accounting for partnership - jims lajpat … of profit and loss account and balance sheet of a...

UNIT 1

CHAPTER 1

ACCOUNTING FOR PARTNERSHIP

( FUNDAMENTALS OF PARTNERSHIP)

LEARNING OBJECTIVES After studying this chapter you will be able to : l Define partnership and list its essential

features; l Explain the meaning and list the contents of

partnership deed; l Recognise the relevant provisions of the

Indian Partnership Act 1932, as applicable to

accounting in the absence of any provision to

the contrary in the partnership agreement;

l Prepare partners' capital account under fixed

and fluctuating capital method; l Distribute profit or loss among the partners

and prepare profit and loss appropriation

account;

l Explain how guarantee of a minimum amount

of profit to a partner is treated in the books of

accounts;

l Carry out past adjustments; l Explain the meaning of goodwill and methods

of its evaluation;

l Describe the accounting implications of

change in profit sharing ratio; and

l Explain 'joint life policy' in relation to

partnership accounts.

A business can be organised in the form of

a sole proprietorship, a partnership firm or

a company. Earlier, you have studied how

to prepare Profit and Loss Account and

Balance Sheet of a sole proprietor. If one

man was intelligent enough and

commanded all the resources that he

needed and also the necessary power to do

everything, he would have carried on his

business as an individual. Alas, this is not

true in life. Every man needs help from

others and this is true in business which

requires huge resources for the ongoing

expansion programmes. Therefore, one of

the inevitable ways is to form partnership

by joining hands with person(s) who can

complement the efforts by bringing in the

necessary intellectual as well as financial

capital. This chapter is devoted to the

basic aspects of partnership accounting

dealing with the

preparation of Profit and Loss Account and Balance Sheet of a partnership firm. Although the

basic accounting procedure is similar in all cases, there are certain special features in the

accounts of a partnership firm. In the case of a partnership firm, for example, the special

features relate to the distribution of profits, the maintenance of capital accounts and the

adjustments required when the firm is reconstituted. In this chapter, we shall study the nature

of partnership and discuss the basic aspects of partnership accounts like preparation of capital

accounts, distribution of profits amongst partners and change in the profit-sharing ratio of the

existing partners along with preparation of Profit and Loss Account and Balance Sheet of the

partnership firm.

Nature of Partnership

The sole proprietorship has its limitations such as limited capital, limited managerial ability

and limited risk-bearing capacity. Hence, when a business expands or when it is to be set up

on a scale, which needs more capital and involves more risk, two or more persons join hands

to run it. They agree to share the capital, the management, the risk and profits of the business.

Such mutual economic relationship based on a written or an oral agreement amongst these

persons is termed as 'partnership'. The persons who have entered into partnership are

individually known as 'partners' and collectively as 'firm'.

The Indian Partnership Act, 1932 defines partnership as "the relation between persons

who have agreed to share the profits of a business carried on by all or any of them acting for

all". Based on this definition, the essential features of partnership are as follows:

1. Two or more persons : To form a partnership, there must be at least two persons. There

is, however, a limit on the maximum number of persons who constitute a partnership

firm. It should not exceed 10 if the firm is carrying on a banking business and 20 if it is

engaged in any other business. 2. Agreement between the partners : A partnership is created by an agreement. It is neither

created by operation of law as in the case of Hindu Undivided Family nor by status. The

agreement forms the basis of economic relationship amongst the partners. The agreement

can be written or oral. 3. Business : The agreement should be for carrying on some legal business. A joint

ownership of some property by itself does not constitute partnership. However, the joint

ownership of the property may be used for forming the partnership in order to pursue the

business objectives for which the partnership is formed.

4. Sharing of profits : The agreement should be to share the profits of the business. If some

persons join hands to carry on some charitable activity, it will not be termed as

partnership. Of course, the ratio in which the partners will share the profits is determined

by the agreement or in the absence of the agreement; it is shared equally amongst the

partners. 5. Business carried on by all or any of them acting for all : The firm's business may be

carried on by all the partners or any one of them acting for all. This means that

partnership is based on the concept of mutual agency relationship. A partner is both an

agent (he can, by his acts, bind the other partners) and a principal (he is bound by the acts

of other partners). The implication of this is that partner binds others and others bind him

in the same way. Further implication of this is that each partner is entitled to participate

in the conduct of business affairs and act for and on behalf of the firm.

