st January 2017 : Amount of depreciation for 3 months A1, 00, 000
10 3 A2,500 100 12
Illustration 4 (Calculation of profit or loss on sale of asset) A vehicle is purchased for A4,00,000. Depreciation is provided @10% p.a. on straight line method. The vehicle is sold for A3,00,000. Calculate the profit or loss on sale of vehicle in the following cases for the year ending 31st March 2017 :
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215
(i) The date of purchase is 1st April 2015and the date of sale is 30th June 2016. (ii) The date of purchase is 1st July 2015 and the date of sale is 31st December 2016. (iii) The date of purchase is 1st October 2015 and date of sale is 30th Sept 2016. (iv) The date of purchase is 1st January 2014 and the date of sale is 31st December 2016. Solution : Calculation of profit or loss on sale Particulars A.Total cost of Vehicle
Case-(i)
Case-(ii)
Case-(iii)
Case-(iv)
A
A
A
A
4,00,000
4,00,000
4,00,000
4,00,000
50,000
60,000
40,000
1,20,000
(4,00,000×
(4,00,000×
B.Depreciation from the date of purchase to date of sale
(4,00,000× (4,00,000×
C. Book value on the date of sale (A-B) D. Sale price E. Profit on sale/loss on sale (D - C)
10 15 ) 100 12
10 18 ) 100 12
10 12 ) 100 12
10 36 ) 100 12
3,50,000 3,00,000
3,40,000 3,00,000
3,60,000 3,00,000
2,80,000 3,00,000
(50,000)
(40,000)
(60,000)
20,000
Journal Entries (i)
For providing depreciation : Depreciation Account To Asset Account
Dr. (with amount of depreciation provided)
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(ii) For Transfer of depreciation to Profit and Loss Account : Profit and Loss Account Dr. To Depreciation Account (iii) For sale of the asset at a profit : Bank Account Dr. (With the selling price) To Asset A/c To profit on sale of asset A/c (with the amounts of profit, i.e., excess realised over the book value of the asset). (iv) For transfer of profit on sale of asset : Profit on sale of asset Account Dr. To Profit and Loss Account (v) For sale of asset at a loss : Bank A/c Dr. (With the sale price of the asset) Loss on sale of asset A/c Dr. (With the difference between book To Asset A/c value and sale price of the asset.) (vi) For transfer of loss on sale of asset. Profit and Loss A/c Dr. (With the amount of loss) To Loss on sale of asset A/c Illustration 5 A machine is purchased on 1st April 2015 for A5,00,000. Depreciation is charged under straight line method @10% per annum. Pass Journal entries for the year ending 31st March 2016 and 31st March 2017. Solution : Journal Date 1st April 2015
Particulars Machinery Account To Bank Account (Being the machinery purchased)
L.F. Dr.
(Dr.) ( A) 5,00,000
(Cr.) (A) 5,00,000
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217
31st March Depreciation Account 2016 To Machinery Account (Being depreciation charged) 31st March Profit and Loss Account 2016 To Depreciation Account (Being transfer of depreciation to Profit and Loss Account) 31st March Depreciation Account 2017 To Machinery Account (Being depreciation charged) 31st March Profit and Loss Account 2017 To Depreciation Account (Being transfer of depreciation
Dr.
50,000 50,000
Dr.
50,000 50,000
Dr.
50,000 50,000
Dr.
50,000 50,000
to Profit and Loss Account) Working Note : Annual Depreciation = A5,00,000
10 A50,000 100
Illustration 6 A businessman bought a machinery on 1st October 2014 at a cost of A2,80,000. Amount spent on installation is A20,000. The business man writes off depreciation @10% per annum on original cost. The books are closed on 31st March every year. Prepare Machinery account and Depreciation account for 3 years.
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Solution : Dr. Date
In the Books of.... Machinery Account Cr. Particulars
A
Date
Particulars
A
2014 2015 Oct 1 To Bank A/c (Purchase price) 2,80,000 Mar 31 By Depreciation A/c (1) 15,000 To Bank A/c (Installation expense) 20,000 Mar 31 By Balance c/d 2,85,000
3,00,000 2015 Apr 11 To Balance b/d
3,00,000 2016
2,85,000 Mar 31 By Depreciation A/c (2) Mar 31 By Balance c/d
3,00,000 2016 Apr 1 To Balance b/d
2017 2,55,000 Mar 31 By Depreciation A/c (2) 30,000 Mar 31 By Balance c/d 2,25,000
2,55,000
Date
2,55,000
Depreciation Account Particulars Date A
Particulars
15,000 Mar 31 By Profit and Loss A/c
2016 Mar 31 To Machinery A/c
30,000 Mar 31 By Profit and Loss A/c
2017 Mar 31 To Machinery A/c
5,000
(Transferred) 2016
30,000
(Transferred)
2017 30,000 Mar 31 By Profit and Loss A/c 30,000 (Transferred)
Working Notes : Calculation of Depreciation : 1. Depreciation for the year ending 31st March 2015 : 10 6 × = A15,000 100 12
A
2015
2015 Mar 31 To Machinery A/c (For half year)
A3,00,000×
30,000 2,55,000 2,85,000
Depreciation
2.
219
Depreciation for the year ending 31st March 2016 and 2017 A3,00,000×
10 = A30,000 100
Illustration 7 Auto Trader purchased a machine on 1st April 2014 at a cost of A1,00,000. It provides depreciation @20% per annum on 31st March every year on original cost of the machine. The plant was sold for A60,000 on 31st December 2016. Prepare Machinery Account from 2014-15 to 2016-17. Solution : In the books of Auto Traders Dr. Machinery Account Cr. Date Particulars Date Particulars A A 2014 Apr 1 To Bank A/c
2015 1,00,000 Mar 31 By Depreciation A/c Mar 31 (20% on A1,00,000) By Balance c/d
1,00,000 2015 Apr 1 To Balance b/d
20,000 80,000 1,00,000
2016
80,000 Mar 31 By Depreciation A/c
20,000
(20% on A1,00,000) By Balance c/d Mar 31
80,000
60,000 80,000
2016
2016 Apr 1 To Balance b/d
60,000 Dec 31 By Depreciation A/c
15,000
Dec-31 To Profit on sale of asset A/c
15,000
(20% on A1,00,000 for 9 months) Dec-31 By Bank A/c 75,000 (sale of machine)
60,000 75,000
(profit on sale)
Working Note : Calculation of profit on sale : Cost price on 1s April 2014 less depreciation from 01.04.14 - 31.03.15
A 1,00,000 20,000
20 I F 1,00,000 G J H 100 K
Book value on 01.04.15
80,000
Accountancy
220
less Depreciation from 01.4.15 to 31.3.16
20,000
20 I F 1,00,000 G J H 100 K
Book value on 01.04.16 less : Depreciation from 01.04.16 to 31.12.16
60,000 15,000
10 9I F 1,00,000 J G H 100 12 K
Book value on 31.12.16 45,000 Sale proceeds 60,000 Profit on sale of machine 15,000 Illustration 8 M/s Mehta Bros purchased a machine for A4,00,000 on 1st April 2015. They spent A20,000 on its installation. Depreciation is charged @10% on original cost. The books are closed on 31st March every year. On 31st March 2017, one half of the machine is sold for A1,50,000. Prepare Machinery Account for 2 years. Solution : Machinery A/c Date
Particulars
2015 April 1 To Bank A/c (Purchase of machine) April 1 To Bank A/c (Installation Charges)
A
Date
A
2016
4,00,000 Mar 31 By Depreciation A/c 42,000 (10% on A4,20,000)
20,000 Mar 31 By Balance c/d
3,78,000 4,20,000
4,20,000 2015 April 1 To Balance b/d
Particulars
2017
3,78,000 Mar 31 By Depreciation A/c 42,000 (10% on A4,20,000) Mar 31 By Bank A/c 1,50,000 (Sale of Machine) Mar 31 By Profit and Loss A/c 18,000 (loss sale of machine) Mar 31 By Balance c/d 1,68,000
2017 April 1 To Balance b/d
3,78,000 1,68,000
3,78,000
Depreciation
221
Working Note : Calculation of loss on sale : A Balance on 01.04.16 3,78,000 less : Depreciation for 2016-17 42,000 Book value on 31.03.17 3,36,000 Half of 3,36,000 1,68,000 Less : Selling price 1,50,000 loss on sale 18,000 Illustration 9 M/s Raman Singh purchased a machine on 1st April 2014 for A2,00,000. On 1st July 2015, additions were made for A1,00,000. On 1st October 2016 further additions were made for A50,000. On 31st December 2016, the machine purchased on 1st April 2014 became obsolete and sold for A1,40,000/-. Depreciation is charged at 10% p.a. under fixed instalment method, and the accounts are closed on 31st March every year. Show Machinery Account for the year 2014-15 to 2016-17. Solution : In the Books of M/s Raman Singh Machinery Account Date Particulars Date Particulars A 2014 April 1 To Bank A/c (Purchase of machine)
2015 2,00,000 Mar 31 By Depreciation A/c 20,000 (10% on A2,00,000 for one year) Mar 31 By Balance c/d 1,80,000
2,00,000
2,00,000 2015 April 1 To Balance b/d July 1 To Bank A/c (purchase of new machinery)
2016
1,80,000 Mar 31 By Depreciation A/c 10% on A2,00,000 for 1,00,000 1 year A2,00,000
10 20,000 100
10% on A1,00,000 for 9 months. 1,00,000
10 9 7,500 100 12
Mar 31 By Balance c/d
2,80,000
27,500 2,52,500 2,80,000
Accountancy
222 2016 April 1 To Balance b/d
2016
2,52,500 Dec 31 By Bank A/c
1,40,000
(obsolete machinery sold)
Oct 1 To Bank A/c (addition of new machinery)
50,000 Dec 31 By Depreciation A/c
10 9I F G H2,00,000 100 12 J K
Dec 31 By Profit and Loss Account (loss on sale of obsolete machinery) 2017 Mar 31 By Depreciation A/c On A1,00,000, 10% p.a. for one year A1,00,000
15,000 5,000
10 A10,000 100
10% p.a. on 50,000 for 6 months. A50,000
10 6 A2 ,500 100 12
12,500
Mar 31 By Balance c/d 1,30,000
3,02,500 1,30,000
2017 Mar 31 To Balance b/d
Working Note Calculation of profit or loss on sale of machine : cost price on 1.4.2014 less Depreciation for 1.4.14-31.3.15 10 12 I F 2,00,000 J G H 100 12 K
Book value on 1.4.15 less Depreciation for 1.4.15-31.3.16 10 2,00,000 100 Book value on 1.4.16 Less Depreciation from 1.4.16 - 31.12.16 for 9 months
F G H
IJ K
3,02,500
A 2,00,000 20,000
1,80,000 20,000
1,60,000 15,000
10 9I F 2,00,000 J G H 100 12 K Balance on 31.12.2016 less Selling price Loss on sale of asset
1,45,000 1,40,000 5,000
Depreciation
223
Illustration 10 Somesh Dutta & Co. purchased a machinery an 1st April 2014 for A50,000. Depreciation is to be provided @10% p.a. according to written down value method. Prepare Journal, Machinery Account and Depreciation Account for 3 years assuming that accounts are closed on 31st March every year. Solution : Journal of Somesh Dutta & Co. Date
L.F. Amount Amount A A
Particulars
01.04.2014 Machinery A/c To Bank A/c (Being the purchase of machinery) 31.03.2015 Depreciation A/c To Machinery A/c (Being the depreciation provided) 31.03.2015 Profit and Loss A/c To Depreciation A/c (Being the transfer depreciation A/c to P/L A/c.) 31.03.16 Depreciation A/c To Machinery A/c (Being depreciation provided) 31.03.16 Profit and Loss A/c To Depreciation A/c (Being the transfer of depreciation A/c) To P/l A/c) 31.03.17 Depreciation A/c To Machinery A/c (Being the depreciation provided) 31.03.17 Profit and Loss A/c To Depreciation A/c (Being the transfer of depreciation to P/L A/c).
Dr.
50,000 50,000
Dr.
5,000 5,000
Dr.
5,000 5,000
Dr.
4,500 4,500
Dr.
4,500 4,500
Dr.
4,050 4,050
Dr.
4,050 4,050
Accountancy
224
Depreciation Account Particulars
Date
31.3.15 To Machinery A/c
31.3.16 To Machinery A.c 31.3.17 To Machinery A.c
Dr. Date
Particulars
1.4.14
To Bank A/c (Purchase of machine)
1.4.15
To Balance b/d
1.4.16
To Balance b/d
1.4.17
To Balance b/d
Particulars
A
5,000 31.3.15 By Profit and Loss A/c (Transferred) 5,000 4,500 31.3.16 By Profit loss A/c 4,500 (Transferred) 4,050 31.3.17 By Profit and Loss A/c 4,050 (Transferred)
Machinery Account Date A 50,000 31.3.15 31.3.15 50,000 45,000 31.3.16 31.3.16 45,000 40,500 31.3.17 31.3.17 40,500 36,450
A 5,000 5,000 4,500 4,500 4,050 4,050
Cr. Particulars By Depreciation A/c By Balance c/d By Depreciation A/c By Balance c/d By Depreciation A/c By Balance c/d
A 5,000 45,000 50,000 4,500 40,500 45,000 4,050 36,450 40,500
Working Notes Depreciation for 2014 – 15 = A50,000
10 A5,000 100
Depreciation for 2015 – 16 = A45,000
10 A4,500 100
Depreciation for 2016 – 17 = A40,500
10 A4,050 100
Illustration 11 A merchant purchased a second hand machinery for A80,000 on 1.4.14. He spent A20,000 for repair and installation. Depreciation is provided @20% p.a. according to written down value method. Pass journal entries, show Machinery Account and Depreciation Account for first three years assuming accounts are closed on 31st March each year.
Depreciation
225
Solution : Journal of the Merchant Date 1.4.14
1.4.14
31.3.15
31.3.15
31.3.16
31.3.16
31.3.17
31.3.17
Machinery A/c To Bank A/c (Being the machinery purchased) Machinery A/c To Bank A/c (Being the repair and installation charges paid) Depreciation A/c To Machinery A/c (Being depreciation provided) Profit and Loss A/c To Depreciation A/c (Being transfer of Depreciation to P/LA/c) Depreciation A/c To Machinery A/c (Being depreciation provided) Profit and Loss A/c To Depreciation A/c (Being transfer of depreciation to P/L A/c) Depreciation A/c To Machinery A/c (Being depreciation provided) Profit and Loss A/c To Depreciation A/c (Being transfer of Depreciation)
Dr.
Date 1.4.14 1.4.14
L.F.
Particulars Dr.
Amount Amount Dr A Dr A 80,000 80,000
Dr.
20,000 20,000
Dr.
20,000 20,000
Dr.
20,000 20,000
Dr.
16,000 16,000
Dr.
16,000 16,000
Dr.
12,800 12,800
Dr.
12,800 12,800
Machinery Account
Particulars To Bank A/c To Bank A/c (Installation and repair)
L.F.
Amount (A )
Date
Cr.
Particulars
80,000 31.3.15 By Depreciation A/c 20,000 31.3.15 By Balance c/d 1,00,000
Amount (A ) 20,000 80,000 1,00,000
Accountancy
226 1.4.15
To Balance b/d
80,000 31.3.16 By Depreciation A/c 31.3.16 By Balance c/d 80,000
16,000 64,000 80,000
1.4.16
To Balance b/d
12,800 51,200 64,000
1.4.17
To Balance b/d
64,000 31.3.17 By Depreciation 31.3.17 By Balance c/d 64,000 51,200 Depreciation Account
Date
Particulars
L.F.
31.3.15 To Machinery A/c
31.3.16 To Machinery A/c
31.3.17 To Machinery A/c
Amount (A )
20 A20,000 100 Depreciation for 2015-16 :
A80,000
20 A16,000 100
Depreciation for 2016-17 :
A64,000
20 A12,800 100
Particulars
20,000 31.3.15 By Profit and Loss A/c (Transferred) 20,000 16,000 31.3.16 By Profit and Loss A/c (Transferred) 16,000 12,800 31.3.17 By Profit and Loss A/c (Transferred) 12,500
Working Notes Depreciation for 2014-15 :
A1,00,000
Date
Amount (A ) 20,000 20,000 16,000 16,000 12,800 12,500
Depreciation
227
Note: In case of purchase of old/second hand machinery, all expenses incurred including the installation expenses are to be capitalised. Illustration 12 X Ltd. purchased a plant on 1st July 2014 for A1,20,000. The plant is subject to depreciation of 10% p.a. on reducing balance method. The plant became obsolete on 31st December 2016 and sold for A20,000. Write up the Plant Account assuming that accounts are closed on 31st March every year. Solution : Dr. Plant Account Cr. Amount Amount Particulars Particulars L.F. (A) Date Date ( A) 1.7.14
To Bank A/c
1.4.15
To Balance b/d
1.4.16
To Balance b/d
1,20,000 31.3.15 31.3.15 1,20,000 1,11,000 31.3.16 31.3.16 1,11,000 99,900 31.12.16
By Depreciation A/c 9,000 By Balance c/d 1,11,000 1,20,000 By Depreciation A/c 11,100 By Balance c/d 99,900 1,11,000 By Bank A/c 20,000 (sale of absolete machinery) 31.12.16 By Depreciation A/c 7,493 31.12.16 By Profit and Loss A/c 72,407 (loss on sale) 99,900 99,900
Working Notes Depreciation for 2014-15 : A1,20,000
10 9 A9,000 100 12
Depreciation for 2015-16 : A111 , ,000
10 A11100 , 100
Accountancy
228
Depreciation for 2016-17 : A99 ,900
10 9 A7 ,493 100 12
Calculation of profit/loss on sale : A 1,20,000 9,000 1,11,000 11,100 99,900 7,493 92,407 20,000 72,407
Cost of the plant on 1.7.14 Less : Depreciation from 1.7.14-31.3.15 Cost on 1.4.15 Less : Depreciation from 1.4.15-31.3.16 Cost on 1.4.16 Less Depreciation from 1.4.16-31.12.16 Written down value on 31.12.16 Less : Sale Price Loss on Sale Illustration 13 (Provision for Depreciation Account) Raman purchased a machinery for A2,00,000 on 1.4.14 and sold for A1,45,000 on 31.3.17. Depreciation is provided @10% p.a. on the original cost of the machinery. Pass the necessary journal entries and prepare necessary ledger accounts assuming that Provision for Depreciation Account is maintained. Solution : Journal Amount Amount L.F. Dr A Date Particulars Dr A 1.4.14 Machinery A/c To Bank A/c (Being the purchase of machinery) 31.3.15 Depreciation A/c To Provision for Depreciation A/c (Being provision for depreciation created) 31.3.15 Profit and Loss A/c To Depreciation A/c (Being transfer of depreciation to P/L A/c)
Dr.
2,00,000 2,00,000
Dr.
20,000 20,000
Dr.
20,000 20,000
Depreciation
229
31.3.16 Depreciation A/c To Provision for Depreciation A/c (Being the provision for made) 31.3.16 Profit and Loss A/c To Depreciation A/c (Being transfer of depreciation Account to P & L A/c) 31.3.17 Depreciation A/c To Provision for Depreciation A/c (Being provision for depreciation made) 31.3.17 Profit and Loss Account A/c To Depreciation A/c (Being transfer of depreciation to P&L A/c) 31.3.17 Bank A/c To Machinery A/c (Being sale of machinery) 31.3.17 Provision for Depreciation A/c To Machinery A/c (Being transfer of Provision for Depreciation to Machinery account on sale) 31.3.17 Machinery A/c To Profit and Loss A/c (Being profit on sale of machinery) Dr.
Dr.
20,000 20,000
Dr.
20,000 20,000
Dr.
20,000 20,000
Dr.
20,000 20,000
Dr.
1,45,000 1,45,000
Dr.
60,000 60,000
Dr.
5,000 5,000
Machinery Account
Date
Particulars
01.4.14 01.4.15 01.4.16 31.3.17
To Bank A/c To Balance b/d To Balance b/d To Profit and Loss A/c (profit on sale of machinery)
L.F.
Amount (A )
Date
2,00,000 2,00,000 2,00,000 5,000
31.3.15 31,.3.16 31,.3.17 31.3.17
2,05,000
Cr.
Particulars
Amount (A )
By Balance c/d By Balance c/d By Bank A/c By Provision for Depreciation A/c
2,00,000 2,00,000 1,45,000 60,000
2,05,000
Accountancy
230 Dr.
Depreciation Account
Date
Particulars
L.F.
31.3.15 To Provision for DepreciationA/c 31.3.16 To Provision for Depreciation A/c 31.3.17 To Provision for Depreciation A/c
Amount (A )
Date
Cr.
Particulars
Amount (A )
20,000 31.3.15 By Profit and Loss A/c
20,000
20,000 31,.3.16 By Profit and Loss A/c
20,000
20,000 31.3.17 By Profit and Loss A/c
20,000
Provision for Depreciation Account
Date
Particulars
31.3.15 To Balance c/d 31.3.16 To Balance c/d
31.3.17 To Machinery A/c
L.F.
Amount (A )
Date
Particulars
20,000 31.3.15 By Depreciation A/c 40,000 01.4.15 By Balance b/d 31.3.16 By Depreciation A/c 40,000 60,000 01.4.16 By Balance b/d 31.3.17 By Depreciation A/c 60,000
Working Notes : Calculation of profit or loss on sale of machinery Cost price of Machinery on 1.4.2014 less : Depreciation for 3 years @ A20,000 p.a. Written down value on 31.03.17 Sale price Profit on sale -0-
Amount (A ) 20,000 20,000 20,000 40,000 40,000 20,000 60,000
A 2,00,000 60,000 1,40,000 1,45,000 5,000
Depreciation
3.8 1. (a)
(b)
(c)
(d)
(e)
(f)
231
QUESTIONS From the alternatives given under each bit, write the correct answer along with its serial number against each bit : Depreciation is calculated on the basis of : (i) Market Price. (ii) Cost Price. (iii) Market Price or cost price whenever is less. (iv) On average of cost price and market price. Under straight line method of depreciation, the amount of annual depreciation : (i) Increases every year. (ii) decreases every year. (iii) Increases in some years and decreases in some other years. (iv) remains constant. Under diminishing balance method, the amount of depreciation : (i) increases every year. (ii) decreases every year. (iii) remains constant. (iv) both Increases and decreases. Depreciation is : (i) an income. (ii) a loss. (iii) an asset. (iv) a liability. Depreciation is calculated on : (i) fixed assets. (ii) current assets. (iii) liquid assets. (iv) fictitious asset. Deprecation is charged to : (i) Trading Account.
232
(g)
(h)
(i)
(j)
(k)
Accountancy
(ii) Profit and Loss Account. (iii) Profit and Loss Adjustment account. (iv) Profit and Loss Appropriation account. Depreciation arises due to : (i) fall in market price of the asset. (ii) physical wear and tear of the asset. (iii) fall in the value of money. (iv) pilferage. Profit on sale of machinery should be credited to : (i) Profit and Loss Account. (ii) Trading Account. (iii) Profit and Loss Appropriation Account. (iv) Provision for Depreciation Account. The cost of the plant is A5,000. Depreciation is provided @10% p.a. on written down value method. The depreciation for 3rd year will be. (i) A500. (ii) A450. (iii) A400. (iv) A405. If the cost of the asset is A31,000 and scrap value is A1,000, then the amount of depreciation @10% p.a. on straight line method is : (i) A3,100 p.a. (ii) A3,000 p.a. (iii) A2,900 p.a. (iv) A3,110 p.a. One of the following assets which is assumed not to be depreciated is : (i) plant. (ii) machinery. (iii) land. (iv) mine.
Depreciation
233
(l)
Depreciation is a process of : (i) valuation of asset. (ii) allocation of cost of asset. (iii) amortisation of the asset. (iv) duplication of asset. [Ans. (a) - (ii) - Cost price (b) - (iv) - Remain constant (c) - (ii) - decreases every year (d) - (ii) - a loss (e) - (i) fixed assets (f) - (ii) - profit and loss account (g) - (ii) - physical wear and tear of the asset (h) - (i) - profit and loss account (i) - (iv) - A405 (j) - (ii) - A3,000 p.a (k) - (iii) - land (l) - (ii) - allocation of cost of asset] 2.
Answer the following questions in one word/term each : (a) Name the type of asset on which depreciation is calculated. (b) Name the type of fixed asset on which depreciation is not calculated. (c) Name the account to be debited for the amount of depreciation charged against an asset. (d) Under which method of charging depreciation, the amount of depreciation for each year remains constant ? (e) Name the asset against which the term ‘depletion’ is used. (f) Name the term used for the amount likely to be realised on sale of fixed asset after its useful life. (g) In which method of depreciation the value of the fixed asset becomes zero at the end of its useful life.
Accountancy
234
(h) Name the account to be debited for loss on sale of fixed asset. (i) Name the method of depreciation in which amount depreciation reduces year after year of use. (j) What is the amount of depreciation on the deminishing balance method on a machinery of A10,000 at the rate at 10% p.a. in the 3rd year of its use ? [Ans.: (a) fixed asset (b) Land (c) Depreciation Account (d) Straight line method (e) wasting asset (f) scrap value or salvage value (g) straight line method (h) profit and loss account (i) reducing balance method (j) A810.] 3.
Answer the following questions in one sentence each : (i) What do you mean by depreciation ? (ii) Write any one cause of depreciation. (iii)On which type of asset, depreciation is chargeed ? (iv) State any one characteristic of depreciation. (v) Give any one difference between depreciation account and provision for depreciation account. (vi) Give the journal entry for writing off depreciation. (vii) Give any one difference between straight line method and written down value method of depreciation. (viii) Which method of depreciation is approved for income tax purpose ? (ix) What do you mean by residual value of the asset ? (x) Explain the meaning of the term “wear and tear” in depreciation.
4.
Fill up the blanks of the following sentences : (a) The word depreciation is derived from the latin word ______. (b) Permanent decrease in the value of the asset is known as ______ . (c) The estimated value realised at the time of discard of fixed assets is known as ______ . (d) Obsolescence is the technical term used as the reason of discarding ______ asset. (e) Total cost of the fixed asset is equal to purchase price – installation expenses.
Depreciation
5.
235
(f) Depreciation refers to ______ in the value of fixed assets. (g) Depreciation is a ______ expense. (h) When depreciation is charged, asset account is ______. (i) ______ is the only asset which is usually not depreciated. (j) Depreciation is charged on ______ assets. [Ans. : (a) Depretium (b) depreciation (c) scrap (d) fixed (e) + (f) decrease/ reduction (g) Non cash (h) credited (i) Land (j) fixed] Correct the underlined partions of the following sentences : (a) In written down value method of depreciation, the written down value of the asset becomes zero at the end of its useful life. (b) In straight line method of depreciation the value of the asset is never zero. (c) Provision for depreciation account always shows Debit balance. (d) Fixed assets are shown in the balance sheet at market price. (e) In case of loss suffered during a financial year, depreciation cannot be provided. (f) Profit and Loss Account is credited with the amount of depreciation. [Ans.: (a) straight line (b) written down value (c) credit (d) cost (e) can (f) debited]
6.
Answer the following questions within 30 words each : (a) Define the term ‘depreciation’. (b) What do you mean by salvage value of the fixed asset ? (c) What is ‘written down value’ of asset ? (d) Write any two differences between straight line method of depreciation and written down value method of depreciation. (e) Why is asset shown in the balance sheet at its original cost under provision for depreciation method ? (f) What are the causes of depreciation ? (g) What is the need for charging depreciation ?
236
7.
8. 9. 10. 11. 12.
13.
Accountancy
(h) What do you mean by reducing balance method of depreciation ? Explain with an example. (i) Write the formula for calculation of depreciation under straight line method. Explain with an example. Answer the following questions within 50 words each : (a) Explain the merits and demerits of straight line method of depreciation. (b) State the merit and demerits of written down value method of depreciation. (c) Show the calculation of depreciation under reducing balance method of depreciation for 3 years with an imaginary example. (d) State the objectives of providing depreciation. (e) Explain the characteristics of depreciation. (f) Which factors affect the depreciations ? (g) Show the calculation of profit on sale of depreciable asset with an imaginary example. (h) Distinguish between straight line method and written down value method of depreciation. (i) Differentiate between sample depreciation method and provision for depreciation method. What is depreciation ? Discuss the causes and objectives of providing depreciation. Define depreciation. Discuss its characteristics. Explain straight line method and written down value method of providing depreciation. Give the Journal entries for charging depreciation under simple method with imaginary example. Show the treatment in the balance sheet also. Write journal entries required for charging depreciation under provision for depreciation method with imaginary example. Show the treatment also in the Balance Sheet. M purchased a machinery for A40,000. The useful life of the machinery is 10 years. The estimated scrap value is A4,000/- M wants to provide depreciation under straight line method. Calculate the rate of depreciation. (Ans. 9%)
Depreciation
14.
15.
16.
17.
18.
19.
237
Raman purchased a machinery on 1st April 2014 for A1,00,000. The estimated life of the machine is 15 years. Its scrap value after 15 years will be A10,000. Pass journal entries for the first three years, under straight line method assuming that the accounts are closed on 31st March, every year. (Annual depreciationA6,000) Madan Purchased a machine on 1.4.14 for A1,20,000. Assuming the life of the machine at 10 years and estimated scrap value at A20,000, prepare the Machinery Account for the first three years under straight line method. Accounts are closed on 31st March each year. (Balance in Machinery Account A90,000) Mr. Kumar purchased a plant on 1.4.13 costing A2,00,000. The life of the plant is estimated at 15 years. The estimated scrap value after the useful life is A20,000. Prepare necessary ledger accounts from 2013-14 to 2016-17 under straight line method of depreciation. (Ans. Balance of Plant Account A1,52,000) Sanjay purchased a fixed asset on 01.01.2014 for A80,000. Depreciation is provided under straight line method @ 10% p.a. Accounts are closed on 31st March every year. Pass Journal entries and prepare necessary ledger accounts till 31st March 2017. (Ans. Balance of Plant Account A54,000) A manufacturer acquires a machine on 1.4.2014 for A80,000. He spent A2,000 on transportation and A18,000 on installation. The manufacturer charges depreciation @10% on original cost every year. Show the Machinery Account and Depreciation Account for 3 years. The books are closed on 31st March every year. (Ans. Balance in Machinery Account A70,000) Mr. Nandan purchased a second-hand machine for A40,000 on 1st April 2014. He spent A10,000 on its overhauling and installation. Depreciation is written off @10% p.a. on original cost. Prepare Machinery Account and Depreciation Account and show the balance sheet entries for first three years assuming that accounts are closed on 31st March every year. (Balance in Machinery Account of A35,000)
Accountancy
238
20.
Mrs. Smruti Purchased a machinery for A50,000 on 1st April 2013. She purchased another machinery on 31st December 2015 for A60,000. Rate of depreciation under straight line method is 10%. Write up Machinery Account and Depreciation Account from 2013-14 to 2016-17 assuming that accounts are closed on 31st March every year. (Balance in Machinery Account A82,500)
21.
On 1st January 2014, an asset was purchased for A64,000. If was decided to write off 10% depreciation on original cost each year. On 31st March 2017, it was sold for A40,200. Prepare asset account till 31st March 2017 assuming that books are closed on 31st March every year. (loss A3,000)
22.
Mr. Ram lal purchased a machine at a cost of A75,000 on 1st January 2014. He spent A5,500 on installation of the machine. He purchased another machine on 1st April 2015 for A60,000. Another machine was purchased on 1st April 2016 for A50,000. Show Machinery Account and Depreciation Account from 1st January 2014 to 31st March 2017 assuming that accounts are closed on 31st March every year. Depreciation is calculated @10% p.a. on original cost of the machine. (Ans. Balance in Machinery account A1,55,000)
23.
24.
Mr. Jambaban purchased a second hand machine for A70,000 on 1st April 2014. He spent A20,000 on repair and installation. He purchased another machine on 1st April 2015 for A58,000. He spent A2,000 on installation of the machine. Depreciation is provided @10% p.a. on straight line method. Pass necessary journal entries, prepare necessery ledger accounts for the period 2014-15 to 2016-17 assuming that accounts are closed on 31st March every year. [Ans. Balance in Machinery Account A1,11,000) The cost of furniture on 1.4.2013 was A30,000. Depreciation is to be provided at 10% p.a. on diminishing balance method. Show the necessary ledger accounts for the first four years assuming that accounts are closed on 31st March every year. [Ans. Depreciationon A3,000, A2,700, A2,430, A2,187]
Depreciation
25.
26.
27.
28.
29.
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Mr. Som Prasad purchased a machine for A3,00,000 an on 1st January 2014. It was decided that depreciation would be charged at 10% p.a. on reducing balance method. Show the Machinery Account and Depreciation Account in the books of Som Prasad from 1st January 2014 to 31st March 2017 assuming that accounts are closed on 31st March every year. [Ans. Balance of Machinery account A2,13,232] The original cost of a plant an 1st April 2013 amounted to A4,00,000. It was decided to charge depreciation at 5% p.a. on written down value method. Show the necessary ledger accounts as these will appear from 2013-14 to 2016-17, assuming that accounts are closed on 31st March every year. [Ans. A3,25,803] On 1st April 2014 a machine was bought at a cost at A2,82,000. Installation charges were A18,000. It was decided to charge depreciation @15% p.a. on dimmishing balance. Show Machinery Account and Depreciation Account for the year 2014-15 to 2016-17 assuming that accounts are closed on 31st March every year. [Ans. Balance in machinery account A1,84,237] A plant was purchased for A5,00,000 on 1st April 2012. It was depreciated @5% p.a. on reducing balance method. It became obsolete on 31st March 2017 due to new method of production and was scrapped. The scrap realised A1,00,000. Show Plant Account from 2012-13 to 2016-17 assuming that accounts are closed on 31st March every year. [Ans. Depreciation A25,000, A23,750, A22,563, A21,434, A20,363, loss on sale A2,86,890) On 1st April 2012 a firm purchased a machine worth A6,00,000. Show, how it will be depreciated under fixed instalment method and written down value method. Annual depreciation is 10%. Show Machinery Account, Depreciation Account and entries in the Balance Sheet for a period of 5 years, assuming that accounts are closed on 31st March every year. [Ans. Depreciation under written down value method : A60,000, A54,000, A48,600, A43,740, A39,366, Balance A3,54,294. Under straight line method : Depreciation each year A60,000, Balance A3,00,000]
240
30.
Accountancy
On 01.4.2016 balance of Machinery Account was A2,00,000. On 30.09.2016 part of the machinery was sold for A40,000 (original cost being A50,000 on 01.04.2015). Machinery was depreciated @10% p.a. under diminishing balance method. Show the Machinery Account for the year 2016-17 assuming accounts are closed on 31st March every year. [Ans. Balance in Machinery Account A1,39,500, loss on sale A2,750] Hints, Balance of machinery sold on 01.04.16 A45,000, Depreciation from 01.4.16-30.9.16 A2,250. Balance of other machine A1,55,000 on 1.4.16]
31.
Amar purchased 3 Trucks @ A5,00,000 for each truck on 01.4.2014. On 30.09.2015 one truck was completely damaged in accident. The insurance company admit a claim of A2,00,000. Prepare Truck Account for 3 years ending 31st March 2017 assuming that depreciation is provided @20% p.a. on W.D.V. method. [Ans. Truck Account blance A6,40,000 (loss on accident A1,60,000) (Hints : original cost of Truck damaged on 01.04.14 A5,00,000 Depreciation from 01.04.2014 to 31.03.2015 @ 20% on A5,00,000 is A1,00,000, on A4,00,000 @20% p.a. for six months from 1.4.2015-30.9.15 A40,000)
32.
A manufacturer purchased a machinery on 01.4.14 for A2,00,000. Additional machinery was purchased on 01.04.2015 for A1,00,000. On 30.9.15, the machinery purchased on 1.4.15 was sold for A72,000. Another machinery for A50,000 was purchased on the same day. Give Machinery Account for the year ending 31st March 2017 assuming that depreciation is provided @10% p.a. on reducing balance method. (Ans. Balance A1,90,800, loss on sale A13,500) [Hint. Machinery purchased on 1.4.15 A1,00,000. Depreciation for 1 year A10,000. depreciation from 1.4.16-30.09.16 for 6 months @10% p.a. 4,500.]
33.
On 01.4.14, Raman purchased a machinery for A10,00,000. On 1st April 2016, a part of the machinery purchased on 1.4.14 costing A1,00,000 was sold for A75,000. The business had adopted the method of providing depreciation at
Depreciation
34.
241
10% p.a. on the original cost of the machine. Accounts are closed on 31st March every year. Show necessary ledger accounts from 2014-15 to 2016-17 assuming that : (a) Provision for depreciation account is not maintained. (b) Provision for depreciation account is maintained. [Ans.: Whe provision for depreciation account is not maintained : Balance of Machinery Account A6,30,000. When provision for depreciation account is maintained-Balance in machinery Account - A8,00,000. Balance in Provision for Depreciation Account A2,70,000.] X purchased a machinery on 1st April 2014 for A12,00,000. On 1st April 2015 a part of the machine purchased on 1.4.14 for A2,00,000 was sold for A1,70,000. Another machine was purchased on 1st April 2016 for A1,00,000. X has adopted method of providing 10% depreciation p.a on the diminishing balance of the machinery. Show necessary ledger accounts from 2014-15 to 2016-17 assuming that : (a) Provision for depreciation account is not maintained. (b) Provision for depreciation account is maintained. [Ans. : - When provision for Depreciation account is not maintained : balance in Machinery account A8,19,000 loss on sale of machine A10,000 When provision for depreciation account is maintained : Balance in Machinery Account A11,00,000 Balance in Provison for Depreciation Account A2,71,000.] -o-
CHAPTER - 4
ACCOUNTING FROM INCOMPLETE RECORDS (Single Entry System) STRUCTURE
4.1
Meaning
4.2
Characteristics
4.3
Limitations
4.4
Difference between Single Entry and Double Entry System
4.5
Difference between Balance Sheet and Statement of Affairs
4.6
Ascertainment of profit and loss by Statement of Affairs Method
4.7
Questions
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243
After going through this chapter, you will be able to understand the meaning, characteristics and limitations of single entry system of book keepaing. You will also understand the difference between : (i) Single entry and Double entry system (ii) Balance Sheet and Statement of Affairs. You will also understand the method of calculation of profit and loss under statement of affairs method. 4.1 MEANING The team “single entry system’’ can be defined as a system which is not exactly double entry system. In other words, incomplete accounting records are those accounting records which are not completed according do double entry principles. Many authors describe it as the single entry system. But majority of accountants describe it as incomplete records. In fact, single entry is not at all a separate system of accounting. Under this system, the principles of Double entry system are followed but in a half-hazard or incomplete manner. Therefore, it is more appropriately described as a incomplete record of keeping accounts. For example, under this system, incomplete record may consist of : (i) in certain cases, both the aspects of some transactions are recorded, e.g., in case of cash received from the debtor and cash paid to the creditors. (ii) in certain other cases, only one aspect of the transaction is recorded. As for example, in case of cash purchase, cash sales, payment for expenses, purchase of fixed assets for cash, etc., only one aspect is recorded and finally, yet in some other cases, (iii) no aspect of a transaction is recorded. For example, writting off depreciation on fixed assets is not at all recorded in the books of accounts.
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Accountancy
Thus, a business is said to be following incomplete records or single entry system, if it is not following the complete system of double entry system of Bookkeeping. The accountant Kohler has defined Single Entry System as, “A system of Book-Keeping in which as a rule only records of cash and personal accounts are maintained, it is always incomplete double entry varying with the circumstances.” 4.2 CHARACTERISTICS The following are the characterstics of the single entry system of book-keeping: (i)
Recording of personal accounts
Under this system, only personal accounts are maintained. Real accounts and Nominal accounts are ignored. For this reason, some accountants define it as a system of personal accounts only. (ii) Maintaining of the cash-book A cash book is maintained by the business adopting single entry system. However, the businessman mixes the personal transactions with the business transactions. (iii) No uniformity This system of maintaning records may vary from business to business as per their requirements, and hence, no uniform system is maintained by all the concerns following this system. (iv) Suitability This system is suitable only to small business units. Small sole traders and partnership firms only adopt this system. The companies and other big business houses cannot adopt the system because of legal requirements. (v)
Dependant on original vouchers
As the business records only cash transactions and personal accounts, complete information is not available. So one has to depend on original vouchers for necessary
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245
information. For example, to find out the total amount of credit purchase or credit sales, one has to depend on original invoices. 4.3 LIMITATIONS Maintenance of incomplete records or single entry system suffers from the following limitations : (i) Arithmetic accuracy of accounts cannot be checked : Under Double entry system of book-keeping both the debit and credit aspects of the transactions are recorded. Trial Balance is prepared to check the arithmetic accuracy of the accounts. But under single entry system, trial balance cannot be prepared. Full information is not recorded under single entry system. So chances of fraud and misappropriation is increased. (ii) True profit of the business cannot be ascertained : True and correct profit can be ascertained from the information like purchases, sales and other expenses. But complete information regarding these items are not available under such system. Hence, Trading and Profit and Loss account cannot be prepared to ascertain the true profit earned or loss suffered by the business. (iii) True financial position of the business cannot be ascertained : Balance Sheet records the position of assets and liabilities on a specific date. The liabilities include true profits of the business. But true profit cannot be ascertained. Correct figures of other assets and liabilities are not available. So Balance Sheet cannot be prepared to know the correct financial position of the business. (iv) No internal check : Internal check is not possible under single entry system. So chances of fraud and misappropriation increase in comparison to Double entry system. (v) Not recognised by law : The legal authorities like Income Tax and other Tax authorities, courts, etc., does not recognise the records under this system. (vi) It is difficult to conduct the audit work. (vii) Planning and decision-making of the business is difficult. (viii) It is difficult to ascertain the worth of the business. So goodwill cannot be valued.
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(ix) It is difficult to exercise control over the assets. As it suffers from so many limitations, the system is not popular. 4.4
DIFFERENCE BETWEEN SINGLE ENTRY SYSTEM AND DOUBLE ENTRY SYSTEM
Basis of Distinction Principles and Assumptions Aspect of transaction Accounts maintained Trial Balance
Calculation of true profit and loss
Financial position
Single entry system It is not based upon any specific and scientific principles and assumptions. It does not record both the aspects of transactions normally. It usually records cash account and personal accounts. Trial Balance cannot be prepared. Hence arithmetical accuracy of the accounts cannot be checked. Trading and Profit and Loss Account cannot be prepared. Hence, only estimated profit and loss can be calculated. Balance Sheet cannot be prepared as complete records of Real and Nominal accounts are not available. Only estimated financial position can be known by preparing statement of affairs.
Double entry system It is based upon certain principles and assumptions. It records both the aspects of the transactions scrupulously. It records all types of accounts-Personal, Real and Nominal accounts. Trial Balance can be prepared as complete records of all transactions are maintained. Artihmetic accuracy of the accounts can be checked. True profit and loss can be determined by preparing Trading and Profit and Loss Account. True financial position of the business can be ascertained by preparing Balance Sheet as complete records of all accounts are available.
Accounting from Incomplete Records
Adjustments
Recognition
Accounts are prepared without considering the adjustments. It is not recognised by Income Tax authorities, Companies Act and other government agencies.
247
Final Accounts are prepared considering all type of adjustments in accounts. The accounts are recognised by all the government agencies.
Usually small business This system is adopted by all enterprises adopt this types of business houses. system. There is scope for There is no scope for Manipulation of manipulation of accounts and manipulation of accounts and Accounts frauds. possibility of frauds. The results draw from this The results drawn from this Free from doubts system are not free from system are completely free from doubts. doubts. 4.5 DIFFERENCE BETWEEN BALANCE SHEET AND STATEMENT OF AFFAIRS Businessman
Both the Balance Sheet (prepared under Double-entry system) and statement of affairs (prepared under single-entry system) show the financial position of the business on a particular date. However, they differ from each other in the following ways : Balance Sheet Basis of Distinction It is prepared on double entry System system It is prepared under the basis Basis of of Trial balance prepared, Preparation from ledger accounts. Time of It is always prepared at the preparation end of the year.
Statement of Affairs It is prepared under single entry system It is prepared on the basis of some ledger accounts and estimates. It is prepared either at the end of the year or beginning of the year.
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248
Balance of capital account
Capital balance can be known from the Capital Account found in the ledger.
Balance of capital account is found out by balancing the Statement of Affairs.
Assets and Liabilities
The assets and liabilities shown in the Balance Sheet are taken from the ledger accounts.
The assets and liabilities shown in Statement of Affairs are taken by physical inspection.
Financial position
It shows the true and fair view of the financial position of the business. Omission of assets and liabilities can be traced.
It shows only estimated financial position of the business. omission of assets and liabilities cannot be traced.
Trial Balance is prepared before preparation of Balance Sheet.
Trial balance is not prepared at all.
Omission of assets and liabilities Trial Balance
4.6 ASCERTAINMENT OF PROFIT OR LOSS BY STATEMENT OF AFFAIRS METHOD The profit or loss of the business maintaining accounts under single entry system can be ascertained by : (i) Statement of Affairs method or Net worth method or pure Single Entry System. (ii) Conversion method or Quasi Single Entry System or Final Accounts System. However, we will discuss only Statement of Affairs Method. Statement of Affairs Method Meaning : A Statement of Affairs is nothing but a balance sheet prepared under single entry system on a particular date. In other words, it is a balance sheet which shows the assets and liabilities of a business concern on a particular date. It lists assets on the right hand side and liabilities on the left hand side. Excess of assets over liabilities is assumed to be capital. It is to be noted that complete information is not available about assets and liabilities from accounting records. Some assets and liabilities are estimated. The proforma of Statement of Affairs is given below :
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249
Statement of Affairs as on ....... Amount (A) Liabilities
Liabilities Sundry Creditors Bills Payable Outstanding expenses Bank Overdraft Income received in advance Loans Capital (Balancing figure)
? ? ? ? ? ? ?
Cash in Hand Cash at Bank Sundry Debtors Bills Receivable Stock Prepaid expenses Accrued Income Fixed Assets
Amount (A) ? ? ? ? ? ? ? ?
Ascertainment of profit or loss According to this method, profit or loss made by the business can be ascertained by comparing net worth (capital) of the business on two different dates. For example, the capital of a business on 01.04.2016 is A2,00,000 and on 31.3.2017 is A3,00,000. We can tell that the business has earned a profit of is A1,00,000 (A3,00,000 – A2,00,000) during the period. The following steps are involved in the ascertainment of profit or loss under statement of affairs method. Step-1 Step-2 Step-3 Step-4 Step-5 Step-6
Prepare statement of affairs at the end of the accounting period and find out closing capital. Deduct additional capital introduced from the closing capital. Add amount of drawings whether cash or in kind. The figure is adjusted closing capital. Prepare statement of affairs in the beginning of the accounting period and find out opening capital. Deduct opening capital from the adjusted closing capital (As per step 3). Make adjustment for interest on capital, interest on drawings, proprietor/ partner’s salary, depreciation on fixed assets, provision for doubtful debts, etc.
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It is to be noted that when adjustments are given in the question, prepare statement of affairs to calculate capital, record assets and liabilities before adjustments. Format for showing profit (loss) for the period ending....... A
Capital at the end of the accounting period
XXXX
Add Drawings (whether in cash or in kind)
XXXX
Less Additional capital introducted during the year
XXXX
Adjusted capital of the end of the accounting period
XXXX
Less Capital of the beginning of the accounting period
XXXX
Profit (or loss) for the accounting period
XXXX
Illustration 1 A keeps the accounts under single entry system. Prepare statement of affairs from the following information : Particulars Cash in hand Cash at Bank Stock Sundry Debtors Bills Receivable Machinery Bills Payable Creditors Investments
1.4.2016
31.3.17
A
A
5,000 13,200 15,300 18,100 7,500 27,500 12,300 17,300 6,000
6,500 18,600 12,700 19,300 8,600 27,500 8,200 18,600 8,000
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251
Solution : Statement of Affairs as on 1.4.2016 Amount (A) Liabilities Assets Bills Payable 12,300 Cash in hand Creditors 17,300 Cash at Bank Capital (Balancing figure) 63,000 Stock Sundry Debtors Bills Receivable Investments Machinery 92,600
Amount (A) 5,000 13,200 15,300 18,100 7,500 6,000 27,500 92,600
Statement of Affairs as on 31.3.2017 Liabilities Bills Payable Creditors Capital (Balancing figure)
Amount (A) Assets 8,200 Cash in hand 18,600 Cash at Bank 74,400 Stock Sundry Debtors Bills Receivable Investments Machinery 1,01,200
Amount (A) 6,500 18,600 12,700 19,300 8,600 8,000 27,500 1,01,200
Illustration 2 Following incomplete information is available from the record maintained by Mr. X : Particulars 1.4.2016 31.3.17 Cash Bank Debtors
A
A
12,200 18,500 22,300
14,300 21,300 17,500
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Creditors 25,200 27,000 Investment 14,000 16,000 Stock 15,600 12,700 Bank Loan 18,000 20,000 Bills Receivable 12,400 14,300 During the year, Mr. X introduced further capital A10,000. His drawings were A2,000 p.m. From the above information, prepare a statement showing the profit or loss made by him for the year ending 31st March 2017. Solution : Statement of Affairs on 01.04.16 Amount (A)
Liabilities Creditors Bank Loan Capital (Balancing figure)
25,200 18,000 51,800
Assets Cash Bank Debitors Stock Bills Receivable Investments
95,000
Amount (A) 12,200 18,500 22,300 15,600 12,400 14,000 95,000
Statement of Affairs as on 31.03.17 Liabilities Creditors Bank Loan Capital (Balancing figure)
Amount (A) Assets 27,000 Cash 20,000 Bank 49,100 Debitors Stock Bills Receivable Investments 96,100
Amount (A) 14,300 21,300 17,500 12,700 14,300 16,000 96,100
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253
Statement of profit of Mr. X for the year ending 31.3.2017 Amount
Particulars
A
Capital as on 31.03.2017 Add Drawings during the year (@A2,000 p.m. for one year)
49,100 24,000 73,100 10,000 63,100 51,800 11,300
Less Capital introduced during the year Less Capital as on 01.4.16 Profit earned during the year
Illustration 3 Following information is available from Jagadamba’s record who is maintaining books under single entry system : Particulars 31.3.2016 31.3.17 A
A
Debtors 25,200 27,300 Creditors 16,800 15,400 Bills Receivable 23,300 24,500 Bills Payable 21,400 25,200 Stock 22,400 28,600 Cash 24,300 31,200 Bank overdraft 24,400 28,300 Building 52,000 52,000 Furniture 21,000 21,000 During the year Jagadamba has withdrawn A15,000 for personal expenses. He introduced further capital of A10,000 in the business. Calculate profit after making the following adjustments : a) Depreciate Furniture by 10% b) Depreciate Building by 2% c) Bad debts A300
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Solution : Statement of Affairs of Jagadamba as on 31.3.2016 and 31.3.2017.
Creditors
31.3.16 A 16,800
31.3.17 Assets A 15,400 Cash
Bills Payable
21,400
25,200 Debtors
25,200
27,300
Bank Overdraft
24,400
28,300 Bills Receivable
23,300
24,500
Stock
22,400
28,600
figure) 1,05,600 1,15,700 Furniture
21,000
21,000
Building
52,000
52,000
Liabilities
Capital (Balancing
1,68,200 1,84,600
31.3.16 31.3.17 A A 24,300 31,200
1,68,200 1,84,600
Statement of profit or loss for the year ending 31.3.2017 Amount (A ) 1,15,700 15,000 1,30,700 10,000 1,20,700 1,05,600 15,100
Particulars Capital as on 31.3.2017 Add Drawings during the year Less Further Capital introduced Adjusted Capital at the end Less Capital as an 01.4.2016 Profit subject to adjustments Less Adjustments : Depreciation on Furniture (10% on A21,000) Depreciation on Building (2% on A52,000) Bad debts Net Profit
2,100 2,400 300
4,800 10,300
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255
Illustration 4 A trader does not keep proper books of accounts. However, he provides you the following information : 31.3.2016 31.3.17 A
Cash in hand Bank overdraft Stock-in-trade Debtors Equipment Creditors Furniture
42,000 33,000 68,000 26,800 50,000 30,000 40,000
A
45,000 37,000 77,000 31,400 50,000 20,000 40,000
The trader had introduced further capital of A30,000. He withdrew 40,000 for his personal use. Depreciation to be provided on equipment and furniture of 5% per annum. Allow interest on capital A2,000. Charge interest on drawings A500. Rent prepaid A500. Salary outstanding A1,000. Prepare a statement showing profit or loss for the year ending 31st March 2017. Solution : Statement of affairs of the trader as of 31.3.2016 and 31.3.2017. 31.3.16 A
31.3.17 A
Bank overdraft
33,000
37,000 Cash in hand
42,000
45,000
Creditors
30,000
20,000 Stock-in-trade
68,000
77,000
26,800
31,400
50,000
50,000
40,000
40,000
Liabilities
Capital (Balancing figure)
Assets
Debtors 1,63,800 1,86,400 Equipment Furniture 2,26,800 2,43,400
31.3.16 A
31.3.17 A
2,26,800 2,43,400
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Accountancy
Statement showing profit or loss for the year ended 31st March 2017 Particulars A A Closing capital (capital on 31.3.2017) 1,86,400 Add Drawings during the year 40,000 2,26,400 Less Additional capital introduced during the year 30,000 Adjusted closing capital 1,96,400 Less Opening capital (capital on 31.3.2016) 1,63,800 Gross Profit 32,600 Less Depreciation on equipements (5% on A50,000) 2,500 Depreciation on Furniture (5% on A40,000) 2,000 Interest on capital 2,000 Outstanding salary 1,000 7,500 25,100 Add Interest on drawings 500 Prepaid Rent 500 1,000 Net Profit 26,100 Illustration 5 Prem commenced business on 1st April 2016 with a capital of A1,00,000. He Immediately purchased furniture and fixtures for A20,000. On 30th September 2016, he borrowed A50,000 from his wife @9% p.a. (Interest not yet paid) and introduced a further capital of A11,500. Prem withdrew @A3,000 p.m. at the end of each month for his household expenses. on 31st March 2017, his position was as follows : Cash-in-hand A28,000; Sunday debtors A48,000; Stock A68,000; Bills Receivable A16,000; Creditors A5,000; Owing for rent A1,500. Furniture and fixtures are to be depreciated by 10%. Ascertain the profit or loss made by Prem during the year ended 31st March 2017.
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257
Solution : Statement of Affairs of Prem as on 31.3.2017 Amount (A)
Liabilities Creditors Loan from Mrs. Prem Capital (Balancing figure)
5,000 50,000 1,25,000
Assets Cash in hand Sundry Debtors Stock Bills Receivable Furniture and Fixtures
Amount (A) 28,000 48,000 68,000 16,000 20,000 1,80,000
1,80,000 Statement of Profit or loss for the year ended 31st March 2017 Particulars Capital as on 31.3.2017 Add Drawings during the year @A3,000 p.m for 12 months Less Capital Introduced during the year Adjusted closing capital Less Capital as on 01.4.2016 Gross profit Less Depreciation on furniture and fixtures (10% on A20,000) Outstanding Rent Interest on Mrs. Prem’s Loan (@9% p.a. on A50,000 for 6 months, i.e., from 30.9.16 to 31.3.17)
Net Profit
A
A
1,25,000 36,000 1,61,000 11,500 1,49,500 1,00,000 49,500 2,000 1,500 2,250 5,750 43,750
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Illustration 6 A trader does not keep proper books of accounts. However, he provides the following information to you : Particulars
31.3.2016 31.03.17 A
Cash at bank Cash in hand Stock-in-trade Debtors Equipment Creditors Furniture
4,500 300 40,000 12,000 5,000 30,000 4,000
A
4,000 3,000 45,000 20,000 5,000 20,000 4,000
During the year ended 31st March 2017, the trader introduced A6,000, as additional capital and withdrew A4,000 for his personal use. Depreciation is to be provided on furniture at 10% p.a. and on equipment at 5% per annum. Prepare statement showing profit or loss made by him for the year ended 31st March 2017. Solution : Statement of Affairs of prem as on 31st March 2016 Liabilities Creditors Capital (Balancing figure)
Amount (A) 30,000 35,800
65,800
Assets Cash in hand Cash at Bank Stock-in-trade Debtors Equipment Furniture
Amount (A) 300 4,500 40,000 12,000 5,000 4,000 65,800
Accounting from Incomplete Records
Liabilities Creditors Capital (Balancing figure)
259
Statement of Affairs as on 31st March 2017 Amount (A) Assets 20,000 Cash in hand 61,000 Cash at Bank Stock-in-trade Debtors Equipment Furniture 81,000
Amount (A) 3,000 4,000 45,000 20,000 5,000 4,000 81,000
Statement of profit or loss for the year ending 31st March 2017 Particulars Capital as on 31st March 2017 Add Drawings made during the year
A
A
61,000 4,000 65,000 6,000 59,000 35,800 23,200
Less Further capital introduced during the year Adjusted Capital Less Capital on 31st March 2016 Gross Profit Less Depreciation on Furniture (10% on A4,000 p.a.) Depreciation on Equipment (5% on A5,000 p.a.) Net Profit
400 250
650 22,550
Illustration 7 Ramesh, who keeps the books under single entry, gives you the following information : Particulars 1.4.2016 31.3.17 A
Debtors Creditors
24,000 18,000
A
28,000 3,000
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260
Stock-in-trade Bills receivable Bills payable Furniture Bank overdraft
36,000 12,000 4,000 16,000 8,600
46,000 15,000 3,000 16,000 6,500
Additional information : (i)
A provison for doubtful debt on debtors amounting A2,100 is to be created.
(ii) Furniture is to be depreciated @5% per annum. (iii) Insurance prepaid A500. (iv) Expenses outstanding A1,200. (v)
Drawing during the year A5,700 Calculate the profit of the year.
Solution : Statement of Affairs as on 31st March 2016 Amount (A)
Liabilities Creditors Bill Payable Bank overdraft Capital (Balancing figure)
18,000 4,000 8,600 57,400 88,000
Assets Debtors Stock-in-trade Bills Receivable Furniture
Amount (A) 24,000 36,000 12,000 16,000 88,000
Statement of Affairs as on 31st March 2017 Liabilities Creditors Bill Payable Bank overdraft Capital (Balancing figure)
Amount (A) 3,000 3,000 6,500 92,500 1,05,000
Assets Debtors Stock-in-trade Bills Receivable Furniture
Amount (A) 28,000 46,000 15,000 16,000 1,05,000
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Statement showing the profit or loss for the year ending 31st March 2017 Particulars
Amount
Amount
A
A
Closing capital (Capital on 31.3.17) Add Drawings during the year Adjusted Capital Less Opening Capital (on 01.4.16) Gross Profit Add Incomes and gains (prepaid insurance) Less Expenses and lossess : Provison for doubtful debts Depreciation on furniture (5% on A16,000 p.a.) Outstanding expenses Net Profit
92,500 5,700 98,200 57,400 40,800 500 41,300 2,100 800 1,200
4,100 37,200
Illustration 8 Mr Joseph keeps his books under single entry system. From the following information, prepare a statement showing profit or loss for the year ended 31st March 2017 : Particulars 1.4.2016 31.3.17 A
Cash Stock Debtors Bank
32,000 47,200 31,400 12,000
Bills Receivable Sundry creditors Investments Furniture (30.9.2016)
7,000 18,000 22,000 --
A
35,500 52,400 32,000 16,000 (overdraft)
8,000 11,000 --18,000
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Plant and Machinery 40,000 40,000 Bills payable 17,500 -During the year he withdrew A20,000 for personal use. He introduced further capital of A21,000. Adjustments : (i) Debtors include A1,000 from a customer who is insolvent. The amount is irrecoverable. (ii) Depreciate furniture by 10% p.a. (iii) Depreciate plant and machinery by 5% p.a. Solution : Statement of affairs as on 01.4.2016 Amount (A) Assets Amount (A) Liabilities Sundry Careditors Bills Payable Capital (Balancing figure)
18,000 17,500 1,56,100
Cash Bank Stock Debtors Bills receivable Investments Plant and machinery
1,91,600
32,000 12,000 47,200 31,400 7,000 22,000 40,000 1,91,600
Statement of affairs as on 31st March 2017 Liabilities Bank overdraft Sundry Creditors Capital (Balancing figure)
Amount (A) 16,000 11,000 1,58,900
1,85,900
Assets Cash Stock Debtors Bills Receivable Furniture Plant and Machinery
Amount (A) 35,500 52,400 32,000 8,000 18,000 40,000 1,85,900
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Statement showing profit or loss for the year ended 31st March 2017 Particulars Closing capital (capital on 31.3.2017) Add Drawings during the year Less Additional Capital introduced Adjusted Capital Less Opening Capital (As on 01.4.2016) Gross Profit Less Loss and expenses : Bad debts Depreciation on Furniture (10% on A18,000 for six months A18,000×
A
A
1,58,900 20,000 1,78,900 21,000 1,57,900 1,56,100 1,800 1,000 900
10 6 × ) 100 12
Depreciation on plant and machinery (5% on A40,000 p.a.) Net loss
2,000 3,900 2,100
Revised Statement of Affairs (or Balance Sheet) is prepared taking the closing assets, liabilities and adjustments. Revised statement of affairs is similar to Balance Sheet.
Illustration 9 Mr. Ratan supplies you the following information, who keeps his books on single entry system : 31.3.2016 31.3.17 A
Creditors Debtors Stock Cash-in-hand Bank Balance
36,700 32,200 37,300 38,300 8,200
A
39,000 28,400 41,300 42,200 7,300
(overdraft)
Bank Loan Furniture Motor car
-22,000 52,000
25,000 22,000 52,000
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9% Investment (on 1.10.16) -- 20,000 Bills receivable 27,000 22,500 During the year he withdrew A17,500 for personal use. Adjustments : (i) Depreciate furniture by 10% and motor car by 15%. (ii) Bad debt is A1,500. (iii) Prepaid insurance A800. (iv) Outstanding salary A2,000. Prepare a statement showing profit or loss for the year ending 31.3.17 and the revised statement of affairs on that date. Solution : Statement of affairs as on 31st March 2016 Amount (A) Liabilities Assets Amount (A) Creditors Bank overdraft Capital (Balancing figure)
36,700 8,200 1,63,900
Cash in hand Bills receivable Debtors Stock Motor Car Furniture
2,08,800 Statement of affairs as on 31st March 2017 Amount (A) Liabilities Assets Creditors Bank Loan Capital (Balancing figure)
39,000 25,000 1,71,700
2,35,700
Cash in hand Bank Balance Bills receivable Stock Debtors 9% Investments Motor Car Furniture
38,300 27,000 32,200 37,300 52,000 22,000 2,08,800 Amount (A) 42,200 7,300 22,500 41,300 28,400 20,000 52,000 22,000 2,35,700
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Statement showing profit or loss for the year ended 31st March 2017 Particulars Closing capital (capital on 31.3.2017) Add Drawings Adjusted Capital Less Opening Capital (As on 31.3.2016) Gross Profit
A
1,71,700 17,500 1,89,200 1,63,900 25,300 9 F G H
6
Add Income and gains : Interest accrued 100 20,000 12 Prepaid Insurance Less Expenses and lossess : Depreciation on Furniture (10% p.a. on A22,000) Depreciation on Motor Car (15% p.a. on A52,000) Bad debts Outstanding salary Net Profit
IJ K
900 800
Less Drawings
1,63,900 13,500 1,77,400 17,500
39,000 Cash in hand 25,000 Bank Balance 2,000 Bills Receivable Debtors Less Bad debts Stock 9% Investments 1,59,900 Add Interest Accrued
1,700 27,000
2,200 7,800 1,500 2,000
Revised Statement of Affairs / Balance Sheet as on 31st March 2017 Amount Liabilities Assets (A ) Creditors Bank Loan Salary outstanding Capital : Opening Balance Add Net Profit
A
13,500 13,500
Amount (A ) 42,200 7,300 22,500 28,400 1,500 20,000 900
26,900 41,300 20,900
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Liabilities
Amount (A )
Amount (A )
Liabilities Prepaid Insurance Motor car A52,000 Less Depreciation (15%) A7,800 Furniture A22,000 Less Depreciation (10%) A2,200
2,25,900
800 44,200 19,800 2,25,900
Illustration 10 Mr. Despande, a small trader who maintains his books of accounts on single entry, supplies the following information : Particular 01.4.2016 31.3.17 A
Furniture Plant and Machinery 8% Investment Motor car (purchased on 1.10.2016) Sundry Debtors Sundry Creditors Cash-in-hand Cash at Bank Stock-in-trade Building
20,000 45,000 25,000 -38,000 42,000 22,000 17,500 40,000 1,20,000
A
20,000 45,000 25,000 50,000 45,000 37,000 23,200 6,500 (overdraft) 45,000 1,20,000
During the year, he withdrew A25,000 for personal use. On 1.11.16, he introduced a further capital of A20,000. Adjustments : (i) Depreciate Furniture, Plant and Machinery and Motor Car by 10%. (ii) Appreciate Building by 10%. (iii) Make a provision of 5% for doubtful debts on sundry debtors. (iv) Interest on capital A3,200.
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(v) Prepaid rent A1,500. (vi) Outstanding salary A1,800. (vii) No interest on investment is received. Prepare a statement showing profit or loss for the year ending 31st March 2017 and the revised statement of affairs as on that date. Solution : Statement of affairs as on 01.4.2016 Liabilities Assets Amount Amount (A ) (A ) Sundry Creditors Capital (Balancing Figure)
42,000 Cash-in-hand 2,85,500 Cash at Bank Sundry Debtors Stock-in-trade 8% Investments Furniture Plant and machinery Building 3,27,500
Statement of affairs as on 31.03.2017 Liabilities Assets Amount (A ) Sundry Creditors Bank overdraft Capital (Balancing figure)
37,000 Cash-in-hand 6,500 Sundry Debtors 3,29,700 Stock-in-trade 8% Investments Motor car Furniture Plant and machinery Building 3,73,200
22,000 17,500 38,000 40,000 25,000 20,000 45,000 1,20,000 3,27,500
Amount (A ) 23,200 45,000 45,000 25,000 50,000 20,000 45,000 1,20,000 3,73,200
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Statement of profit or loss for the year ending 31st March 2017 Particular Closing capital (As on 31.3.2017) Add Drawings Less Further capital introduced Adjusted Capital Less Opening capital (As on 01.4.2016) Gross Profit Add Income and Gains : Appreciation in Building (10% on A1,20,000) Prepaid Rent Interest on investment (8% on A25,000 p.a) Less Expenses and Losses : Depreciation on furniture (10% on A20,000 p.a) Depreciation on plant and machinery (10% A45,000 p.a.) Depreciation on Motor Car (10% on A50,000 for six months) Provision for doubtful debts (5% on A45,000) Interest on Capital Outstanding salary Net profit
A
A 3,29,700 25,000 3,54,700 20,000 3,34,700 2,85,500 49,200
12,000 1,500 2,000
15,500 64,700
2,000 4,500 2,500 2,250 3,200 1,800
16,250 48,450
Accounting from Incomplete Records
Revised Statement of Affairs / Balance Sheet As on 31st March 2017 Liabilities Assets Amount (A )
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Amount (A )
Cash-in-hand 23,200 Prepaid Rent 1,500 Sundry Debtors 45,000 Less : Provision for Bad debts 2,250 42,750 Stock-in-trade 45,000 Building 1,20,000 Add Appreciation 12,000 1,32,000 8% Investments 25,000 Add Interest Accured 2,000 27,000 Motor car 50,000 Less Depreciation 2,500 47,500 Furniture 20,000 Less Depreciation 2,000 18,000 Plant and Machinery 45,000 Less Depreciation 4,500 40,500 3,77,450 3,77,450
Sundry Creditors 37,000 Bank overdraft 6,500 Outstanding salary 1,800 Capital : Opening Balance A2,85,500 Add Net profit A48,450 Add Further Capital introduced A20,000 Add Interest on Capital A3,200 A3,57,150 Less Drawings 25,000 3,32,150
4.7 QUESTIONS 1. From the alternatives given under each bit, write the correct answer along with its serial number against each bit : (a) When adjusted closing capital is greater than opening capital, it denotes : (i) Profit. (ii) Loss. (iii) No profit no loss. (iv) Sometimes profit and sometimes loss. (b) When adjusted closing capital is less than opening capital, it denotes : (i) Profit. (ii) Loss.
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(c)
(d)
(e)
(f)
(g)
(h)
Accountancy
(iii) No profit no loss. (iv) Either profit or loss. Incomplete records are generally maintained by : (i) Company. (ii) Government. (iii) Sole trader. (iv) Banks. The other name of single entry is : (i) Incomplete records. (ii) Complete records. (iii) Single record. (iv) Full records in one book Incase of networth method of single entry, profit of the business can be ascertained by : (i) Preparing trading and profit and loss account. (ii) Preparing statement of affairs in the beginning and end of the accounting period. (iii) Preparing Balance Sheet in the beginning and end of the period. (iv) adopting any convenient method. The opening capital (capital in the beginning of the accounting period) can be ascertained by preparing : (i) Capital Account. (ii) Opening Balance Sheet. (iii) Opening statement of affairs. (iv) Cash account. The capital at the end of the accounting period can be ascertained by preparing : (i) Capital Account. (ii) Closing Balance Sheet. (iii) Closing Statement of Affairs. (iv) Cash Account Adjusted closing capital is : (i) Opening Capital – Drawings – Additional Capital. (ii) Opening Capital – Drawings + Additional Capital. (iii) Opening Capital + Drawings + Additional Capital. (iv) Opening Capital + Drawings – Additional Capital.
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[Answer : a (i) Profit b (ii) Loss c (iii) Sole trader d (i) Incomplete records e (ii) Preparing statement of affairs in the beginning and end of the period f (iii) Opening statement of affairs g (iii) Closing statement of affairs h (iv) Opening capital + Drawings – Additional capital ] 2. Answer the following questions in one word/term each : (i) Name the capital under single entry system which is arrived by taking capital at the end+Drawings –fresh capital introduced. (ii) Name the term which represents the increase in closing capital under single entry system. (iii) Name the term which represents the decrease in closing capital under single entry system. (iv) Name the system of accounting followed by the business which is not following complete system of double entry system of Book-keeping. (v) Under which system of Book-keeping arithmetic accuracy of the accounts cannot be checked ? (vi) State wheather single entry system of Book-keeping is recognised by law ? (vii) State wheather internal check is possible under single entry system ? (viii) Is it possible to find but the true financial position of the business under single entry system ? [Answer : (i) Adjusted closing capital (ii) Profit (iii) Loss (iv) Single entry system (v) Single entry system (vi) No (vii) No (viii) No ] 3. Answer the following questions in one sentence each : (i) What do you mean by adjusted closing capital ? (ii) What do you mean by single entry system of Book-Keeping ?
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4.
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(iii) State one difference between single entry and double entry system of Book-Keeping. (iv) Write any one characteristic of single entry. (v) State any one limitation of single entry system of book-keeping. (vi) Explain one difference between Balance Sheet and Statement of Affairs. (vii) Write the name of the methods used to ascertain the profit or loss of the business under single entry system of Book-keeping. (viii) What do you mean by opening capital under single entry system of BookKeeping ? (ix) How to calculate closing capital under single entry system ? (x) State any one reason of maintaining books of accounts under single entry system. Fill up the blanks of the following sentences : (i) In case of single entry, a ______ picture of all transactions will be available. (ii) Under single entry system, closing capital is adjusted by adding ______ to find out the profit. (iii) Under single entry system, closing capital is adjusted by subtracting ______ capital to find out the profit. (iv) If Closing capital is A5,000, Drawings A500, Profit A1,000, then Opening capital is _______ . (v) Closing capital is A15,000, Drawings A2,000, Opening capital A10,000, then profit is _______ . (vi) Increase in adjusted closing capital represents _______. (vii) Decrease in adjusted closing capital represents _______ . (viii) Opening capital is A18,000, Drawings A5,000, Profit A12,000, then Closing capital would be _______ . [Answer : (i) Partial (ii) Drawings (iii) Additional (iv) A4,500 (v) A7,000 (vi) Profit (vii) Loss (viii) A25,000.]
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5.
6.
7.
273
Correct the underlined portions of the following sentences : (i) Single entry system is used in large business enterprises. (ii) Single entry system and double entry system are same. (iii) Closing capital A17,000, Drawings A5,000, Opening Capital A12,000. Profit is A15,000. (iv) Opening Capital A18,000. Profit A12,000, Drawings A6,000. Closing capital is A14,000. (v) Opening capital A27,000. Profit A11,000. Closing capital A30,000. Drawings is A18,000. [Answer : (i) small (ii) different (iii) A10,000 (iv) A24,000 (v) A8,000. ] Answer the following questions within 30 words each; (i) Define single entry system. (ii) What do you mean by “Statement of Affairs” ? (iii) What do you mean by ‘Incomplete accounting records’ ? (iv) “Arithmetic accuracy of the accounts maintained under single entry cannot be checked”. explain. (v) Why cannot the true profit of a business be ascertained under the single entry system of keeping accounts ? (vi) Name the different laws of the country which have not recognised single entry system ? (vii) Why cannot goodwill be valued under single entry system ? (viii) Why is internal check not possible under single entry system ? (ix) Why is the single entry system not popular ? Answer the following questions within 50 words each : (i) How can you ascertain the profit under single entry system ? (ii) Explain the advantages of single entry system. (iii) State the meaning of single entry system.
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(iv) (v) (vi) (vii)
8. 9. 10. 11. 12. 13.
Explain the characteristics of single entry system. Explain the disadvantages of single entry system. Explain the reasons for maintaining the single entry system. How can opening capital be ascertained under single entry system ? Explain with example. (viii) How can you calculate the profit under single entry system ? Explain with example. (ix) Prepare a statement of affairs with imaginary figures and ascertain the profit. (x) Prepare the statement of affairs with imaginary figures and ascertain the capital. What do you mean by single entry system ? What are its advantages ? Discuss the characteristics and limitations of single entry system. Discuss, in brief with suitable example, the ascertainment of profit under net worth method. Distinguish between Single entry and Double entry system. Differentiate between Balance Sheet and Statement of Affairs. Ascertain the opening and closing capital from the following balances : Particulars Cash Bank Bills receivable Debtors Creditors Stock-in-trade Furniture Machinery [Ans : Opening capital A75,900 Closing capital A91,900]
01.4.2016
31.3.17
A
A
12,200 4,000 (over draft) 8,200 7,500 16,400 8,400 20,000 40,000
15,600 6,300 12,300 6,300 12,500 10,200 20,000 40,000
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14. Prepare the statement of affairs and ascertain the profit from the following information : Particulars Stock Debtors Creditors Cash-in-hand Bank balance Bills receivable Furniture Prepaid expenses
01.4.2016
31.3.17
A
A
22,200 18,300 17,400 22,500 8,200 14,200 25,000 --
25,700 20,200 12,600 28,600 7,300 16,400 25,000 500
[Ans. Opening capital - A93,000 Closing capital - A1,10,600 Gross profit - A17,600 Net profit - A17,100] 15. Jivan keeps his books under single entry system. His position on 31st March 2016 was as follows : Cash in hand A15,200, Cash at Bank A6,300, Sundry Debtors A7,600, Sundry Creditors A8,400, Bills receivable A4,200, Fixture and fittings A18,000. He introduced A15,000 as further capital during the year. His drawings were A1,000 p.m. His position on 31st March 2017 was as follows : Cash in hand A16,400, Cash at Bank A7,200, Sundry Debtors A8,200, Sundry Creditors A7,200, Bills receivable A5,400, Fixture and fittings A18,000. Prepare statement of affairs and statement of profit or loss for the year ending 31st March 2017. [Ans. Opening capital A42,900 Closing capital A48,000 Profit - A2,100]
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16. Jaydeep commenced business on 1st April 2016 with a capital of A50,000. He bought furniture worth A10,000. On 1st Octorber, 2016 he borrowed A20,000 from his wife at 12% p.a. (Interest not paid yet). He introduced further capital of A10,000. He withdrew @ A1,500 p.m. for household expenses. On 31st March, 2017 his position was as follows : Cash in hand A12,000, Bank A16,700, Debtors 16,800, Creditors A12,500, Stock A32,200. Furniture is to be depreciated by 10%. Prepare a statement showing Jaydeep’s profit or loss in the business for the year ending 31st March 2017. [Ans.: Closing capital A55,200 Profit - A11,000] 17. Mr. Raghubir who maintains his accounts under single entry system, supplies you the following information : 31.3.2016 31.3.2017 A A Cash in hand 30,000 35,000 Cash at Bank 12,000 16,200 Sundry Debtors 28,000 26,400 Stock 45,000 55,200 Furniture 30,000 30,000 Sundry Creditors 38,000 28,600 Loan from Mrs. Raghubir 30,000 30,000 He withdrew A5,000 every month from the business to meet his private expenses. He had sold a private investment for A30,000 and invested the amount in the business. Adjustments : Interest on Mrs. Raghubir’s loan @ 12% p.a. is not paid. Depreciate furniture by 10% p.a. [Ans. Opening capital A77,000 Closing capital A1,04,200 Profit - A50,600]
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18. Mr. Rama keeps the books under single entry system. He supplies you the following information : Particulars 01.4.2016 31.3.2017 A A Bank overdraft 10,000 12,000 Furniture 20,000 20,000 Land and Building 70,000 70,000 Investments -10,000 Sundry Debtors 20,000 30,000 Sundry Creditors 30,000 40,000 Stock 45,000 50,000 Motor Car (01.10.2016) -20,000 Cash 10,000 20,000 Plant and Machinery 40,000 40,000 During the year, he withdrew A10,000 for personal use. On 01.10.2016 he introduced further capital of A20,000 by selling his private investment. Adjustment : (a) (b)
Appreciate land and Building by 20%. Debtors include A1,000 from a customer who is insolvent and nothing can be recovered from him. (c) Maintain reserve for bad debts at 5% on debtors. (d) Depreciate plant and machinery at 10%, furniture at 5% and motor car at 10%. Prepare a statement showing profit and loss for the year ending 31st March 2017 and a revised statement of affairs on that date. [Ans. Opening capital A1,65,000, Closing capital A1,98,000, Profit A38,550, Revised statement of affairs Total A2,65,550.] 19. Chandraswami keeps his books under single entry system. Ascertan the profit of Chandraswami for the year ending 31st March 2017 and prepare revised statement affairs as on that date.
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Particulars Cash in hand Cash at Bank Debtors Creditors Bills receivable Bills payable Stock Furniture Machinery
31.3.2016 A 12,000 6,500 18,000 21,300 22,500 17,600 45,000 32,000 48,000
31.3.2017 A 16,000 17,600 32,000 17,400 19,600 18,400 55,300 32,000 48,000
During the year, he introduced a fresh capital of A26,000. He withdrew @A3,000 p.m. for domestic expenses. Adjustments : (i)
Depreciate Furniture by 10% and Machinery by 5%.
(ii) Bad debts amounting to A2,000 to be written off. (iii) Outstanding salaries A2,000. (iv) Prepaid rent A3,000. [Ans. Opening capital A1,45,100, Closing A1,84,700, Profit A43,000, Revised statement of affairs total A2,15,900.] 20. Amarendra, who keeps his books on single entry system, provides the following information : Particulars 01.4.2016 31.3.2017 A A Cash in hand 22,000 27,800 Cash at Bank 13,200 24,300 Sundry Debtors 18,000 22,500 Sundry Creditors 27,000 22,000 Stock-in-trade 45,000 65,000 Building 1,20,000 1,20,000
Accounting from Incomplete Records
Furniture Bills receivable Bills payable
279
40,000 27,500 12,000
40,000 28,300 14,000
Additional capital introduced during the year A20,000. He was drawing @A2,500 p.m. for his domestic expenses. Adjustments : 1. 2. 3. 4. 5.
Depreciate furniture at 10% p.a. Appreciate building by 5%. Write off a bad debt of A2,500 Outstanding rent A2,000. Prepaid salary A3,000. Prepare a statement of profit for the year ending 31.3.17 and a revised statement of affairs as on that date. [Ans.- Opening Capital A2,46,700, Closing Capital A2,91,900, Profit A55,700, Revised Statement of Affairs total A3,30,400] 21. Mr Javedkar, who maintains his accounts on single entry system, supplies the following information : Particulars Debtors Creditors Bills receivable Bills payable Cash in hand Cash at Bank Motor car Furniture Stock
01.4.2016 A 18,700 17,200 14,400 16,800 14,400 17,600 50,000 30,000 42,600
31.3.2017 A 25,300 12,300 8,600 7,600 18,600 14,400 50,000 30,000 70,300
He introduced a further capital of A30,000. He drew @A5,000 p.m. for his personal expenses.
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Adjustments : (i)
Depreciate motor car by 10% and furniture by 71/2%.
(ii) Allow Interest on capital A2,500. (iii) Interest on drawings is A1,600. (iv) Outstanding Rent A3,200 (v)
Prepaid salary A2,300
(vi) Create a provison for Bad debts @2% on debtors. Prepare statement of affairs for the year ending 31.3.2016 and 31.3.2017. Show the statement of profit and loss for the year ending 31st March 2017 and revised statement of affairs as on that date. [Ans. Opening capital A1,53,700, closing capital A1,97,300, profit A64,044, Revised statement of affairs total A2,11,744.] 22. Mr. Swapan, who keeps his books on single entry system, supplies the following information : Particulars 01.4.2016 31.3.2017 A A Building 2,50,000 2,50,000 Motor car 60,000 60,000 Furniture 30,000 30,000 Cash in hand 22,000 25,000 Cash at Bank 17,000 19,300 Debtors 18,000 32,000 Creditors 22,000 17,000 Bills receivable 31,000 36,000 Bills payable 17,000 14,000 Furniture 35,000 35,000 He withdrew @A3,000 p.m. for his domestic expenses.
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Adjustments : (i)
Depreciate furniture @10% p.a., Motor car @ 20%, Building @2% p.a.
(ii) A customer became insolvent. A1,000 due from him was irrecoverable. (iii) Outstanding salary A3,000. (iv) Prepaid expenses A2,500. (v)
Interest on capital amounts to A3,200. Prepare statement of profit or loss for the year ending 31st March 2017. [Ans.:Opening capital A4,24,000, closing capital A4,56,300, profit - A93,500] -o-
CHAPTER - 5
ACCOUNTING FOR PARTNERSHIP FIRM STRUCTURE
5.1
Meaning, Definition and Features of Partnership
5.2
Right of Partners
5.3
Partnership Deed 5.3.1 Provisions of Partnership Act, 1932 in the absence of Partnership Deed 5.3.2 Some other important provisions of the Partnership Act, 1932.
5.4
Partners' Capital Accounts (Fixed vs. Fluctuating)
5.5
Profit and loss Appropriation Account
5.6
Questions.
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283
5.1 MEANING, DEFINITION AND FEATURES OF PARTNERSHIP Partnership is an association of two or more persons to carry on, as co-owners, a business and to share its profits or losses. When two or more persons agree to carry on business for their mutual benefits, they are said to form a partnership. Partnership firm in India is governed by the Indian Partnership Act, 1932., According to sec-4 of the Indian Partnership Act, 1932 the term 'Partnership' is ‘‘the relation between two or more persons who have agreed to share the profits of a business carried on by all or any of them acting for all.’’ ESSENTIAL CHARACTERISTICS OF PARTNERSHIP The essential characteristics of partnership are : 1.
Two or More Persons : There nust be at least two persons to form a partnership and all such persons must be competent to contract. According to Indian contract Act, 1872, every person except the following is competent to contract : (i) Minor (ii) Persons of unsound mind (Lunatics, idiots, etc.) (iii) Persons disqualified by any law to which they are subjected (insolvent, alien enemy etc.)
2.
Agreement - Partnership comes into existence by an agreement. The agreement may be written or oral. The relation of partnership arises out of contract and not from status. A written agreement or deed is preferred to oral one, because it helps in resolving the disputes, if any, arising in future among partners.
3.
Lawful Business : There must exist a lawful business. The business may be of the nature of any trade, occupation or profession.
4.
Profit-sharing : The agreement between/among the partners must be to share profits or losses of the business. It is not essential that all the partners must
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share losses also. There may be a provision in the Partnership Deed that a particular partner or partners shall not bear the losses. In the absence of a specific mention regarding profit-sharing in the Partnership Deed the partners must share the proft/loss equally as provided in the partnership Act. 5.
Good faith : The partnership lies on the mutual trust and good faith of all the partners. Each and every partner should act honestly and fairly in the conduct of business.
6.
Implied Agency : Each and every partner is regarded as an agent of the business. All the partners are entitled to take active part in the day to day management of the business. Every partner can bind the firm for acts undertaken by him in good faith and on behalf of the firm.
7.
No Separate Legal Entity:- A partnership firm has no separate legal entity of its own. It is represented collectively by its partners. Persons who have entered into a partnership with one another are called partners individually, and collectively, a firm, and the name under which their business in carried on is called the firm name.
8.
Unlimited Liability : Each and every partner is liable, jointly and severally for the amount of all the debts owed by the firm. As a rule, the liability of the partners is unlimited. If assets of the business are not sufficient to meet the obligations of the business at the time of dissolution of the firm, the private property of partners can be used to meet them.
5.2 RIGHT OF PARTNERS 1.
All the partners have the right to participate in the management of the business.
2.
All the partners have the right to be consulted about the affairs of the business.
3.
All the partners have the right to inspect the books of accounts and have a copy of it.
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4.