Partnership Deed Meaning A partnership is formed by an agreement. This agreement may be written or oral. Though the

law does not expressly require that there should be an agreement in writing but the absence of

a written agreement may be a source of trouble in managing the affairs of the partnership

firm. Therefore, a partnership deed should be written, assented and signed by all the partners. Contents of Partnership Deed The partnership deed usually contains the following particulars: l Name of the firm; l Names and addresses of all partners; l Nature and place of the business; l Date of commencement of partnership; l Duration of partnership, if any; l Amount of capital contributed or to be contributed by each partner; l Rules regarding operation of bank accounts; l Ratio in which profits are to be shared; l Interest, if any, on partners' capital and drawings;

l Interest on loan by the partners(s) to the firm; l Salaries, commissions, etc. if payable to any partner(s); l The safe custody of the books of accounts and other documents of the firm;

l Mode of auditor's appointment, if any; l Rules to be followed in case of admission, retirement, death, of a partner; l Settlement of accounts on dissolution of the firm; and l Mode of settlement of disputes among the partners. Provisions Affecting Accounting Treatment Normally, a partnership deed covers all matters relating to the mutual relationship amongst

the partners. But if the deed is silent on certain matters or in the absence of any deed or an

express agreement, the relevant provisions of the Partnership Act shall become applicable. It

is, therefore, necessary to know the provisions of the Act, which have a direct bearing on the

accounting treatment of certain items. These are as follows:

1. Profit Sharing : The partners shall share the profits of the firm equally irrespective of

their capital contribution. 2. Interest on Capital : No interest is allowed to partners on the capital contributed by

them. Where, however, the agreement provides for interest on capital, such interest is

payable only out of the profits of the business. In other words, if there are losses, interest

on capital will not be allowed even if the agreement so provides.

3. Interest on Loan : If any partner, apart from his share of capital, advances money to the

firm as a loan, he is entitled to interest on such amount at the rate of 6 per cent per

annum. Such interest shall be paid even out of the assets of the firm. This means that

interest on loan shall be paid even if there are losses. Implying, thereby, that it is a

charge against the revenues. 4. Interest on Drawings : No interest will be charged on drawings made by the partners.

5. Remuneration to Partners : No partner is entitled to any salary or commission for

participating in the business of the firm.

It should be remembered that the above rules are applicable only in the absence of any

provision to the contrary in the partnership agreement.

Special Aspects of Partnership Accounts

Following are the specific issues that require special attention in case of partnership accounts:

l Maintenance of capital accounts of partners; l Ascertainment and allocation of profit and losses; l Adjustment for wrong allocation of profits and losses; l Allocation of profits involving minimum guaranteed profit to a partner; l Reconstitution of the partnership firm; and l Dissolution of the firm.

The first four aspects are discussed in this chapter and the last two are dealt with in the

following chapters. Partners' Capital Accounts In case of partnership firm, the transactions relating to partners are recorded in their

respective capital accounts. Normally, each partner's capital account is prepared separately.

But these accounts can also be shown in a tabular form as shown later in this chapter.

There are two methods by which the capital accounts of partners can be maintained.

These are: l Fluctuating Capital Method; and l Fixed Capital Method. Fluctuating Capital Method Under the fluctuating capital method, only one account viz., the capital account for each

partner, is maintained. It records all items affecting partner's account like interest on capital,

drawings, interest on drawings, salary, commission, and share of profit or loss in the capital

account itself. As a result of these, the balance in the capital account keeps on fluctuating.

The items that usually appear on the debit and the credit side of the Partners' capital

account are : l Credit Side

1. Capital introduced or the opening balance;

2. Additions to capital made during the year, if any;

3. Interest on capital, if any; 4. Salary to the partners, if any; 5. Commission and bonus to the partners; 6. Share of profit.

l Debit Side

1. Drawings made during the year, if any; 2. Interest on drawings, if any; 3. Share of loss, if any; 4. Withdrawal of capital, if any; 5. Closing Balance.

Thus, the capital account of a partner will appear as follows: Partners' Capital Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount (Rs.) (Rs.)