All the partners have the right to share profits or losses with others in the agreed ratio.
5.
If a partner has advanced loan, he has the right to receive interest on it at an agreed rate of interest. If rate of interest is not agreed upon, interest is paid @6% p.a.
6.
In case of an emergency, a partner has the right to act according to his best judgement and be indemnified for the expenses incurred by him.
7.
A partner has the right not to allow the admission of a new partner.
8.
After giving proper notice, a partner has the right to retire from the firm.
9.
If a partner incurs expenses on the business or he pays some money on behalf of the firm, that partner may get indemnified against these payments from the firm.
5.3 PARTNERSHIP DEED Meaning - Partnership arises out of contractual relationship among partners. This contract or agreement may either be oral or written. But it is always advisable to have it in black and white. 'Partnership Deed' or 'Partnership Agreement' is a document which contains the terms of partnership as agreed among the partners. The deed is required to be duly stamped as per Indian Stamp Act, 1889 and duly signed by all the partners. To solve all future disputes, that may creep into the partnership, all firms should have their own partnership deed. CONTENTS OF PARTNERSHIP DEED : The contents of the deed may vary from firm to firm. But certain clauses are usually incorporated to ensure smooth working of the business, which are outlined below : 1.
The name of the firm;
2.
Name and address of all the partners;
3.
The nature of business to be carried on;
4.
The place of business;
286
5.
6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17.
5.3.1
Accountancy (Part-II)
Duration of partnership - It may be dissolved at will, if no limit has been fixed for its duration so that it can be disolved at any moment; or it may be for a fixed term, if the time of dissolution has been previously fixed by the original agreement; The amount of capital investment to be made by each partner; Ratio in which profits and losses are to be shared The drawings, i.e., the sums the partners can withdraw during a particular period; The interest to be allowed on capital and charged on drawings; Interest on loan by a partner to the firm; Remuneration by way of salary, commission etc.; if any, payable to the partners; Method of computation and treatment of goodwill; Mode of settlement of accounts in case of retirement or death of a partner; Mode of settlement of accounts in case of dissolution of firm. Maintenance of proper books of accounts; Operating bank accounts. Arbitration clause, laying down the procedure to be followed in the event of disputes. However, the partnership deed must not contain any term which is in contravention with the provisions of the Indian Partnership Act. PROVISIONS OF PARTNERSHIP ACT, 1932 IN THE ABSENCE OF PARTNERSHIP DEED
We know that drafting a deed is not compulsory, though it is advisable to have it to resolve all future disputes among partners. In the absence of a written deed, the following provisions of the Indian partnership Act shall be applicable for making accounting treatments : 1.
No remuneration by way of salary or commission is payable to any partner for taking part in the conduct of business (Sec. 13(a)]
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2.
Profit and losses are to be shared equally [sec-13(b)]
3.
No interest is allowed on capital [sec-13(c)]. If the deed provides for the payment of interest on capital, it is payable only out of available profits.
4.
Interest @6% p.a. is allowed on loan or advance given to the firm by a partner. [sec 13(d)]
5.
No interest is to be charged on drawings made by a partner.
5.3.2
SOME OTHER IMPORTANT PROVISIONS OF THE PARTNERSHIP ACT, 1932 (i) With the consent of all the partners, a minor may be admitted for the benefit of partnership. [sec-30] (ii) A person may be admitted as a partner either with the consent of all the existing partners or in accordance with an express agreement among the partners. [sec-31] (iii) A partner may retire from the firm either with the consent of all the other partners or in accoriance with an express agreement among the partners. [sec.32] (iv) Registration of the firm is optional and not compulsory. [sec-69] (v) Unless otherwise agreed by the partners, a firm is dissolved on the death of a partner. [sec-35]
Note:
It should be noted that the above provisions of the Act are applicable when partnership deed does not have a clause to this effect.
Illustration 1 A, B and C are partners in a firm. They do not have a Partnership Deed. (i) A, who has contributed more capital than other partners, demands interest on capital at 10% p.a. and share of profit in the capital ratio. But B and C donot agree with him. (ii) B has devoted full time to run the business and demands a salary of A5,000p.m. But A & B donot agree with him.
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(iii) C demands interest on the loan of A50,000 advanced by him, at the market rate of interest which is 12% p.a. (iv) Net profit before taking into account any of the above claims amounted to A50,000 at the end of the first year of the business. How will the disputes be settled ? Solution : The partners do not have a Partnership Deed. Therefore, provisions of the Indian Partnership Act, 1932 will apply to settle the disputes : (i) Interest on capital is not payable to any partner. Therefore, A is not entitled to interest on capital. (ii) Remuneration is not payable to any partner. Therefore, B is not entitled to any salary. (iii) Interest on loan is payable @6% p.a., which comes to A3,000 and the balance of A47,000 to be distributed equally. Profit cannot be shared in capital ratio, as claimed by A. 5.4 PARTNERS' CAPITAL ACCOUNTS : (Fixed vs Fluctuating) A separate Capital Account is maintained for each partner. For example, if A, B and C are three partners in a firm, there shall be three Capital Accounts, one each for A, B and C. The partners' Capital Accounts may be maintained by following any of the two methods : (i) Fixed Capital Accounts Method (ii) Fluctuating Capital Accounts Method Fixed Capital Accounts Method When capital contribution of partners are fixed, it is called fixed capital. When fixed Capital Accounts method is followed, a separate Current Account is opened for each partner in addition to the Capital Account. Capital Account : Fixed capital means that the capital remains unaltered, i.e., fixed unless additional capital is introduced or withdrawal is made from the existing
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capital. Thus, if fresh capital is not introduced or capital is not withdrawn, Capital Account of a partner will continue to show the same balance year after year. Current Account : Current Account is maintained to record transactions other than introduction and withdrawals of capital such as interest on capital, interest on drawings, salary or commission to a partner, share of profits/losses. As a result, the balance of Current Account fluctuates with every transaction with the partner. Current Account of each partner is debited with : (i) Drawings made by him; (ii) Interest on drawings; (iii) Share of loss; (iv) Transfer of any amount to Capital Account permanently, in case of deficiency in capital balance as per new agreement, if any. Similarly, Current Account of each partner is credited with : (i) Interest on capital; (ii) Salary or commission; (iii) Share of profit; and (iv) Transfer of any amount from Capital Account permanently, in case of excess capital balance as per new agreement, is any. Normally, partner's Current Account has a credit balance but, if a partner has drawn more than his or her share of profits or there are losses in the business year after year, it will have a debit balance. The balance of the partners' Capital Accounts are shown on the liabilities side of the Balance Sheet, as that much amount is due to them. Credit balance in Current Account is shown on the liabilities side and debit balance on the asset side of the Balance Sheet. The outline of the two accounts. maintained under the Fixed Capital Method are:-
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PARTNER'S CAPITAL ACCOUNTS Dr.
Cr. Particulars
To Cash/Bank A/c (withdrawal of capital) To Balance c/d
A(A) B(A) C(A)
Particulars
A (A) B(A) C(A)
---
---
---
By balance b/d
---
---
---
---
---
---
By cash/Bank A/c (Additional capital)
---
---
---
PARTNER'S CURRENT ACCOUNTS Dr. Particulars To Balance b/d (in case of debit opening balance) To Drawings A/c To Interest on Drawings A/c To Profit and Loss A/c (loss) To Balance c/d*
A(A) B(A) C(A) ---
---
---
---
-----
-----
Particulars
--- By balance b/d (in case of credit --- opening balance) By Interest on Capital --- By Commission A/c --- By Salary A/c By Profit and loss Appropriation A/c (profit)
Cr. A(A) B(A) C(A) ---
---
---
-------
-------
-------
* The balance may be on the opposite (credit) side also FLUCTUATING CAPITAL ACCOUNTS METHOD Under this method, only one account namely ‘capital’ is maintained for each partner. All transactions of a partner (e.g., salary or commission, interest allowed on
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capital, drawings, interest charged on drawings, share of profit or share of loss, etc.) are recorded in the Capital Account. As a result, balance in the Capital Account fluctuates with every transaction. Capital Accounts having credit balances are shown on the liabilities side while Capital Accounts having debit balances are shown on the assets side of the Balance Sheet. Fluctuating Capital Method is normally followed for maintaining Capital Accounts and therefore, in the absence of any instruction, this method should be followed for maintaining the partners’ Capital Accounts. The outline of Capital Accounts under the Fluctuating Capital Method is as follows : PARTNERS’ CAPITAL ACCOUNTS Dr. Particulars To Balance b/d (in case of debit balance) To Drawings A/c To Interest on Drawings A/c To Profit and Loss A/c (loss) To Balance c/d*
A (A)
B (A)
---
---
---
---
---
---
-----
-----
-----
---
---
---
C (A)
Particulars By Balance b/d (in case of credit balance) By Cash/Bank A/c (Additional Capital) By Interest on Capital A/c By Commission A/c By Salary A/c By Profit and Loss A/c (Profit)
* The balance may be on the opposite (credit) side also.
A (A)
B (A)
Cr. C (A)
---
---
---
---
---
---
-------
-------
-------
---
---
---
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Difference between Capital Account and Current Account Basis 1.- Need
2.- Balance Account
3.- Nature
4.- Transactions
Capital Account
Current Account
Capital Account is maintained in all the cases, i.e., under fixed capital account and fluctuating capital account.
Current Account is maintained only when fixed capital account method is followed.
of When fixed capital method Current Account may have a is followed, Capital credit or debit balance. Account will show a credit balance. In case of fixed Capital, Capital Account balance generally remains unchanged from year to year. It will change only when further capital is introduced or capital is withdrawn from business. Capital Account records the amount invested by a partner in the firm.
Current Account balance fluctuates with every transaction.
Current Account records the transactions such as drawings, interest on capital, interest on drawings, salary, profit, ctc.
Difference between Fixed Capital Account and Fluctuating Capital Account. Basis Fixed Account Fluctuating Account accounts are Only one account (viz, 1.- No. of Acconts Two maintained for each Capital Account) is Maintained partners, i.e., Capital maintained for each partner. Account and Current Account.
Accounting for Partnership Firm
2. Frequency of Balance in fixed capital Account does not change change except under specific circumstances. 3. Adjustment for All adjustments for drawings, interest on drawings, etc. drawings, interest on capital, salary, share of profit / loss are made in Current Account. 4. Balance
293
The balance changes frequently from period to period. All entries for drawings, interest on drawings, interest on capital, salary, share of profits and losses are made in Capital Account.
It always shows credit Capital Account can also balance in Capital Account. show debit balance
The important question, in this connection, is whether the firm should adopt Fluctuating Capital System or Fixed Capital System. The answer is that if Partnership Deed prescribes any definite system, it should be followed. In the absence of a clear mention, partners' decision should be treated as final, However, in most of the cases, fluctuating capital system is followed. Interest on Drawings The amount drawn by a partner from the partnership firm to meet his personal needs is termed as drawings. As per the partnership agreement, the firm may impose restrictions on the maximum amount of withdrawals by a partner. Similarly the partnership deed may provide for charging interest on drawings at an agreed rate. In the absence of such an agreement no interest can be charged on drawings. Interest on drawings is an income for the firm and an expense for the partner. The partner usually does not pay this interest amount to the firm in cash. This may be charged to his drawings account which may reduce his capital in case of fluctuating capital. It the capital is treated as fixed, the drawings may be charged to the partner's Current Account. Drawings may be made in cash or in the form of goods.
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Accounting Treatment (i)
When drawings made by cash : Partner's Drawings Account
Dr.
To Cash A/c (ii) When drawings made in the form of goods : Partner's Drawings Account
Dr.
To Purchases A/c (iii) For charging interest on drawings : Partner's Drawings / current A/c
Dr.
To Interest on Drawings A/c (iv) For transferring the interest on drawings to Profit and Loss Appropriction A/c : Interest on Drawing A/c To Profit and Loss Appropriation A/c Sometimes, the (iii) and (iv) entries above are combined and only one entry is passed which is as under : Partner's Drawings / Current A/c
Dr.
To Profit and Loss Appropriation A/c Calculation of Interest on Drawings : Interest on Drawings is calculated with reference to the time period for which the money is withdrawn by the partner. Depending upon the different situations of drawings, interest may be calculated under various ways, which are discussed below : (i) When date of drawings is not given : If the date of drawings by a partner is not given and the total drawings during the period are given, the interest on drawings is calculated at the agreed rate for a period of six months on the assumption that, the drawings have been made by the partner uniformly throughout the year.
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Illustration 2 During the period total drawings made by a partner is A9,000 and interest on drawings is to be charged at 5% p.a. Calculate the interest on drawings. Solution : Since no date of drawings is given, it may be assumed that the total drawings of A9,000 has been uniformly made throughout the total period. That is, the partner has drawn every month a sum of A750 Interest on Drawings - A9,000
5 1 A225 100 2
(ii) When dates of drawings are given : If the dates of drawings and the amounts of drawings on these dates are specifically given, the interest on drawings may be calculated by the product method, which is explained in the following illustration : Illustration 3 Calculate the interest on drawings of Y, a partner, for the year ending 31st December 2016, from the following data by product method, by charging interest at 6% p.a. Date of drawings
Amount of drawings (A)
1st April, 2016
5,000
1st July, 2016
4,000
1st Oct, 2016
3,000
1st Dec, 2016
6,000
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Solution : Date of drawings
Amount of drawings (A)
1st April, 2016 1st July, 2016 1st Oct, 2016 1st Dec, 2016
Period of drawings (in months)
5,000 4,000 3,000 6,000
9 6 3 1
Product (A ) 45,000 24,000 9,000 6,000
Sum of the products = 84,000 Interest on Drawings = A84,000
6 1 A420 100 12
Note: Interest on sum of the products is calculated for 1 month at the given rate. The interest calculated under the product method for 1 month may also be calculated individually for the amount and period of drawings. Taking the above illustration, the interest on drawings may be calculated individually as follows : Date of drawings
Amount of Period of drawings drawings (in A) (in months)
Product
1st April, 2016
5,000
9
5,000
9 6 225 12 100
1st July, 2016
4,000
6
4,000
6 6 120 12 100
1st Oct, 2016
3,000
3
3,000
3 6 45 12 100
1st Dec, 2016
6,000
1
6,000
1 6 30 12 100 Total Interest
420
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(iii) When a fixed amount is withdrawn on the first day of each month for a period of 12 months. In this situation, interest on the total amounts withdrawn during the period is
1 calculated at the given rate for a period of 6 months. 2 (iv) When a fixed amount is withdrawn on the last day of each month for a period of 12 months. In this case, interest on the total amounts withdrawn during the period is 1 calculated at the given rate for a period of 5 months. 2 Interest on Capital If the partnership deed provides for allowing interest on capital, then only this is allowed to all the partners on their capital contributions. In the absence of such a provision, no interest on capital is allowed to any partner. This is calculated before distributing the profits to the partners. The rationale behind allowing interest on capital is to compensate the partner who subseribes capital in excess of what is required as per the profit sharing ratio. Accounting Treatment : The interest on capital allowed to a partner is normally not given in cash. It is credited to his capital or current account as in case of fluctuating or fixed capital method respectively. (i)
For allowing interest on capital : Interest on capital A/c
Dr.
To Partner's Capital / Current A/c (ii) For transferring the interest on capital to profits and loss appropriation account. Profit and Loss Appropriation A/c To Interest on capital A/c.
Dr.
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298
Sometimes only one entry is passed instead of the above, which is : Profit and loss Appropriation A/c
Dr.
To Partner's Capital/Current A/c. The interest on capital allowed to the partners is a charge against the profits of the firm and is income for the partners. If the same is not withdrawn in cash, this increases their capital. However, instead of treating the interest on capital as a charge against profit, it may be regarded as an appropriation of profit. In this case, interest on capital is shown on the debit side of profit and loss appropriation A/c before distributing the profits among the partners. It will be more appropriate to treat this as an appropriation of profit. It is important to note that interest on capital is allowed onlywhen the firm has earned some profits. In case of loss, no interest on capital is allowed to the partners. Calculation of Interest on Capital While calculating the interest on capital, the drawings and introduction of additional capital, if any, should be taken into account. Interest is calculated at the given rate with reference to the time period for which the capital has been used. If there is no withdrawal or no introduction on of additional capital during a year, the interest on capital is calculated for the whole year on the opening balance of capital. On the otherhand, if there are drawings or introduction of additional capital, the effective use of capital for the time period will be calculated separately upto and after the date of drawing or introduction of additional capital. Illustration 4 Amiya and Binoy are partners in a firm providing capitals of A60,000 and A50,000, respectively. They are allowed interest on capital @8% p.a. Calculate the interest on capital to be allowed to them for the year ending 31st march, 2016.
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Solution : Interest on Capital to Amiya A60,000
8 100
A4,800 . Interest on capital to Binoy A50,000
8 A4,000 100
Illustration 5 In continuation of the above illustration, if the drawings and introduction of additional capital by the partners are given as below, calculate the interest on capital allowed to them. Amiya withdrew A10,000 on 1st July,2015 and Binoy introducted additional capital of A5,000 on 1st October, 2015. Solution : Amiya's capital of A60,000 has been used for 3 months, i.e., from 1st April, 2015 to 1st July, 2015. After drawings of A10,000, his capital of 50,000 has been used for next 9 months i.e., from 1st July 2015 to 31st March, 2016. Interest on Capital to Amiya A60,000
3 8 A1,200 12 100
A50,000
9 8 A3,000 12 100
Total interest = A1,200 + A3,000 = A4,200 Binoy's Capital of A50,000 has been used for 6 months i.e., from 1st April, 2015 to 1st october, 2015. After introducing additional capital of A5,000 on 1st October, his capital of A55,000 has been used for next 6 months i.e., from 1st October, 2015 to 31st March, 2016.
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Interest on Capital to Binoy
A50,000
6 8 A2,000 12 100
A55,000
8 6 A2,200 12 100
So total interest = A2,000 + A2,200 = A4,200. Interest on Loan given by a Partner : If a partner provides loan to the firm at the time of its need for additional funds, he is entitled to interest on loan amount. If there is an agreement to this effect, interest on loan is paid at the agreed rate. If there is no agreement as to the rate of interest, interest at the rate of 6% p.a. is payable to the partner as per the provisions of the partnership Act. The partner provides the loan to the firm over and above his capital contribution. So this amount of loan is credited to the partner's loan Account which represents liability for the firm, hence, shown on the liability side of the Balance Sheet. Interest on loan may be paid in cash. Since interest on loan is an expense of the firm, it is debited to the profit and loss account of the firm for determining the profit/loss. Accounting treatment (i) When loan is taken : Cash A/c Dr. To Partners Loan A/c (ii) When interest on Loan becomes due : Interest on Loan A/c Dr. To Partner's Loan A/c or (iii) When interest on Loan is paid in cash : Interest on Loan A/c Dr. To Cash A/c (iv) When interest on Loan is transferred to Profit and Loss A/c. Profit and Loss A/c Dr. To Interest on Loan A/c.
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Illustration 6 X and Y are partners sharing profits and losses in the ratio of 2:1. On 1st April, 2015, X gave a loan of A60,000 and on 1st July, 2015, Y gave a loan of A50,000 to the firm. Show, how profit of the firm will be distributed for the year ending 31st March, 2016, in the following cases : (i) If the profit before interest is A28,350 (ii) If the profit before interest is A4,350 (iii) If the loss before interest is A7,050 Solution : (i) Profit and Loss Appropriation Account Dr. Cr. A A Particulars Particulars To interest on Loan By Profit before interest 28,500 X 3,600 5,850 Y 2,250 To Profit transferred to Capital A/c X - 15,000 Y - 7,500 22,500 28,350 28,350 (ii) Dr. Particulars To interest on Loan X- 3,600 Y- 2,250
Profit and Loss Appropriation Account A
5,850
5,850
Particulars By Profit before interest By loss transferred to Capital A/c X - 1,000 Y - 500
Cr. A 4,350
1,500 5,850
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(iii) Dr.
Profit and Loss Appropriation Account
A Particulars To Loss before interest To Interest on Loan X- 3,600 Y- 2,250
7050
5,850
Particulars By Loss transferred to Capital A/c X - 8,600 Y - 4,300
12,900
Cr. A
12,900 12,900
N.B.: Since no interest rate is given, it is charged at 6% p.a. as per the provision of Partnership Act. It should be noted that the loan given by a partner has to be kept quite distinct from his capital and in the Balance Sheet also, it should be separately shown. Therefore, interest due on loan should be credited to loan account and not to Partner’s Capital Account. The justification for this is that in the case of dissolution of partnership firm, partners loans have priority in repayment over partner's capitals. Salary, commission payable to partners : Normally no salary or commission is payable to a partner for the work done by him, because it is his duty to work for the firm sincerely and honestly However, if he is given any extra work, may be remunerated for the same by way of salary, commission, fees, etc. For this purpose, there must be an agreement between all the partners as to who is to be entitled to salary, commission, etc. and by what amount. In the absence of this agreement, no salary or commission is payable to any partner Salary or commission payable to a partner is regarded as an appropriation of profit and not an expense or a charge against profits. So this is debited to the profit and loss appropriation account and not to the profit and loss account. However, salary
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or commission payable to the manager or any other employee of the firm is regarded as an expense and hence, debited to the profit and loss account. Calculation of Commission based on profit : Sometimes, commission may be allowed to partners or manager of the firm, as a percentage of the profits earned by the firm. The objective behind this way of remunerating them is to make them more involved in the activities of the firm and to put their best for earning more profits so that their income can be enhanced. Commission may be calculated as a certain percentage of net profits before charging such commission or after charging such commission. Commission on Net profit before charging commission Commission = Net profit before commission ×
Rate of commission 100
Commission on Net Profit after Charging Commission Commission = Net profit before commission ×
Rate of Commission 100 Rate of Commission
Accounting Treatment (i)
For Salaries, Commission, etc. due to a partner : Partner's Salaries / Commission A/c
Dr.
To Partner's Capital / Current A/c. (ii) For Transfer of Salaries / Commission to Profit and Loss Appropriation A/c Profit and Loss Appropriation A/c
Dr.
To Partner's Salaries / Commission A/c. Illustration 7 Anita and Binita share the profits of a firm in the ratio of 3:2. Anita, being an active partner, is entitled to a salary of A2,000 p.m. Binita is entitled to a commission
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of 10% on net profit before charging her commission. Profit for the year ending 31st March, 2016, before charging salary and commission is A55,000. Show, how you will divide the profit between Anita and Binita. Profit and Loss Appropriation Account Dr.
Cr. Particulars
To Salary to Anita To Commission to Binita To Net profit transferred to capital A/c Anita - A16,740 Binita - A11,160
A 24,000
Particulars By Profit b/d from profit and loss A/c
A 55,000
3,100
27,900 55,000
55,000
5.5 PROFIT AND LOSS APPROPRIATION ACCOUNT Meaning : Profit and loss Account is prepared to ascertain the net profit/loss. The profit earned by the firm is to be distributed among the partners in their profit sharing ratio. Before distribution of profits, certain adjustments like interest on drawings, salary or commission due to partners, etc. are to be accounted for. This is done by means of a 'Profit and Loss Appropriation A/c, This is merely an extension of the Profit and Loss Account. This account shows, how the profits earned by the firm have been utilised and distributed among the partners. Accounting treatment : (i)
This account is credited with the net profits as calculated in Profit and Loss Account and interest on drawings.
(ii) It is debited with interest on capital, salary, commission payable to the partners.
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(iii) It is debited with the amount transferred to General Reserve/Reserve fund, Specific Reserve, etc. Format of Profit and Loss Appropriation Account (i) Dr.
Profit and Loss Appropriation Account Cr. Particulars
To Interest on Capital X - ............. Y - ............. To Salary to Partners X- ............. Y- ............. To Commission to Partners X- ............. Y- ............. To General/Specific Reserve To Profit transferred to capital A/cs X- ............. Y- .............
Particulars
A
A
By Profit and Loss A/c (Net Profit b/d) By Interest on Drawings X- ............. Y- .............
Illustration 8 What entries are passed to record the following transactions in the books of the firm of A and B before distributing the profits earned ? (i) Commission of A5,000 payable to B. (ii) Interest on Capital A - A8,000; B - A5,000. (iii) Salary payable to A - A20,000 p.a. (iv) Transfer to the General Reserve - A25,000.
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Solution : Date (i)
(ii)
(iii) (iv)
L.F Dr. (A)
Particulars Profit and Loss Appropriation A/c To B's Capital A/c (Being the amount of commission payable to B) Profit and Loss Appropriation A/c To A's Capital A/c To B's Capital A/c (Being interest on capital payable to A and B) Profit and Loss Appropriation A/c To A's Capital A/c (Being salary payable to A) Profit and Loss Appropriation A/c To General Reserve A/c (Being the amount transferred to general reserve.
Dr.
5,000
Dr.
13,000
Dr.
20,000
Dr.
25,000
Cr. (A) 5,000
8,000 5,000
20,000 25,000
Note : Capital Accounts are assumed to be fluctuating. Miscellaneous Illustrations on Division of Profits : Illustration 9 X and Y started a partnership on 1st January 2016 by contributing capital of A70,000 and A60,000 respectively.The agreement between the partners was as follows: (i) X and Y to get a monthly salary of A1,500 and A2,000 respectively and share the profits in the ratio of 3:2. (ii) Interest on Capital to be allowed at 10% p.a. (iii) Interest on Drawings to be charged at 8% p.a. (iv) X is entitled to a commission of A5,000. (v) 15% of the profits to be transferred to General Reserve. The profit for the year ending 31st December 2015 before above mentioned adjustments was A1,44,000. X and Y have drawn A35,000 and A30,000 respectively during the year. You are required to pass journal entries relating to the above appropriations. Prepare Profit and Loss Appropriation Account and Partner's Capital Accounts.
Accounting for Partnership Firm
Solution :
Date
307
Journal of X and Y Particulars
L.F
Dr. 2015 Salary A/c To X's Capital A/c Dec 31 To Y's Capital A/c (Being the salary due to X & Y) Profit and Loss Appropriation A/c Dr. ’’ To Salary A/c (Being transfer of salary of X & Y to P & L App. A/c) Interest on Capital A/c Dr. ’’ To X's Capital A/c To Y's Capital A/c (Being interest on capital allowed to X & Y) Profit and Loss Appropriation A/c Dr. ’’ To Interest on Capital A/c (Being transfer of interest on capital to P & LApp. A/c.) X's Capital A/c ’’ Y's Capital A/c To Interest on Drawings A/c (Being interest on drawings charged) Interest on Drawings A/c To Profit and Loss Appropriation A/c ’’
Cr. Dr. Amt. (A) Amt (A) 42,000
42,000
13,000
13,000
1,400 1,200
2,600
18,000 24,000
42,000
7,000 6,000
13,000
2,600
2,600
(Being transfer of interest on drawings to P & L App. A/c.)
’’ ’’
Commission to X’s A/c To X's Capital A/c (Being commission due to X) Profit and Loss Appropriation A/c To Commission to X’s A/c
5,000
Dr.
5,000
5,000
5,000
(Being transfer of commission to X’s A/c to P&L Appr. A/c)
’’
Profit and Loss Appropriation A/c To General Reserve A/c
Dr.
21,600
21,600
(Being 15% of the profits transferred to General Reserve)
’’
Profit and Loss Appropriation A/c To X's Capital A/c To Y's Capital A/c (Being transfer of Net Profits to X and Y)
Dr.
65,000
39,000 26,000
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Profit and Loss Appropriation A/c for the year ended 31st December 2016
Dr.
Particulars
A
To Salary X - 18,000 Y - 24,000 To Interest on Capital X - 7,000 Y - 6,000 To Commission to X To General Reserve To Net Profit transferred to Capital A/cs. X - 39,000 (3/5) Y - 26,000 (2/5)
Particulars
A
By Net Profit transferred from P & L A/c 42,000 By Interest on Drawings X - 1,400 Y - 1,200 13,000 5,000 21,600
65,000 1,46,000
Particulars To Drawings To Interest on Drawings
To balance c/d
X
Y
1,44,000
2,600
1,46,000
Partner's Capital Accounts
Dr.
Cr.
Particulars
Cr. X
Y
(A)
(A)
(A)
(A)
35,000 1,400
30,000 By Cash A/c 1,200 By Salary By Interest on Capital By Commission By Profit & Loss App. A/c 84,800
70,000 60,000 18,000 24,000
1,02,600
1,39,000 1,16,000
7,000 5,000
6,000
39,000 26,000
1,39,000 1,16,000
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309
Illustration 10 X and Y are partners in a firm. X is to get a commission of 10% of net profit before charging any commission. Y is to get a commission of 10% of net profit after charging all commissions. Net profit for the year ended 31st March, 2016 before charging any commission was A5,50,000. Find the commission of X and Y, Also, show the distribution of profits. Solution : PROFIT AND LOSS APPROPRIATION ACCOUNT for the year ended 31st March, 2016 Dr.
Cr. Particulars
To X's Commission A/c
10 I F 5,50,000 G J H 100 K
A
Particulars
55,000 By Profit (before any commission)
A 5,50,000
To Y's Commission A/c (Note)
10 O L 5 , 50 , 000 55 , 000 a f M 100 P N Q
45,000
To Net profit transferred to capital A/cs.
1
X 2 2,25,000
1
Y 2 2,25,000
4,50,000 5,50,000
5,50,000
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Note - The above stated amount of Y's commission can be verified. After charging all commissions, net profit comes to 4,50,000 [i.e. 5,50,000-(55,000+45,000)]. Now, Calculate 10% of 4,50,000. It works out to 45,000 which means the amount of commission calculated by the given formula i.e., Net profit before commission × Rate of commission I F G H100 Rate of commission JKis correct.
Illustration 11 X and Y are partners sharing profits and losses in the ratio of 3:1. On 1st April, 2015, their capitals were : X-A50,000 and Y-A30,000. During the year ended 31st March, 2016, they earned net profit of A74,000. The terms of partnership are : (i) Interest on capital is to be allowed @6% p.a. (ii) X will get commission @3% on turnover. (iii) Y will get a salary of A500 per month. (iv) Y will get commission of 5% on profits after deductions of interest, salary and commission (including his own commission) (v) X is entitled to a rent of A2,000 per month for the use of his premises by the firm. It is paid to him by cheque at the end of every month. Partner's drawings for the year were : X-A8,000 and Y-A6,000. Turnover for the year was A3,00,000. After considering the above factors, you are required to prepare Profit and Loss Appropriation Account and Capital Accounts of the Partners.
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Solution : In the Books of X and Y PROFIT AND LOSS APPROPRIATION ACCOUNT for the year ended 31st March, 2016 Dr.
Cr. Particulars
A
To Interest on Capital A/cs-
6 I F G H 100JK 3,000 FA30,000 6 IJ 1,800 YG H 100 K
By Profit and Loss A/c
X- A3,00,000×
3I F G H4 JK F1IJ Y- G H4 K
50,000
4,800 6,000
2 = 6,000 100
Y- (WN-1) 1,581 To Partner's capital A/cs (Profit) X-
A
- Net profit (A74,000-Rent A24,000)
X 50,000
To salary A/c (Y) A500×12 To Commission A/cs :
Particulars
7,581
23,714
7,905
31,619 50,000
50,000
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PARTNER'S CAPITAL ACCOUNTS Dr. Particulars
Date
2016 To Drawings A/c March 31 ’’
To Balance c/d
X (A)
Y (A)
8,000
6,000
Date 2015 April 2016
Particulars
By Balance b/d By Interest on Capital A/c By Salary A/c 74,714 41,286 March By Commission A/c 31 By Profit and loss Appropriation A/c (Profit) 82,714 47,286
X (A)
Cr. Y (A)
50,000 30,000 3,000 1,800 .... 6,000 6,000 1,581
23,714 7,905 82,714 47,286
Working Notes : 1. Y's Commission : Net profit after charging interest, salary and X's commission but before charging Y's commission. = A(50,000-4,000-6,000-,6000)=A33,200 Profit after commission Commission Profit before commission 100 5 105 x 33,200
5 ×A33,200 = A1,581. 105 2. Rent payable to partner for the use of his premises is a charge against profit not an oppropriation of profit Hence, it is deducted from Net profit, while preparing profit & loss appropriation A/c. x=
Illustration 12 A, B and C are partner in a firm. According to the partnership Deed, the partners are entitled to draw a maximum amount of A7,000; per month. On the 1st day of every month A, B and C draw A7,000; A6,000 and A5,000 respectively. Interest on capitals and interest on Drawings are fixed at 8% and 10% respectively. Profit for the
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year ended 31st March, 2016 was A7,55,000 out of which A2,00,000 are to be transferred to General Reserve. B and C are entitled to receive salary of A30,000 and A45,000 p.a. respectively and A is entitled to receive commission @10% on net distributable profits after charging such commission. On 1st April, 2015, the balances of their Capital Accounts were A5,00,000, A4,00,000 and A3,50,000 respectively. You are required to show profit and loss Appropriation Account for the year ended 31st March, 2016 and capital Accounts of Partners in the books of the firm. PROFIT AND LOSS APPROPRIATION ACCOUNT for the year ended 31st March, 2016 Dr.
Cr. Particulars
A
To Interest on capital : A's Capital A/c (A5,00,000×
8 ) 100
By Profit as per Profit and loss A/c By Interest on Drawing (WN-1): A's Capital A/c
40,000
B's Capital A/c (A4,00,000×
8 ) 100
32,000
(A84,000×
C’s Capital (A3,50,000×
8 ) 100
Particulars
A 7,55,000
10 ) 100
8,400
10 ) 100
7,200
10 ) 100
6,000
B's Capital A/c 28,000
To Partners' Salaries : B's Capital 30,000 C's Capital 45,000 To General Reserve To Commission A/c (A's Capital A/c) (Working Note-3) To profits transferred to : A's Capital A/c 1,21,697 B's Capital A/c 1,21,697 C's Capital A/c 1,21,696
1,00,000
(A72,000× C's Capital A/c
75,000 2,00,000 36,510
3,65,090 7,76,600
(A60,000×
7,76,600
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PARTNER'S CAPITAL ACCOUNTS Dr.
Cr. A (A)
Particulars
B (A)
C (A)
Particulars
A (A)
B (A)
C (A)
5,00,000 4,00,000 3,50,000 To Drawings A/c 84,000 72,000 60,000 By Balance b/d By Interest on Capital A/c 40,000 32,000 28,000 To Interest on Drawings A/c 8,400 7,200 6,000 By Partners' salaries A/c ...... 30,000 45,000 To Balance c/d 6,05,807 5,04,497 4,78,696 By Commission A/c 36,510 ...... ....... By Profit and Loss Appropriation A/c
6,98,207 5,83,697 5,44,696
1,21,697 1,21,697 1,21,696
6,98,207 5,83,697 5,44,696
Working Notes : 1.
Interest on capital and interest on drawings are @8% and 10% (and not 8% p.a. and @10% p.a.) respectively. Therefore, the time factor is ignored.
2.
Unless otherwise stated in the deed, all partners are equal partners. Thus, profits of the year is divided among partners equally.
3.
Commission payable to A is calculated as : 10 ×(A7,55,000+A21,600-A1,10,000-A75,000-A2,00,000=A36,510 100
Illustration 13 X, Y and Z were partners, sharing profits and losses in the ratio of 5:3:2, after providing for interest at 5% per annum on their capitals, which were : X-A50,000; YA30,000 and ZA20,000 and allowing Y and Z salary of A5,000 each per annum. During the year 2016 X has drawn A10,000; YA7,500 and ZA1,000 in addition to their salaries. The profit during the year before charging interest on capital and partner's salaries, amounted to A45,000. On 1st January 2016, the balances in the Current
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Accounts of the partners were - X A4,500 (Cr), Y A1,000 (Dr) and ZA2,500 (Cr). Show the Profit and Loss Appropriation A/c, Partners' Capital and Current Accounts as on 31st December 2016. Solution : Profit and Loss Appropriation A/c Dr.
Cr. Particulars
Particulars
A
To Current A/c (Interest on capital) X - 2,500 Y - 1,500 Z - 1,000 To Current A/c (Salary) X - 5,000 Y - 5,000 To Current A/c (Profit) X - 15,000 Y - 9,000 Z - 6,000
A
By Net Profit transferred from P&LA/c
45,000
5,000
10,000
30,000 45,000
45,000
PARTNER'S CAPITAL ACCOUNTS Dr. Particulars To Balance c/d
Cr. A (A)
B (A)
C (A)
Particulars
A (A)
B (A)
C (A)
By Balance b/d
50,000 30,000 20,000
By balance b/d
50,000 30,000 20,000 50,000 30,000 20,000
50,000 30,000 20,000 50,000 30,000 20,000
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Illustration 14 Ajaya, Bijoy and Chita are in partnership with respective fixed capitals of A40,000, A30,000 and A20,000. Bijoy and Chita are entitled to annual salaries of A2,000 and A1,500 respectively payable before division of profits. Interest on capital is allowed at 5% p.a., but no interest is charged on drawings. Of the profits earned during a year, the first A12,000 is divided between Ajaya, Bijoy and Chita as to 50%, 30% and 20% and profit in excess of this, is shared equally. The profit for the year ended 31st Decemeber, 2016 was A20,100 after debiting partner's salaries but before charging interest on Capital. The drawings during the year were, Ajaya A8,000, Bijoy A7,500 and Chita A4,000. The balances on partners' Current Accounts on 1st January, 2016 were- Ajaya A3,000 (Cr.), Bijoy A500 (Cr.) and Chita A1,000 (Dr.). Prepare Profit and Loss Appropriation Account and the partner's Current Accounts for the year 2016. Solution : Profit and Loss Appropriation A/c for the year ending 31st December, 2016 Dr. Cr. Particulars To Current A/c (Interest on capital) Ajaya - 2,000 Bijoy - 1,500 Chita - 1,000 To Current A/c (Salary) Ajaya - 2,000 Bijoy - 1,500 To Current A/c (Profit) Ajaya - 7,200 Bijoy - 4,800 Chita - 3,600
A
Particulars By Net Profit before salaries A(20,100+2,000+1,500)
A
23,600
4,500
3,500
15,600 23,600
23,600
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Current Accounts Dr. Particulars To Balance b/d To Cash (Drawings) To Balance c/d
Ajaya (A)
Bijay Chita (A) (A)
Particulars
.....
.....
8,000 4,200
7,500 1,300
1,000 By Balance b/d By P/L App. A/c 4,000 Interest on capital 1,100 Salary Profit
12,200
8,800
6,100 By Balance b/d
Ajaya (A)
Cr. Bijay Chita (A) (A)
3,000
500
---
2,000 --7,200
1,500 2,000 4,800
1,000 1,500 3,600
12,200
8,800
6,100
4,200
1,300
1,100
Working Note : Calculation of Share of Profit Profits after interest on capital = A20,100-4,500 = A15,600, First A12,000 distributed as to 50%, 30% and 20% among Ajaya, Bijoy and Chita respectively.
Ajaya's share = A6,000, Bijoy = A3,600 and Chita = A2,400 Remaining profit = A15,600 - A12,000 = A3,600, which is to be shared equally (i.e., each parter gets A1,200) Now total share of Ajaya= A6,000 + A1,200 = A7,200, that of Bijay A3,600+A1,200=A4,800 and of Chita is = A2,400+A1200=A3,600. -o-
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5.6 QUESTIONS 1. From the given alternatives, under each bit choose and write the correct answer along with its serial number against each bit: (i)
Indian Partnership Act was enacted in the year : (a) 1956. (b) 1961. (c) 1932. (d) 1912.
(ii) Current Account of a partner : (a) will always have a credit balance. (b) can never have a debit balance. (c) will always have a debit balance. (d) may have a debit balance or credit balance. (iii) In the absence of an agreement profits and losses are divided by the partners in the ratio of : (a) Capital. (b) Drawing. (c) Time devoted by each partner. (d) Equality. (iv) In the absence of an agreement to contrary, the partners : (a) are entitled to 6% interest on loans to the firm, only when there are profits. (b) are entitled to 6% interest on loans to the firm, whether there are profits or not. (c) are not entitled to any interest on loans to the firm. (d) are entitled to 9% interest on loans to the firm, when there are profits.
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319
Interest payable on the capitals of the partners is charged to (a) Profit and Loss Account. (b) Profit and Loss Adjustment Account. (c) Realisation Account. (d) Profit and Loss Appropriation Account.
(vi) Interest on partners drawings under Fluctuating Capital Accounts is debited to : (a) Partner's Capital Account. (b) Profit and Loss Account. (c) Drawings Account. (d) Profit and Loss Appropriation Account. (vii) Partners Current Accounts are opened : (a) When capital is fixed. (b) When capital is fluctuating. (c) always. (d) as and when desired by partners. (viii) Minimum number of persons required to start a partnership is (a) Three. (b) Two. (c) Seven. (d) Eleven. (ix) Interest on partner's capital is calculated on the : (a) capital at the beginning of the period. (b) capital af the end of the period. (c) capital at the end less drawings. (d) average capital employed. (x)
Profit and Loss Appropriation Account is prepared after the preparation of : (a) Trading Account
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Accountancy (Part-II)
(b) Manufacturing Account (c) Profit and Loss Account (d) Balance Sheet [Ans.: (i) c, (ii) d , (iii) d, (iv) b, (v) d, (vi) a, (vii) a, (viii) b, (ix) d, (x) c.] 2.
Answer the following questions in one word/term each :
(i)
What is the maximum number of partners for a banking business ?
(ii) In which year the Indian Partnership Act was enacted ? (iii) Which account is opened to record the transactions of a partner with the firm when capital is fixed ? (iv) What is the minimum number of persons required to start a partnership business ? (v)
Under which capital method, the Current Accounts of partners are maintained ?
(vi) If the partnership Deed doesnot specify the rate of interest payable on loan by a partner, at what rate will the interest be paid ? (vii) If the partnership Deed doesnot specify the profit sharing ratio, in what ratio is the profit or loss shared by the partners ? (viii) If the partner's Capital Accounts are fixed, where will you record the fresh capital introduced by a partner ? Ans: (i) 10, (ii) 1932, (iii) Current Account, (iv) two, (v) Fixed Capital, (vi) 6%, (vii) Equally, (viii) Capital Account 3.
Correct the underlined portions of the following sentences.
(i)
In case of fixed capital method, the additional capital introduced by a partner is recorded in his current account.
(ii) The written agreement among the partners is known as partnership will. (iii) In the absence of agreement, profit is divided among the partners in their capital ratio. (iv) Registration of partnership is compulsory. (v)
At the time of admission of a partner, the firm is dissolved.
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321
(vi) In the absence of partnership deed, the partners are allowed to get 5% interest on loan given to the firm. (vii) The liability of partners is limited in case of partnership business. (viii) Interest on capital is a charge against profit. [Ans. (i) Capital, (ii) partnership deed, (iii) Equal, (iv) voluntary, (v) partnership, (vi) 6%, (vii) Unlimited, (viii) appropriation.] 4.