Drawings * * * Opening balance * * * Interest on * * * Addition to capital * * * drawings Interest on capital * * * Share of loss * * * Salary * * * Withdrawal of * * * Commission/Bonus * * * capital Share of profit * * * Closing balance * * *

Total * * * Total * * *

Format under fluctuating method Note : A Partners' Capital Account usually shows a credit balance. It can, however, show a debit balance

under certain circumstances, such as over withdrawal or insolvency of the partner. Fixed Capital Method Under the fixed capital method, the capitals of the partners shall remain fixed unless some

additional capital is introduced or some amount of capital is withdrawn by an agreement

among the partners. Hence, all items like interest on capital, drawings, interest on drawings,

salary, commission, and share of profit or loss are not to be shown in the capital accounts. For

all these transactions, a separate account called 'Partner's Current Account' is opened. Thus,

under fixed capital method, two accounts are maintained for each partner viz., (i) Capital

Account, and (ii) Current Account. It may be noted that the capital account will continue to

show the same balance from year to year unless some amount of capital is introduced or

withdrawn, while the balance of current account will fluctuate from year to year.

Under the fixed capital account method, the capital account and the current account

would appear as shown below: Partners' Capital Account

Dr. Cr.


Withdrawal * * * * Opening balance * * * * of capital Addition to capital * * * * Closing balance * * * *

Total * * * * Total * * * *

Format under fixed capital method

Partners' Current Dr. Cr.


Opening balance* * * * * Opening balance* * * * * Drawings * * * * Interest on capital * * * * Interest on * * * * Salary * * * * drawings * * * * Commission/Bonus * * * * Share of loss * * * * Share of profit * * * * Closing balance* * * * * Closing balance* * * * *

Total * * * * Total * * * *

Format of Current Account * In Partners' Current Account, opening balance and closing balance may appear on either side, i.e. debit

or credit. Illustration 1 (Fixed and Fluctuating Capital Account) Amit and Sumit commenced business as partners on April 1, 2000. Amit contributed Rs.

40,000 and Sumit Rs. 25,000 as their share of capital. The partners decided to share their

profits in the ratio of 2:1. Amit was entitled to a salary of Rs. 6,000 p.a. Interest on capital

was to be provided @ 6% p.a. The drawings of Amit and Sumit for the year ending March 31,

2001were Rs. 4,000 and Rs. 8,000, respectively. The profits of the firm after providing Amit's

salary and interest on capital were Rs. 12,000.

Draw up the Capital Accounts of the partners:

(i) When capitals are fluctuating, and

(ii) When capitals are fixed.

Solution (i) When capitals are fluctuating

Books of Amit and Sumit Amit's Capital Account

Dr. Cr.


Drawings 4,000 Cash 40,000 Balance c/f 52,400 Salary 6,000 Interest on Capital 2,400 Profit and Loss

Appropriation A/c. 8,000 (Share of profit 2/3

of Rs. 12,000)

Total 56,400 Total 56,400

Sumit's Capital Account

Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount

(Rs.) (Rs.) Drawings 8,000 Cash 25,000 Balance c/f 22,500 Interest on Capital 1,500 Profit and Loss 4,000 Appropriation A/c

(Share of profit 1/3

of Rs.12,000)


(ii) When capitals are fixed. Books of Amit and Sumit

Amit's Capital Account

Dr. Cr.


Balance c/f 40,000 Cash 40,000


Amit's Current Account

Dr. Cr.


Drawings 4,000 Salary 6,000 Balance c/f 12,400 Interest on Capital 2,400 Profit and Loss 8,000 Appropriation


of Rs. 12,000)


Sumit's Capital Account


(Rs.) (Rs.)

Balance c/f 25,000 Cash 25,000

Sumit's Current Account

Dr. Cr.


Drawings 8,000 Interest on Capital 1,500 Profit and Loss 4,000 Appropriation


of Rs. 12,000)

Balance c/f 2,500


Distribution of Profit In case of partnership firm, the net profit (after charging the interest on capital, partners'

salary and commission and after taking into account the interest on drawings) is to be shared

by all the partners in the agreed profit sharing ratio. As stated earlier, in the absence of any

specific agreement to this effect, the profit is to be distributed equally among the various

partners.

Profit and Loss Appropriation Account As stated above, the net profit as shown by the profit and loss account of a partnership firm

needs certain adjustments with regard to interest on capitals, interest on drawings, salary,

commission to the partners, if provided, under the agreement. For this purpose, 'Profit and

Loss Appropriation Account' may be prepared. This is merely an extension of the profit and

loss account and is prepared to show how net profit is to be distributed among the partners.

This account is credited with net profit and interest on drawings, and debited with interest on

capitals, salary or commission to partners. If, however, the profit and loss appropriation

account shows a net loss, it will be shown on the debit side of the profit and loss

appropriation account. After these adjustments have been made, the Profit and Loss

Appropriation Account will show the amount of profit or loss, which shall be distributed

among the partners in the agreed profit sharing ratio.