Answer the following questions in one sentence each : (i) Define Partnership. (ii) Where will the drawings made by a partner be recorded if the partners' Capital Accounts are fixed ? (iii) What is the purpose of preparing Profit and Loss Appropriation account ? (iv) What share of profits would a "sleeping partner", who has contributed 75% of the total capital, get in the absence of a deed ? (v) How is interest on drawings calculated, if the drawings are made on the 15th day of each month ? (vi) Why is a Partners Current Account prepared ? (vii) What is partnership deed ?
5.
Fill up the blanks of the following sentences : (i) In the absence of any mention in the partnership Deed, the partners share profits in ______ ratio. (ii) The document containing the terms of an agreement of a partnership is known as partnership ______ . (iii) Under the ______ capital method, capital at the beginning and capital at the end will be different. (iv) In absence of agreement, ______ is not paid on capitals. (v) Partnership Deed is a ______ agreement among partners. (vi) When date of drawings is not given, interest for ______ months is calculated on total drawings during a period.
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(vii) When drawings by partner is made in the form of goods, ______ account is credited by the firm. (viii) Salary to a partner is a/an ______ of profit. [Ans.- (i) equal, (ii) Deed, (iii) fluctuating, (iv) interest, (v) written, (vi) six, (vii) purchase, (viii) appropriation] 6.
Answer the following questions within 30 words each : (i) What is fixed capital ? (ii) How do you calculate interest on drawings, if no date of drawing is given ? Explain with illustration. (iii) What is the maximum number of partners under different situations ? (iv) Is it essential that each partner should contribute capital ? Explain. (v) Is it always necessary to have a written agreement ? (vi) At what rate of interest on capital and interest on drawings is calculated in the absence of any specific agrement. (vii) What is oral agreement ? (viii) Can minor be admitted as a partner ? (ix) What do you mean by a partnership firm ?
7.
Answer the following questions within 50 words each : (i) What is the objective of preparing Profit and Loss Appropriation Account ? (ii) Give four important contents of a "Partnership Deed". (iii) Discus the provisions of Indian Partnership Act applicable for a firm in the absence of Partnership Deed. (iv) Mention the items that may appear on the credit side of the Capital Account of a partner when the capitals are fluctuating. (v) List any four items appearing on the Profit and Loss Appropriation Account. (vi) How will you compute the commission payable to a partner based on net profit ?
Accounting for Partnership Firm
8.
What is Partnership Deed ? Discuss its important clauses.
9.
Discuss and distinguish between fixed and fluctuating capital.
323
10. X and Y, two partners, drew for private use A1,20,000 and A80,000 respectively. Interest is chargeable @6% p.a. on drawings. What is the total interest changeable to X and Y ? [Ans. X-A3,600 and Y-A2,400.] 11. B and C are partners in a firm. They withdraw A48,000 and A36,000 respectively during the year evenly at the middle of every month. According to the partnership agreement, interest on drawings is to be charged @10% p.a. Calculate interest on drawings of the partners using the appropriate formula. [Ans. B-A4,400 and C-A1,800.] 12. A and B are partners sharing profits and losses equally. A drew regularly A4,000 in the beginning of every month for six months ended 30th September, 2016. Calculate interest on drawings @5% p.a. [Ans. Interest on drawings A350] 13. Amit and Binit are partners sharing profits and losses equally. Amit drew regularly A4,000 at the end of every month for six months ended 30th September, 2016. Calculate interest on drawings @5% p.a. [Ans. Int. on drawings A250] 14. For the year ending 31st March 2016, A has withdrawn an amount of A13,000 on 1st December 2015. As per the deed, interest on drawings is charged at 6% p.a. upto maximum drawings of A10,000. Beyond this limit, interest on drawings is charged at 10% p.a. Calculate the interest on drawings payable by A. [Ans. Int. on drawings A300] 15. A and B are partners sharing profit, and loss in the ratio of 3:2 having Capital Account balances of A50,000 and A40,000 respectively on 1st April 2015. On 1st July 2015, A introduced A10,000 as his additional capital whereas B introduced only A1,000. If the interest on capital is allowed to partners @10%
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p.a., calculate interest on capital assuming that the financial year closes on 31st March. [Ans. Total int. payable A-A5,750 and B-A4,075] 16. Ram and Rahim are partners in a business. Their capitals at the end of the year were A24,000 and A18,000 respectively. During the year 2015-16, Ram's drawings and Rahim's drawings were A4,000 and A6,000 respectively. Profit (before changing interest on capital) during the year was A16,000. Calculate interest on capital @5% p.a. for the year ended 31st March, 2016. 17. The capital of A and B at the end of the year was A1,00,000 and A1,50,000 respectively. Their drawings were A20,000 and A40,000 during the year. They had shared profits of A60,000 in the ratio of 3:2 for the year. Interest on capital @10% has been omitted. Find out the interest on capital to be allowed to them. 18. From the following Balance Sheet of X and Y, Calculate interest on Capital @6% p.a. payable to Y for the year ended 31st March, 2016 : Balance Sheet as on 31st March 2016 Liabilities
A
Assets
A
X's Capital A/c
50,000
Sundry Assets
1,10,000
Y's Capital A/c
40,000
Profit & Loss Appropriation A/c 2015-16
20,000 1,10,000
1,10,000
During the year Y's drawings were A15,000 and profit during 2015-16 was A30,000. [Ans. Interest on Y's capital A3,000] 19. M and N are partners sharing profit and loss in the ratio of 2:3 having capital account balances of A50,000 and A60,000 on 1st April, 2015. On 1st July, 2015, A introduced A10,000 as his additional capital whereas B introduced only
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A5,000. If the interest on capital is allowed to partners @10% p.a., calculate interest on capital assuming that the financial year closes on 31st March. 20. A and B are partners in a firm having profit sharing ratio of 3:2 respectevely. They had advanced to the firm a sum of A30,000 as a loan in their profit sharing ratio on 1st october, 2015. The partnership deed is silent on the question of interest on loans from partners. Compute interest on loan payable by the firm to the partners, if the firm closes its books of accounts on 31st March. [Ans: AA540, B-A360] 21. X and Y are partners sharing profit and losses in the ratio of 2:3 with capital of A2,00,000 and A3,00,000 respectively. On 1st october, 2015. X and Y advanced loans of A80,000 and A40,000 respectively to the firm. Show the distribution of profits/losses for the year ended 31st March, 2016 in each of the following alternative cases : Case 1. If the profits before any interest for the year amounted to A21,000. Case 2. If the profits before any interest for the year amounted to A3,000. Case 3. If the profits before any interest for the year amounted to A5,000. [Ans : Int. to X's lean A2,400, Int. to Y's lean A1,200 Case -1. Profit X A6,960; YA10, 440 Case-2. Loss X A240; YA360 Case-3. Profit XA560; YA540] 22. Y has advanced a loan of A80,000 to the firm on 01.07.2015, without any agreement as to the rate of interest with his co-partner X. Calculate the amount of interest on loan allowable to him for the year ending 31st March,2016. [Ans : A3,600] 23. A and B are partners in a firm. A has advanced a loan to the firm at the rate of 12% p.a. amounting to A60,000 on 1st August 2015. Calculate the amount of
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Accountancy (Part-II)
interest payable to him for the year ending 31st March, 2016. [Ans : Int on loan to A A4,800] 24. Arjun and Bhima are partners in a firm sharing profits and losses in the ratio of 3:2. A gets a salary of A2,000p.m. and B is entitled to a commission of 5% on net profits before charging his commission. Distribute a profit of A70,000 earned during a year before allowing salary and commission. [Ans : A's share of profit A24,840, B's share A16,560] [Total share of A = A48,840, Total share of B = A21,160] 25. X. Y and Z are partners sharing profits and losses equally. As per Partnership Deed, Z is entitled to a commission of 10% on the net profits after charging such commission. The net profit before charging commission is A2,20,000. Findout the commission payable to Z. [Ans : commission payable to Z = A11,000] 26. A and B are partners in a firm. A is entitled to a salaryof A10,000 per month together with a commission of 10% of the net profit after partner's salaries but before charging any commission. B is entitled to a salary of A25,000 p.a. together with a commission of 10% of the net profit after charging all commission and partners' salaries. The net profit before providing for partners' salaries and commission for the year ended 31st March, 2016 was A4,20,000. Show distribution of profit. [Ans: A's commission A27,500 B's commission A22,500 Net profit - A2,25,000 A and B share A1,12,500 each] 27. X and Y are partners in a firm sharing the profits and losses equally. They contributed capital of A10,000 and A12,000 respectively on which they are entitled to interest at 5% p.a. A gets A500 p.m. as salary. If the total profits for the year before the above adjustments are A26,100, distribute the profit by
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preparing a Profit and Loss Appropriation Account. [Ans. X's profit A9,500, Y's A9,500] 28. A, B and C entered into a partnership providing capital of A50,000, A50,000 and A20,000 respectively and agreed to share the profits and losses in the ratio of 4:3:3 after allowing interest on capital @9% p.a. and charging interest on drawings @10% p.a. During the year 2015, drawings of A,B and C were A10,000; A6,000 and A8,000 respectively. C, being a working partner is entitled to a salary of A6,000 p.a. The firm earned a profit of A30,000 before charging or allowing interest and salary payable to partners. Prepare Profit and Loss Appropriation Account and Capital Accounts of the partners for the year. [Ans. Share of profits A = A5,760; B= A4,320; C=A4,320 Capital Accounts A = A49,760; B= A52,520; C= A3,350] 29. A and B started business with capitals of A1,00,000 and A60,000 respectively on 1st January 2016. B is allowed a salary of A800p.m. Interest on capital and drawings are at 6% p.a. Profits are distributed equally after making the above noted adjustments. Drawings of A and B during the year amounted to A16,000 and A20,000 respectively. Profits as per profit and loss account for the year amounted to A60,000. Assuming the capitals to be fixed, prepare Profit and Loss Appropriation Account and accounts relating to partners. [Ans : Profit A = A20,940, B=A20,940. Current Account Balance, A = A10,460, B= A13,540] 30. X, Y and Z are partners in a firm with capital contribution of A50,000, A60,000 and A80,000 respectively. They agreed to share the profits in the ratio of 2:3:5. Partnership deed provides for allowing interest on capital @6% p.a. and charging interest an drawings @8% p.a. A is allowed a salary of A1,200 p.m. B is entitled
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to a commission of 10% on net profits after charging his commission. Drawing during the year by X, Y and Z amounted to A5,000, A10,000 and A20,000 respectively. Profit during the year before the above adjustments amounted to A1,12,840. Prepare Profit and Loss Appropriation Account and Capital Accounts of partners. [Ans.: Profit×=A16,080, Y=A24,120 and Z=A10,200] 31. A and B are partners sharing profits and losses in the ratio of 3:2. They have contributed capitals of A60,000 and A40,000 respectively. Drawings during the year were A10,000 and A5,000 respectively by A and B. The partnership deed provides for the following adjustments : (i) Interest on capital is allowed at 5% p.a. (ii) Interest on drawings is charged at 6% p.a. (iii) A is allowed a salary of A1,500 p.m. for managing the business. (iv) A has assured B of earning a minimum profit of A60,000 for the firm. Any short fall is to be borne by him. (v) A3,000 is to be credited to a Reserve Fund. Profits before the above adjustment were A55,000. Distribute the profit and prepare capital accounts. [Ans.: Profit A=A20,000, B= A13,780 Capital A/cs A = A86,370, B = A50,630] -o-
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CHAPTER-6
ACCOUNTING FOR PARTNERSHIP FIRM (GOODWILL) STRUCTURE
6.1
Meaning, Nature and Factors affectig Goodwill
6.2
Methods of valuation of Goodwill : 6.2.1 Average profit method 6.2.2 Super profit method 6.2.3 Capitalisation of super profit method
6.3
Questions
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6.1 MEANING, NATURE AND FACTORS AFFECTING GOODWILL Meaning : Goodwill is an intangible asset. It is the reputation of a firm which is acquired in course of time. It is neither visible nor can be dealt with like any other tangible asset. It is the value of reputation of a firm in respect of profits expected in future over and above the normal profits earned by similar firms belonging to the same industry. This excess profit over the normal profit earned by a firm is called super profit. Thus, goodwill exists only when the firm earns super profits. In this connection, it would be pertinent to go through the views expressed by certain authorities on goodwill. Lord Eldon says "Goodwill is nothing more than the probability that the old customers will resort to the old place" Similarly, Dicksee remarks : "When a man pays for goodwill, he pays for something which places him in the position of being able to earn more than he would be able to do by his own unaided efforts." However, if time value of money is considered, Goodwill may be defined as the present value of firm's anticipated excess earnings. Nature of Goodwill 1. Goodwill is an intangible asset which cannot be seen, nor touched but it has a value. 2. No value is attached to goodwill of a firm which is incurring losses. 3. A price for the goodwill may be realised if the business is sold as a going concern. 4. It helps to earn higher profit. It is the capitalised value of super profits. 5. It is an attractive force which brings in customers to old place of business. 6. It is an extra value attached to a prosperous business beyond the intrinsic worth of the net assets. 7. It is usually calculated at the time of admission, retirement or death of a partner. 8. No such concrete method is laid down for its valuation. Factors affecting Goodwill The goodwill of a firm arises due to the following factors : 1. Nature of Business : A firm which deals with quality products having a stable demand in the market is in an advantageous position to earn more profit and therefore, is in a position to earn more and more goodwill. 2. Suitable Location : If the business is situated in a busy shopping complex or is centrally located, it acquires more goodwill. 3. Greater managerial Talent : If a firm is well managed because of expert
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knowledge of the managers in their respective fields, economy arises in every field which leads to cost efficiency and ultimately results in the acquisition of more goodwill. 4. Degree of competition : If a firm enjoys monopoly over the products dealt in by it or the products are in short supply in the market, it stands to earn more profits which leads to higher value of goodwill. 5. Commitment towards customers : If a firm fulfills all its commitments towards customers like prompt supply of goods, provision of timely after-sales service, it attracts more goodwill. 6. Degree of Risk : If the risk involved in the business is less, it creates more goodwill and vice-versa. 7. Advantages of Patents : Normally, patents are necessary for the manufacture or production of certain types of articles. A firm which possesses the necessary patents will have an edge over its competitors having no such patents and hence, in a position to earn more goodwill. 8. Profit Trend : If the business is showing an upward trend in profits for years together, it has the scope for earning more goodwill. 9. Market situation : If a firm is in a business wherein, demand for the products dealt in is higher than the supply, it will lead to more turnover as well as more profit, which will increase the value of goodwill. 10. Nature of Business : If the business of a firm is of the nature where the products dealt in are in high demand, the profit will be higher. It will, thus, increase the value of goodwill. 11. Other factors : General economic conditions, political stability, Government policies, money market conditions, trade cycles, etc. are the other factors influencing the value of goodwill. 6.2 METHODS OF VALUATION OF GOODWILL In actual practice, it is very difficult to value goodwill of a firm on any particular date. We know that the value of goodwill depends upon the earning capacity of a firm, yet no simple procedure or rule can be laid down for its valuation. However, taking the profit as the basis, goodwill may be valued by any of the three following methods : (i) Average profit method; (ii) Super profit method;
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(iii) Capitalisation method. (i) Average Profit method : Under this method, usually goodwill is valued at a few years' purchase of adjusted average of past profits. Goodwill under this method is calculated as follows : (a) Calculate normal past business profits for each year by deducting abnormal gains and non-business incomes and adding abnormal losses and non-business expenses. (b) Add the profits calculated as per (a) above. (c) Calculate Average Profits as follows : Average Profit =
Total Profits (as per (b) above) Number of years for which profit and loss are given
Note - Above average profit is known as Actual Average profit or average maintainable profit in future. In actual practice, this method is used very rarely by the business firms as it is not a scientific method. The only advantage of this method is that it is a very simple method which can be easily understood and applied by everybody. (d) Calculate Goodwill applying the formula : Goodwill = Average Profit (as per c) above × Number of years purchase For example, goodwill of a firm is to be valued at three years purchase of four years average profit. The firm earned in the previous four years profits of A17,000; A11,500, A19,000 and A16,500. Goodwill will be valued as follows :
A17,000 + A11,500 + A19,000 + 16,500 A16,000 4 Goodwill = A16,000 × 3 = A48,000. Illustration 1 Calculate the value of goodwill of a firm on the basis of three years purchase of the average profits of the last five years. The profits for the last five years are Year Profit (A) 2012 40,000 2013 47,000 2014 60,000 Average Profit =
Accounting for Partnership Firm (Goodwill)
2015 2016 Solution :
333
68,000 75,000
Total profits of the given 5 years = A(40,000+47,000+60,000+68,000+75,000) =A2,90,000 Average Profits = Goodwill
Total Profits A2,90,000 A58,000 No. of years 5
= Average Profits × No. of years purchase
= A58,000×3 = A1,74,000 (ii) Super Profit Method : Captial employed in a business yields a profit. Some of the enterprises earn more profit, while others in the same line of business earn less profit on the capital employed. When a similar type of business earns profit as a certain percentage of the capital employed, it is called normal return. But an investor's advantage lies in the excess of normal return on capital employed. It is only such enterprises which enjoy goodwill. The excess of actual profit over the normal profit is called super profit. For calculating goodwill under this method, the steps are : (a) Calculate Average Capital Employed as :
Opening Capital Employed + Closing Capital Employed 2 Capital Employed = Capital + Free Reserves - Fictitious Assets (if any) OR All Assets (other than goodwill, fictitious assets and non-trade investments) – outsiders' liabilities. (b) Calculate actual expected profit, i.e., actual average profit. (c) Calculate normal profit on average capital employed by applying the following formula : Average Capital Employed ×
Normal Rate of Return 100
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Note - Normal Rate of Return refers to the rate of return normally earned by other firms in the same industry. (d) Calculate super profit, i.e., Actual Average Profit - Normal Profit. (e) Calculate value of goodwill as follows : Goodwill = Super Profit × Number of years purchase Illustration 2 (Super Profit Method) A firm earned net profits during the last three years as follows : Year
Profit (A)
2014
18,500
2015
20,300
2016
22,100
The capital investment of the firm is A60,000. A fair return on the capital having regard to the risk involved is 10%. Calculate the value of goodwill on the basis of three years purchase of the average super profit for the last three years. Solution :
A18,500 + A20,300 + A22,100 =A20,300 3
a)
Average Profit =
(b)
Normal Profit = A60,000×
(c)
Super Profit
(d)
Goodwill
10 = A6,000 100 = Average profit - Normal profit = A20,300 – A6,000=A14,300 = Super profit × No. of years' purchase = A14,300 × 3 = A42,900.
Illustration 3 (Super Profit Method) Average net profit of ABC Ltd. expected in the future is A54,000 per year. The average capital employed in the business is A3,00,000. Normal profit expected from capital investment in this class of business is 10%. The remuneration of the partners is estimated to be A9,000 p.a.
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Find out the value of goodwill on the basis of two year's purchase of super profit. Solution : A A Average annual profit 54,000 Less : Partners remuneration 9,000 Normal profit on capital employed 30,000 39,000 Annual super profit 15,000 Goodwill, being two year's purchase of super profit = A15,000×2=A30,000 Difference between average Profit and Super Profit : Basis
Average Profit
1. Meaning
It is average of the profits of past few years.
Super Profit It is excess of average profit over normal profit.
2. Normal Normal rate of return is not Rate of return relevant in the calculation of average profit.
Normal rate of return is considered while calculating super profit.
3. Average Capital Employed
Average capital employed is taken into account while calculating the super profit.
Average Capital Employed is not taken into account in the calculation of average profit.
4. Relevance Average profit is relevant for of valuing Average profit method, Super Goodwill. profit method and Capitalisation method of valuing Goodwill.
Super profit is relevant for super profit method and capitalisation of super profit method of valuation of Goodwill.
(iii) Capitalisation Method : Under this method, goodwill can be valued in two ways :
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(a) Capitalisation of Average Profits; or (b) Capitalisation of Super Profit. (a)
Capitalisation of Average Profit :
Under this method, goodwill is calculated by deducting capital employed (i.e., Net Assets as on the date of valuation) in the business from the capitalised value of average profit on the basis of Normal Rate of Return. Capitalised value of the business is ascertained by capitalising profits earned at the normal rate of profit. It is calculated as follows: Average Profit 100 Normal Rate of Return
Net Assets = All Assets (other than goodwill, fictitious assets and non-trade investments) at their current values minus outsiders' liabilities. If a firm earns a profit of A24,000 annually and firms in the same time of business normally earn 10%, the total capitalised value of the firm will be A2,40,000, i.e., 24,000×
100 . 10
For calculating goodwill under this method, the steps are : Calculate average normal profit earned. Calculate capitalised value of the firm by using the above formula. Determine the value of Net Assets, on the date of valuation of goodwill. Net Assets = All Assets (other than goodwill, fictitious assets and non-trade investments) at their current values minus outsiders' liabilities. Goodwill = Capitalised Value- Net Assets. This method is suitable when the actual profits are less than the normal profit.
Illustration 4 (Capitalisation Method) A firm earns A65,000 as its annual profit, the normal rate of profit being 10%. Assets of the firm are A7,20,000 (excluding goodwill) and liabilities are A2,40,000. Find the value of goodwill by Capitalisation Method.
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Solution : Total Capitalised Value of the Firm = = Net Assets of the Firm
Average Profit 100 Normal Rate of Return R65,000 100 R6,50,000 10
= Total Assets - Liabilities
= A7,20,000 - A2,40,000 = A4,80,000 Goodwill = Total Capitalised Value of Business - Net Assets = A6,50,000 - A4,80,000 = A1,70,000. (b)
Capitalisation of Super Profit :
Under this method, goodwill is calculated by capitalisation of super profit. In other words, goodwill is ascertained by capitalising the super profit on the basis of Normal Rate of Return. For example, where average profit is A60,000 and normal profit is A48,000, the super profit will be A12,000 (i.e., A60,000-A48,000). Assuming that the Normal Rate of Return is 10%, the goodwill will be A1,20,000 (i.e., A12,000×
100 ). 10
For calculating the goodwill under this method. the steps are : (a)
Calculate Capital Employed (i.e., Net Assets of the firm as on the date of valuation.
(b)
Calculate Normal Profit on Capital Employed by using the following formula: Normal Profit = Capital Employed × Normal Rate of Return/100
(c)
Calculate Average Profit of past years, i.e., three to five years.
(d)
Calculate Super Profit, i.e., Actual Average Profit-Normal Profit.
(e)
Goodwill = Super Profit ×
100 . Normal Rate of Return
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Illustration 5 Average profit of the firm is A1,50,000. Total Tangible assets in the firm are A15,00,000 and outside liabilities A4,00,000. In the same type of business, the normal rate of return is 10% of the capital employed. Calculate the value of goodwill by capitalisation of Super Profit Method. Solution : Capital Employed = Total Tangible Assets - outside liabilities = A15,00,000 - A4,00,000 = A11,00,000 Normal Profit = Capital Employed × Normal Rate of Return = A11,00,000 ×
10 = A1,10,000 100
Super Profit = Average Profit - Normal Profit = A1,50,000 – A1,10,000 = A40,000 Goodwill
=
Super Profit 100 Normal Rate of Return
A40,000 100 A4,00,000 . 10
Illustrations 6 Average net profit expected in future by U.C. Lal & Co is A30,000 per year. Average capital employed in the business by the firm is A2,00,000. Normal rate of return on capital employed in a similar business is 10%. Calculate goodwill of the firm by : (i) Super Profit Method on the basis of two years' purchase, and (ii) Capitalisation of Super Profit Method. Solution : (i) Super Profit Method : Average Profit = A30,000 Normal Rate of Return - 10%
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Capital Employed = A2,00,000 Normal profit = 10% of A2,00,000 = A20,000 Super profit = Average Profit - Normal Profit = A30,000 - A20,000 = A10,000 Goodwill = Super Profit × Number of years purchase = A10,000 × 2 = A20,000 (ii)
Capitalisation of Super Profit Method : Goodwill = Super Profit × = A10,000 ×
100 Normal Rate of Return 100 = A1,00,000 10
6.3
Questions
1.
From the given alternatives under each bit, choose and write the correct answer along with its serial number against each bit:
(i)
The excess of actual profit over normal profit is called : (a) Gross profit. (b) Net profit. (c) Super profit. (d) Average profit.
(ii)
Goodwill is a/an : (a) tangible asset. (b) fictitious asset. (c) intangible asset.
(iii)
(d) wasting asset. Profit of last three years were A13,000, A10,000 and A7,000. Value of goodwill at 3 years purchase will be : (a) A27,000.
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(b) A28,000. (c) A29,000. (d) A30,000. (iv)
Under capitalisation of super profit method, goodwill is calculated by : (a) Average profit × years of purchase (b) Super profit × years of purchase (c) Super profit divided by expected rate of return. (d) Total of the discounted value of expected future profit.
(v)
When the incoming partner pays for goodwill in cash, the amount should be debited to: (a) goodwill account (b) Capital account of the incoming partner. (c) Cash.
(vi)
(d) Capital account of the existing partners. Super profit is equal to : Total profit
(a) No. of years (b)
Average profit Normal rate of return
Weighted profits
(c) No. of weights
(d) Average profits - Normal profits. [Ans.: (i) c, (ii) c, (iii) d, (iv) c, (v) c, (vi) d] 2.
Answer the following questions in one word/term each : (i) What is the term used for expressing the reputation of a firm in monetary term ?
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(ii) Name the asset which is intangible but not fictitious. (iii) Name the term used for writting off of Goodwill. (iv) Name the method of calculating goodwill, when average maintainable profit and normal profit of a firm are given. [Ans.: (i) Goodwill, (ii) Goodwill, (iii) Amortisation (iv) Super profit method.] 3.
Answer the following in one sentence each : (i) Define Goodwill. (ii) What is meant by number of years' purchase ? (iii) What do you mean by super profit ? (iv) Write two factors which affect the value of Goodwill. (v) What is normal profit ? (vi) What is meant by average maintainable profit ?
4.
Correct the underlined portions of the following sentences : (i) Super profit is the shortage of average profit over normal profit. (ii) Three years purchase of super profit means, super profit divided by 3. (iii) In case of partnership business goodwill is valued, when partnership firm is dissolved. (iv) Capitalised value of average profit method for valuing goodwill is used frequently. (v) For writing off the decrease in the value of goodwill, the term depreciation is used. [Ans.: (i) excess, (ii) multiplied, (iii) sold/reconstituted, (iv) rarely, (v) amortisation]
5.
Fill in the blanks with appropriate words : (i) Excess of actual adjusted profit over normal profit is called ______ profit. (ii) Negative super profit indicates that there is no _______ of business concern.
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(iii) When a business is taken over by another business, the excess of purchase price over its net asset value is referred to as _______. (iv) Goodwill is a/an _______ asset. (v) The number of methods of valuation of goodwill is _______. [Ans.: (i) Super, (ii) goodwill, (iii) goodwill, (iv) intangible, (v) three.] 6.
Answer the following questions within 30 words each : (a) What do you mean by Goodwill ? (b) State any four factors which influence the valuation of Goodwill of a partnership firm. (c) Distinguish between Average Profit and Super Profit Methods of valuation of Goodwill. (d) Briefly explain the Average Profit method of valuation of goodwill. (e) Briefly explain the super profit method of valuation of goodwill.
7.
Answer the following questions within 50 words each : (a) What are the circumstances under which valuation of goodwill is necessary in case of partnership ? (b) How do you calculate goodwill in Average Profit method ? Give one example. (c) Name the methods of valuation of goodwill. (d) Explain the method of calculation of goodwill under capitalisation of super profit with an example.
8.
What is goodwill ? How is it valued ?
9.
"Goodwill is intangible but not fictitious" Justify the statement giving examples.
10.
Define goodwill. On what occasions does the need for valuation of goodwill arise ?
11.
What do you mean by goodwill ? Describe the factors affecting goodwill.
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12. Goodwill is to be valued at three years purchase of four years average profit. Profits of a partnership firm for last four years were : 2013- A1,20,000; 2014-A1,80,000; 2015-A1,60,000; 2016-A1,40,000 [Ans. Goodwill-A4,50,000] 13. The profits of a firm for the last five years were as follows : Year Profit (A)
2012
2013
2014
2015
2016
24,000
36,000
48,000
60,000
66,000
Calculate the value of goodwill on the basis of three years purchase of average profits. [Ans.: A1,40,400] 14. X and Y were partners in a firm. In order to admit Z into their firm, the need for valuation of goodwill arises. Goodwill for this purpose is to be calculated at two years purchase of the average normal profit of past three years. Profits of the last three years were: 2014- Profit A5,00,000 (including profits on sale of assets A50,000) 2015- Loss A2,00,000 (including loss by fire A3,00,000) 2016- Profit A7,00,000 (including insurance claim received A1,80,000 and interest on investments A80,000) [Ans. A6,60,000] 15. A and B are partners in a firm sharing profits and losses in the ratio of 2:1. They decide to take C into partnership for 1/4th share on 1st April, 2016. For this purpose, goodwill is to be valued at four times the average annual profit of the previous four or five years whichever is higher. The profits for the goodwill purpose of the past five years are : Year Profit (A)
2012
2013
2014
2015
2016
24,000
25,500
20,000
26,000
25,000
Find the value of goodwill.
[Ans.: A96,500]
16. Bini and Gini had a firm in which they had invested A5,00,000. On an average, the profits were A1,60,000. The usual rate of earning in the industry is 15%.
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Goodwill is to be valued at four years' purchase of profits in excess of profits @15% on the money invested. Value the goodwill. [Ans. A3,40,000] 17. The average net profits expected in the future by ABC firm are A36,000 per year. The average capital employed in the business by the firm is A2,00,000. The rate of interest expected from capital invested in this class of business is 10%. The remuneration of partners is estimated to be A6,000 p.a. Find out the value of goodwill on the basis of two years purchase of super profit. [Ans. A20,000] 18. A and B are partners in a firm investing capitals of A6,00,000 and A4,00,000 respectively. The normal rate of return for the same business is 15%. If the firm makes an average profit of A2,50,000, compute goodwill by taking it to be five years' purchase of super profits. [Ans. A5,00,000] 19. From the following information, calculate the value of goodwill on the basis of 3 years' purchase of the super profits : (i)
Average Capital employed in the business is A15,00,000.
(ii) Rate of interest expected from capital is 10%. (iii) Net trading profits for the firm for last four years were : A2,70,800; A3,20,000; A2,70,500 and A3,05,100. (iv) Fair remuneration to the partners for their services for the firm is A36,000p.a. [Ans. A2,56,800] 20. The following particulars are available in respect of a firm carried on by X and Y : (i)
Profit earned, 2014 A50,000; 2015 A60,000 and 2016 A55,000
(ii) Normal rate of profit 10% (iii) Capital Employed A3,00,000. (iv) The profit included non-recurring profits on an average basis of A3,000p.a. You are required to calculate goodwill as per capitalisation of super profit method. [Ans. A2,20,000]
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21. A firm earns profit of A5,00,000. Normal Rate of return in a similar type of business is 10%. The value of total assets (excluding goodwill) and total outsiders liabilities as on the date are A55,00,000 and A14,00,000 respectively Calculate value of goodwill according to capitalisation of Super Profit Method as well as capitalisation of Average Profit Method. [Ans. Value of Goodwill- A9,00,000 in both cases] 22. From the following information, calculate value of goodwill of the firm by applying Capitalisation Method : Total Capital of the firm A16,00,000. Reasonable rate of return 10%. Profit for the year A2,00,000. [Ans. A4,00,000] 23. From the following particulars, calculate value of goodwill of a firm, by applying capitalisation of Average Profit Method : (i) Profit of last five consecutive years ending 31st March are 2012-A59,000; 2013-A67,000; 2014-A39,000; 2015-A42,000 and 2016-A54,000. (ii) Capitalisation rate 20%. (iii) Net assets of the firm A2,00,000. [Ans. A61,000] 24. A business has earned average profit of A4,00,000 during the last few years and the normal rate of return in similar business is 10%. Find the value of goodwill by : (i) Capitalisation of super profit method, and (ii) Super profit method, if the goodwill is valued at 3 years purchase of super profits. Assets of the business were A40,00,000 and its external liabilities A7,20,000. [Ans. (i) A7,20,000, (ii) A2,16,000]
CHAPTER - 7
RECONSTITUTION OF PARTNERSHIP FIRM STRUCTURE
7.1
Meaning
7.2
Circumstances leading to Reconstitution
7.3
Change in Profit Sharing Ratio
7.4
Accounting for Revaluation of Assets and Liabilities
7.5
Distribution of Reserve and Accumulated Profits and Losses
7.6
Questions
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347
7.1 MEANING Partnership is created by an agreement among the partners. The agreement may be changed if all the partners so like. Any change in the existing agreement of partnership, amounts to reconstitution of a firm. As a result, the old agreement comes to an end and a new one comes into existence. In other words, reconstitution of partnership means change in relationship among the partners. 7.2 CIRCUMSTANCES LEADING TO RECONSTITUTION The various circumstances which lead to reconstitution of partnership, are discussed below : (i)
Change in the existing profit-sharing ratio : When partners decide to change the existing profit-sharing ratio, reconstitution is said to take place. A change in such ratio usually occurs when a partner starts putting in more effort into the business, brings in additional capital, shoulder additional responsibilities, etc.
(ii) Admission of a new partner : When a new partner is admitted into the partnership, reconstitution is said to take place. A new partner must have a share in the further profits of the business. It is bound to change the profit-sharing ratio of the existing old partners. (iii) Retirement of a partner : When a partner retires, he ceases to be a partner in the firm. In such a case, reconstitution is said to take place and the share of profit which was earlier taken by the retiring partner would be shared by the continuing partners in their old profit sharing ratio unless it is otherwise agreed upon by them. (iv) Death of a partner : When a partner dies, reconstitution is said to take place. For example, X, Y and Z are partners in a firm sharing profits and losses equally, i.e, 1/3rd each. Z dies on September 20, 2016 leaving behind X and Y who would now to share profits
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(v)
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and losses in the ratio of 1:1, i.e., having equal profit sharing ratio unless it is otherwise agreed upon. Insolvency of a partner : When a partner turns insolvent, that is, his assets are insufficient to meet his liabilities, reconstitution is said to take place. For example, X, Y and Z are in partnership sharing profit in the ratio of 1:2:3. X declares himself to be insolvent and can only repay 20 paise in a rupee. As a result of this, he now cases to be a partner which leads to reconstitution of the partnership firm.
(vi) Amalgamation of two Partnership Firms : When two or more partnership firms amalgamate, reconstitution is said to take place. For example, a partnership firm consisting of X, Y and Z sharing profits and losses equally get merged with another partnership firm consisting of A and B sharing profits and losses in the ratio of 2:1. Amalgamation is usually preferred for better availability of capital, increased marketing opportunities, decreased costs through economies of scale, streamlined administration, spreading of risks, more effective allocation of resources, lesser competition, etc. In all of the above cases reconstitution takes place because respective shares of the partners get re-distributed and there occurs a change in profit sharing ratio. 7.3 CHANGE IN PROFIT-SHARING RATIO Change in the profit sharing ratio among the existing partners means reconstitution of the firm without admission of a new partner or retirement or death of a partner. A change in the profit-sharing ratio in a partnership firm means, one (or more) partner(s) acquires share of profit in the business from another partner(s). Therefore, the aggregate amount of gain by one (or more) partner(s) is equal to the
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aggregate amount of sacrifice made by the other partner (s). In other words if share of profit of one or more partners increases, the share of profit of other partner(s) decreases. A change in profit sharing ratio usually takes place due to change in capital contribution, more active participation of a partner(s) in management, looking after greater responsibilities by one or more partners and similar other reasons. Goodwill is the means of compensation by which the gaining partners provide to the sacrificing partners, with a proportionate amount in scenarios where reconstitution takes place through a change in profit-sharing ratio. Various other adjustments also take place at the time of reconstitution of a firm through a change in profit sharing ratio which are as follows : (i) Determination of sacrifice ratio and gaining ratio. (ii) Accounting treatment of goodwill (iii) Accounting treatment of reserve and accumulated profits or losses, and (iv) Revaluation of assets and reassessment of liabilities. Sacrificing ratio Wherever there is a change in the profit-sharing ratio, one or more of the existing partners have to surrender some of their old share in favour of one or more other partners. The ratio of surrender of the share of profit is called sacrificing ratio. It is calculated as : Sacrificing Ratio = Old Share – New Share. The sacrificing ratio determines the compensation that has to be paid through a proportionate amount of goodwill by the gaining partners to the sacrificing partners. The gaining partners are those that acquire a greater share in profits when the reconstitution occurs. Similarly, the sacrificing partners are those that lose a proportionate share of profits during reconstitution.
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Gaining ratio The ratio in which a gain in profit-sharing ratio is made is called the gaining ratio. In other words, gaining ratio is the proportion in which a partner receives an increased share of profits than his earlier share. As a result of change in the ‘profit sharing ratio’, one or more of the existing partners gains/gain some portion of other partner’s share of profit. The ratio of gain of profit-sharing ratio is called gaining ratio. It is calculated as : Gaining Ratio = New share – Old share. The objective of calculating gaining ratio is exactly the same as above mentioned for sacrificing ratio, that is, through this ratio it may be determined what proportion of amount has to be paid by the gaining partner/partners to the sacrificing partner/ partners under circumstances of change in profit-sharing ratio. Illustration 1 A, B, and C were in partnership sharing profits and losses in the ratio 4:3:1. The partners agreed to share future profits in the ratio 5:4:3. Calculate each partner’s gain or sacrifice due to change in ratio. Solution : Old ratio of A, B and C = 4:3:1 and New ratio of A, B and C = 5:4:3. Sacrificing = Old share – New share.
For
A
4 5 12 10 2 (Sacrifice ) 8 12 24 24
B
3 4 98 1 (Sacrifice ) 8 12 24 24
1 3 36 3 C (Gain) 8 12 24 24
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A has sacrificed
351
2 1 3 2 1 . , B has sacrificed and C has gained 24 24 24 4 4
It is important to note that sacrifices of A and B is equal to the gain of C. Illustration 2 X, Y, and Z were partners in a firm sharing profits and losses in the ratio of 3:2:1. The partners decide to share future profits and losses in the ratio of 2:2:1. Indicate each partner’s gain or sacrifice due to change in ratio. Solution : Old ratio of X, Y and Z = 3:2:1 New ratio of X, Y and Z = 2:2:1 Sacrifice/ Gain = Old share – New share
For X 3 2 15 12 3 (Sacrifice ) 6
Y
5
30
30
2 2 10 12 2 (Gain) 6 5 30 30
1 1 56 1 Z (Gain) 6 5 30 30
X has sacrificed
3 2 1 ; Y has gained and Z has gained . 30 30 30
( negative sacrifice=gain) Illustration 3 A, B, C and D are partners in a firm sharing the profits and losses in the ratio of 5:4:3:1. They agreed to share the future profits of the firm in the ratio of 4:3:4:2
Accountancy (Part-II)
352
respectively. Find the sacrificing and gaining ratio of the partners. Also verify that sum of sacrifice is equal to sum of gain. Solution : Old Ratio A:B:C:D = 5:4:3:1 i.e.,
A’s share
B’s share
C’s share
D’Share
5/13
4/13
3/13
1/13
4/13
3/13
4/13
2/13
Share in New Ratio
5
4
1
4
3
1
A’s Sacrifice = 13 13 13 , B’s Sacrifice = 13 13 13 C’s Gain =
4 3 1 , 13 13 13
D’s Gain =
2 1 1 ( Gain = New Ratio - Old Ratio) 13 13 13
Verification : Total sacrificing ratio of A and B =
1 1 2 13 13 13
and total gaining ratio of C and D =
1 1 2 13 13 13
Hence, Sum of sacrifice = Sum of gain. 7.4 ACCOUNTING FOR REVALUATION OF ASSETS AND LIABILITIES Assets are revalued and the liabilities are reassessed at the time of change in profit-sharing ratio and the profit of loss arising from it, is credited or debited to the Partner’s Capital Accounts in their old profit-sharing ratio. The reason for revaluation of assets and reassessment of liabilities is that any increase or decrease in the value
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353
of assets and liabilities up to the date of change in profit-sharing ratio should be shared by the partners in their old profit-sharing ratio. For revaluation of assets and reassessment of liabilities, an account entitled ‘Revaluation Account’ or ‘Profit and Loss Adjustment Account’ is opened. Increase in value of assets and decrease in liabilities is credited to this account while decrease in the value of assets and increase in liabilities is debited. Unrecorded assets, if any, are credited and unrecorded liabilities are debited. The balance in the account is gain (profit), if total of credit side is larger than the total of debit side and loss, if total of debit side is larger than the total of credit side. Gain (profit) or loss on revaluation and reassessment is credited or debited to Partner’s Capital Accounts in their old profit-sharing ratio. Specimen of Revaluation Account is given below : Revaluation Account Dr.
Cr. Particulars
A
Particulars
To Assets (Individually) (Decrease in value on revaluation)
By Assets (Individually) (Increase in value)
To Liabilities (Individually) (Increase on reassessment)
By Liabilities - (Individually) (Decrease in reassessment)
To Partner’s Capital A/cs (Individually) (profit on revaluation)
A
By Partner’s Capital A/cs. (Individually)–(Loss on revaluation)
Important note : When Revaluation Account is prepared, assets and liabilities appear in the Balance Sheet of the reconstituted firm at their revised values.
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Accounting Entries to Record the Revaluation of Assets and Reassessment of Liabilities 1. For increase in the value of an asset 2. For decrease in the value of an asset 3. For increase in the amount of a liability 4. For decrease in the amount of a liability 5. For recording an unrecorded asset 6. For recording an unrecorded liability 7. For transfer of Balance in Revaluation Account (a) If credit side exceeds debit side (Net Gain) (b) If debit side exceeds credit side (Net Loss)
Asset A/c(Individually) To Revaluation A/c Revaluation A/c To Asset A/c (Individually) Revaluation A/c To LiabilityA/c (Individually) LiabilityA/c (Individually) To Revaluation A/c Unrecorded Asset A/c. To Revaluation A/c Revaluation A/c. To Unrecorded Liability (a) Revaluation A/c To Partner’s Capital A/cs (Individually in old profit-sharing ratio)
Dr. Dr. Dr. Dr. Dr. Dr. Dr.
(b) Partner’s Capital A/cs. (Individually in old profit sharing ratio) To Revaluation A/c
Illustration 4 Pass Journal entries to record the following cases relating to revaluations : (a) Machinery of A70,000 brought down by 15%. (b) Value of Stock A50,000 appreciated by 10%. (c) Furniture of A10,000 is brought down to A7,000. (d) Stock of A35,000 is written down to A30,000. (e) Building of A1,00,000 is written up to A1,30,000. (f) Provision for doubtful debt @5% is created on Sundry Debtors of A40,000. (g) Creditors were over-estimated by A6,000. (h) Interest accrued on investment A2,000 is to be brought into account. (i) A claim of A750 for damages should be created against the firm. (j) An old typewriter having a book value of A2,500 is to be written off fully.
Reconstitution of Partnership Firm
Solution : Date (a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
(j)
355
LF Dr. (A)
Particulars
Revaluation A/c To Machinery A/c (Being machinery brought down by 15%) Stock A/c To Revaluation A/c (Being value of stock increased by A5,000) Revaluation A/c To Furniture A/c (Being value of furniture decreased by A3,000) Revaluation A/c To Stock A/c (Being value of stock decreased by A5,000) BuildingA/c To Revaluation A/c (Being value of Building increased) Revaluation A/c To Provision for doubtful debt A/c (Being provision for doubtful debts created) Creditors A/c To Revaluation A/c (Being creditors written down) Accrued Interest A/c To Revaluation A/c (Being interest accrued on investment brought into account) Revaluation A/c To Claim for damages A/c (Being a claim for damages provided for) Revaluation A/c To Typewriter A/c (Being old typewriter written off)
Dr.
Cr. (A)
10,500 10,500
Dr.
5,000 5,000
Dr.
3,000 3,000
Dr.
5,000 5,000
Dr.
30,000 30,000
Dr.
2,000 2,000
Dr.
6,000 6,000
Dr.
2,000 2,000
Dr.
750 750
Dr.
2,500 2,500
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356
Illustration 5 X, Y and Z are partners in a firm sharing profits and losses in the ratio of 3:3:2. Their Balance Sheet as at 31st March, 2016 was : Liabilities
Assets
A
A
Sundry Creditors
24,000 Cash at Bank
27,000
General Reserve
36,000 Sundry Debtors
50,000
Capital A/cs :
Stock
1,20,000
X
2,00,000
Machinery
1,59,000
Y
2,00,000
Building
2,00,000
Z
1,00,000
5,00,000 Advertisement Expenditure (Deferred Revenue) 5,60,000
4,000 5,60,000
Partners decided that with effect from 1st April, 2016 they would share profits and losses in the ratio of 4:3:2. It was agreed that : (i)
Stock to be valued at A1,10,000.
(ii) Machinery is to be depreciated by 10%. (iii) A provision for doubtful debts is to be made on Sundry Debtors @5%. (iv) Building to be appreciated by 20%. (v)
A liability for A3,000 included in Sundry creditors is not likely to arise. Partners agreed that revised values of assets and liabilities are to be recorded in
the books. They decided to retain the General Reserve in the books. Give necessary accounting entries.
Reconstitution of Partnership Firm
Solution : Date
357
Journal LF Dr. (A)
Particulars
Revaluation A/c Dr. To Stock A/c 2016 To Machinery A/c April 1 To Provision for doubtful debts A/c (Being decrease in the value of assets and provision for doubtful debts) April 1 BuildingA/c Dr. Sundry Creditors A/c. Dr. To Revaluation A/c. (Being increase in the value of building and decrease in creditors) Dr. April 1 Revaluation A/c To X’s Capital A/c To Y’s Capital A/c To Z’s Capital A/c (Being the transfer of profit on revaluation to the Capital Accounts of partners in old profit sharing ratio(WN-1)
5
R36,000 April 1 X’s Capital A/c 72
To Y’s Capital A/c R 36,000
Dr. 3 72
10,000 15,900 2,500
40,000 3,000 43,000
14,600 5,475 5,475 3,650
2,500
Dr.
1,500
2 Dr. 72 (Being the adjustment of general reserve on change in profit-sharing ratio) (W.N.-2) To Z’s Capital A/c R 36,000
April 1
X’s Capital A/c Y’s Capital A/c Z’s Capital A/c To Advertisement expendture A/c (Being transfer of advertisement expenditure to all partners in old profit-sharing ratio.)
Dr Dr Dr
Cr. (A)
28,400
1,000
1,500 1,500 1,500 4,000
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358
Working Notes : 1.
Revaluation A/c Particulars
Particulars
A
To Stock A/c
10,000
By Building A/c
To Machinery A/c
15,900
By Sundry Creditors A/c
To Provision for Doubtful Debt A/c To X’s Capital A/c
5,475
To Y’s Capital A/c
5,475
To Z’s Capital A/c 3,650 (Profit on revaluation)
A 40,000 3,000
2,500
14,600
43,000
2.
43,000
Calculation of Sacrifies /Gain in share of Partners : X
Y
Z
Old Ratios
3/8
3/8
2/8
New Ratios
4/9
3/9
2/9
–5/72
3/72
2/72
Gaining
Sacrificing
Sacrificing
Partner
Partner
Partner
Difference (Gain or Sacrifies)
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359
Illustration 6 X, Y and Z are partners in a firm sharing profits and losses in the ratio of 8:5:3. Their Balance Sheet as at 31st December, 2016 was as follows : Date
Particulars Sundry Creditors General Reserve Partners’ Loan A/cs X Y Partners’ capital A/cs: X Y Y
A 30,000 16,000 8,000 6,000 20,000 16,000 14,000
14,000
Date
Particulars Cash Bills Receivable Sundry Debtors Stock Fixed Assets
50,000 1,10,000
A 12,000 10,000 8,000 24,000 56,000
1,10,000
(a)
From 1st January, 2017, they agreed to alter their profit-sharing ratio as 5:6:5. It is also decided that : The fixed assets should be valued at A66,200.
(b)
A provision of 7 % on sundry debtors be made for doubtful debts.
1 2
(c)
The stock be reduced to A22,400. They have decided to make revaluation of assets and liabilities before bringing into force the new ratio. Pass necessary journal entries, prepare Revaluation Account and calculate gain or sacrifice of partners. Solution : Journal Date
LF Dr. (A)
Particulars
2017 Fixed Assets A/c Jan 1. To Revaluation A/c (Being value of fixed assets increased)
Dr.
Cr. (A)
10,200 10,200
Accountancy (Part-II)
360 Revaluation A/c Dr. To Provision for doubtful debt A/c To Stock A/c (Being value of liability increased and asset decreased)
2,200
Revaluation A/c Dr. To X's Capital A/c To Y's Capital A/c To Z's Capital A/c (Being profit on revalutation transferred to partner's capital accounts in old profit sharing ratio.)
8,000
600 1,600
4,000 2,500 1,500
Revaluation Account Dr.
Cr. Particulars
To Provision for doutful debts A/c To Stock A/c To X's Capital A/c 4,000 To Y's Capital A/c 2,500 To Z's Capital A/c 1,500 (Profit on revaluation)
A 600 1,600
Particulars
A
By Fixed Assets
10,200
8,000
10,200
10,200 Working Notes : (i)
Calculation of Gain or Sacrifice of partners : Old Share New Share Difference Effect
X 8/16 5/16 3/16 (sacrifice)
Y 5/16 6/16 -1/16 (gain)
Z 3/16 5/16 -2/16 (gain)
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361
When assets and liabilities are to appear in the books at the old values (Memorandum Revaluation Account) The partners may decide that the value of assets and liabilities will continue to appear in the books at the existing value. In such a case, an increase or decrease in the amount of assets and liabilities is recorded in the Memorandum Revaluation Account. This account is divided into two parts. First part is similar to the Revaluation Account and in the second part, entries are reversed. The balance of the first part (i.e., profit or loss on revaluation) is transferred to the Capital Accounts of the old partners in thier old profit sharing ratio. The balance of the second part is transferred to all the partners, including the incoming partners, in the new profit-sharing ratio. The journal entries for the same are as follows: (i) For increase in the value of assets and decrease in the value of liabilities : Assets A/c (individually) Dr. Liabilitis A/c (individually) Dr. To Memorandum Revaluatin A/c (ii) For decrease in the value of assets and increase in the account of liabilities: Manorandum Revaluation A/c Dr. To Assets A/c (individually) To Liabilities A/c (individually) (iii) For transferring the balance of the first part of Memorandum Revaluation Account : (If credit side exceeds debit side, i.e., in case of profit): Memorandum Revaluation A/c Dr. To Old partners capital A/cs (This entry is reversed if debit side exceeds credit side, i.e., in case of loss on revaluation) (iv) For reversing the first entry, entry (i) : Memorandum Revaluation A/c Dr. To Assets (individually) A/c To Liabilities (individually) A/c
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362
(v)
For reversing the second entry, i.e., entry (ii) : Assets (individually) A/c
Dr.
Liabilities (individually) A/c
Dr.
To Memorandum Revaluation A/c (vi) For transferring the balance of the second part of the Memorandum Revaluation Account (if debit side exceeds credit side) All Partners' Capital A/c
Dr.
To Memorandam Revaluation A/c (This entry is reversed if credit side exceeds the debit side) It should be kept in mind that if the first part of the Memorandum Revoluation Account results in profit, the second part will result in loss and vice versa. It may be noted that value of assets and liabilities except the cash and capital accounts, will not change and they will continue to appear at old values in the Balance Sheet of the firm after the reconstitution. Difference between the Revaluation Account and the Memorandum Revaluation Account : Basic
Revaluation Account
Memorandum Revoluation Account
1.Purpose
It is prepared to record the effect of revaluation of assets and liabilities when the assets and liabilities are to appear at their revised figures.
It is prepared to record the effect of revaluation of assets and liabilities which are to appear at their old figures.
2.Parts
It is not divided into two parts.
It is divided into two parts, viz, the first part to record the changes in the value of assets and liabilities and the second part to nullify the changes recorded in the first part.
Reconstitution of Partnership Firm
3.Transfer The balance of the Revaluation Account is transferred to the old of Balance partners' capital accounts in the old profit-sharing ratio.
7.5
363 The balance of first part (profit or loss) of this account is transferred to the capital A/cs of the old partners in their old profit sharing ratio. The balance (Profit or loss) of the second part is transferred to the capital A/cs. of all the partners including the new partner in the new profit sharing ratio in case of the admission of a partner and continuing partner in the case of retirement of a partner.
DISTRIBUTION OF RESERVE AND ACCUMULATED PROFITS / LOSSES
If at the time of admission of a partner, a balance in reserve and accumulated profits/losses exists in the Balance Sheet, those are transferred to old partners' Capital Accounts (or Current Accounts in case of fixed capital) in their old profit-sharing ratio. Those are transferred to the old partners' Capital Accounts because those had been set aside out of profits in the earlier periods, i.e., before the new partner was admitted. As a rule, the new partner should not be put to advantage or disadvantage on this account. Thus, the journal entry will be : Profit and loss A/c Dr. General Reserve A/c Dr. Workmen's Compensation Reserve A/c Dr. (excess of reserve over liability) Investments Fluctuation Reserve A/c Dr. (excess of reserve over the difference between book value and market value) (in old ratio) to old partners' capital (or current) A/cs. (Being the reserve and profits transferred to old partners in their old ratio) The effect of this entry is that in the new Balance Sheet, balance of the General Reserve or the Profit and Loss Account (credit) will not appear. Similarly if Profit
Accountancy (Part-II)
364
and Loss Account (debit balance) appears on the asset side of the Balance Sheet, it is transferred to the old partners' Capital Accounts in their old profit-sharing ratio by passing the following entry : Old partners' capital (or current) A/cs Dr. To Profit and Loss A/c To Deferred Revenue Expenditure A/c * (like Advertisement Expenditure) (Being the accumulated losses transferred to old partners capital A/cs. in their old ratio). * It is an accumulated loss which should be borne by the old partners only. The loss will not appear in the new Balance Sheet. Important Note When the partners decide to record the net effect of accumulated profits, losses or reserves without affecting their old figures single adjustment entry through Capital Accounts or Current Accounts of gaining partners and sacrificing partners should be passed. In that situation, the Accumulated profits, Losses or Reserves shall appear in the Balance Sheet of new firm at their old figures. For example, X and Y sharing profits in the ratio of 2:1 decide to share future profits in equal proportion. Suppose, reserves appearing in the Balance Sheet amount to A60,000 and partners do not want to distribute that. In such a case, in the old arrangement, X is entitled to A40,000 and Y to A20,000 of such reserve. But in future, after the change in the profit-sharing ratio, each partner would be entitled to A30,000 of such reserves. Hence, Y must compensate X to the extent of A10,000. This amount is proportionate to the 1/6th share gained by him. The following jounral entry will be passed : Y's Capital A/c To X's Capital A/c
Dr
10,000 10,000
(Being proportionate share of reserves adjusted between existing partners)
Reconstitution of Partnership Firm
365
When partners decide not to close the reserves and undistributed Profit and Loss Account: (i) For accumulated profits Gaining Partner's Capital A/c Dr. [with his respective share] To Sacrificing Partner's Capital A/c (ii) For accumulated losses : Sacrificing Partner's Capital A/c Dr. [with his respective share] To Gaining Partner's Capital A/c Illustration 7 Amit and Sumit are two partners sharing profits and losses in the ratio of 3:2. On 31.03.2016 they had A80,000 in general reserve and A40,000 in profit and loss account. They have decided to change the profit sharing ratio to 1:1 with effect from 1.4.2016. Pass adjusting entry if : (i) They decide not to show the accumulated profits in the Balance Sheet. (ii) They decide to show the accumulated profits in the Balance Sheet. Solution : (i) The accumulated profits are to be distributed among themselves in the old ratio if they do not want to show in the Balance Sheet. The journal entry will be; General Reserve A/c Dr. 80,000 Profit and loss A/c Dr. 40,000 To Amit's Capital A/c 72,000 To Sumit's Capital A/c 48,000 (ii) If they want to show the accumulated profits in the Balance Sheet, the following adjustment entry will be passed : Sumit's Capital A/c Dr. 12,000 To Amit's Capital A/c 12,000 (Being gaining partner's capital A/c debited and sacrificing partner’s capital A/c credited)
Accountancy (Part-II)
366
Working Note Amit
Sumit
Old share
3 5
2 5
New share
1 2
1 2
Difference
1 10
Effect Adjusted amount
(sacrifice)
1 10
(gain)
1 1, 20, 000 12, 000 10
Students are advised to transfer the accumulated profits/reserves or accumulated losses to old partners’ capital account in old profit sharing ratio, even if the question is silent on this point. Illustration 8 A, B and C are three partners sharing profit in the ratio of 5:3:2. They decided to change the ratio to 2:2:6. On that date, they had a debit balance of A18,000 in Profit and Loss Account and A6,000 in Deferred Revenue Expenditure Account. (a) They decide not to show the accumulated losses in the books of accounts. (b) They decide to show the same in the books of accounts. Solution : (a) The accumulated losses are to be divided among themselves in their old ratio. If they do not want to show that in the books of accounts, the journal entry will be: A's Capital A/c Dr. 12,000 B's Capital A/c Dr. 7,200 C's Capital A/c Dr. 4,800 To Profit and Loss A/c 18,000 To Referred Revenue Expenditure A/c 6,000 (Being accumulated losses shared by old partners in their old profit securing ratio)
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367
(b) If they want to show the accumulated losses, necessary adjustment shall be made through capital accounts. In such a case, journal entry will be : A's Capital A/c
Dr.
7,200
B's Capital A/c
Dr.
2,400
To C's Capital A/c
9,600
Working Note A
B
C
Old Share
5/10
3/10
2/10
New Share
2/10
2/10
6/10
Difference
3/10
1/10
- 4/10
(sacrifice)
(Sacrifice)
(gain)
Effect Adjusted
amount
3 10 24000 7200 ,
1 10 24, 000 2, 400 ,
4 10 24, 000 9, 600 .
When both Accumulated Profits and Losses Exist When the partners decide to record the net effect of accumulated profits, losses or reserves, without disturbing the old figures, the reserves/accumulated profits or losses continue to appear at the same amount in the Balance Sheet of the reconstituted firm. In such a situation, a single adjusting entry is passed involving the capital accounts of the gaining and sacrificing partners. Illustration 9 P, Q and R were sharing profits and losses in the ratio of 5:3:2. They decided to share future profits and losses in the ratio of 2:3:5 with effect from 1.4.2016. They also decided to record the effect of the following, without affecting their book values:
Accountancy (Part-II)
368
(i) General Reserve A24,000 (ii) Profit and Loss Account (losses) A12,000. Pass necessary adjusting journal entry. Solution: Step-I : Calculation of Amount to be adjusted. General Reserve
A24,000
Less : Profit and Loss (losses)
A12,000 A12,000
Amount to be adjusted 12,000×
3 =3,600 10
Step-II : Calculation of sacrifice or gaining ratio : Particulars
P
Q
R
Partners' Old Share
5/10
3/10
2/10
Partners' New Share
2/10
3/10
5/10
3/10
NIL
-3/10
Sacrifice
No effect
Gain
Difference Effect Step-III : Date
Journal Particulars
2016 R's Capital A/c Apri-1 To P's Capital A/c (Being adjustment of profit on change in profit sharing ratio.)
L.F. Dr.
Dr. (A) Cr. (A) 3,600 3,600
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369
7.6 QUESTIONS 1.
From the alternatives given under each bit, write the correct answer along with its serial number against each bit :
(i)
The profit on revaluation of assets and liabilities are shared by : (a) Old partners in sacrificing ratio. (b) Old partners in old profit sharing ratio. (c) all partners including new partner in new ratio. (d) Old partners equally.
(ii) When assets are revalued, any increase in the value of assets is debited to : (a) Revaluation Account. (b) Asset Account. (c) Profit and loss Account. (d) Profit and loss Appropriation Account. (iii) X and Y sharing profits in the ratio of 3:2 admit Z as a partner with
1 th share. 6
The new profit and loss sharing ratio is : (a) 2:2:2 (b) 4:3:2 (c) 5:3:2 (d) 3:2:1 (iv) A and B sharing profits in the ratio of 5:3 admit C and new profit sharing ratio of A,B and C is fixed at 4:2:2. The ratio of sacrifice of A and B is: (a) 5:3 (b) 1:2 (c) 1:1 (d) 2:1
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370
(v)
Increase in liability amounts to : (a) Gain to old partners. (b) Loss to old partners. (c) Neither gain nor loss, (d) More gain and less loss.
(vi) An old Partner's Capital Account is debited, when there is : (a) Credit balance in Profit and Loss A/c. (b) Debit balance in Profit and Loss A/c. (c) General Reserve. (d) Workmen's compersation Fund. (vii) When new partner acquires (a)
2 5
(b)
1 5
(c)
2 3
(d)
9 10
1 th share from X, then X's sacrifice is: 5
(viii) When all the partners including the incoming partner decide not to change the value of assets and liabilities, then the account which is prepared is called : (a) Revaluation Account (b) Profit and Loss Adjustment Account (c) Memorandum Revaluation Account (d) Suspense Account. (ix) Revaluation Account is a : (a) Real Account
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371
(b) Nominal Account. (c) Personal Account. (d) Statement. (x)
The purpose of Profit and Loss Adjustment account is : (a) to find out gross profit. (b) to find out net profit. (c) to know the financial position. (d) to find out results of revaluation of assets and liabilities. [Ans.: (i) b (ii) b (iii) d (iv) c (v) b (vi) b (vii) b (viii) c (ix) b (x) d]
2.
Answer the following questions in one word / term each : (i)
To which partner's capital Account, profit or loss on revaluation is not transferred ?
(ii) What would be the result by deducting new ratio from old ratio ? (iii) On which side of Revaluation Account, unrecorded assets are recorded ? (iv) On which side of Revaluation Account, unrecorded liabilities are recorded ? (v) Name at least one item which is debited to partner’s capital account, even if the question is silent about that item at the time of reconstitution of the firm. [Ans.(i) New partner (ii) sacrificing ratio (iii) credit side (iv) Debit side (v) Debit balance of profit and loss A/c.] 3.
Fill up the blanks:
(i)
Profit on revaluation of assets and liabilities is credited to capital accounts of old partners in ______ ratio.
(ii) Appreciation in the value of investment is ______ to the Revaluation Account. (iii) A partner whose share is increased due to change in profit sharing ratio, is called ______ partner. (iv) Revaluation of assets becomes necessary because present value of assets may be ______ from their book value.
372
(v)
Accountancy (Part-II)
If all the partners decide that the assets and liabilities in the new balance sheet should be shown at the old figure after reconstitution of the firm, then ______ revaluation account should be prepared. [Ans. (i) Old (ii) credited (iii) gaining (iv) different (v) Memorandum]
4.
Correct the underlined portions of the following sentences :
(i)
Unrecorded assets are shown in the Revaluation Account as decrease in assets.
(ii) Loss on revaluation is credited to old partners' capital accounts in old ratio. (iii) The excess of new ratio over old ratio is called sacrificing ratio. (iv) If provision for bad and doubtful debt is created for a reconstituted firm, the revaluation account will be credited. (v)
In case of change in profit sharing ratio, the gaining partner’s capital account is credited and losing partner's capital account debited. [Ans.: (i) increase (ii) debited (iii) gaining (iv) debited (v) debited and credited]
5.
Answer each of the following questions in one sentence :
(i)
What is reconstitution of firm ?
(ii) What is meant by revaluation of assets ? (iii) State the ratio in which old partners share the accumulated profits or losses or reserves. (iv) Why is 'Memorandum Revaluation Account' prepared ? (v)
What is the nature of Revaluation Account ?
(vi) On which side of Revaluation Account, unrecorded assets are recorded ? (vii) State whether Revaluation Account is debited or credited to record the increase in the value of Building. (viii) State whether revaluation Account is debited or credited to record the amount recovered that was earlier written off as bad debt. (ix) State whether the partner's Capital Account is debited or credited to record the profit of revaluation account. (x)
When the General Reserve is distributed, is the partner's Capital Account debited or credited ?
Reconstitution of Partnership Firm
6.
Answer the following questions within 30 words each;
(i)
What is reconstitution of partnership ?
373
(ii) Define Revaluation Account. (iii) Define sacrificing ratio. (iv) What should be the profit-sharing ratio of partners if there is no mention about it in the agreement ? (v)
What is gaining ratio and who is gaining partner ?
(vi) List any three features of Revaluation Account. (vii) What is the necessity of revaluation of assets and reassessment of liabilities at the time of change in profit sharing ratio among the existing partners. (viii) Give a specimen of Revaluation Account. 7.
Answer the following questions within 50 words each: (i) Distinguish between 'Revaluation Account' and Memorandum Revaluation Account. (ii) Distinguish between gaining partner and sacrificing partner. (iii) What is Revaluation Account ? Draw Revaluation Account with imaginary items. (iv) What is meant by revaluation of assets and reassessment of liabilities on the reconstitution of a firm ? What purpose does it serve at the time of reconstitution of partnership ?
8.
What is a ‘Revaluation Account’ ? How does it differ from a ‘Memorandum Revaluation Account’ ?
9.
Explain the need for and calculation of different ratios to be calculated at the time of reconstitution of a partnership firm.
10. List the various issues that need to be taken care of when there is a change in profit sharing ratio among the existing partners. Explain any one issue with example. 11. Pass necessary journal entries relating to revaluation of assets and liabilities on the reconstitution of a firm.
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374
12. X, Y and Z are partners sharing profits and losses in the ratio of 2:2:1. Now they decide to change the ratio to 3:2:1. Calculate gaining or sacrificing ratio of each partner. [Ans.: A’s gain 3/30, B’s sacrifice 2/30 and C’s sacrifice 1/30] 13. Amit, Sumit and Ranjeet are partners sharing profits in the ratio of 5:3:2. They decided to share future profits and losses in the ratio of 2:3:5 rerpctively. You are required to calculate the sacrifice and gaining ratio of each partner. [Ans.: Amit sacrifices
3 3 and Sumit gains ] 10 10
14. X, Y and Z are partners sharing profits in the ratio of 3:2:1. X gave away and Y gave away
1 to Y 5
1 to Z. Find the new ratio, gaining and sacrificing ratio. 10
[Ans.: New Ratio : 9:13:8, Xs sacrifice
6 3 3 , Y's gain , Z's gain ] 30 30 30
15. A, B and C share the profits of a firm in the ratio of 5:3:2. Now decided to share the profits equally. Find the sacrifice and gain of each partner. [Ans.: A's sacrifice
5 1 4 , B's gain , C's is gain ] 30 30 30
16. A and B are sharing profits and losses equally. With effect from 1st April, 2016, they agree to share profits in the ratio of 4:3. Calculate individual partner's gain or sacrifice due to the change in ratio. [Ans. A gains and B sacrifices
1 th share] 14
17. X, Y and Z are sharing profits and losses in the ratio of 5:3:2. With effect from 1st April 2016, they decide to share future profits and losses in the ratio of 5:2:3. Calculate each partner's gain or sacrifice due to change in ratio. [Ans.: Z's gain
1 1 th share and Y's sacrifice th share.] 10 10
Reconstitution of Partnership Firm
375
18. Anita and Binita are partners in a firm. They have A60,000 in Profit and Loss A/c and A80,000 in general reserve on 1st April 2016. On this day, they decided to change their profit sharing ratio from 3:2 to 1:1. They also decided to distribute profits and reserves before bringing the new profit sharing ratio into force. Pass the necessary adjustment entry. [Ans.: Anita's Capital A/c Cr. A84,000 and Binita's Capital A/c Cr. A56,000] 19. A and B are Partners in a firm sharing profits in the ratio of 3:2. They decided to share future profits equally. On the date of change in the profit sharing ratio, Profit and Loss Account showed a debit balance of A60,000. Pass Journal entry for distribution of balance in Profit and loss Account immediately before change in the profit sharing ratio. [Ans.: Debit A's capital A/c A36,000 and B's capital A/c A24,000 and credit profit and loss A/c 60,000] 20. X and Y are partners in a firm sharing profits and losses in the ratio of 3:2. With effect from 1st April, 2016, they decided to share future profits equally. On the date of change in the profit sharing ratio, the Profits and loss Account showed a credit balance of A1,50,000. Record the necessary journal entry for the distribution of the balance in the Profit and Loss Account immediately before the change in the profit sharing ratio. [Ans.: Dr. Profit and Loss A/c by- A1,50,000; Cr. X's Capital A/c by A90,000 and Y's Capital A/c by A60,000] 21. A, B and C are sharing profits and losses in the ratio of 5:3:2. They decide to share future profits and losses in the ratio of 2:3:5 with effect from 1.4.2016. They also decide to record the effect of the following accumulated profits, losses and reserves without affecting their book figures by passing a single entry: Book Figure (A) General Reserve
6,000
Profit and loss A/c (credit)
24,000
Advertisement Suspense A/c
12,000
[Ans.: Debit C and credit A by A5,400]
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376
22. X and Y are partners sharing profits and losses in the ratio of 2:1. On 31st March, 2016, their Balance Sheet showed General Reserve of A60,000. It was decided that in future they will share profits and losses in the ratio of 3:2. Pass necessary journal entry in each of the following alternative cases: (i) If they do not want to show General Reserve in the new Balance Sheet. (ii) If they want to show General Reserve in the new Balance sheet. [Ans.: (i) Dr. General Reserve A/c by A60,000; credit X's capital A/c by A40,000 and Y's capital A/c by A20,000. (ii) X's sacrifice=
1 1 ; Y's gain , Debit Y's Capital A/c by A4,000 and 15 15
credit X's Capital A/c by A4000) 23. X, Y and Z who presently sharing profits and losses in the ratio of 5:3:2 decide to share future profits and losses in the ratio of 2:3:5. Give the journal entry to distribute workmen’s compensation reserve of A1,20,000 at the time of change in profit sharing ratio, when there is no claim against it. [Ans: Debit Workmen’s is Compensation Reserve A/c A1,20,000; Credit X's Capital A/c A60,000; Y's Capital A/c A36,000 and Z's Capital A/cA24,000] 24. A, B and C are partners sharing profits and losses in the ratio of 2:1:1. They decided that with effect from 1st April, 2016, A shall receive
1 th share in the 4
profits. On March 31, 2016, their Balance Sheet stood as follows : Liabilities Creditors Capital A/cs : A B C
Assets
A 20,000 50,000 25,000 25,000
1,00,000 1,20,000
Cash Debtors Stock Land
A 10,000 35,000 15,000 60,000
1,20,000
Reconstitution of Partnership Firm
377
On this date, land was valued at A75,000; stock at A30,000 and a provision of A2,000 on debtors is to be created. Pass necessary journal entries in the books of the firm regarding the revaluation of assets and prepare Revaluation Account. [Ans.: Profit on Revaluation A28,000] 25. A, B and C are sharing profits and losses in the ratio of 5:3:2. They decided to share future profit and losses in the ratio of 2:3:5 with effect from 1st April, 2016. They also decide to record the effect of the following revaluation without changing the book value of the assets and liabilities : Particulars Land and Building Plant and Machinery Trade Creditors Outstanding expenses
A
A
10,00,000 5,00,000 1,20,000 1,20,000
11,00,000 4,80,000 1,10,000 1,50,000
Show the accounting treatment to give effect to the new arrangement. [Ans.: Debit C's Capital A/c by A18,000 and credit A's Capital A/c by A18,000.] 26. P, Q and R are partners sharing profits and losses in the ratio of 7:5:4. Their Balance Sheet as at 31st March, 2016 stood as : Liabilities Capital A/cs : P Q R General Reserve Profit and loss A/c Creditors
A 2,10,000 1,50,000 1,20,000
Assets Sundry Assets
A 7,00,000
4,80,000 65,000 25,000 1,30,000 7,00,000
7,00,000
Partners decided that with effect from 1st April, 2016, they will share profit and losses in the ratio of 3:2:1. For this purpose, goodwill of the firm was valued at
Accountancy (Part-II)
378
A1,50,000. The partners neither want to record the goodwill nor want to distribute the General Reserve or profits. Pass a journal entry to record the change and prepare revised Balance Sheet. [Ans.: Debit P's Capital A/c by A15,000; Q's Capital A.c by A5,000; credit Z's capital A/c by A20,000 and Total Balance Sheet - A7,00,000] 27. X,Y and Z are partners in a firm sharing profits and losses in the ratio of 5:4:3 respectively. Their Balance Sheet as at 31st March, 2016 was : Liabilities Sundry Creditors outstanding Expenses General Reserve Capital A/cs : X Y Z
Assets
A 40,000 15,000 75,000 1,30,000 4,00,000 3,00,000 2,00,000
Cash at Bank SundryDebtors Stock Furniture Plant and Machinery
A 40,000 2,10,000 3,00,000 60,000 4,20,000
9,00,000 10,30,000
1,030,000
From 1st April, 2016, they agree to alter their profit sharing ratio as 4:3:2. It is also decided that : (a)
Furniture be taken at 80% of its value.
(b)
Stock be appreciated by 20%.
(c)
Plant and Machinery be valued at A4,00,000.
(d)
Outstanding expenses be increased by A13,000. Partners agreed that altered values are not to be recorded in the books and they also donot want to distribute General Reserve. You are required to pass a single journal entry to give effect to the above. Also, prepare revised Balance Sheet. [Ans.: Profit on Revaluation-A15,000, Adjustment for Revaluation and General Reserve: Debit X's Capital A/c and credit Z' Capital A/c by A2,500 and Balance Sheet Total-A10,50,000] -0-
CHAPTER-8
ADMISSION OF A PARTNER STRUCTURE
8.1
Meaning of Admission of a Partner
8.2
Rights of a new Partner
8.3
Effects of Admission of a Partner
8.4
Adjustments required on the Admission of a Partner
8.5
8.4.1
New profit sharing ratio
8.4.2
Accounting treatment of Goodwill
Questions
380
Accountancy (Part-II)
8.1 MEANING OF ADMISSION OF A PARTNER Admission of a partner is one of the modes of reconstituting the firm under which old partnership comes to an end and a new one (among all partners including incoming partner) comes into existence. Capital contribution by the new partner, his share of profits and other conditions are agreed upon. The new partner, on joining, becomes liable for the liabilities of the firm and is entitled to assets and profits of the firm. According to section 31 of the Indian Partnership Act, 1932, a person can be admitted as a new partner only with the consent of all the existing partners, unless otherwise agreed upon. 8.2 RIGHTS OF A NEW PARTNER After admission, the new partner gets the following two main rights : (i) Rights to share future profits of the firm and (ii) Right to share in the assets of the firm At the same time, he becomes liable for any liability of the business incurred after admission and any loss incurred by the firm. The new or incoming partner receives share in future profits that is equal to the sacrifice of profit by an existing partner or partners of the firm. The new partner compensates the partner or partners who sacrifice their share in profits in his or her favour. The amount he pays for their sacrifice is called Goodwill or Premium for Goodwill. Besides the goodwill or premium for goodwill, new partner may bring in capital to get right in the assets of the firm. 8.3 EFFECTS OF ADMISSION OF A PARTNER The effects of admission of a new partner are : (i)
Old partnership comes to an end and new partnership comes into existence but the firm continues.
Admission of a Partner
381
(ii) New partner becomes entitled to share future profits of the firm and the combined share of the old partners get reduced. (iii) New partner contributes an agreed amount of capital. (iv) New partner acquires right on the assets and also becomes liable for the liabilities of the firm. (v)
Adjustment is made in regard to accumulated profits or losses which are credited or debited to the old partners capital accounts respectively.
(vi) Assets are revalued and liabilities are reassessed. The net change is adjusted in old partners’ capital accounts in their old profit sharing ratio, by opening one Profit and Loss Adjustment Account or Revaluation Account. (vii) Goodwill of the firm is valued to be paid to sacrificing partners for their sacrified share, by the new partner. 8.4 ADJUSTMENTS REQUIRED ON THE ADMISSION OF A PARTNER The adjustments required on admission of a partner are : (i)
Determining new profit-sharing ratio.
(ii) Valuation and adjustment of Goodwill (iii) Adjustment of profit/loss arising from revaluation of assets and reassessment of liabilities. (iv) Adjustment of accumulated profits, reserves and losses. (v)
Adjustment of capital (if agreed).
8.4.1 New Profit-Sharing Ratio New partner is entitled to share future profits of the firm. In effect, there is a change in the old profit-sharing ratio. Since, new partner acquires his share from old partners, it is necessary to determine new profit-sharing ratio and also sacrificing ratio.
Accountancy (Part-II)
382
New profit sharing ratio is the ratio in which all partners, including new partner, share future profits and losses of the firm. New partner may acquire his share from old partners through any of the following alternatives : (1) In their old profit-sharing ratio; or (2) In a particular ratio or surrendered ratio; or (3) In a particular fraction from some or all of the partners. Let us now discuss each of the above cases in detail. Case 1 : When new partner acquires his share from old partners in their old profit-sharing ratio In such a situation, share of the new partner is given and it is assumed that the new partner has acquired his share from old partners in their old profit sharing ratio. Old partners, therefore, continue to share balance profits or losses in their old profit-sharing ratio. In other wards, unless otherwise agreed, profit-sharing ratio among the existing partners remains unchanged. New profit-sharing ratio among all the partners is ascertained by deducting new partner’s share from 1 and then dividing the balance in old profit-sharing ratio of the old partners. Illustration 1 (new partner’s share is given) X and Y are partners sharing profits in the ratio of 5:3. Z is admitted for 1/4th share in the profits. Calculate new profit-sharing ratio of the partners. Solution : Calculation of new profit sharing ratio : Old ratio of X and Y=5:3 or
5 3 and 8 8
Let the total share be 1; Z’s share =
1 4
Admission of a Partner
383
Remaining share of X and Y = 1-
1 3 = 4 4
X’s new share =
3 5 15 × = , 4 8 32
Y’s new share =
3 3 9 1 8 × = and Z’s share or . 4 8 32 4 32
Hence, new profit-sharing ratio of X, Y and Z =
15 9 8 : : or 15:9:8. 32 32 32
Since only share of Z is given, it is assumed that Z has acquired his share from X and Y in their old profit-sharing ratio. Illustration 2 P, Q and R were partners in a firm sharing profits and losses in 3:2:1 ratio. They admitted S for 10% profits. Calculate new profit-sharing ratio. Solution : S’s share = 10% or
10 1 1 9 or , remaining share = 1- = . 100 10 10 10
P’s new share =
9 3 27 × = 10 6 60
Q’s new share =
9 2 18 × = 10 6 60
R’s new share =
9 1 9 × = 10 6 60
New profit sharing ratio of P,Q,R and S
=
27 18 9 1 6 : : : or 27:18:9:6 or 9:6:3:2. 60 60 60 10 60
Case 2 : When share of new partner and new ratio of old partners are given In this situation, new partner’s share is deducted from I and balance is divided among old partners in their new ratio. This gives new profit-sharing ratio of all the partners of the new firm.
Accountancy (Part-II)
384
Illustration 3 X and Y are partners. They admit Z for
1 th share. In future, profit sharing ratio 4
between X and Y would be 2:1. Calculate new profit-sharing ratio. Solution : Let the total share be = 1. Share of new partner Z is 1 4
1 . 4
3 4
Remaining share = 1- = . Existing partners’ share being calculated by dividing remaining share in their future profit-sharing ratio (i.e., 2:1) as under : X’s new share =
2 3 6 3 4 12
Y’s new share =
1 3 3 3 4 12
6
3 1
3
New profit-sharing ratio of X, Y and Z = 12 : 12 : 4 or 12 =6:3:3 or 2:1:1. Case 3
When new partner acquires his share from old partners in a particular ratio
New partner may acquire a part of share of profits from one partner and part of share of profits from another partner. In such a case, existing partners’ profit-sharing ratio will change to the extent of share sacrificed on admission of the new partner. Existing partners’ share of profits in the reconstituted firm is determined by deducting the sacrifice made from the existing share of profits. Illustration 4 X and Y are in partnership sharing profits and losses in the ratio of 5:3. Z is admitted as a partner for
1 1 1 th share for which he takes th from X and th from Y. 5 10 10
Admission of a Partner
385
Calculate the new profit-sharing ratio of the partners. Solution : Calculation of future profit sharing ratio : Old profit-sharing ratio of X and Y = 5:3 Z acquires his share
1 1 th from X and th from Y. 10 10
X’s share after sacrifice =
5 1 25 4 21 8 10 40 40
Y’s share after sacrifice =
3 1 15 4 11 8 10 40 40 21 11 1
8
: : The new profit-sharing ratio of X, Y and Z = 40 : 40 : 5 or 40 21118
Illustration 5 M and N are partners sharing profits in the ratio of 5:4. They admit O for
1 th 10
share of profits which he acquires, in equal proportions from both. Find out the new profit-sharing ratio. Solution : O’s share of profit in the firm is
1 , which he acquires from M and N in equal 10
proportions. It means, M has surrendered N has surrendered
1 1 1 of = 2 10 20
1 1 1 of = 2 10 20
M’s share of profit in the new firm
5 1 100 9 91 9 20 180 180
N’s share of profit in the new firm
Accountancy (Part-II)
386
4 1 80 9 71 9 20 180 180
O’s share of profit in the new firm =
1 18 or 10 180
Hence, new profit-sharing ratio of M, N and O
91 71 18 : : 917118 : : . 180 180 180
Case-4
When new partner acquires his share by surrender of a particular fraction of their share by the old or existing partners
In this case, shares surrendered by the old partners in favour of new partner are added up in order to arrive at the share of new partner. The share surrendered by old partners is deducted from their respective shares to determine old partners share in the reconstituted firm. Illustration 6 P and Q were partners in a firm sharing profits and losses in the ratio of 3:2. P surrendered
1 2 th of his share, and Q surrendered th of his share in favour of R, the 5 5
new partner. Calculate the new profit-sharing ratio. Solution : P’s share =
3 3 1 3 , P surrendered in favour of R = 5 5 5 25 3 5
So P’s new share
3 15 3 12 25 25 25
2 5
Q’s share , Q surendered in favour of R So Q’s new share
2 4 10 4 6 5 25 25 25
2 2 4 5 5 25
Admission of a Partner
387
R’s share is the sum total of shares surrendered by P and Q Now the new profit-sharing ratio of P,Q and R
3 4 7 25 25 25
12 6 7 : : or 12:6:7 25 25 25
Illustration 7 A and B share profits in the ratio of 5:4. They admit C as a partner. A surrenders 1 1 th of his share and B, rd of his share in favour of C. Calculate new profit-sharing 6 3
ratio. Solution : 5 1 9 6
A’s share was . th of A’s share 5 9
A’s new share was
5 1 5 9 6 54
5 30 5 25 54 54 54
4 1 9 3
B’s old share was . rd of B’s share = 4
4
12 4
4 1 4 9 3 27
8
B’s new share = 9 27 27 27 Hence, C’s share will be (sum of)
5 4 5 8 13 54 27 54 54
Therefore, New ratio of A, B and C will be : 25 8 16 13 : or : or 25:16:13 54 27 54 54
Case 5 When new partner’s share contributed solely by only one existing partner Illustration 8 X and Y are partners sharing profits and losses in the ratio of 3:2. They admit Z as a new partner who gets ratio.
1 th of profit, entirely from X. Calculate new profit-sharing 5
Accountancy (Part-II)
388
Solution : X’s original share =
3 5
X’s sacrifice in favour Z =
1 5
X’s new share = old share - share sacrificed =
3 1 2 5 5 5
Hence, new profit sharing ratio of X, Y and Z will be
2 2 1 : : or 2:2:1 . 5 5 5
Illustration 9 Ajay and Bijay are partners sharing profits in the ratio of 5:3. Chita is admitted for
3 th share, half of which was gifted by Ajay and the remaining share was taken by 10
Chita equally from Ajay and Bijay. Calculate new profit-sharing ratio. Solution : Ajay Bijay 5 8
3 8
(ii) Share gifted by Ajay
3 1 3 10 2 20
--
(iii) Share acquired by Chita
3 1 3 20 2 40
3 1 3 20 2 40
(i) Their old share
New share of Ajay = old share - share gifted – share acquired by Chita
5 3 3 25 6 3 16 8 20 40 40 40
3 8
New share of Bijay
3 15 3 12 40 40 40
Admission of a Partner
New profit-sharing ratio of Ajay, Bijay and Chita or
389 16 12 3 12 : : or 40 40 10 40
16 12 12 : : 4:3:3 40 40 40
8.4.2 Accounting treatment of Goodwill Accounting Standard-26 (AS-26) on ‘Intangible Assets’ prescribes that goodwill should be recorded in the books only when consideration in money or money’s worth has been paid for it, i.e., goodwill is purchased. Thus, in case of admission or retirement/death of a partner or in case of change in the profit sharing ratio among partners, goodwill should not be raised in the books of the firm because no consideration in money or money’s worth is paid for it. If any partner brings any premium over and above his capital contribution at the time of his admission, such premium should be distributed among the existing partners in their sacrificing ratio. If goodwill is evaluated at the time of change in the constitution of the firm (by way of admission/retirement/death/change in profit-sharing ratio), goodwill should not be brought into books as it is inherent goodwill. The value of goodwill should be adjusted through partners’ capital accounts. As you know, Goodwill is an intangible asset which enables a firm to earn profit over and above the normal profit (i.e., super profit) earned by other firms in the industry. It arises due to efforts made by the old partners in the past. Therefore, at the time of admission, new partner who acquires the share in future profits from the old or existing partners, should compensate sacrificing partners by paying them an amount, termed as goodwill or premium for goodwill. So, goodwill is a way for compensating the old partners for the sacrifice they make in favour of new partner. From the accounting point of view, there may be different situations related to treatment of goodwill and these are : (i) Goodwill paid privately : When goodwill or premium for goodwill is paid privately (i.e., outside the business) by the new partner to the old partners, it is not recorded in the books of account of the firm and hence, no entry is passed.