For preparing the profit and loss appropriation account, the following journal entries

have to be recorded for various items:

1. For Interest on Capital

(i) For Crediting Interest on Capital to Capital/Current Account : Interest on Capital a/c Dr.

Partners' Capital/Current a/c

(ii) For transferring Interest on Capital to Profit and Loss Appropriation Account:

Profit and Loss Appropriation a/c Dr. Interest on Capital a/c

2. For Interest on Drawings

(i) Interest on Drawings is a gain to the firm and is charged to Partner's Capital/Current Account

Partners Capital/Current a/c Dr.

Interest on Drawings a/c

(ii) For transferring Interest on Drawings to Profit and Loss Appropriation Account, the following

entry is to be recorded:

Interest on Drawings a/c Dr. Profit and Loss Appropriation a/c

3. Partner's Salary

(i) Salary allowed to a partner is a gain of the individual partner and charge against the profits of the

firm as per partnership agreement. For this following entry is recorded:

Salary to Partner a/c Dr. Partner Capital/Current a/c

(ii) For charging salary allowed to a partner:

Profit and Loss Appropriation a/c Dr.

Salary to partner a/c

4. Partner's Commission

(i) Commission is an expense for the firm and a gain to the partner. For this, following entry is made:

Commission to partner a/c Dr.

Partner's capital/current a/c

(ii) Commission paid to a partner is charged to Profit and Loss Appropriation account by recording

the following entry:

Profit and Loss Appropriation a/c Dr. Commission to partners a/c

5. For Transfer to Reserve:

Profit and Loss Appropriation a/c Dr. Reserve

6. For share of Profit or Loss on Appropriation

If Profit:

Profit and Loss Appropriation a/c Dr. Partner's Capital/Current a/c

If Loss:

Partner's Capital/Current a/c Dr.

Profit and Loss Appropriation a/c

The Profit and Loss Appropriation Account will appear as follows: Profit and Loss Appropriation Account

Dr. Cr.


Net Loss as per * * Net profit as per ..... Profit and Loss A/c Profit and Loss A/c

(if loss) (if profit)

Interest on Capital Interest on drawings

A × × A × ×

B × × * * B × × × × × Partner's Salary ...... Capital A/cs Share

Partner's ...... of loss (if loss)

Commission A × ×

Reserve (transfer) ...... B × × × × × Capital A/cs - ......

Share of profit

(if profit)

A × × B × × * * *

Total ......... Total .........

Proforma of Profit and Loss Appropriation Account

Illustration 2 (Preparation of Profit and Loss Account and Balance Sheet) Aakriti and Akash are partners sharing profits in the proportion of 3:2. The undermentioned

trial balance was extracted from their books on December 31, 2000.

Trial Balance as on December 31, 2000

Rs. Rs.

Aakriti's Capital 65,000 Akash's Capital 40,000 Aakriti's Drawings 4,000

Akash's Drawings 3,000

Goodwill 10,000

Plant and Machinery 40,000

Office Furniture 5,000

Purchases 85,000

Sales 1,60,000

Total c/f 1,47,000 2,65,000

Total b/f 1,47,000 2,65,000

Sundry Debtors 40,500

Sundry Creditors 14,510

Returns Inwards and Outwards 1,500 2,500

Rent 3,750

Postage and Telegrams 500

Advertising Expenditure 9,000

Opening stock 11,500

Cash in hand 16,000

Wages 14,000

Telephone Charges 500

Salaries to staff 12,250

Printing and Stationery 750

Commission 5,000

Travelling Expenses 2,000

Carriage Inwards 5,800

Motor Van 20,860

Bills payable 8,900

Total 2,90,910 2,90,910

You are required to prepare the Profit and Loss Account for the year ended December

31, 2000 and Balance Sheet as at that date. The following adjustments are to be made:

1. The value of stock on December 31, 2000 was Rs. 12,500.

2. Write off Rs. 250 from office furniture; 10% on plant and machinery and 20% on

motor van.

3. Create a provision of 5% on the sundry debtors for bad debts.

4. Write off 1/5th of the advertising expenses.

5. Partners are entitled to interest on capital @ 5% p.a. and Akash is entitled to a

salary of Rs. 1,800 p.a.

Solution

Books of Akriti and Akash Profit and Loss Account for the year ended December 31, 2000.

Dr. Cr.

Particulars Amount Particulars Amount (Rs.) (Rs.)