Accountancy (Part-II)
390
(ii) Goodwill/Premium for Goodwill brought in cash by the new partner and retained in the business : Under this situation, cash brought in by the new partner for his share of goodwill is credited to goodwill account and then the same amount is credited to old partners’ capital accounts in their sacrificing ratio, debiting the goodwill account. The process is illustrated by means of the following journal entries : 1)
When new partner brings his share of capital and goodwill in cash. Cash A/c
Dr. (with share of capital brought in)
To New Partner’s Captial A/c To Goodwill A/c 2)
The amount of goodwill is credited to the old partners’ capital accouts in sacrificing ratio. Goodwill A/c
Dr.
To old partners’ capital A/c (individually) Illustration 10 P and Q share profits in the ratio of 5:3. They admit R with
1 th of share in the 5
future profits. R is required to pay A50,000 as capital and his share of goodwill in cash. The Goodwill of the firm is valued at A80,000. Record the above transactions in the books of the firm. Solution : 5 3 8 8
Profit sharing ratio of Pand Q = 5:3 = : R’s share in the profit =
1 5
1
4
Remaining share = 1- 5 = 5
Admission of a Partner
391
P’s share =
4 5 20 × = 5 8 40
Q’s share =
4 3 12 × = 5 8 40
Hence, profit-sharing ratio of P,Q and R =
20 12 1 20 12 8 5 3 2 : : : : or : : 40 40 5 40 40 40 10 10 10
Therefore, their new profit sharing ratio = 20:12:8 or 5:3:2 Sacrificing ratio = old ratio - new ratio 5
5
P’s Sacrifice 8 10 3 8
Q’s sacrifice
25 20 5 40 40
3 15 12 3 10 40 40
So, sacrificing ratio of P and Q = 5:3 Total goodwill of the firm = A80,000 R’s share of goodwill, for Date
1 1 th of profit = A80,000 × = A16,000 5 5
Journal Particulars Cash A/c Dr. To R’s Capital A/c To Goodwill A/c (Being the amount brought in by R towards his Capital and Goodwill) Goodwill A/c Dr. To P’s Capital A/c To Q’s Capital A/c (Being the amount of goodwill credited to the old partners’ Capital Accounts in their sacrificing ratio)
L.F.
Dr. A 66,000
Cr. A 50,000 16,000
16,000 10,000 6,000
392
Accountancy (Part-II)
(iii) When the new partner brings his share of goodwill in cash which is withdrawn by the old partners either partly or fully : In this situation, the cash paid by the new partner towards goodwill, is credited to the goodwill account and subsequently the amount in credited to the old partners’ capital accounts in their sacrificing ratio debiting goodwill account. At the time of withdrawal of the same amount by the old partners, their capital accounts are debited with their individual share of withdrawal and the cash/bank account is credited. The following journal entries need to be passed : 1.
For cash paid by the new partner towards his share of goodwill. Cash A/c Dr. To Goodwill A/c (Being cash received from new partner towards goodwill) 2. Old partner’s capital accounts are credited in their sacrificing ratio debiting goodwill A/c. Goodwill A/c Dr. To Old Partner’s Capital A/cs (individually) (Being the goodwill credited to the old partners capital accounts in their sacrificing ratio) 3. Amount is withdrawn from the business by the old partners. Old Partners’ Capital A/cs Dr. (Individually) To Cash (Being the amount withdrawn from business) Illustration 11 A and B share profits of a firm in the ratio of 2:1. They admit C with
1 th share 4
in the profit with the understanding that C will pay A68,000 in cash towards his share of capital and goodwill. The total goodwill of the firm is valued at A72,000. Pass journal enties in the books of the firm if :
Admission of a Partner
393
(a)
A and B withdraw their share of goodwill from the business fully.
(b)
A and B withdraw 25% of the amount of goodwill brought in by the new partner.
Solution : Profit-sharing ratio of A and B = 2:1. C is admitted for 1 4
3 4
2
2
1 th share in the profits, 4
hence, remaining share = 1- = . This is to be shared by A and B in their profit sharing ratio. 3
A’s new share = 4 × 3 = 4 B’s new share C’s share
3 1 1 4 3 4
1 4 2 1 1 or 2:1:1 4 4 4
Hence, new profit-sharing ratio of all partners : :
Again sacrificing ratio of A and B = 2:1 (same as old ratio) Total value of goodwill = A72,000 C’s share for
1 1 th profit = A72,000× =A18,000. 4 4
C pays A68,000 for capital and goodwill. Therefore, his capital contribution would be A68,000 - A18,000 = A50,000. JOURNAL Date Particulars L.F. Dr. Cr. A A ? Cash A/c Dr. 68,000 To C’s Capital A/c 50,000 To Goodwill A/c 18,000 (Being the amount brought in by C towards his Capital and Goodwill)
Accountancy (Part-II)
394
(a)
(b)
Goodwill A/c To A’s Capital A/c To B’s Capital A/c (Being the amount of goodwill credited to the old partners’ Capital Accounts in their sacrificing ratio) A’s Capital A/c B’s Capital A/c To Cash A/c (Being the amount of goodwill withdrawn by A and B fully) A’s Capital A/c B’s Capital A/c To Cash (Being 25% of the amount of goodwill withdrawn from business by A and B)
Dr.
18,000 12,000 6,000
Dr.
12,000 6,000 18,000
Dr. Dr.
3,000 1,500 4,500
(iv) When the new partner is unable to bring his share of goodwill in cash : When a new partner is admitted, he contributes his share of capital as agreed upon but may express his inability to pay his share of goodwill in cash. Under this situation, goodwill is treated by debiting the new partner’s capital account with his share of goodwill and crediting the old partners’ capital accounts with their sacrificing ratio. The following journal entries are passed : 1. Cash A/c Dr. To New Partner’s Capital A/c (Being cash brought in by new partner towards his capital) 2. New Partner’s Capital A/c Dr. (with his share of goodwill) To Old Partners’ Capital A/c (in sacrificing ratio) (Being the new partners’ share of goodwill debited to his capital account and credited to old partners’ capital accounts in sacrificing ratio) When the value of goodwill of the firm is not specifically given, the value of goodwill has to be inferred on the basis of the net worth of the firm (hidden goodwill) which is arrived at as follows :
Admission of a Partner
A. B. C.
395
Net worth (including goodwill) on the basis of capital brought in by incoming partner. (Incoming partner’s capital X reciprocal of share of the incoming partner) Networth (excluding goodwill) of the reconstituted firm (i.e., after taking into consideration the capital brought in by the incoming partner) Value of Goodwill (A-B)
Illustration 12 A and B were partners sharing profits and losses equally having capital of A10,000 each. C is admitted for
1 th share in the profits of the firm and contributes A12,000 4
as his share of capital. Record the above transactions showing the treatment of goodwill. Solution : Working Note : C’s Capital for
1 th share = A12,000 4
So, A and B’s share for
3 th profit = 12,000×3=A36,000 4
But the combined capital of A and B = A20,000 Hence, Goodwill of the firm may be inferred at A36,000 – A20,000=A16,000 1
C’s share in the goodwill = A16,000× 4 =A4,000. JOURNAL Particulars
Date ? Cash A/c To C’s Capital A/c (Being capital brought in by C) C’s Capital A/c To A’s Capital A/c To B’s Capital A/c (Being the share of C’s goodwill in the firm credited to old partners’ capital accounts in sacrificing ratio)
Dr.
L.F. Dr. (A) 12,000
Cr.(A) 12,000
Dr.
4,000 2,000 2,000
396
Accountancy (Part-II)
Illustration 13 Pass journal entries to record the following adjustments relating to revaluation of assets and liabilities : (a) Machinery of A80,000 brought down by 15%. (b) Value of stock A30,000 appreciated by 10%. (c) Furniture of A12,000 is brought down to A9,000. (d) Stock of A35,000 is written down to A28,000. (e) Building of A1,00,000 is written up to A1,20,000. (f) Provision for doubtful debts @5% on Sundry Debtors of A50,000. (g) Creditors were over estimated by A5,000. (h) Interest accrued on investments A2,000 is to be brought into account. (i) A claim of A750 for damages should be created against the firm. (j) An old typewriter having a book value of A1,500 is to be written off fully. Solution : Date Particulars L.F. Dr. (A) Cr. (A) (a) Revaluation A/c Dr. 12,000 To Machinery A/c 12,000 (Being machinery brought down by 15%) (b) Stock A/c Dr. 3,000 To Revaluation A/c 3,000 (Being value of stock increased by A3,000) (c) Revaluation A/c Dr. 3,000 To Furniture A/c 3,000 (Being value of furniture decreased by A3,000) (d) Revaluation A/c Dr. 7,000 To stock 7,000 (Being value of stock decreased by A7,000) (e) Building A/c Dr. 20,000 To Revaluation A/c 20,000 (Being value of building increased) (f) Revaluation A/c Dr. 2,500 To Provision for doubtful debts A/c 2,500 (Being provision for doubtful debts created)
Admission of a Partner
397
(g) Creditors A/c To Revaluation A/c (Being creditor written down) (h) Accrued Interest A/c To Revaluation A/c (Being interest accrued on investment brought into account) (i) Revaluation A/c To Claim for damages A/c (Being claim for damages created) (J) Revaluation A/c To Typewriter A/c (Being old typewriter written off)
Dr.
5,000 5,000
Dr.
2,000 2,000
Dr.
750 750
Dr.
1,500 1,500
Illustration 14 The following was the Balance sheet of X and Y on 1st April 2016 : Liabilities
Amount (A) Sundry creditors Cash in hand 4,000 Bills Payable Sundry Debtors 12,000 Capital Accounts : Stock 14,000 X - 40,000 Machinery 10,000 70,000 Buildings 30,000 Y - 30,000 Furniture 5,000 75,000 75,000 X and Y share profits and losses in the ratio of 2:1. They decided to admit Z as a new partner with
Amount (A) 3,000 2,000
Assets
1 th share in the profits of the firm. Z paid in A35,000 on his share 4
of capital. It was agreed to revalue the assets and liabilities as follows : a) Stock to be appreciated by 10% b) Machinery to be depreciated by 5% c) Buildings to be written up to A38,000 d) Furniture is valued at A4,300
Accountancy (Part-II)
398 1
e) A provision for doubtful debts is to be created at 2 % on Sundry Debtors. 2 f) Creditors waive out their claim by A500. You are required to pass necessary journal entries and open necessary ledger accounts and show the Balance Sheet after Z’s admission. Solution : Journal Date Particulars L.F. Dr. (A) Cr. (A) ? Stock A/c Dr. 1,400 Buildings A/c Dr. 8,000 Creditors A/c Dr. 500 To Revaluation A/c 9,900 (Being revaluation of assets and liabilities made) ? Revaluation A/c Dr 1,500 To Machinery A/c 500 To Furniture A/c 700 To Provision for doubtful debts A/c 300 (Being assets revalued) Revaluation A/c Dr 8,400 To X’s Capital A/c 5,600 To Y’s Capital A/c 2,800 (Being profit on revaluation transferred to X’s and Y’s capital A/cs in old profit-sharing ratio) Cash A/c Dr. 35,000 To Z’s Capital A/c 35,000 (Being capital brought in by Z) Revaluation A/c Particulars Amount (A) Particulars To Machinery A/c 500 By Stock A/c To Furniture A/c 700 By Buildings A/c To Provision for doubtful debts A/c 300 By Creditors A/c To X’s capital A/c (profit) 5,600 To Y’s capital A/c (profit) 2,800 9,900
Amount (A) 1,400 8,000 500
9,900
Admission of a Partner
399
Partners Capital Accounts
Dr. X (A)
Y (A)
Z (A)
X (A)
Y (A)
Cr. Z (A)
By Balance b/d 40,000 30,000 -By Revaluation A/c (Profit) 5,600 2,800 By Cash --- 35,000 To Balance c/d 45,600 45,600
32,800 32,800
35,000 35,000 By Balance b/d
45,600 32,800 35,000 45,600 32,800 35,000
Cash Account
Dr Particulars To Balance b/d To Z’s Capital A/c
Amount (A) 4,000 35,000
Particulars
By Balance c/d 39,000 39,000
To Balance b/d
Cr. Amount (A)
39,000 39,000
Balance Sheet of X, Y and Z as on 1st April 2016 Liabilities Sundry Creditors Bills Payable Capital A/cs. X- 45,600 Y- 32,800 Z- 35,000
Amount (A) 2,500 2,000
Assets Amount (A) 39,000
Cash in hand Sundry Debtors 12,000 Less provision for doubtful debtrs 300 11,700 Stock 15,400 1,13,400 Furniture 4,300 Machinery 9,500 Buildings 38,000 1,17,900 1,17,900
Accountancy (Part-II)
400
Illustration 15 The following is the Balance Sheet of A, B and C who were equal partners : Balance Sheet of A, B and C as on 1st April 2016 Liabilities Amount Assets (A) Capital Accounts : Buildings A - 16,800 Furniture B - 12,600 Stock C - 6,000 35,400 Debtors Trade creditors 6,000 Cash Bills payable 3,600 45,000
Amount (A) 19,500 2,400 11,400 10,800 900 45,000
They agreed to take D into partnership and give him 1/4th share in the profits, on the following terms : (a)
D should bring a capital of A20,000.
(b)
Stock and Furniture be depreciated by 10%.
(c)
A provision for doubtful debts be created at 5% on sundry debtors.
(d)
A liability of A1,080 be created against bills discounted.
(e)
The value of building be increased to A27,000.
(f)
The assets and liabilities to appear in the new Balance Sheet at the old figures.
Prepare Memorandum Revaluation Account and the Balance Sheet after D’s admission into the firm. Solution : Memorandum Revaluation Account Dr. Particulars
Amount (A) To Stock A/c 1,140 To Furniture A/c 240 To Provision for doubtful debt A/c 540 To Reserve for bills discounted 1,080
Particulars By Buildings A/c
Cr. Amount (A) 7,500
Admission of a Partner
401
To Capital Accounts : A - 1,500 B - 1,500 C- 1,500
4,500
To Building A/c
7,500 7,500
7,500
7,500 By Stock A/c 1,140 By Furniture A/c 240 By Provision for doubtful debts 540 By Reserve for bills discounted 1,080 By Capital Accounts : A - 1,125 B - 1,125 C - 1,125 D - 1,125 4,500 7,500
Balance Sheet of A, B, C and D as on 1st April 2016 Liabilities Capital Accounts : A 17,175 B 12,975 C 6,375 D 18,875 Trade creditors Bills Payable
Amount (A)
55,400 6,000 3,600 65,000
Assets Buildings Furniture Stock Debtors Cash
Working Note : Balance of Capital Accounts : A’s Capital = A16,800+A1,500 – A1,125 = A17,175 B’s Capital = A12,600+A1,500 – A1,125 = A12,975 C’s Capital = A6,000+A1,500 – A1,125 = A6,375 D’s Capital = A20,000 – A1,125 = A18,875
Amount (A) 19,500 2,400 11,400 10,800 20,900
65,000
Accountancy (Part-II)
402
Illustration 16 P and Q are partners sharing profits in the ratio of 3:2. R is admitted and the new profit-sharing ratio is 2:2:1. R brings in A20,000 as his capital and could not pay any thing towards his share of goodwill which is valued at A3,000. The balance sheet of P and Q as on 31.03.2016 was as follows : Liabilities Amount (A) Assets Amount (A) Capital Accounts : Cash in hand 15,000 P - 15,000 Sundry assets 45,000 Q - 15,000 30,000 Profit and Loss A/c 10,000 General Reserve 8,000 Sundry Creditors 12,000 60,000 60,000 It was further agreed by all partners that the value of sundry assets be written down to A42,000 and sundry creditors be valued at A10,000, Pass journal entries to give effect to the above adjustments and prepare necessary ledger accounts and show the opening balance sheet of the firm after R’s admission. Solution : Working Note : P:Q = 3:2 P:Q:R = 2:2:1 Q’s profit – sharing ratio remains intact, i.e., P’s old profit sharing ratio was sacrificed
2 5
3 2 and new share is , which means P alone has 5 5
1 in favour of R. Hence, he is entitled to the compensation (goodwill) 5
from the new partner R. Date
Journal Particulars
? Cash A/c To R’s Capital A/c (Being capital brought in by R)
L.F. Dr.
Dr. Amt.(A) 20,000
Cr. Amt.(A) 20,000
Admission of a Partner
R’s Capital A/c Dr. To P’s Capital A/c (Being R’s share of goodwill debited to R’s capital and credited to P’s capital A/c) Revaluation A/c Dr. To Sundry Assets A/c (Being decrease in the value of assets) Sundry Creditors A/c Dr. To Revaluation A/c (Being decrease in the value of sundry creditor) P’s Capital A/c Dr. Q’s Capital A/c Dr. To Revaluation A/c (Being loss on revaluation transferred to Capital Accounts of old partners in old profit-sharing ratio) Profit and Loss A/c Dr. To P’s Capital A/c To Q’s Capital A/c (Being the undistributed profits transferred to old partners’ capital accounts in their old profit–sharing ratio) General Reserve A/c Dr. To P’s Capital A/c To Q’s Capital A/c (Being general reserve transferred to old partners’ Capital Accounts in old profit-sharing ratio.)
403
3,000 3,000
3,000 3,000 2,000 2,000
600 400 1000
10,000 6,000 4,000
8,000 4,800 3,200
Accountancy (Part-II)
404
Dr. Particulars To Sundry Assets
Dr.
Ledger Revaluation A/c Cr. Amount Particulars Amount (A) (A) 3,000 By Sundry Creditors 2,000 By Loss on Revaluation transferred to P’s Capital 600 Q’s Capital 400 3,000 3,000
General Reserve A/c Amount Particulars (A)
To P’s Capital A/c To Q’s Capital A/c
4,800 3,200
By Balance b/d
8,000
Cr. Amount (A) 8,000
8,000
Profit and Loss A/c Dr. Particulars To P’s Capital To Q’s Capital
Amount (A) 6,000 4,000 10,000
Particulars By Balance b/d
Cr. Amount (A) 10,000
10,000
Admission of a Partner
405
Partners’ Capital Accounts
Dr. P (A) To P’s Capital
Q (A) --
To Revaluation A/c 600 To Balance c/d 28,200 ` 28,800
Dr Particulars To Balance b/d To R’s Capital A/c
To Balance b/d
Liabilities Capital Accounts P- 28,200 Q- 21,800 R- 17,000 Sundry Creditors
R (A)
Cr. P (A)
15,000 400 -- By Cash -21,800 17,000 By R’s Capital A/c 3,000 By P and L A/c 6,000 By General Reserve A/c 4,800 22,200 20,000 28,800 By Balance b/d 28,200 --
3,000 By Balance b/d
Cash Account Amount Particulars (A) 15,000 20,000 By Balance c/d
35,000 35,000 Balance Sheet of P, Q,R as on 1st April 2016 Amount Assets (A) Cash in hand Sundry Assets
Q (A)
R (A)
15,000 --- 20,000 --4,000 -3,200 -22,200 20,000 21,800 17,000
Cr. Amount (A) 35,000
35,000
Amount (A) 35,000 42,000
67,000 10,000 77,000
77,000
406
Accountancy (Part-II)
8.5 QUESTIONS 1.
From the alternatives given under each bit write the correct answer along with its serial number against each bit :
(i)
When the share of goodwill of a new partner is brought in cash, it is shared by : (a) old partners in old profit – sharing ratio. (b) old partners in sacrificing ratio. (c) old partners in gaining ratio. (d) all the partners in new profit – sharing ratio.
(ii) A new partner may be admitted to the partnership : (a) without the consent of all partners. (b) with the consent of all partners. (c) with the consent of majority of partners. (d) with the consent of any one partner. (iii) At the time of admission of new partner, goodwill appearing in the books is shared among old partners in : (a) New profit sharing ratio. (b) Old profit sharing ratio. (c) Sacrificing ratio. (d) Equally. (iv) When assets are revalued, any increase in the value of assets is debited to : (a) Revaluation Account. (b) Asset Account. (c) Profit and Loss Account. (d) Profit and Loss Appropriation Account. (v)
The profit on revaluation of assets and liabilities are shared by : (a) old partners in sacrificing ratio.
Admission of a Partner
407
(b) old partners equally. (c) old partners in old profit – sharing ratio. (d) all partners including new partner in new ratio. (vi) A, B and C are partners in a firm. If D is to be admitted as a new partner : (a) old parnership has to be dissolved (b) old firm has to be dissolved. (c) Both old partnership and firm have to be dissolved. (d) Neither firm nor partnership need to be dissolved. (vii) The balance of Memorandum Revaluation Account (second part) is transferred to the capital accounts of the partners in : (a) Capital ratio (b) Old profit sharing ratio (c) New profit sharing ratio (d) Equally among all partners (viii) A and B who are partners sharing profits in the ratio of 3:1 and admit C for one –fourth share in the future profits, the profit sharing ratio will be : (a) A 9/16; B 3/16; C 4/16 (b) A 10/16; B 2/16; C 4/16 (c) A 8/16; B 4/16; C 4/16 (d) A 6/16; B 6/16; C 4/16 (ix) A and B sharing profits in the ratio of 2:1 admit C for The new profit and loss sharing ratio is : (a) 4:2:1 (b) 5:3:7 (c) 8:4:3 (d) 5:7:3
1 th share in future profits. 5
Accountancy (Part-II)
408
(x)
A and B sharing profits in the ratio of 5:3 admit C and new profit sharing ratio of A, B and C is fixed at 4:2:2. The ratio of sacrifice of A and B is : (a) 5:3 (b) 1:2 (c) 1:1 (d) 2:1
(xi) X and Y who shared profits in the ratio of 3:1 respectively admit Z to one – fourth share in the future profits. Z acquired his share equally from X and Y. The new profit sharing ratio would be : (a) 9:3:4 (b) 2:1:1 (c) 3:2:3 (d) 5:1:2 (xii) A and B are partners in a business sharing profits in the ratio of 5:3. They admit C as a partner with
1 3 1 th share in the profits which he acquires from A and th 4 4 4
from B. He pays A8,000 for his share of goodwill. A and B will be credited by: (a) A5,000 and A3000 respectively (b) A6,000 and A2000 respectively (c) A3,000 and A5,000 respectively (d) A4,000 each. [Ans. i (b), ii(b), iii(b), iv(b), v(c), vi(a), vii(c), viii(a), ix(c), x(c), xi(d), xii(b)] 2.
Answer the following questions in one ward or term each : (i)
By what name is the compensation, paid by a new partner to the old partners, known ?
(ii) By what name is the undistributed profit of a firm known ? (iii) What is the name given to the excess of desired total capital of a firm over the actual combined capital of all the partner ?
Admission of a Partner
409
(iv) On which side of Revaluation Account, unrecorded liabilities are recorded ? (v)
On which side of Revaluation Account, appreciation in building is recorded ?
(vi) In which ratio, goodwill brought in by new partner, is distributed among old partners ? [Ans.: (i) Goodwill, (ii) General Reserve/ Profit and Loss Account credit balance, (iii) Hidden goodwill, (iv) Debit side, (v) Credit side, (vi) Sacrificing ratio] 3.
Fill in the blanks with appropriate words : (i)
Share of goodwill brought in cash by the new partner in also called ____.
(ii) Reduction in provision for bad debts will be ______ to Revaluation A/c. (iii) Profit and loss arising from revaluation of assets and liabilities is shared by _______ partners. (iv) Old ratio is also the _______ ratio unless otherwise mentioned. (v)
_______ assets are debited to old partners’ Capital Accounts at the time of admission of partners.
[Ans : (i) Premium; (ii) credited, (iii) old, (iv) sacrificing, (v) Fictitious] 4.
Correct the underlined partions of the following sentences : (i)
Profits and loss adjustment account is otherwise known as profit and loss appropriation account.
(ii) The Employees’ Provident Fund represents profits. (iii) At the time of retirement of a partner, sacrificing ratio is calculated. (iv) As per AS-20 only purchased goodwill be recorded in the books of account. (v)
The sum of closing capital and opening capital divided by two is known as total capital employed.
(vi) Profit on revaluation of assets and liabilities is transferred to the capital of old partners in the sacrificing ratio. [Ans.: (i) Revaluation, (ii) liability, (iii) admission, (iv) AS-26, (v) average, (vi) old.]
Accountancy (Part-II)
410
5.
Answer the following questions in one sentence each : (i)
What do you understand by admission of a partner ?
(ii) State any one purpose of admitting a new partner into a firm. (iii) State any one right acquired by a newly admitted partner. (iv) What is sacrificing ratio ? (v)
State the ratio in which the old partners share all the accumulated profits, reserves and losses.
(vi) State whether Revaluation Account is debited or credited to record the increase in the value of an asset. (vii) List any two items that need adjustments in the books of accounts of a firm at the time of admission of a partner. (viii) State whether partner’s Capital Account is debited or credited to record the profit on Revaluation Account. (ix) Under what circumstance will the premium for goodwill paid by the incoming partner, not be recorded, in the books of accounts ? (x) 6.
State whether at the time of admission of a partner, partnership is dissolved or partnership firm is dissolved.
Answer the following questions within 30 words each : (i)
What is hidden goodwill ? How is it treated when a new partner is admitted ?
(ii) What is the effect of Memorandum Revaluation Account on partners’ capital accounts ? (iii) Explain the AS-26 with regard to the treatment of goodwill. (iv) Pass the journal entries when a new partner is unable to bring his share of goodwill in cash. (v)
On admission of a partner, what journal entries will be passed for : (a) Increase in assets (b) Increase in liabilities
7.
Answer the following questions within 50 words each : (i)
What do you mean by Memorandum Revaluation Account ?
Admission of a Partner
411
(ii) State any two circumstances when Revaluation Account will be debited and any two situation when Revaluation Account will be Credited. (iii) Why is it necessary to revalue the assets and reassess the liabilities in case of the admission of a partner ? (iv) Draw a Revaluation Account with imaginary amounts. (v) 8.
What entry will be passed when new partner brings in goodwill in cash ? In what ratio the old partners will divide it ?
A and B share the profits of a firm in the ratio of 3:2. They admit C as a partner and the new profit-sharing ratio becomes 3:2:1. The goodwill of the firm is valued at 2 years purchase of the average of three years profits. The profits of the firm for the last 3 years were A58,000; A68,000 and A54,000. C brings his share of goodwill in cash. Journalise the above transactions. [Ans.: Goodwill of the firm A1,20,000]
9.
P and Q are partners sharing profits and losses in the ratio of 3:2. They admit R into partnership with
1 1 th share in the profits which he acquires th from P and 4 6
1 th from Q. The goodwill of the firm is valued at A72,000. R pays A1,00,000 12
as capital and pays his share of goodwill in cash. Half of the amount of goodwill is withdrawn by the old partners. Give necessary journal entries. [Ans : P’s withdrawal A6,000 and Q’s withdrawal A3,000] 10. A, B and C are partners sharing profits in the ratio of 5:3:2. D is admitted with 1 th share. Goodwill of the firm is valued at A60,000. D brings in A80,000 as 10
his share of capital but could not pay anything for goodwill in cash. New ratio is fixed at 4:4:1:1. Pass journal entries. [Ans : B’s capital and D’s capital wil be debited by A6,000 each and A’s capital C’s capital will be credited by A6,000 each]
412
Accountancy (Part-II)
11. X and Y are partners sharing profits in the ratio of 3:2. Z is admitted and the new profit sharing ratio is 2:2:1. Z brings in cash A20,000 as capital and A3,000 as goodwill. The balance sheet of X and Y is as follows : Liabilities Amount Assets Amount (A) (A) Capital Accounts : X 40,000 Sundry Assets 80,000 Y 30,000 Reserve Fund 10,000 80,000 Give journal entries and prepare the balance sheet of new firm. 12. A and B are equal partners. They decided to admit C as a partner and readjust the Balance Sheet values for this purpose. The Balance Sheet of A and B as on 31st. December, 2016 was as follows : Liabilities Amount Assets Amount (A) (A) Creditors 1,000 Cash 600 Bills Payable 1,000 Debtors 1,500 Reserve Fund 400 Stock 1,400 A’s Capital 1,500 Furniture 400 B’s Capital 1,000 2,500 Machinery 1,000 4,900 4,900 The following adjustments are to be made before C’s admission : (a) A300 were to be provided for doubtful debts. (b) Furniture was valued at A250. (c) Investments worth A400 not shown in the Balance Sheet were to be taken into account. (d) C brings A1,000 as capital and A1,000 for goodwill which amount was withdrawn by A and B fully. Give journal entries, Revaluation Account and Balance Sheet of the new firm. [Ans.: Loss on Revaluation A50]
Admission of a Partner
413
13. X, Y and Z are partners in a firm sharing profits and losses in the ratio of 2:2:1.
Their Balance Sheet as on 31st March, 2017 was as follows : Liabilities
Sundry Creditors Outstanding liabilities General Reserve Capital Accounts : X 12,000 Y 12,000 Z 5,000
Amount (A) 12,850 1,500 6,500
Assets Land and Building Furniture Closing Stock Sundry Debtors Cash in hand Cash at Bank
29,000 49,850
Amount (A) 25,000 6,500 11,750 5,500 140 960 49,850
P is admitted as a partner with effect from 1st April 2017 on the following terms : a)
P shall bring A5,000 towards his capital.
b)
The value of stock be intereased by A2,500.
c)
Provision for bad and doubtful debts should be provided at 10% of the debtors.
d)
The furniture to be depreciated by 10%.
e)
The value of land and building be appreciated by 20%.
f)
The outstanding liabilities of A1,000 has been paid by X, for which no entry has been made in books.
g)
General reserve will be transferred to the capital accounts of partners.
h)
The new profit sharing ratio shall be 5:5:3:2 among X, Y, Z and P respectively.
Prepare Revaluation Account, Capital Accounts of partners and their new Balance Sheet. [Ans.: Profit on revaluation A6,300]
Accountancy (Part-II)
414
14. A, B and C are partners in a firm sharing profits and losses in the ratio of 2:3:1. They decided to admit D as a partner with
1 th share in the future profits. Their 4
Balance Sheet as on 31st March 2017 was as follows : Liabilities B’s Capital C’s Capital
Amount (A) 35,000 22,000
57,000
Assets Amount Furniture Motor Car Cash at Bank A’s Capital
(A) 10,000 20,000 18,000 9,000 57,000
The following adjustments are to be made : a) The motor car is taken over by B at a value of A25,000. b) The furniture is revalued at A18,000. c) D is to bring A20,000 as his capital and his share of goodwill in cash. The goodwill of the firm is valued of A48,000. d) Unrecorded debtors of A11,000 be brought into account. e) Expenses incurred, but not paid A3,000 are to be provided for. Pass journal entries and prepare Revaluation Account, Capital Accounts of Partners and the new Balance Sheet after D’s admission. 15. The following is the Balance Sheet of P, Q and R as on 31.03.2017. Liabilities Amount Assets Amount (A) (A) Creditors 11,000 Cash 1,500 Bills Payable 6,000 Debtors 26,500 Capital Accounts : Stock 30,000 P 40,000 Furniture 7,500 Q 33,500 Land and Building 50,000 R 25,000 98,500 1,15,500 1,15,500
Admission of a Partner
415
They share profits in the ratio of 6:5:3. On 1st April 2017, they agreed to admit S as a partner giving him
1 th share in future profits. The following 10
arrangements were made : a)
S should bring A14,840 as his capital.
b)
Stock be depreciated by 10% and furniture by A900.
c)
A reserve of A1,300 be made for outstanding repair bill.
d)
The value of land and buildings be brought upto A65,000.
e)
S does not contribute anything for goodwill which was valued at 8,400 for the firm. Pass necessary journal entries to record the above and prepare the new Balance Sheet.
16. The Balance Sheet of A, B and C sharing profits in the ratio of 3:2:1, is given below : Liabilities Amount Assets Amount (A) (A) Trade creditors 1,60,000 Cash at Bank 40,000 Employee’s Provident Fund 20,000 Debtors 2,00,000 Contingency Reserve 1,26,000 Less provision 3,000 1,97,000 Stock 2,03,000 A’s Capital 4,00,000 Furniture 30,000 B’s Capital 4,00,000 Machinery 5,30,000 C’s Capital 2,00,000 Buildings 3,00,000 Advertisement Suspense A/c 6,000 13,06,000 13,06,000 They decided to admit D into partnership on the following terms and conditions: a)
New profit – sharing ratio will be 3:3:2:2.
416
Accountancy (Part-II)
b)
Goodwill of the firm is valued at A3,00,000 and D brings his share of goodwill in cash.
c)
D should bring a capital of A1,50,000.
d)
Contingeney Reserve is no more required.
e)
Provision for doubtful debts to be raised to 5% on debtors.
f)
Machinery is found overvalued by A30,000 and Building is found undervalued by A67,000. Prepare Revaluation Account, Capital Accounts of partners and the new Balance Sheet. [Ans.: Revaluation profit A1,56,000]
17. The Balance Sheet of A and B who share profits and losses in the ratio of 3:2 as on 31st March 2017 was as follows : Liabilities Amount Assets Amount (A) (A) A’s Capital 1,00,000 Goodwill 20,000 B’s Capital 75,000 Plant 45,000 Creditors 70,000 Furniture and Fittings 37,500 Provident Fund 20,000 Stock 57,500 Bills Receivable 10,000 Debtors 55,000 Cash 40,000 2,65,000 2,65,000 On 1st April, 2017, C was admitted into partnership on the following terms : a)
New profit – sharing ratio will be 2:2:1.
b)
C is to bring his capital of A50,000 in cash and to pay his share of goodwill in cash. Goodwill for this purpose, is to be valued at 2 years purchase of average of the previous 4 years profits. The profits for the past four years were A25,000; A22,500; A25,000 and A27,500.
Admission of a Partner
c)
417
Other assets are valued as under : Plant A52,000; Furniture and Fittings A32,000; Stock A63,000; Debtors A50,000.
d)
The value of assets except cash shall remain unchanged. Give necessary journal entries and the opening Balance Sheet of the reconstituted firm. [Ans : value of goodwill A50,000. Revaluaiton profit A2,500]
18. A and B are partners sharing profits in the ratio of 2:1. Their Balance Sheet as on 31st March 2017 is as follows : Liabilities Amount Assets Amount (A) (A) Sundry Creditors 44,000 Cash 17,000 Capital Accounts : Sundry Debtors 15,000 A 30,000 Bills Receivable 4,000 B 20,000 50,000 Stock 25,000 Furniture and Fixtures 3,000 Land & Buildings 30,000 94,000
94,000
C is admitted to partnership with effect from 1st April 2017 on the following terms : a)
That he brings in A15,000 as his capital for
1 th share and pays A6,000 for 4
goodwill, half of which is to be withdrawn by A and B. b)
Provision to the extent of A1,500 is to be made since there is likely to be claim against the firm for damages.
c)
A liability on account of unpaid electricity bill of A500 is to be provided for.
d)
That the stock is to be reduced to A23,000 and furniture and fittings by A1,000.
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e)
That a 5% reserve for bad debt is to be created.
f)
That value of land and buildings be appreciated by 20%.
g)
An item of A1,200 included in creditors has to be written off.
h)
That the value of assets and liabilities will not change except cash. Prepare the necessary accounts and opening Balance Sheet the firm. [Ans : Profit on Revaluation (1st part A1,450)]
-o-
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Accountancy (Part-II)
9.10 QUESTIONS 1.
From the alternatives given below, choose and write the correct answer along with its serial number against each :
(i)
Minimum number of shareholders in a private limited campany other than one person company is : (a) 7 (b) 50 (c) 2 (d) 10
(ii)
Minimum number of shareholders in a public limited company is : (a) 2 (b) 7 (c) 50 (d) 20
(iii)
Maximum number of shareholders in a private company is : (a) 200 (b) 50 (c) 7 (d) No limit as to maximum number
(iv)
Maximum number of shareholders in a public limited company is : (a) No limit as to maximum number (b) 50 (c) 7 (d) 100
(v)
As per the Comapnies Act, 2013, minimum amount of paid up share capital in a private limited company is : (a) A5 lakh (b) A1 lakh (c) A2 lakh (d) A10 lakh
(vi)
As per the Comapnies Act, 2013, minimum amount of paid up share capital in a public limited company is : (a) A2 lakh (b) A5 lakh (c) A1 lakh (d) No such minimum amount
(vii)
The equity shareholders of a company are : (a) creditors (b) debtors (c) owners (d) customers of the company
(viii) The preference shareholders of a company have preferential right : (a) to receive dividednd (b) to return of capital when the company goes into liquidation (c) both (a) and (b) above (d) to participate in management
Accounting for Companies : Accounting for Share Capital
(ix)
549
Preference shareholders who do not have any right to share the surplus left over after paying equity shareholders are called : (a) Non-participating preference shareholders (b) Non-convertible preference shareholders (c) Non-cumulative preference shareholders (d) Irredeemable preference shareholders
(x)
Nominal share capital is : (a) the amount of share capital issued by a company (b) the amount of share capital subscribed by the public (c) the amount of share capital which is actually paid by the shareholders (d) the maximum amount of capital which a company is authorised to raise
(xi)
(xii)
The part of share capital which can be called up only in the event of winding up of a company is known as : (a) authorised capital
(b) called up capital
(c) reserve capital
(d) uncalled capital
The minimum share application money as per Companies Act is : (a) 5% of the nominal value of shares (b) 10% of the nominal value of shares (c) 25% of the nominal value of shares (d) 5% of the issue price of shares
(xiii) As per the guidelines of Securities and Exchange Board of India, the minimum share application money is : (a) 5% of the nominal value of shares (b) 25% of the nominal value of shares (c) 5% of the issue price of shares (d) 25% of the issue price of shares
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(xiv) When excess application money is to be adjusted towards allotment, the accoutn to be credited is :
(xv)
(a) share applicatiion account
(b) share allotment account
(c) share capital account
(d) calls-in-advance account
According to Table F ot the Companies Act, 2013, the maximum amount of one call should not exceed : (a) 5% of the nominal value of shares (b) 25% of the nominal value of shares (c) 10% of the nominal value of shares (d) 25% of the issue price of shares
(xvi) When shares are allotted, one of the following accounts to be credited is : (a) share allotment account
(b) share capital account
(c) share application account
(d) bank account
(xvii) Securities premium cannot be utilised for : (a) issuing fully paid bonus shares to the members (b) writing off the preliminary expenses of the company (c) writing off discount on issue of debentures of the company (d) declaration of dividend to the shareholders (xviii) If the Articles of Association are silent, interest on calls-in-arrear in charged at a maximum rate of : (a) 5% p.a. (b) 10% p.a. (c) 12% p.a. (d) 6% p.a. (xix) As per the provisions of Table F of the Companies Act, 2013, interest on calls-in-advance is payable by the company at : (a) 5% p.a. (b) 10% p.a. (c) 12% p.a. (d) 6% p.a.
Accounting for Companies : Accounting for Share Capital
(xx)
551
Amount of calls-in-advance is : (a) added to share capital in the Balance Sheet (b) deducted from share capital in the Balance Sheet (c) shown on the assets side of the Balance Sheet (d) shown on the Equity and Liabilities side of the Balance Sheet
(xxi) A company offered 10,000 shares of A10 for public subscription. 8,000 shares were subscribed on which A8 per share was called up. Amount due on 7,000 shares was received at A8 per share and A6 per share on 1,000 shares. The paid up capital of the company is : (a) A64,000 (b) A8,000 (c) A62,000 (d) A56,000 (xxii) On forfeiture of shares, the account to be debited is : (a) Share forfeiture A/c
(b) Capital reserve A/c
(c) Shareholders' A/c
(d) Share capital A/c
(xxiii) Shares can be forfeited : (a) for failure to pay the allotment or call money (b) for failure to attend the shareholders' meeting (c) for failure to repay the loan to the bank for which the shares are pledged as security (d) for not buying the products of the company (xxiv) On forfeiture, share capital account is debited with : (a) the amount received on such forfeited shares (b) the nominal value of shares forfeited (c) the called up amount on the forfeited shares (d) the amount not received on the shares forfeited
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(xxv) The profit on reissue of forfeited shares is transferred to : (a) General Reserve A/c
(b) Capital reserve A/c
(c) Capital Redemption Reserve A/c
(d) Securities Premium Reserve A/c
(xxvi) On forfeiture of shares, the share forfeiture account is credited with : (a) the amount not received on shares forfeited (b) the amount received on such forfeited shares (c) the nominal value shares forfeited (d) the called up amount on the shares forfeited (xxvii) If a share of A100 issued at par is forfeited on which A80 has been called up and A60 paid, the share capital account is debited with : (a) A60 (b) A80 (c) A20 (d) A40 (xxviii) The balance of share forfeiture account is shown in the Balance Sheet under the head : (a) Reserves and Surplus
(b) Share Capital
(c) Current Liabilities
(d) Non-current Liabilities
(xxix) If a share of A100 issued at a premium of A20, is forfeited in respect of which the full amount has been called up and A80 (including premium) is paid, the share capital account is debited with : (a) A120 (b) A100 (c) A80 (d) A20 (xxx) X Ltd. forfeited 100 shares of A10 each issued at par and fully called up, on whih A4 per share was paid. The minimum price which the company must charge, if all the forfeited shares are reissued as fully paid up is : (a) A600 (b) A1,000 (c) A400 (d) A800 [Ans : (i) c, (ii) b, (iii) a, (iv) a, (v) b, (vi) b, (vii) c, (viii) c, (ix) a, (x) d, (xi) c,
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553
(xii) a, (xiii) d, (xiv) b, (xv) d, (xvi) b, (xvii) d, (xviii) b, (xix) c, (xx) d, (xxi) c, (xxii) d, (xxiii) a , (xxiv) c, (xxv) b, (xxvi) b, (xxvii) b, (xxviii) b, (xxix) b, (xxx) a.] 2.
Answer the following questions in one word/term each :
(i)
Name the company which has only one person as its member.
(ii)
Name the company which limits the number of its members to 200.
(iii)
Which type of comapny has a minimum paid up capital of rupees five lakh or such higher paid up capital as may be prescribed ?
(iv)
Which type of shares have voting rights ?
(v)
Which type of shares carry preferential rights as regards payment of dividend and repayment of capital ?
(vi)
What is the other name of authorised capital ?
(vii)
Under which head of the Balance Sheet 'securities premium reserve accoun' is shown ?
(viii) Which balance does calls-in-arrear account show ? (ix)
What is the maximum rate of interest charged on 'calls-in-arrear' as per Table F of schedule I of the Companies Act, 2013 ?
(x)
What is the maximum rate of interest paid on 'calls-in'advance' as per the Table F of schedule I of the Companies Act, 2013 ?
(xi)
Under which head of the Balance Sheet, Share Forfeiture A/c' is shown ? [Ans : (i) one person company, (ii) Private Limited company, (iii) Public Limited company, (iv) Equity shares (v) Preference shares (vi) Nominal or Registered capital (vii) Reserves and surplus, (viii) Debit, (ix) 10%, (x) 12%, (xi) current liabilities, (xii) Share Capital.]
554
Accountancy (Part-II)
3.
Answer the following questions in one sentence each:
(i)
State any one essential feature of a joint stock company.
(ii)
Write any one feature of a private limited company.
(iii)
Write any one essential feature of a public limited comapny.
(iv)
What is a share ?
(v)
What do you mean by redeemable preference shares ?
(vi)
What is authorised capital of a company ?
(vii)
What is subscribed capital ?
(viii) How does 'Securities premium Reserve' appear in the Balance Sheet ? (ix)
What do you mean by Over-subseription ?
(x)
What is under-subscription ?
(xi)
What are calls-in arrear ?
(xii)
What are calls-in-advance ?
(xiii) How are calls-in-advance shown in the Balance Sheet ? (xiv) How are calls-in-arrear shown in the Balance Sheet ? (xv)
What is the name given to the part of capital of a company which is called up only on winding up ?
(xvi) State the meaning of 'subscribed and fully paid up capital ? (xvii) What is the maximum amount of discount which may be allowed on reissue of forfeited shares ? (xviii) What is meant by 'Issue of shares at par' ? (xix) Where would you transfer the balance left in the 'Share Forfeiture Account' after the reissue of such shares ? (xx)
How does 'Capital Reserve' appear in the Balance Sheet ?
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4.
Correct the underlined portion of the following sentences:
(i)
Liability of a shareholder is limited to paid up value of the shares allotted to him.
(ii)
Calls-in-advance is shown separately in the Balance Sheet under the main head 'Current Assets'.
(iii)
The maximum rate of interest on calls-in-advance payable by a company is 6% p.a. as per Table F of schedule I of the Companies Act, 2013.
(iv)
As per Table F of schedule I of the Companies Act, 2013, a company can charge interest @5% p.a. on calls-in-arrear.
(v)
Subscribed capital refers to the maximum amount which a company is authorised to issue shares.
(vi)
Shares are said to have been issued at par when an applicant has to pay a sum more than the face value of the share.
(vii)
Shares are said to be under-subscribed when the number of shares applied for is more than the number of shares offered to the public for subscription.
(viii) Redeemable preference shareholders have a right to get their preference shares converted into equity shares at their option according to the terms of issue. (ix)
Authorised capital is that part of issued capital which is subscribed for by the public.
(x)
Paid up capital is that part of subscribed capital. which has been called up for payment by the directors, from shareholders. [Ans.: (i) face, (ii) Liabilities, (iii) 12%, (iv) 10%, (v) Authorised, (vi) premium, (vii) over-subscribed, (viii) convertible, (ix) subscribed, (x) called.]
5.
Fill up the blanks: (i) Maximum number of shareholders in a private limited company is _______.
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Accountancy (Part-II)
(ii) Minimum number of shareholders in a public limited company is _______. (iii) The equity shareholders are the _______of a company. (iv) The part of share capital which can be called up only is the event of winding up of a company is known as _______capital. (v)
The minimum share application money is _______% of the issue price of shares as per the guidelines of Securities and Exchange Board of India.
(vi)
When shares are allotted, share _______account is credited.
(vii)
The balance of calls-in-arrear account is shown on the Equity and Liabilities side of the Balance Sheet by way of _______from called up capital under the head 'subscribed but not fully paid capital ?
(viii) The amount of calls-in-advance is a _______of the company. (ix)
Calls-in-advance is shown on the Equity and Liabilities side of the Balance Sheet under the main head 'Current Liabilities' and sub-head 'Other _______Liabilities.
(x)
As per Table _______of schedule I of the Companies Act, 2013, a company may pay maximum 12% p.a. interest on calls-in-advance.
(xi)
When shares are forfeited, share _______account is debited for the amount already called up on shares forfeited.
(xii)
After the reissue of all the forfeited shares, the credit balance of share forfeiture acount is tranferred to capital reserve account and is shown under the head 'Shareholders' Funds' and sub-head 'Reserve and _______.
(xiii) The company cannot proceed with the allotment of shares, unless it receives _______subscription. (xiv) If any shareholder fails to pay the allotment money or any call money within the specified period, the company may _______his shares.
Accounting for Companies : Accounting for Share Capital
(xv)
557
According to the guidlines of SEBI, minimum subscription has been fixed at _______% of the issued amount. [Ans.: (i) 200, (ii) 7, (iii) owners, (iv) reserve, (v) 25, (vi) capital, (vii) deduction, (viii) debt, (ix) other, (x) F, (xi) capital, (xii) surplus, (xiii) minimum, (xiv) forfeit, (xv) 90.)
6.
Answer the following questions within 30 words each: (i) Write any two features of a joint stock company. (ii) State any two features of a private limited company. (iii) Write any two essential features of a publci limited company. (iv) What are the types of shares which a company can issue ? (v) What are preference shares ? (vi) What are equity shares ? (vii) What is cumulative preference share ? (viii) What do you mean by redeemable preference share ? (ix) What is participating preference share ? (x) What do you mean by convertible preference shares ? (xi) What is authorised capital ? (xii) What is subscribed capital ? (xiii) What do you mean by 'Issued capital' ? (xiv) What is meant by 'Reserve Capital' ? (xv) What do you mean by 'sweat equity shares' ? (xvi) What is meant by 'Issue of shares at a premium' ? (xvii) Write any two purposes for which securities premium can be utilised by a company. (xviii) What is meant by 'over-subscription' ? (xix) What is pro rata allotment of shares ?
558
Accountancy (Part-II)
(xx) What is calls-in arrear ? (xxi) What is calls-in-advance ? (xxii) What is meant by 'Issue of shares for consideration other than cash' ? (xxiii) What is forfeiture of shares ? (xxiv) How are forfeited shares reissued ? (xxv) State the steps a company can take in case of over-subscription of shares other than rejecting applications. 7.
Answer the following questions within 50 words each : (i) State any three points of distinction between private limited company and public limited company. (ii) Write any three points of distinction between an equity share and a preference share. (iii) Write any three points of distinction between calls-in-arrear and calls-inadvance. (iv) What do you mean by 'private placement of shares' ? (v) What is pro rata allotment of shares ? (vi) What is 'Minimum subscription' ? (vii) What is meant by 'Issue of shares for consideration other than cash' ? (viii) State the purposes for which securities premium can be utilised. (ix) State any six essential features of a joint stock company. (x) Mention the alternatives while allotting shares in case of over-subscription by public.
8.
Define a joint stock company. Discuss the essential features of a joint stock company.
9.
What is a public limited company ? State the differences between a private limited and a public limited company.
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10.
What do you mean by 'share' ? Describe the different classes of shares which a company can issue.
11.
What is a preference share ? Distinguish between preference share and equity share.
12.
What is share capital ? Explain different classes of share capital. How are they shown in the Balance Sheet ?
13.
Discuss brifely the different kinds of companies.
14.
Can the shares be issued at a premium ? State the purposes for which securities premium reserve can be utilised.
15.
What is over-subscription of shares ? How does a company allot shares in case of over-subscription ? Illustrate your answer.
16.
What is 'calls-in-arrear' ? Explain the accounting treatment of calls-in-arrear with suitable examples.
17.
What is calls-in-advance ? Discuss the accounting treatment of calls-in-advance with imaginary figures.
18.
What is forfeiture of shares ? Can forfeited shares be reissued at discount ? If so, th what extent ? Where would you transfer the balance of share forfeiture account after reissue of the forfeited shares ? Explain with examples.
19.
A Ltd. was incorported with an authorised capital of A50,00,000, divided into 5,00,000 Equity shares of A10 each. The company offered 1,00,000 Equity shares for public subscription. The public applied for 80,000 Equity shares and the amount due on these shares was duly received. How will you show the 'Share Capital' in the Balance Sheet of the company as per Schedule III of the Companies Act, 2013 ? Also prepare 'Notes to Accounts' for the same. [Ans.: Subscribed and fully paid up capital A8,00,000.]
20.
B. Ltd. was registered with an authorised capital of A50,00,000 in Equity shares of A10 each. If offered 1,00,000 Equity shares for public subscription.
560
Accountancy (Part-II)
The public applied for 80,000 Equity shares and the shares were fully allotted. The Directors called up A8 per shares on these shares. The entire called up amount on shares was received except A2 per share on 1,000 shares. Prepare an extract of the Balance Sheet of B. Ltd. showing 'share capital' as per the schedule III, of Companies Act, 2013 and also prepare 'Notes to Accounts'. [Ans: Subscribed but not fully paid up capital A6,38,000.] 21.
AB Ltd. was formed on 1.1.2016 with an authorised capital of A50,00,000 divided into 5,00,000 Equity shares of A10 each. It offered 20% of the shares to the public for subscription. Public applied for 80,000 shares and the shares were duly allotted. All calls were made and the amount duly received except A2 per share on 500 shares. Show the 'share capital' is the Balance Sheet of the company as per schedule III of the Companies Act, 2013 at the end of financial year. Also prepare 'Notes to Accounts' for the same. [Ans.: Subscribed and fully paid up capital A7,95,000 and Subscribed but not fully paid up capital A4,000.]
22.
X Ltd. was incorporated on 1.6.2015 with an authorised capital of A50,00,000, divided into 5,00,000 Equity shares of A10 each. Out of these, 20,000 Equity shares were issued to the vendors as fully paid up as purchase consideration for a machine purchased and issued 80,000 Equity shares to the public for subscription, the entire issue being subscribed and duly allotted. The amounts due on these shares were received in full except A2 per share on 6,000 shares. You are required to : (a) show the 'share capital' in the Balance Sheet of X Ltd. as per schedule III of the Companies Act, 2013 as at 31st March, 2016, and (b) prepare 'Notes to Accounts' relating to share capital. [Ans : Subscibed and fully paid up capital A9,40,000, and subscribed but not fully paid up capital A48,000.]
Accounting for Companies : Accounting for Share Capital
23.
561
Y Ltd. was formed on 1.10.2015 with an authorised capital of A50,00,000, divided into 4,00,000 Equity shares of A10 each and 1,00,000 6% Preference shares of A10 each. The company issued 80,000 Equity shares and 20,000 6% preference shares for public subscription. Applications for 75,000 Equity shares and 15,000 6% preference shares were received and duly allotted by the directors. The amounts due on these shares were received in full except A2 per share on 500 Equity shares and A3 per share on 1,000 6% preference shares. Prepare an extract of the Balance Sheet of Y Ltd. as at 31st March, 2016 showing 'share capital' as per the Schedule III of the Companies Act, 2013 and also prepare 'Note to Accounts'. [Ans. Subscribed and fully paid up capital: Equity share capital A7,45,000, 6% Preference share capital A1,40,000 Subscribed but not fully paid up capital : Equity share capital A4,000, 6% Preference share capital A7,000.]
24.
Moon Ltd. issued 20,000 Equity shares of A10 each, payable on application A3, on allotment A3, A2 on each two subsequent calls. All shares were subscribed in full and were duly allotted. All the calls were made and money realised. Show the journal entries to record the above transactions in the books of Moon Ltd.
25.
Star Ltd. issued 50,000 Equity shares of A10 each, payable A3 on application, A2 on allotment, A2.50 on first call and A2.50 on final call. The public applied for all the shares which were subsequently allotted. All the calls were duly made and amounts were fully realised. Pass the journal entries, prepare the cash book and necessary ledger accounts in the books of Star Ltd. [Ans. Cash at Bank A5,00,000]
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26.
Skyview Ltd. offered for public subscription 30,000 Equity shares of A10 each and 50,000 10% preference shares of A10 each, payable as follows: For Equity Shares
For Preference shares
On application
A3.50
A3.00
On allotment
A4.50
A5.00
On first and final call
A2.00
A2.00
Public applied for 40,000 Equity shares and 60,000 10% preference shares. The company rejected the application for 10,000 Equity shares and 10,000 preference shares and remaining applications were accepted in full. All the calls were duly made and money was realised. Prepare the cash book and pass journal entries in the books of Skyview Ltd. [Ans. Cash at Bank A8,00,000] 27.
Sunshine Ltd. offered 80,000 Equity shares of A10 each for public subscription on 1.5.2016, payable as follows : On application A3 per share On allotment (1.7.2016) A5 per share On first and final call A2 per share (one month after allotment) Public applied for 75,000 shares and the application money was duly received by 1.6.2016. All amounts due on allotment were received by 25.7.2016 and amounts due on call were received by 25.8.2016. Journalise the transactions. The company maintains the joint account for application and allotment.
28.
Sun Ltd. issued 1,00,000 Equity shares of A10 each at a premium of A2 per share payable as follows: On application A3.00
Accounting for Companies : Accounting for Share Capital
563
On allotment A6.00 On first and final call A3.00 The issue was fully subscribed and duly allotted. The call was also made. All sums were received. Pass journal entries if, a)
Securities premium is included with application money,
b)
Securities premium is included with allotment money, and
c)
Securities premium is included with call money.
29.
Mind fire Ltd. was incorporated with an authorised capital of A50,00,000 in Equity shares of A100 each. The company issued 30,000 Equity shares of A100 each at A120 per share, payable on application A50, on allotment A50 (including premium of A10), and on call A20 (including premium of A10). All the shares were applied for and allotted. All the amounts including call money were duly received. Share issue expenses amounted to A5,000, which were fully written off against securities premium. Prepare the Bank Account, pass necessary journal entries in the looks of the company and show the Balance Sheet after the issue of shares. [Ans.: Subscribed and fully paid up capital A30,00,000, Reserves and Surplus A5,95,000 cash, Cash at Bank A35,95,000]
30.
AB Ltd. had an authorised capital of A30,00,000 in Equity shares of A100 each. The company issued 20,000 Equity shares of A100 each at A120 per share, payable as follows : On application
A40
On allotment
A60 (including premium)
and on first and final call A20.
Accountancy (Part-II)
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All the shares were subscribed by the public and the directors made the allotment in full to all the applicants. All the amounts due on allotment and first and final call were received except the first and final call money on 5,000 Equity shares. Prepare the Cash Book and Journal of the company. Also prepare the Balance Sheet showing the items in respect of the above issue of shares, (a) without opening Calls - in - Arrear A/c and (b) by opening Calls-in-Arrear A/c. [Ans.: Subscribed and fully paid up capital A15,00,000 Subscribed but not fully paid up capital A4,00,000 Reserves and Surplus A4,00,000 Cash at Bank A23,00,000.] 31.
BK Ltd. was incorporated with a capital of 5,00,000 Equity shares of A10 each. The company issued 2,00,000 Equity shares of A10 each at A12 per share, payable as follows : On application
A5
On allotment
A5 (including premium)
and on call
A2
(three months after allotment) All the shares were subscribed. The allotment was made and all the amounts received except the allotment money on 2,000 shares, which was received with the call money (the amount due on call received in full) together with interest as per the provisions of Table F. Pass entries in the Cash Book and Journal. [Ans.: Cash at Bank A24,00, 250.] Note : Interest on calls-in-arrear is calculated at the maximum rate of 10%
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565
p.a. as per Table F. 32.
ABC Ltd. with authorised capital of A1,00,00,000 in Equity shares of A100 each, issued 60,000 of such shares payable as follows : On application
A30
On allotment
A50 (including premium)
On first call
A20
On final call
A20.
All the shares were subscribed by the public. The allotment was duly made and money was received. On first call being made, Rakesh to whom 3,000 shares were allotted, paid the entire amount due on his shares. Final call is yet to be made. Pass journal entries to record the above transactions and prepare the Balance Sheet. [Ans.: Subscribed but not fully paid up capital A48,00,000 Reserves and Surplus A12,00,000 Other Current Liabilities A60,000 Cash at Bank A60,60,000.] 33.
New India Ltd. issued 50,000 Equity shares of A10 each at a premium of A2 per share, payable as follows : On application
A3
On allotment
A5 (including premium)
and the balance by two equal calls. The due dates of the instalments were : application on 1.10.2015
Accountancy (Part-II)
566
allotment on 1.11.2015 first call on 1.1.2016 final call on 1.3.2016 Interest was to be paid @12% p.a. on calls-in-advance as per the Articles of Association of the company. All the shares were fully subscribed and duly allotted, The amounts were received on the due dates. Ram, holding 5,000 shares, paid the entire amount due on his holdings with the allotment money. You are required to prepare the Cash Book and the Journal in the books of the company. [Ans.: Cash at Bank A5,99,400.] 34.
AB Ltd. was registered with a capital of A60,00,000 in Equity shares of A100 each. 30,000 of such Equity shares were issued for public subscription at a premium of A20 per share and payable as follows : On application
A25 per share
On allotment
A45 per share including premium
On first call
A20 per share and
the balance as and when required. All the amounts were received except Mr. A, holding 3,000 shares, failed to pay the amount due on first call and Mr. B, holding 6,000 shares, paid the entire amount due on final call (not yet made) along with the first call money. Record these transactions in the Journal of the company and prepare the Balance Sheet. [Ans .: Subscribed but not fully paid up capital A20,40,000 Reserves and Surplus A6,00,000 Other Current Liabilities A1,80,000 Cash at Bank A28,20,000.]
Accounting for Companies : Accounting for Share Capital
35.
567
Star Ltd. invited applications for issue of 60,000 Equity shares of A10 each, payable as follows : On application
A3
On allotment
A5
On call
A2.
Applications were received for 50,000 shares and allotment was made in full. Akash to whom 1,000 shares were allotted, failed to pay the amount due on allotment and call. Surya, who had applied for 500 shares, failed to pay the amount due on call. Pass the necessary journal entries to record the above transactions. [Ans.: Total calls-in-arrear A8,000.] 36.
XYZ Ltd. invited applications for 30,000 Equity shares of A100 each, payable as follows : On application
A40
On allotment
A40
On call
A20
Applications were received for 40,000 shares. The Board of Directors accepted applications for 30,000 shares and rejected the remaining applications. Excess application money was refunded. Allotment money was received in full and call money was received on 28,000 shares. Pass journal entries. [Ans.: Excess application money refunded A4,00,000 Calls-in-Arrear A40,000.] 37.
Jay Prakash Ltd. invited applications for issue of 30,000 Equity shares of A100 each, payable A60 on application, A20 on allotment and A20 on first
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Accountancy (Part-II)
and final call. Applications were received for 45,000 shares. It was decided by the Board of Directors to allot 30,000 shares on pro-rata basis and utilise the excess application money towards the amount due on allotment and the balance, if any, to be refunded. Prepare the Cash Book and Journal in the books of the company assuming the amounts due were duly received. [Ans. Excess application money refunded A3,00,000. Cash at Bank A30,00,000.] 38.
Himalaya Ltd. invited applications for issue of 20,000 Equity shares of A100 each, payable A60 on application, A20 on allotment and A20 on first and final call. Applications were received for 30,000 shares. Directors decided to allot 20,000 shares on pro-rata basis and utilise the excess application money towards the amounts due on allotment and call. Pass journal entries in the books of Himalaya Ltd. assuming the amounts due were duly received. [Ans.: Excess application money adjusted on allotment A4,00,000 and on call A2,00,000]
39.
XY Ltd. issued 50,000 Equity shares of A10 each for public subscription, payable as A5 on application, A3 on allotment and A2 on first and final call. Applications for 80,000 shares were received. The directors allotted the shares as follows : I. To the applicants for 20,000 shares- 20,000 shares II. To the applicants for 50,000 shares-30,000 shares III. To the applicants for 10,000 shares - NIL Call was made and the amounts due were received. Pass the jounal entries for
Accounting for Companies : Accounting for Share Capital
569
the above transactions, assuming that the excess application money on partial allotment category was adjusted towards allotment and call. [Ans.: Excess application money adjusted towards allotment A90,000 and call A10,000. Excess application money refunded A50,000.] 40. Sunshine Ltd. issued 5,000 Equity shares of A100 each for public subscription, payable on application A50, on allotment A30 and first and final call A20. Applications were received for 12,500 shares. It was decided : (i) to refuse allotment to the applicants for 2,500 shares, (ii) to allot at 50% to Mr. X who had applied for 4,000 shares, (iii) to allot in full to Mr. Y who had applied for 2,000 shares, (iv) to allot balance of available shares on pro-rata basis among remaining applicants, (v) to utilise excess application money towards allotment and call. Pass necessary journal entries assuming that the entire amount due on allotment and call was received. [Ans.: Excess application money adjusted towards allotment A90,000 and call A60,000. Allotment money received A60,000 and call money received A40,000. Excess application money refunded A2,25,000.] 41. Sunrise Ltd. issued 6,000 Equity shares of A100 each at A120 per share for public subscription, payable on application A50, on allotment (including premium) A50 and balance on call at the end of 3 months from the date of allotment. Application for 8,500 shares were received by 5.4.2016 and shares were allotted on 24.4.2016
Accountancy (Part-II)
570
at the rate of 3 shares for every 4 shares applied for and an amount of 25,000 was refunded on the same date. All the amounts due on allotment and call were received on due dates. Pass Journal entries in the books of the company. [Ans.: Excess application money adjusted towards allotment A1,00,000, Allotment money received A2,00,000] [Hints. : Applications for 500 shares, i.e, A25,000 / 50 rejected and 6,000 shares were allotted among applicants for 8,000 shares] 42. X Ltd. issued for public subscription 5,000 Equity shares of A100 each at par, the entire amount being payable with application. Applications received for all the shares and shares were duly allotted. Pass necessary journal entries in the books of the Company. 43. A Ltd. Purchased a Building for A12,00,000 from Biswakarma Builders. It issued Equity shares of A100 each as fully paid up is full satisfaction of their claim. Pass Journal entries in the books of A Ltd. in case such issue is (a) at par and (b) at a premium of 20%. [Hints. : (a) 12,000 Equity shares were issued. (b) 10,000 Equity shares were issued] 44. S Ltd. Purchased a machine from Utkal Machinary for A2,50,000. An amount of A10,000 was paid by way of cheque and for the balance fully paid up Equity shares of A10 each at a premium of 20% were issued. Journalise the transactions in the books of the Company. [Hint - 20,000 Equity share were issued.] 45. AB Ltd. purchased a business with the following Assets and Liabilities from XY Ltd. and issued 10,000 fully paid up Equity shares of A100 each in full satisfaction of their claims : A Land and Buildings
6,00,000
Plant and Machinery
2,50,000
Accounting for Companies : Accounting for Share Capital
571
Stock-in-trade
30,000
Sundry Debtors
70,000
Bills Receivable
50,000
Cash at Bank
2,00,000
Sundry Creditors
1,80,000
Bills Payable
25,000
Journalise the above tranasactions in the books of AB Ltd. [Hint - Goodwill A5000.] 46. RK Ltd. purchased a running business, which had the following Assets and Liabilities, from BK Ltd. for A20,00,000, payable as A15,00,000 is fully paid up Equity shares of A100 each and balance in Account Payee cheque : Buildings
12,00,000
Plant
8,00,000
Stock-in-trade
30,000
Sundry Debtors
70,000
Cash at Bank Sundry Creditors
1,00,000 50,000
Pass journal entries in the books of the company [Hint - Capital Reserve A1,50,000.] 47. Bharat Ltd. issued 10,000 Equites shares of A100 each credited as fully paid to the promoters for their services. The company also issued 1,000 Equity shares of A100 each credited as fully paid to the underwriters for their commission. Pass necessary journal entries. 48. AB Ltd. issued 10,000 Equity shares of A100 each at par, payable on application A30, on allotment A30, on first call A20 and on second and final call A20. Mr. X was allotted 100 Equity shares. Show the journal entries in respect of forfeiture of shares in each of the following cases :
572
Accountancy (Part-II)
a)
Mr. X failed to pay the allotment money and his shares were forfeitcd.
b)
Mr. X failed to pay the allotment money and on his subsequent failure to pay the first call money, his shares were forfeited.
c)
Mr. X failed to pay the first call money and on his failure to pay the second and final call money, his shares were forfeited.
49. Sunflower Ltd. issued 1,00,000 Equity shares of A10 each, payable on application A4, on allotment A2, on first call A2 and on final call A2 per share. All the shares were applied for by the public and were duly allotted. All the amounts due were received except from a shareholder holding 1,000 shares on which only application and allotment money were received. Pass journal entries in respect of forfeiture of shares if, a)
Shares were forfeited after first call,
b)
Shares were forfeited after final call.
50. A Ltd. with an authorised capital of 5,00,000 Equity share of A10 each, invited applications for 50,000 shares of A10 each for public subscription, payable on application A3, on alllotment A3, on first call A2 and on final call A2 per share. The issue was fully subscribed and shares were duly allotted. All the amounts due on shares were received except the following : Mohan, to whom 100 shares were allotted, failed to pay the amount due on allotment and calls. Rohan, who holds 200 shares, failed to pay the money due on first and final call. Sohan, who holds 300 shares, failed to pay the final call money. The shares allotted to Mohan, Rohan and Sohan were forfeited by the company after the final call. Pass journal entries to record the above issue and forfeiture of shares. Also show how share capital will appear in the Balance Sheet after the forfeiture of shares. Prepare the Notes to Accounts for the same. [Ans : Subscribed and fully paid up capital A4,90,100, Share Forfeiture Account A3,900] 51. A Ltd. invited applications for issue of 40,000 Equity shares of A10 each at par. The amount payable on each share was as follows :
Accounting for Companies : Accounting for Share Capital
On application
A4
On allotment
A4
On first and final call
A2
573
Applications were received for 67,000 shares. Allotment was made as follows : a)
To applicants for 20,000 shares - full
b)
To applicants for 40,000 shares - 50%
c)
To applicants for 7,000 shares - NIL A76,000 was realised on account of allotment (excluding the amount carried from application money) and A78,000 was realised towards first and final call. The directors decided to forfeit the shares of those applicants to whome full allotment was made and on which allotment money and call money were over due. Pass necessary journal entries in the books of the company to record the above transactions. [Hint - Number of shares forfeited 1,000]
52. XY Ltd. was registered with an authorised capital of A50,00,000 in A100 Equity shares. Of these shares, 2,000 Equity shares were issued as fully paid to a vendor for the purchase a machine and 12,000 Equity shares were subscribed for by the public and were duly allotted. The company had so far called up A60 per share, payable as A30 on application, A10 on allotment, A10 on first call and A10 on second call. The amounts received in respect of these shares were as follows : on 8,000 shares - full amount called up on 2,400 shares - A50 per share on 1,000 shares - A40 per share on 600 shares - A30 per share The directors forfeited 1,600 shares on which less than A50 per share had been received.
574
Accountancy (Part-II)
Pass the journal entries in the books of the company and show the ‘share capital’ as it would appear in the Balance Sheet of the company with Notes to Accounts. [Ans. : Subscribed and fully paid up capital A2,00,000, Subscribed but not fully paid up capital A6,00,000, Share Forfeiture A/c A58,000.] 53. DLC Ltd. invited applications for 80,000 Equity shares of A100 each at A120 per share, payable A50 on application (including premium), A50 on allotment and the balance on first and final call. Applications for 1,00,000 Equity shares were received. Of the amounts received on applications, A2,50,000 was refunded and A7,50,000 was applied for the amount due on allotment. All the shareholders paid the amounts due on their shares allotted with the exception of one shareholder, holding 1,000 shares, failed to pay the call amount. These shares were forfeited. Journalise the transactions in the books of the company. [Ans. : Share Forfeiture A/c A80,000] 54. A limited company issued 50,000 Equity shares of A10 each at A12 per share, payable on application A3, on allotment (including premium) A7 and on first and final call A2. All the shares were subscribed by the public and duly allotted by the directors. All the amounts due on the shares were received except on 1,000 shares for non-payment of allotment and call money. These shares were forfeited subsequently. Pass necessary journal entries in the books of the company. [Ans. : Share Forfeiture A/c A3,000.] 55. MK Ltd. invited applications for 10,000 Equity shares of A100 each at a premium of A50 per share. The amount was payable as follows: on application A50 per share (including premium of A20) on allotment A70 per share (including premium of A20) on first and final call A30 per share (including premium) of A10) Applications for 8,000 shares were received. All the applications were accepted and shares were duly allotted. Mr. A to whom 100 shares were allotted, failed to
Accounting for Companies : Accounting for Share Capital
575
pay the allotment money. His shares were forfeited immediatly after allotment. Afterwards, the first and final call was made. Mr. B, the holder of 50 shares, failed to pay the call money. His shares were also forfeited. Pass the journal entries in the books of the company. [Ans : Share Forfeiture Account A7,000] 56. XYZ Ltd. issued 50,000 Equity shares of A10 each for public subscription at a premium of A2 per share, payable A5 on application, A5 (including premium) on allotment and A2 on first and final call. Applications were received for 60,000 shares. The directors rejected applications for 10,000 shares and remaining applications were accepted. The allotment money was received in full. But the holders of 1,000 shares failed to pay the first and final call money. These shares were forfeited and subsequently reissued at A8 per share as fully paid up. Pass the journal entries. [ Ans. : Capital Reserve A6,000.] 57. FM Ltd. issued for public subscription 10,000 Equity shares of A10 each at par payable as follows : on application A3 on allotment A5 on first and final call A2. All the shares were subscribed and duly allotted. All the amounts due were received except on 2,000 shares held by Mr. Z who failed to pay the call money. These shares were forfeited and subsequently 1,500 of these shares were reissued at A8 per share as fully paid up. Journalise the transactions in the books of the company. [ Ans.: Capital Reserve A9,000, Balance of Forfeiture A/c A4,000.] 58. A limited company issued 2,000 Equity shares of A10 each to A, 4,000 Equity shares of A10 to B and 6,000 Equity shares of A10 each to C. The details of the
576
Accountancy (Part-II)
amount received from them were : A paid the application money @ A2.50 per share. B paid the application Money of A2.50 and allotment money of A3 per share. C paid the application money of A2.50, allotment money of A3 and first call money of A2.50 per share. They could not pay their arrears of different calls made and also the amount due on final call @A2 per share. Directors forfeited the shares held by them. These shares were subsequently reissued for cash at 10% discount. Pass journal entries relating to forfeiture and reissue in the books of the company. [Ans : Capital Reserve A 63,000] 59. XY Ltd. issued 50,000 Equity shares of A 10 each at a premium of A 6 per share. The amount was payable as follows: On application A 8 per share (including A 3 premium) On allotment balance amount. The issue was fully subscribed. One shareholder holding 500 shares paid the full amount due on his holdings with application. Another shareholder holding 300 shares could not pay the allotment money and his shares were forfeited. Subsequently these shares were reissued for A 4,800 as fully paid up. Pass journal entries. [Ans : Allotment money received A 3,93,600, Capital Reserve A 1,500] 60. AB Ltd. issued 5,00,000 Equity Shares of A 10 each for public subscription, payable A 3 on application, A 5 on allotment and the balance on first and final call. Applications were received for 15,00,000 shares and the shares were allotted on pro-rata basis. The excess application money was to be adjusted towards allotment only. A shareholder who had applied for 12,000 shares, could not pay the call money and his shares were forfeited. Subsequently, these shares were reissued at A 9 per share as fully paid up. Pass journal entries for the above transactions.
Accounting for Companies : Accounting for Share Capital
577
[Ans. Capital Reserve A 28,000] 61. BC Ltd., issued for public subscription 20,000 Equity shares of A 10 each at a premium of 20%, payable as, A 5 on application, A 5 on on allotment (including Premium), and A 2 on first and final call. Applications for 30,000 shares were received. Applications for 6,000 shares were rejected and allotment was made on pro-rata basis among the remaining applicants. Sandeep was allotted 400 shares and he failed to pay the allotment money and call money. The directors forfeited his shares and subsequently those shares were reissued at A 9 per share. Prepare the Cash Book and pass the journal entries in the books of the company. [Ans. : Capital Reserve A 2,000] 62. Utkal Ltd. invited applications for 50,000 Equity shares of A 100 each at a premium of A 20 per share, payable as follows : on application
A 30,
on allotment
A 50 (including premium),
on first call
A 20, and
on final call
A 20.
Applications were received for 1,00,000 shares and allotment was made on prorata basis. Excess money paid on application was utilised in respect of amounts due on allotment. X, to whom 1,000 shares were allotted , failed to pay the allotment money and on subsequent failure to pay the first call money, his share were forfeited. Y, to whom 2,000 shares were allotted, failed to pay the two calls and his shares were forfeited after the final call. Out of these forfeited shares, 2,000 shares (whole of X' s shares included) were reissued to Z @ A 80 per share.
Accountancy (Part-II)
578
Prepare the Cash Book and pass the journal entries. Show how will the Share Capital be shown in the company's Balance Sheet. Also prepare the Notes to Accounts. [Ans.: Capital Reserve A 80,000, Balance in Share Forfeited A/c A 60,000.] 63. A Ltd. invited applications for 10,000 Equity shares of A 100 each, payable as follows : on application
A 40 per share,
on allotment
A 40 per share, and
on first and final call
A 20 per share.
Applications were received for 15,000 shares and allotment was made on pro rata basis as follows : Applicants for 8,000 shares were allotted 6,000 shares on pro-rata basis and applicants for 7,000 shares were allotted 4,000 shares on pro-rata basis. A (an applicant of the first category), who was allotted 240 shares, failed to pay the allotment money and his shares were forfeited after allotment. B (an applicant of the second category), who had applied for 140 shares, could not pay the first and final call money and his shares were also forfeited. Out of the forfeited shares, 200 shares (including all forfeited shares of B) were reissued @ A 80 per share fully paid up. Journalise the above transactions in the books of the company. [Ans :. Balance is Share Forfeited A/c A 6,400, Capital Reserve A 8,800.]
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CHAPTER-10
ACCOUNTING FOR COMPANIES : ACCOUNTING FOR DEBENTURES STRUCTURE
10.1
Introduction
10.2
Meaning, Definition and Features of Debentures
10.3
Types of Debentures
10.4
Distinction between Share and Debenture
10.5
Issue of Debentures 10.5.1
Issue of Debentures for Cash
10.5.2
Issue of Debentures for Consideration Other than Cash
10.5.3
Issue of Debentures as Collateral Security
10.6
Issue of Debentures Considering the Terms and Conditions of Redemption
10.7
Questions
580
10.1
Accountancy
INTRODUCTION : Debentures play a significant role while preparing financial planning for a company. A company requires long-term funds for its initial needs and for expansion of its activities. For this purpose, a company may borrow money by issue of debentures in addition to raising funds by issue of shares. Thus, debentures are one of the important sources of raising long-term finance for a company. 10.2 MEANING, DEFINITION AND FEATURES OF DEBENTURES The word 'debenture' has been derived from a Latin word 'debere' which means to borrow. Debenture is a written acknowledgement of a debt by a company under its common seal. A debenture issued by a company is usually in the form of a certificate under the seal of the company. A Debenture Certificate contains terms of payment of interest at a fixed rate and the terms of repayment of the principal sum on a specified date. Debentrues normally create a charge on the assets of the company. It is usual to prefix 'Debentures' with the rate of interest. Thus, if the rate of interest is 10%, the name given will be '10% Debentures'. Debentureholders are the creditors of the company. Debentures are shown under the head 'Non-current Liabilities' and subhead 'Long-term Borrowings' on the Equity and Liabilities side of the Balance Sheet. According to section 2(30) of the Companies Act, 2013, "Debenture includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not." Features or Characteristics of Debentures The features or characteristics of a debenture are as follows : (i) A debenture is a certificate of acknowledgement of indebtedness and as such, the inner significance of a debenture is indebtedness. (ii) A debenture is issued under the seal of the company. (iii) Debenture certificate contains a contract for the repayment of principal sum at a specified date. Usually, the debentures are repaid after a long period, such as ten years or twelve years. Debentureholders have priority over shareholders as to repayment in case of winding up of a company. (iv) As per the Companies Act, 2013 no company is allowed to issue debentures having a maturity period of more than 10 years from the date of issue. But a
Accounting for Companies : Accounting for Debentures
581
company, engaged in infrastructure projects, can issue debentures for more than 10 years, but not exceeding 30 years. (v) Debentures are issued with a specified rate of interest. A debentureholder receives the interest on his debentures at the specified rate mentioned in the debenture certificate. Payment of interest is made, usually after every six months, whether the company makes a profit or not. (vi) Usually a debenture creates a floating charge on the assets of the company. This signifies that if the company is unable to repay to the debentureholders as per the terms of the issue, the debentureholders can take legal action to realise their money out of the sale proceeds of the assets of the company. (vii) Sometimes a debenture creates a fixed charge on particular assets of the company instead of floating charge. (viii) A debentureholder, being a creditor, has no right to vote in the meetings of the company. 10.3 TYPES OF DEBENTURES The following types of debentures can be issued by a company : (a) From Security point of view : (i) Unsecured or Naked Debentures Unsecured or Naked debentures are those debentures which are issued without any security in respect of interest or the repayment of the principal. Solvency of the company is the only security. Such debentureholders are treated as unsecured creditors at the time of liquidation of the company. Such debentures are not common these days. (ii) Secured or Mortgage Debentures Secured or Mortgage debentures are those debentures which are secured by a charge on the assets of the company. When such debentures are secured on specific assets of the company, these are known as 'Secured Debentures having fixed charge'. If the company is unable to repay the debenturholders on the due date, such type of debentureholders can realise their money from the assets mortgaged with them. On the other hand, when the debentures are secured on all assets of the company, these are known as 'Secured Debentures having floating charge'. Such type of
582
Accountancy
debentureholders can claim their dues for repayment on priority basis before anything is paid to the unsecured creditors in the event of liquidation of the company. (b) From Permanence point of View : (i) Redeemable Debentures Redeemable debentures are those debentures which are repaid by the company either in lump sum at the end of a specific period or by instalments during the life time of the company. Most of the debentures are of this type. (ii)
Irredeemable or Perpetual Debentures Irredeemable or Perpetual debentures are those debentures which are not repayable by the company during its life time. Such debentures are to be paid only in the event of liquidation of the company, as in case of shares. As per the Companies Act, 2013, no company is allowed to issue such type of debentures. (C) (i)
From Convertibility point of view : Convertible Debentures Convertible debentures are those debentures which are convertible into equity shares or other securities at a stated rate of exchange either at the option of the debentureholders or at the option of the company after a specified period. When full amount of debenture is convertible into shares, such debentures are called 'Fully Convertible Debentures.' But when only a part of the amount of debenture is convertible into shares, such debentures are called 'Partly Convertible Debentures'. As per SEBI guidelines where the conversion is to be made at or after 18 months from the date of allotment but before 36 months, any conversion in part or whole shall be optional on the part of the debentureholders. Convertible debentures are very popular these days as they provide liquidity, safety, capital appreciation and assured return to the investors. (ii) Non-Convertible Debentures Non-convertible debentures are those debentures which cannot be converted into equity shares or other securities. (d) From Records point of view : (i) Bearer Debentures Bearer debentures are those debentures which are transferable by mere
Accounting for Companies : Accounting for Debentures
583
delivery and the company does not keep any record of names and addresses of the debantureholders. Interest is paid at the end of the stipulated period to the bearers of such debentures. In other words, interest is paid to the holders irrespective of identity. Coupons are attached with these debutures and interest is paid to such persons who produce the coupons in the specified bank. (ii) Registered Debentures Registered debentures are those debentures which are registered in the name of a holder in the books of the company. Names and addresses of the holders of registered debentures are recorded in a register of the company. Such debentures are not freely transferable. The transfer of such debentures needs the execution of a proper transfer deed. Principal amount and interest on such debentures are paid to the person whose name appears is the register of the company. (e) From Priority point of view : (i)
First Debentures First debentures are those debentures which are repayable prior to other debentures.
(ii)
Second Debentures Second debentures are those debentures which are payable only after the redemption of the first debentures.
10.4
DISTINCTION BETWEEN SHARE AND DEBENTURE Share and Debenture can be distinguished as follows:
Basis
Share
1.Nature Share is a unit of owned capital.
Debenture Debenture is a part of loan capital.
2. Owner A person holding a share, is a joint A person holding a debenture, is a creditor of the company. ship owner of the company. 3. Reward
Dividend is the reward for the Interest is the reward for the debentureholders. shareholders.
Accountancy
584
4. Rate of Dividend and Interest
The rate of dividend on equity shares may change from year to year depending upon the profits and decision of the directors.
The rate of interest on debentures is fixed and interest must be paid irrespective of the fact that the company makes a profit or incurs a loss.
5. Priority Payment of dividend gets no Payment of interest gets priority over of payment priority over payment of interest. payment of dividend. of reward 6. Priority In case of winding up, the payment In case of winding up, the repayment of repayment of share capital is made after the of debentures is made before the of principal repayment of debentures. payment of share capital. in case of winding up 7. Secured Shares are not secured by any Debentures are generally secured and by charge charge. Hence, shareholders bear carry a charge on the assets of the company. Hence, debentureholders more risk. bear little risk.
8. Voting right 9. Voluntary or compulsory redemption
10. Restriction on issue at discount 11. Mortgage
12. Convertibility
Shareholders generally enjoy voting right. It is at the option of the company to return the amount of share capital by buying back its own shares. Under section 53 of the Companies Act, 2013, shares cannot be issued at a discount except sweat equity shares. There can be no mortgage shares. Assets of the company cannot be mortgaged in favour of shareholders. Equity shares are not convertible. However, preference shares may be converted into equity shares.
Debentureholders do not enjoy any voting right. The amount of debentures must be returned as per the terms of the issue.
There is no restriction on the issue of debentures at a discount.
There can be mortgage debentures. Assets of the company can be mortgaged in favour of debentureholders. Debentures may be converted into shares.
Accounting for Companies : Accounting for Debentures
10.5
585
ISSUE OF DEBENTURES
Issue of debentures means issue of a certificate by the company under its seal, which is an acknowledgement of debt taken by the company. The procedure of issue of debentures is similar to that of the issue of shares. A prospectus is issued, applications are invited, applications are received with application money and letters of allotment are issued. On rejection of applications, application money in respect of rejected applications is refunded. In case of partial allotment, excess application money may be adjusted towards allotment and subsequent calls. The company may also ask for the entire amount due on debentures to be paid in one instalment on application. As per section 39 of the Companies Act, 2013, condition of minimum subscription applies on every type of securities including debentures. Issue of debentures takes various forms which are as follows :
Issue of Debentures for cash
Issue of Debentures for consideration other than cash
Issue of Debentures as collateral security
10.5.1 Issue of Debentures for Cash Debentures are normally issued by a company for cash. The amount due on debentures may be called by the company in lump sum with application or it may also be called in instalments as in the case of shares, such as on application, on allotment and on one or more calls. Accounting entries on issue of debentures are also the same as in the case of issue of shares. The only difference is that 'Debenture A/c' will be opened instead of 'Share Capital A/c'. As mentioned earlier, it is usual to prefix the rate of interest to the debentures. Like shares, debentures may be issued either at par or at a premium or at a discount. It is to be mentioned here that there is no restriction to issue debntures at a discount. Journal Entries: (assuming that the debentures carry 10% interest) A. When the amount is payable in lump sum on application :
Accountancy
586
When the full amount on debentures issued, is received in one instalment, the amount should be credited to 'Debenture Application and Allotment A/c' instead of 'Debenture Application A/c'. 1.
When the debentures are issued at par :
(i)
Bank A/c Dr. (With the amount To 10% Debenture Application and Allotment A/c received) (Being the application money received)
(ii)
10% Debenture Application and Allotment A/c Dr. To 10% Debentures A/c (Being transfer of application memory to Debentures A/c.) When the debentures are issued at a premium :
2. (i)
Bank A/c Dr. To 10% Debenture Application and Allotment A/c (Being the application money received)
(ii)
10% Debenture Application and Allotment A/c To 10% Debentures A/c To Securities Premium Reserve A/c (Being application money transferred to Debentures A/c and Security Premium Reserve A/c.)
(With the amount received)
Dr. (With the amount received) (with the nominal value of debentures)
(With premium amount)
3.
When the debentures are issued at a discount :
(i)
Bank A/c To 10% Debenture Application and Allotment A/c
(Being the application money received)
(With the face value of Debentures)
Dr.
(With the amount received)
Accounting for Companies : Accounting for Debentures
(ii)
10% Debenture Application and Allotment A/c Discount on issue of Debentures A/c To 10% Debentures A/c
587
Dr. (With the amount received) Dr. (With the discount on issue) (With the face or nominal value of Debentures.)
(Being application money transferred to 10% Debentures and Discount on issue of Debentures A/c being debited.) Illustration 1 X Ltd. invited applications for issue of 10,000, 10% Debentures of 100 each at par. The full amount was payable on applicaton. All the debentures were fully subscribed and duly allotted. Pass necessary journal entries is the books of X Ltd. Solution : Books of X Ltd. Journal Date
LF Dr. (A) Cr. (A)
Particulars Bank A/c Dr. To 10% Debenture Application and Allotment A/c (Being receipt of application money on 10,000
10,00,000
10,00,000
debentures @A100 each.) 10% Debenture Application and Allootment A/c To 10% Debentures A/c (Being transfer of application money to 10% Debentures A/c.)
Dr.
10,00,000
10,00,000
Illustration 2 Y Ltd. invited applications for 10,000, 10% Debentures of A100 each at a premium of A20 per debenture. The full amount due on debentures was payable on application. Applications were received for 12,000 debentures. Applications for 2,000 debentures were rejected and money was refunded. The remaing applications were accepted in full and duly allotted. Pass journal entries in the books of Y Ltd.
Accountancy
588
Solution : Books of Y Ltd. Journal Date
Particulars
LF Dr. (A) Cr. (A)
Bank A/c Dr. To 10% Debenture Application and Allotment A/c (Being application money received for 12,000 debentures @A120 each.)
14,40,000
10% Debenture Application and Allotment A/c Dr. To 10% Debentures A/c To Securities Premium Reserve A/c To Bank A/c (Being transfer of application money to 10% Debentures A/c @A100 and to Securities Premium Reserve A/c @A20 each, the money on rejected applications being refunded.)
14,40,000
14,40,000
10,00,000 2,00,000 2,40,000
Illustration 3 Z Ltd. invited applications for 10,000, 10% Debentures of A100 each at a discount of A10 per debenture. The full amount due on debentures was payable on application. Applications were received for 9,000 debentures. Directors accepted all the applications and debentures were duly allotted. Pass the journal entries in the books of Z Ltd. Solution : Books of Z Ltd. Journal Date
Particulars Bank A/c Dr. To 10% Debenture Application and Allotment A/c (Being application money received on 9,000 debentures @A90 per debenture)
LF
Dr. A
Cr.A
8,10,000 8,10,000
Accounting for Companies : Accounting for Debentures
589
10% Debenture Application and Allotment A/c
Dr.
8,10,000
Discount on issue of Debentures A/c
Dr.
90,000 9,00,000
To 10% Debentures A/c (Being transfer of Debenture Application money to 10% Debentures A/c and Discount on issue of Debenture A/c being debited @A10 per debenture)
B. 1.
When the amount is payable in instalments : When Debentures are issued at par : When debentures are issued at face value or nominal value of debentures, it is said to be issued at par. When debentures are issued at par, the following entries are recorded in the books of the company assuming that the debentures carry 10% interest :
(i)
On receipt of application money Bank A/c To 10% Debenture Application A/c.
(ii)
Dr. (With the amount refunded)
On transfer of excess application money on partially accepted applications10% Debenture Application A/c To 10% Debenture Allotment A/c
(v)
Dr. (with the amount of application money on debentures allotted)
On refund of application money on rejected applications 10% Debenture Application A/c To Bank A/c
(iv)
money received)
On transfer of application money to Debentures A/c 10% Debenture Application A/c To 10% Debentures A/c
(iii)
Dr. (with the amount of application
Dr. (with excess application money adjusted for allotment)
On allotment money becoming due10% Debenture Allotment A/c To 10% Debentures A/c
Dr. (with the allotment money due)
Accountancy
590
(vi)
On receipt of allotment moneyBank A/c
Dr. (with allotment money received)
To 10% Debenture Allotment A/c (vii)
On first call money becoming due10% Debenture First Call A/c
Dr. (with the amount due on first call)
10% Debentures A/c
(viii)
On receipt of first call moneyBank A/c
Dr. (With first Call money received)
To 10% Debenture First Call A/c (ix)
On final call money becoming due10% Debenture Final Call A/c To 10% Debentures A/c
(x)
Dr. (With the amount due on final call)
On receipt of final call moneyBank A/c To 10% Debenture Final Call A/c
Dr. (with the final call money received)
Illustration 4 Rose Ltd. issued 10,000, 15% Debentures of A100 each at par, payable as follows: On application A30, on allotment A30, On first call A20 and on final call A20. Public applied for 12,000 debentures. Applications for 9,000 debentures were accepted in full. Application for 1,600 debentures were allotted 1,000 debentures and applications for 1,400 debentures were rejected. Excess money on applications was utilised towards allotment. All amounts due were duly received. Pass journal entries in the books of the company.
Accounting for Companies : Accounting for Debentures
591
Solution: Date
Books of Rose Ltd. Journal Particulars Bank A/c To 15% Debenture Application A/c (Being application money for 12,000 debentures received @A30 each.) 15% Debenture Application A/c To 15% Debentures A/c To 15% Debenture Allotment A/c To Bank A/c (Being application money transferred to 15% Debentures A/c, 15% Debentures Allotment A/c and Money refunded to rejected applicants for 1,400 debentures.) 15% Debenture Allotment A/c To 15% Debentures A/c (Being Allotment money due on 10,000 debentures @A30 each.) Bank A/c To 15% Debenture Allotment A/c (Being balance of allotment money received i.e. A3,00,000-A18,000)
LF Dr. (A) Cr. (A) Dr.
3,60,000
Dr.
3,60,000
Dr.
3,00,000
Bank A/c To 15% Debenture Final Call A/c (Being final call money received)
3,00,000 18,000 42,000
3,00,000
Dr.
2,82,000 2,82,000
2,00,000
15% Debenture First Call A/c To 15% Debentures A/c (Being first call money due @20 each.) Bank A/c To 15% Debenture First Call A/c (Being first call money received.) 15% Debenture Final Call A/c To 15% Debentures A/c (Being final call money due @A20 each)
3,60,000
Dr.
2,00,000
Dr.
2,00,000
Dr.
2,00,000
2,00,000
2,00,000
2,00,000
2,00,000
Accountancy
592
Illustration 5 Sunflower Ltd. invited applications for 5,000, 12% Debenture of A100 each at par and payable as follows: A30 on application, A40 on allotment, A20 on first call and A10 on final call. Public applied for all the debentures and allotment was duly made. All sums on allotment and calls were received. However, Bijay who holds 100 debentures, failed to pay the allotment money and Bimal who holds 200 debentures, paid the money due on calls in advance with allotment money. Bijay paid the arrear amount with the first call money. Journalise the above in the books of the company. Solution:
Date
Books of Sunflower Ltd. Journal Particulars
LF Dr.(A)
Bank A/c To 12% Debenture Application A/c (Being application money received on 5,000 debentures @A30 each)
Dr.
1,50,000
12% Debenture Application A/c To 12% Debentures A/c (Being transfer of Debenture Application money to 12% Debentures A/c on allotment)
Dr.
1,50,000
12% Debenture Allotment A/c To 12% Debentures A/c (Being allotment money due on 5,000 debentures @A40each.) Bank A/c To 12% Debenture Allotment A/c To Calls-in-Advance A/c (Being allotment money received on 4,900 debentures @A40 each and calls-in-advance received on 200 debentures @A30 each.)
Dr.
2,00,000
Dr.
2,02,000
Cr.(A) 1,50,000
1,50,000
2,00,000
1,96,000 6,000
Accounting for Companies : Accounting for Debentures
Dr.
1,00,000
Dr. Dr.
1,00,000 4,000
12% Debenture Final Call A/c Dr. To 12% Debentures A/c (Being final call due on 5,000 debentures @A10 each.) Bank A/c Dr. Calls-in-Advance A/c Dr. To 12% Debenture Final Call A/c (Being final call money received after adjusting the advance of final call @A10 each on 200 debentures.)
50,000
12% Debenture First Call A/c To 12% Debentures A/c (Being first call due on 5,000 debentures @A20 per debenture.) Bank A/c Calls-in-Advance A/c To 12% Debenture First Call A/c To 12% Debenture Allotment A/c (Being first call money received after adjusting the advance of first call @A20 on 200 debentures and arrear on allotment received on 100 debentures @A40 each)
2.
593
48,000 2,000
1,00,000
1,00,000 4,000
50,000
50,000
When Debentures are issued at Premium :
When debentures are issued at a price more than the face value or nominal value of debentures, it is said to be issued at a premium. If the face value or nominal value of debentures of a company is A100 and such debentures are issued at A120 each, the debentures are said to have been issued at a premium, the premium amount being A20 per debenture. The amount of premium should be credited to a separate account called 'Securities Premium Reserve A/c' since the debentures are also securities like shares. It is a capital profit for the company and is shown separately on the Equity and Liabilities side of the Balance Sheet under the sub-head 'Reserves and Surplus' and head 'Shareholders' Funds'.
Accountancy
594
Journal Entries : (a) When premium is collected with application money : (i) On receipt of application money Bank A/c
Dr.
To Debenture Application A/c (ii)
(With application money including premium)
On transfer of Debenture Application A/c to Debenture A/c Debenture Application A/c
Dr.
(with application money including premium)
To Debentures A/c
(with application money excluding premium)
To Securities Premium Reserve A/c
(with the amount of premium)
(b)
When premium is collected with allotment money :
(i)
On allotment money due Debenture Allotment A/c
(ii)
Dr.
(\with allotment money including premium)
To Debentures A/c
(with allotment money excluding premium)
To Securities Premium Reserve A/c
(with premium amount)
On receipt of allotment money Bank A/c To Debenture Allotment A/c
Dr.
(with allotment money received)
Illustration 6 X Ltd. invited applications for 20,000, 10% Debentures of A100 each at a premium of 20%, payable as A50 on application (including premium), A50 on allotment and A20 on first and final call. Applications were received for 30,000 debentures and allotment was made on pro-rata basis. All the money due was duly received. Pass journal entries in the books of X Ltd.
Accounting for Companies : Accounting for Debentures
595
Solution : Books of X Ltd. Journal Particulars
Date
LF Dr.(A)
Bank A/c To 10% Debenture Application A/c (Being application money received for 30,000 debentures @A50 each.)
Dr.
15,00,000
10% Debenture Application A/c To 10% Debentures A/c To Securities Premium Reserve A/c To 10% Debenture Allotment A/c (Being transfer of application money to 10% Debentures A/c @A30 each and Securities Premium Reserve A/c @A20 each, and Excess money transferred to Allotment A/c)
Dr.
15,00,000
10% Debenture Allotment A/c To 10% Debentures A/c (Being allotment money due on 20,000 debentures @A50each.) Bank A/c To 10% Debenture Allotment A/c (Being allotment money received after adjusting the excess application money.) 10% Debenture First and Final Call A/c To 10% Debentures A/c (Being first and final call money due on 20,000 debentures @A20 each.) Bank A/c To 10% Debenture First and Final Call A/c (Being first and final call money received.)
Cr.(A) 15,00,000
6,00,000 4,00,000 5,00,000
Dr.
10,00,000
Dr.
5,00,000
Dr.
4,00,000
Dr.
10,00,000
4,00,000
5,00,000
4,00,000
4,00,000
Illustration 7 A Ltd. issued 10,000, 14% Debentures of A100 each at 10% premium, payable as A50 on application, A40 on allotment (including premium) and balance on call.
Accountancy
596
Debentures were fully subscribed and duly allotted. All the amounts due were realised. Journalise the above transactions. Solution : Books of A Ltd. Journal Date
Bank A/c To 14% Debenture Application A/c (Being application money received on 10,000 debentures @A50 each per debentures) 14% Debenture Application A/c To 14% Debentures A/c (Being transfer of application money to 14% Debentures A/c.) 14% Debenture Allotment A/c To 14% Debentures A/c To Securities Premium Reserve A/c (Being allotment money due @A30 towards 14% debentures and A10 towards premium) Bank A/c To 14% Debenture Allotment A/c (Being allotment money received) 14% Debenture Call A/c To 14% Debentures A/c (Being amount due on call @A20 each on 10,000 debentures.) Bank A/c To 14% Debenture Call A/c (Being call money received.)
3.
LF Dr. (A) Cr. (A)
Particulars Dr.
Dr.
5,00,000
5,00,000
Dr.
4,00,000
Dr.
4,00,000
Dr.
2,00,000
Dr.
2,00,000
5,00,000
5,00,000
3,00,000 1,00,000
4,00,000 2,00,000
2,00,000
When Debentures are issued at discount : When the issue price of debentures is less than the face value or nominal value, it is said that debentures are issued at discount, e.g., an issue of debentures of A100 each at A90 per debenture. There is no restriction regarding the maximum limit for discount on debentures in the Companies Act, 2013.
Accounting for Companies : Accounting for Debentures
597
As per Accounting standard 26, borrowing costs and discount on issue of debentures could be amortised over loan period. Unamortised portion of such discount on issue or expenses on issue of debentures is shown on the aseets side of the Balance Sheet under the head, 'Current or Non-current Assets' depending on whether the amount will be amortised in the next 12 months or thereafter. For example, if the discount or expense on issue of debentures amounts to A1,00,000 and it is to be written off in 10 years, then : A10,000 shall be debited to Statement of Profit and Loss of the current year; A10,000 shall be shown under 'Other Current Assets' and, A80,000 shall be shown under 'Other Non-Current Assets' in the Balance Sheet. Discount or Expense on issue of debentures is a capital loss. It should be written off within the life time of the debentures as early as possible. It can be written off against Securities Premium Reserve Account or Statement of Profit and Loss. Discount on issue of debentures is recorded usually at the time of allotment by debiting 'Discount on issue of Debentures A/c.' Journal Entries : 1.
On allotment of debentures Debenture Allotment A/c
Dr.
(With allotment money)
Discount on issue of Debentures A/c
Dr.
(With discount amount)
To Debentures A/c 2.
(With the total amount)
On receipt of allotment money Bank A/c To Debenture Allotment A/c
Dr.
(With allotment money received)
Illustration 8 B Ltd. issued 10,000, 15% Debentures of A100 each at a discount of 10%, payable as A30 on application, A40 on allotment and A20 on first and final call. Public
Accountancy
598
applied for 12,000 debentures. Allotment was made for 10,000 debentures and the remaining applications were rejected. All the amounts due were duly received. Pass journal entries in the books of the company. Solution: Books of B Ltd. Journal Date
Particulars
LF Dr. (A) Cr. (A)
Bank A/c To 15% Debenture Application A/c (Being application money received for 12,000 debentures @A30 per debenture.)
Dr.
3,60,000
15% Debenture Application A/c To 15% Debentures A/c To Bank A/c (Being application money transferred to 15% Debentures A/c and excess money refunded.)
Dr.
3,60,000
15% Debenture Allotment A/c Discount on issue of Debentures A/c To 15% Debentures A/c (Being the amount due on allotment, discount on issue being A1,00,000 @A10 per debenture.) Bank A/c To 15% Debenture Allotment A/c (Being allotment money received.)
Dr. Dr.
15% Debenture First and Final Call A/c To 15% Debentures (Being the amount due on first and final call.)
Dr.
Bank A/c To 15% Debenture First and Final Call A/c (Being first and final call money received.)
Dr.
3,60,000
3,00,000 60,000
4,00,000 1,00,000 5,00,000
Dr.
4,00,000 4,00,000 2,00,000 2,00,000 2,00,000 2,00,000
Accounting for Companies : Accounting for Debentures
599
Illustration 9 Moonlight Ltd. issued 5,000, 10% Debentures of A100 each at a discount of 10%, payable as follows : A30 on application, A40 on allotment, and the balance on first and final call. Applications were received for 4,000 Debentures and allotment was duly made. All sums were duly received. Expenses on issue of debentures amounted to A5,000. It was decided by Directors to write off 1/5th of expenses on issue of debentures and discount on issue of debentures from Statement of Profit and Loss each year. Pass journal entries for the year in which debentures are issued. Solution :
Date
Books of Moonlight Ltd. Journal Particulars
LF Dr. (A) Cr. (A)
Bank A/c To 10% Debenture Application A/c (Being application money received on 4,000 debentures @A30 each.)
Dr.
1,20,000
10% Debenture Application A/c To 10% Debentures A/c (Being application money transferred to 10% Debentures A/c.)
Dr.
1,20,000
10% Debenture Allotment A/c Discount on issue of Debentures A/c To 10% Debentures A/c (Being the amount money due @A40 per debenture on 4,000 debentures and discount on issue of debentures being @A10 each.)
Dr. Dr.
1,60,000 40,000
1,20,000
1,20,000
2,00,000
Accountancy
600
Date
LF Dr. (A) Cr. (A)
Particulars Bank A/c To 10% Debenture Allotment A/c (Being allotment money received.)
Dr.
10% Debenture First and Final Call A/c To 10% Debentures A/c (Being first and final call money due on 4,000 debentures @A20 per debenture.)
Dr.
Bank A/c To 10% Debenture First and Final Call A/c (Being first and final call money received.) Expenses on issue of Debentures A/c To Bank A/c (Being expenses paid on issue of debentures)
Dr.
Statement of Profit and Loss A/c To Discount on issue of Debentures A/c To Expenses on issue of Debentures A/c (Being 1/5th of discount on issue of debentures and 1/5th of expenses on issue of debentures written off.)
1,60,000 1,60,000 80,000
80,000
80,000 80,000
Dr.
5,000 5,000
Dr.
9,000 8,000 1,000
10.5.2 Issue of Debentures for Consideration Other than Cash Sometimes a company purchases assets from vendors or acquires a running business and instead of paying cash, the company decides to issue debentures in discharge of purchase consideration. Such an issue of debentures to vendors is known as issue of debentures for consideration other than cash. Such debentures may be issued at par or at a premium or at a discount. Journal Entries : (i)
For Purchase of Assets Assets A/c (individually) To Vendor's A/c
Dr. (With the agreed value of assets) (With purchase Price)
Accounting for Companies : Accounting for Debentures
(ii)
601
For Purchase of Business Assets A/c (individually) To Liabilities (individually)
Dr. (with agreed value of assets) (with agreed value of liabilities)
To Vendor's A/c
(Price payable to vendor)
Notes : 1. If price payable to the vendor is more than the net assets (Assets-Liabilities) purchased, the difference is to be debited to Goodwill A/c. 2. If price payable to the vendor is less than net assets purchased, the difference is to be credited to Capital Reserve A/c. (iii)
For Issue of Debentures as consideration Vendor's A/c Discount on issue of Debentures A/c To Debentures A/c
Dr. (with the purchase price) Dr. (with discount on issue, if any) (with nominal value of debentures issued) To Securities Premium Reserve A/c (with premium on issue of debenture, if any.)
Illustration 10 B Ltd. purchased a Building from Mr. X at an agreed value of A19,20,000. It was agreed to pay the purchase price by issuing 10% Debentures of A100 each. Pass journal entries in the books of the company if, (a) Debentures are issued at par, (b) Debentures are issued at a premium of 20%, and (c) Debentures are issued at discount of 20%.
Accountancy
602
Solution : Books of B. Ltd. Journal Particulars
Date
(a)
(b)
Buildings A/c To X's A/c (Being Buildings purchased from X).
Dr.
19,20,000
X's A/c To 10% Debentures A/c (Being issue of 10% Debentures at par to X)
Dr.
19,20,000
X's A/c To 10% Debentures A/c To Securities Premium Reserve A/c (Being issue of 16,000, 10% Debentures of A100 each at a premium of 20%, calculated
Dr.
19,20,000
Dr. Dr.
19,20,000 4,80,000
as follows : (c)
LF Dr. (A) Cr. (A) 19,20,000
19,20,000
16,00,000 3,20,000
A19,20,000 16,000 Debentures.) A120
X's A/c Discount on issue of Debentures A/c To 10% Debentures A/c (Being issue of 24,000, 10% Debentures of A100 each at 20% discount, calculated as follows :
24,00,000
A19,20,000 24,000 Debentures.) A80
Illustration 11 D Ltd. acquired assets of A5,45,000 and creditors of A50,000 from A Ltd. and issued 12% Debentures of A100 each at a premium of 10% as purchase consideration. Pass journal entries in the books of D Ltd. Solution : Working Note : Purchase consideration = Assets - Creditors = A5,45,000-A50,000=A4,95,000
Accounting for Companies : Accounting for Debentures
603
A4,95,000 4,500 A110 Books of D Ltd. Journal Particulars
No. of Debentures issued =
Date
LF Dr. (A) Cr. (A)
Assets A/c Dr. To Creditors A/c To A Ltd. (Being acquisition of assets and creditors from A Ltd.)
5,45,000
A Ltd. To 12% Debentures A/c To Securities Premium Reserve A/c (Being issue of 4,500, 12% Debentures
4,95,000
Dr.
50,000 4,95,000
4,95,000 45,000
of A100 each at 10% premium)
Illustration 12 P Ltd. purchased a running business having the following assets and liabilities from X and issued 50,000, 10% Debentures of A100 each at par in full satisfaction of his claim : A Land and Building
25,00,000
Plant and Machinery
15,00,000
Stock-in-trade
10,00,000
Sundry Debtors
5,00,000
Sundry Creditors
8,00,000
Journalise the above transactions in the books of P Ltd.
Accountancy
604
Solution : Books of P Ltd. Journal Date
Particulars Land and Buildings A/c Plant and Machinery A/c Stock-in-trade A/c Sundry Debtors A/c Goodwill A/c (Balancing figure) To Sundry Creditors To X's A/c (Being purchase of assetes and liabilities from X, the excess of consideration over net assets being debited to Goodwill A/c.) X's A/c To 10% Debentures A/c
LF Dr. (A) Cr. (A) Dr. Dr. Dr. Dr. Dr.
25,00,000 15,00,000 10,00,000 5,00,000 3,00,000
Dr.
50,00,000
8,00,000 50,00,000
50,00,000
(Being issue of 50,000, 10% Debentures of A100 each to X for purchase consideration.)
Illustration 13 S Ltd. purchased a running business consisting of the following assets and liabilities from B Ltd. for A10,00,000, payable as A8,00,000 by issuing 12% Debentures of A100 each and balance in A/c Payee cheque : Land and Buildings Plant and Machinery Furniture and Fixture Sundry Debtors Cash at Bank Sundry Creditors Bills Payable
A 6,00,000 3,00,000 2,00,000 20,000 5,000 80,000 20,000
Pass necessary journal entries in the books of S Ltd.
Accounting for Companies : Accounting for Debentures
605
Solution : Date
Books of S Ltd. Journal Particulars
LF Dr. (A) Cr. (A)
Land and Buildings A/c Plant and Machinery A/c Furniture and Fixture A/c Sundry Debtors A/c Cash at Bank A/c To Sundry Creditors A/c To Bills Payable A/c To Capital Reserve A/c (Balancing figure) To B Ltd. (Being purchase of assets and liabilities from B Ltd., the excess of net assets over the consideration being credited to Capital Reserve A/c.)
Dr. Dr. Dr. Dr. Dr.
6,00,000 3,00,000 2,00,000 20,000 5,000
B Ltd. To 12% Debentures A/c To Bank A/c (Being issue of 8,000, 12% Debentures of A100 each and balance of A2,00,000 paid in A/c Payee cheque to B Ltd. for purchase consideration.)
Dr.
10,00,000
80,000 20,000 25,000 10,00,000
8,00,000 2,00,000
Illustration 14 R Ltd. purchased a plant worth A4,80,000 from M Ltd. An amount of A1,00,000 was paid immediately and the balance of purchase price was discharged by issue of 4,000, 15% Debentures of A100 each. Pass journal entries to record the above transactions in the books of R Ltd. Solution : Books of R Ltd. Journal Date Particulars LF Dr. (A) Cr. (A) Plant A/c To M Ltd. (Being purchase of plant from M Ltd.)
Dr.
4,80,000 4,80,000
Accountancy
606 M Ltd. To Bank A/c (Being an amount of A1,00,000 paid in part payment of consideration.)
Dr.
1,00,000
M Ltd. Discount on issue of Debentures A/c To 15% Debentures A/c (Being balance amount of A3,80,000 settled by issue of 4,000, 15% Debentures of A100 each at a discount)
Dr. Dr.
3,80,000 20,000
1,00,000
4,00,000
Illustration 15 H Ltd. purchased a plant worth A2,70,000 from M Ltd. An amount of A50,000 was paid immediately and the balance of purchase price was discharged by issue of 10% debentures of A2,00,000 at a premium of A10%. Pass journal entries in the books of H Ltd. Solution : Books of H. Ltd. Journal Date
Particulars
LF Dr.(A)
Plant A/c To M Ltd. (Being purchase of plant from M Ltd.)
Dr.
2,70,000
M Ltd. To Bank A/c (Being A50,000 paid in part payment of purchase price.)
Dr.
50,000
M Ltd. To 10% Debentures A/c To Securities Premium Reserve A/c (Being the balance amount of A2,20,000 settled by issue of 10% Debentures of A2,00,000 at 10% premium.)
Dr.
2,20,000
Cr.(A) 2,70,000
50,000
2,00,000 20,000
Accounting for Companies : Accounting for Debentures
607
Illustration 16 A Ltd. purchased the following assets of X Ltd. for a purchase consideration of A48,00,000 : Land and Buildings of A40,00,000 at A35,00,000, and Plant and Machinery of A20,00,000 at A15,00,000. An amount of A12,00,000 was paid by drawing a Promissory Note in favour of X Ltd. and the balance of consideration was discharged by issue of 10% Debentures of A100 each at a premium of 20%. Record the necessary journal entries in the books of A Ltd. Solution : Books of A Ltd. Journal Date Particulars LF Dr. (A) Cr. (A) Land and Buildings A/c Dr. Plant and Machinery A/c Dr. To Capital Reserve A/c (Balancing figure) To X Ltd. (Being purchase of assetes from X Ltd., the excess of agreed value over the consideration being credited to Capital Reserve A/c.) X Ltd. Dr. To Bills Payable A/c (Being promissory note of A12,00,000 issued for part payment of consideration to X Ltd.)
35,00,000 15,00,000
X Ltd. To 10% Debentures A/c To Securities Premium Reserve A/c (Being issue of 30,000, 10% Debentures of A100 each
36,00,000
at 20% premium. No. of Debentures issued =
A36,00,000 30,000 .) A120
2,00,000 48,00,000
12,00,000
12,00,000
30,00,000 6,00,000
Accountancy
608
10.5.3
Issue of Debentures as Collateral Security
A Company may take a loan from a bank or any other financial institution or any other person and may have to issue debentures as an additional or secondary security besides other principal security like property or asset of the company. Such an issue of debentures as additional security is termed as 'Issue of Debentures as collateral security'. Collateral securrity means secondary security in addition to principal security. The lenders to whom such debentures are issued as collateral security, will not be entitled to any interest on these debentures. They are only entitled to get interest on the loan advanced by them. If a default is made either in the payment of interest or in the repayment of loan, the lender will realise the amount of debt from the principal security. If the debt is not fully realised from the principal security, the lender may claim all the rights of a debentureholder. But if the company pays the loan amount with interest in full, the lender will return back the debentures to the company for cancellation. There are two methods to deal with such type of issue of debentures in the books of the company : 1. First Method : Under this method, no entry is passed in the books of the company at the time of issue of debentures as collateral security. But entry is passed only for taking loan. If a loan is taken from a bank, the entry will be: Bank A/c Dr. (with the amount of loan) To Bank Loan A/c On the equity and liabilities side of the Balance Sheet, a note is given below the loan that the loan is secured by the issue of debentures as collateral security under the sub-head "Long-term Borrowings" and head "Non-current Liabilities." 2. Second Method : Under this method, entry is passed in the books of the company for issue of debentures as collecteral security with the entry for taking loan. a. On taking a loan from bank Bank A/c Dr. (with the amount of loan) To Bank Loan A/c
Accounting for Companies : Accounting for Debentures
b.
609
On issue of Debentures as collateral security Debenture Suspense A/c To Debentures A/c
Dr. (with the nominal value of Debentures issued as collateral security)
Debenture Suspense A/c will be shown as a deduction from Debentures A/c on the equity and liabilities side of the Balance Sheet and also a note is given below the Loan that the loan is secured by issue of debentures as collateral securities under the sub-head "Long-term Borrowings" and head "Non-Current Liabilities". Illustration 17 A Ltd. had A20,00,000, 10% Debentures outstanding on 1st April, 2015. During the year 2015-16, the company took a loan of A5,00,000 from bank for which the company issued A6,00,000, 10% Debentures as collateral security. Pass journal entries, if any. Show how the Debentures and Bank Loan will appear in the Balance Sheet of A Ltd. as at 31st March, 2016. Solution : (a) First Method : Books of A Ltd. (i) No entry for issue of Debentures as collecteral security. (ii) On taking the Bank LoanJournal Date
Particulars Bank A/c To Bank Loan A/c
LF Dr. (A) Cr. (A) Dr.
(Being loan of A5,00,000 taken from bank and A6,00,000, 10% Debentures issued as collateral security.)
5,00,000 5,00,000
Accountancy
610 Extract of Balance Sheet as at 31st March, 2016
Note 31st March, No. 2016 (A)
Particulars I. EQUITY AND LIABILITIES : Non-Current Liabilities : Long-term Borrowings
1
25,00,000
Notes to Accounts : I. Long-term Borrowings : 10% Debentures (In addition, Debentures of A6,00,000 have been issued as collateral security) Bank Loan (on collateral security of 10% Debentures of A6,00,000)
31st March, 2015 (A)
20,00,000 A 20,00,000 5,00,000 25,00,000
(b) Second Method : Books of A Ltd. Journal
Date
LF Dr. (A) Cr. (A)
Particulars Bank A/c To Bank Loan A/c (Being Loan of A5,00,000 taken from bank and A6,00,000,10% Debentures issued as collateral security.)
Dr.
10% Debenture Suspense A/c To 10% Debentures A/c (Being issue of 10% Debentures of A6,00,000 as collateral security to secure a loan of A5,00,000 from bank.)
Dr.
5,00,000 5,00,000
6,00,000 6,00,000
Extract of Balance Sheet as at 31st March, 2016
Particulars I.
EQUITY AND LIABILITIES : Non-Current Liabilities : Long-term Borrowings
Note 31st March, 31st March, No. 2016 (A) 2015 (A) 1
25,00,000
20,00,000
Accounting for Companies : Accounting for Debentures
611
Notes to Accounts : Particulars I.
Long-term Borrowings : 10% Debentures Less 10% Debenture Suspense A/c Bank Loan (on collateral security of 10% Debentures of A6,00,000)
A A26,00,000 A6,00,000
20,00,000 5,00,000 25,00,000
Illustration 18 Bright Ltd. issued 5,000,12% Debentues of A100 each at a premium of 10% on 1.10.2015. On the same date, the company purchased fixed assets of the value of A5,00,000 and took over current liabilities of A60,000 and issued 12% Debentures at a premium of 10% to the vendor. It also took a loan from bank for A2,00,000 and issued 12% Debentures as collateral security on the same date. Journalise the transactions in the books of Bright Ltd. and prepare the extract of the Balance Sheet as at 31st March, 2016. Ignore interest. Solution : Books of Bright Ltd. Journal Date
Particulars
LF Dr. (A) Cr.(A)
2015 Bank A/c Oct. 1 To 12% Debentures A/c To Securities Premium Reserve A/c (Being 5,000, 12% Debentures of A100 each issued at a premium of 10%)
Dr.
Oct. 1 Fixed Assets A/c To Current Liabilities A/c To Vendor's A/c (Being purchase of fixed assets and take over of current liabilities)
Dr.
5,50,000 5,00,000 50,000
5,00,000
60,000 4,40,000
Accountancy
612 Oct. 1 Vendor's A/c To 12% Debentures A/c To Securities Premium A/c (Being issue of 4,000 debentures of A100 each at 10% premium, No. of debentures issued
Dr.
4,40,000 4,00,000 40,000
A4,40,000 4,000.) A110
Oct. 1 Bank A/c To Bank Loan A/c (Being loan taken from bank by issuing 12% Debentures as collateral security.)
Dr.
Oct. 1 12% Debentures Suspense A/c To 12% Debentures A/c (Being issue of 12% Debentures as collateral security)
Dr.
2,00,000 2,00,000
2,00,000 2,00,000
Extract of Balance Sheet as at 31st March, 2016
Particulars I.
II.
EQUITY AND LIABILITIES : Shareholders' Funds : Reserve and surplus Non-current Liabilities : Long-term Borrowings Current Liabilities Assets : Non-current Assets : Fixed Assets Current Assets : Cash and Cash Equivalents
Note 31st March, 31st March, No. 2016 (A) 2015 (A)
1
90,000
2
11,00,000 60,000
2,50,000 3
7,50,000
Accounting for Companies : Accounting for Debentures
613
Notes to Accounts :
A
Particulars 1. 2.
3.
10.6
Reserves and Surplus : Securities Premium Reserve A/c Long term Borrowings : 12% Debentures Less 12% Debenture Suspense A/c Bank Loan (on collateral security of 12% Debenture of A2,00,000) Cash and Cash Equivalents : Cash at Bank
90,000 A 11,00,000 A 2,00,000 A 9,00,000 A 2,00,000
11,00,000
7,50,000
ISSUE OF DEBENTURES CONSIDERING THE TERMS AND CONDITIONS OF REDEMPTION A company may issue debentures on different terms. These terms may not
only relate to issue but also to redemption, i.e., repayment of the amount of debentures to the debentureholders. As discussed earlier, there are three possible terms of issue, i.e., at par, at premium and at discount.Debentures may be redeemed either at par or at premium according to the terms determined at the time of issue. Debentures generally are not redeemed at discount although a company may redeem its debentures by purchasing them at a discount in the open market. Thus, considering the terms and conditions of redemption of debentures, the following situations are commonly found in practice: a. Debentures issued at par and redeemable (repayable) at par, b. Debentures issued at discount but redeemable at par, c. Debentures issued at premium but redeemable at par, d. Debentures issued at par but redeemable at premium,
Accountancy
614
e. Debenutres issued at discount but redeemable at premium, f. Debentures isued at premium and redeemable at premium. The journal entries passed at the time of issue and redemption of debentures in all the above cases are as follows : a.
Debentures issued at par and redeemable at par :
(i)
On issue of Debentures Bank A/c
Dr. (With money received on application)
To Debenture Application and Allotment A/c (Being application money received on issue of debentures) Debenture Application and Allotment A/c
Dr. (With nominal value of debentures issued)
To Debentures A/c (Being transfer of application money to Debentures A/c) (ii)
On redemption of Debentures Debentures A/c
Dr. (with nominal value of debentures redeemed)
To Debentureholders A/c (Being amount due to debentureholders on redemption) Debentureholders A/c To Bank A/c (Being amount paid to debentureholders.)
Dr. (with nominal value of debentures redeemed)
Accounting for Companies : Accounting for Debentures
b.
Debentures issued at discount but redeemable at par :
(i)
On issue of Debentures Bank A/c
615
Dr. (with money received on To DebentureApplicaton andAllotment A/c application) (Being application money received on issue of debentures) Debenture Application and Allotment A/c
Discount on issue of Debentures A/c To Debentures A/c
Dr. (with amount received on application) Dr. (with the discount amount on issue) (with nominal value of debentures issued)
(Being transfer of application money to Debentures A/c, discount issue of debentures debited for discount) (ii)
On redemption of Debentures Debentures A/c
Dr. (with nominal value of debentures redeemed.)
To Debentureholders A/c (Being amount due to debentureholders on redemption.) Debentureholders A/c
Dr. (with nominal value of debentures redeemed)
To Bank A/c (Being amount paid to debentureholders) 'Discount on issue of Debentures' is a capital loss and will be written off during the life time of the debentures by debiting 'Securities Premium Reserve A/c' or 'Statement of Profit and Loss.' The amount not written off or unamortised portion of discount on issue of debentures will be shown on assets side of the Balance Sheet, under the head 'Current/Non-current Assets' depending on the fact that whether the amount will be amortised is the next 12 months or thereafter, and sub-head 'other current/Non-current Assets'
Accountancy
616
C.
Debentures issued at premium but redeemable at par :
(i) On issue of Debentures Bank A/c
Dr. (with amount received on issue of debentures)
To Debenture Application and Allotment A/c
(Being money received on application) Dr. (with application money received) To Debentures A/c (with nominal value of debenuture issued) To Securities Premium Reserve A/c (with the premium amount on issue) (Being transfer of application money to Debentures A/c and Securities Premium Reserve A/c.)
Debenture Application and Allotment A/c
(ii) On redemption of Debentures Debentures A/c
Dr. (with nominal value of debentures redeemed)
To Debentureholders A/c (Being the amount due to debentureholders on redemption) Debentureholders A/c
Dr. (with nominal value of debentures redeemed)
To Bank A/c (Being amount paid to debentureholders) 'Securities Premium Reserve' is a capital profit and to be shown on the equity and liabilities side of the Balance Sheet under the head 'Shareholders' Funds and sub-head 'Reserves and Surplus'.
Accounting for Companies : Accounting for Debentures
d.
617
Debentures issued at par but redeemable at premium :
When debentures are redeemable at a premium, it is a capital loss for the company. Though such premium amount will be paid at the time of redemption, the company records such premium at the time of issue of debentures by debiting 'Loss on issue of Debenture A/c' considering the convention of conservatism. Such loss is written off from Securities Premium Reserve or from Statement of Profit and Loss gradually every year during the life time of the debentures. The balance of 'Loss on issue of Debentures A/c' is shown on the assets side of the Balance Sheet under the head 'Current/Non-current Assets' and sub-head 'Other current/Non-current Assets'. 'Premium on redemption of Debentures' is a personal account and shows a credit balance. It is a liablity of the company and shown under the head 'Non-current Liabilities' and sub-head 'Other Long-term Liabilities' on the equity and liabilities side of the Balance Sheet till the debentures are redeemed. At the time of redemption, this account is debited and closed. (i)
On issue of DebenturesBank A/c
Dr. (with amount received on application)
To Debenture Application and Allotment A/c
(Being application money received on issue of debentures) Debenture Application and Allotment A/c
Dr. (with the amount of application money received)
Loss on issue of Debentures A/c
Dr. (with the premium payable on redemption) (with nominal value of debentures issued) (with the premium payable on redemption)
To Debentures A/c
To Premium on Redemeption of Debentures A/c (Being application money transferred to Debentures A/c, loss on issue of debentures debited for premium on redemptin of debentures)
618
Accountancy
(ii) On Redemption of Debentures Debentures A/c
Dr. (with the nominal value of debentures redeemed) Premium on Redemption of Debentures A/c Dr. (with premium payable on on redemption) To Debentureholders A/c (with total amount payable on redemption) (Being the amount due to debentureholders on redemption at premium.) Debentureholders A/c To Bank A/c
Dr. (with the amount payable to to debentureholders)
(Being the amount paid to debentureholders) e.
Debentures issued at discount but redeemable at Premium :
In such case, both the amount of discount allowed on issue and premium payable on redemption of debentures are capital loss and the total amount is to be debited to 'Loss on issue of Debentures A/c'. Such Loss on issue of Debentures A/c is shown on the assets side of the Balance Sheet under the head 'Current/Non-current Assets' and sub-head 'Other current/Non-Current Assets' till it is written off. (i)
On issue of Debentures Bank A/c To Debenture Application and Allotment A/c (Being application money received on issue of debentures)
Dr. (with amount received on application)
Accounting for Companies : Accounting for Debentures
619
Debenture Application and Allotment A/c Dr. (with application money received) Loss on issue of Debentures A/c Dr. (with the total amount of discount allowed on issue and premium payable on redemption) To Debentures A/c (with the nominal value of debentures issued) To Premium on Redemption of (with premium payable on Debentures A/c redemption) (Being transfer of application money to Debentures A/c and debiting loss on issue of debentures A/c for both discount on issue and premium payable on redemption) (ii) On redemption of Debentures Debentures A/c Dr. (with the nominal value of debentures redeemed) Premium on Redemption of Debentures A/c Dr. (with premium payable on redemption) To Debentureholders A/c (with the amount payable on redemption) (Being amount due to debentureholders, debiting Debentures A/c and Premium on Redemption of Debentures A/c.) Debentureholders A/c
Dr. (with the amount payable to on redemption)
To Bank A/c (Being the amount paid to debentureholders)
f. Debentures issued at premium and redeemable at Premium : (i) On issue of Debentures Bank A/c Dr. (with the amount received on application) To Debenture Application and Allotment A/c (Being application money received on issue of debentures)
Accountancy
620 Debenture Application and Allotment A/c
Dr. (with application money received)
Loss on issue of Debentures A/c
Dr. (with premium payable on redemption)
To Debentures A/c
(with the nominal value of debentures issued)
To Securities Premium Reserve A/c
(with premium on issue)
To Premium on Redemption of Debentures A/c (with premium payable on
redemption) (Being transfer of application money to Debentures A/c, Loss on issue of Debentures A/c debited for premium payable) (ii) On redemption of Debentures Debentures A/c
Dr. (with the nominal value of debentures redeemed) Premium on Redemption of Debentures A/c Dr. (with premium payable on redemption) To Debentureholders A/c (with total amount payable on redemption of debentures) (Being amount due to debentureholders on redemption of debentures.) Debentureholders A/c To Bank A/c (Being the amount paid to debentureholders on redemption of debentures.)
Dr. (With the amount due to debentureholders)