Opening Stock 11,500 Sales 1,60,000 Purchases 85,000 Less : Returns 1,500 1,58,500

Less: Returns 2,500 82,500

Wages 14,000

Carriage Inwards 5,800

Gross Profit c/f 57,200 Closing Stock 12,500

1,71,000 1,71,000

Salaries to staff 12,250 Gross Profit b/f 57,200 Rent 3,750

Postage and Telegram 500

Advertising Exp. written off 1,800

Telephone Charges 500

Printing and Stationery 750

Commission 5,000

Travelling Expense 2,000

Depreciation

Plant 4,000

Furniture 250

Motor Van 4,172 8,422

Provision for Bad Debts 2,025

Salary to Akash 1,800

Interest on capital :

Aakriti 3,250

Akash 2,000 5,250

Net Profit Transferred to

Capital a/c:

Aakriti 7,892

Akash 5,261 13,153


Balance Sheet as at December 31, 2000

Liabilities Amount Assets Amount (Rs.) (Rs.)

Aakriti's Capital 65,000 Goodwill 10,000 Less:Drawings 4,000 Plant and Machinery 40,000

61,000 Less: Depreciation 4,000 36,000 Add: Interest on Capital 3,250

Net profits 7,892 72,142 Office Furniture 5,000

Less: Depreciation 250 4,750 Akash's Capital 40,000

Less: Drawings 3,000 Motor Vans 20,860

37,000 Less: Depreciation 4,172 16,688 Add: Interest on Capital 2,000

Salary 1,800 Sundry Debtors 40,500

Net profits 5,261 46,061 Less: Provision 2,025 38,475 Sundry Creditors 14,510 Cash on hand 16,000 Bills Payable 8,900 Advertising exp. 9,000

Less: Written-off (1/5) 1,800 7,200 Stock on hand 12,500

Total 1,41,613 Total 1,41,613

Illustration 3 (Distribution of profit) Ajit, Choudhary and Vishal set up a partnership firm on January 1, 2001. They contributed

Rs. 50,000, Rs. 40,000 and Rs. 30,000 respectively as their capitals and decided to share

profits in the ratio of 3:2:1. The partnership deed provided that Ajit is to be paid a salary of

Rs. 1,000 p.m. and Choudhary a commission of Rs. 5,000. It also provided that interest on

capital be allowed @ 6% p.a. The drawings for the year were: Ajit Rs. 6,000, Choudhary Rs.

4,000 and Vishal Rs. 2,000. Interest on drawings Rs. 270 on Ajit's drawings, Rs. 180 on

Choudhary's drawings and Rs. 90 on Vishal's drawings. The net amount of profit as per the

profit and loss account for the year ended 2001 was Rs. 35,660.

You are required to record the necessary journal entries relating to appropriation of

profit and prepare the profit and loss appropriation account and the partners' capital accounts.

Solution

Books of Ajit, Chaudhary and Vishal Journal

Date Particulars L.F. Debit Credit Amount Amount

2001 (Rs.) (Rs.)

End of Profit and Loss a/c Dr. 35,660 the year Profit and Loss Appropriation a/c 35,600

(Transfer of Profit to Profit and Loss

Appropriation Account)

Ajit's Salary a/c Dr. 12,000 Ajit's Capital a/c 12,000 (Amount of Ajit's Salary)

Profit and Loss Appropriation a/c Dr. 12,000 Ajit's Salary a/c 12,000 (Transfer of Ajit's Salary to

Profit and Loss Appropriation Account)

Choudhary's Commission a/c Dr. 5,000 Choudhary's Capital a/c 5,000 (Amount of Choudhary's Commission)

Profit and Loss Appropriation a/c Dr. 5,000 Choudhary's Commission a/c 5,000 (Transfer of Choudhary's Commission

to Profit and Loss Appropriation Account)

Interest on Capital a/c Dr. 7,200 Ajit's Capital a/c 3,000 Choudhary's Capital a/c 2,400 Vishal's Capital a/c 1,800 (Amount of interest on capital)

Profit and Loss Appropriation a/c Dr. 7,200 Interest on Capital a/c 7,200 (Transfer of Interest on Capital to


Ajit's Capital a/c Dr. 270 Choudhary's Capital a/c 180 Vishal's Capital a/c 90 Interest on Drawings a/c 540 (Amount of interest on drawings)

Interest On Drawings a/c Dr. 540 Profit and Loss Appropriation a/c 540 (Transfer of Interest on drawings to


Profit and Loss Appropriation a/c Dr. 12,000 Ajit's Capital a/c 6,000 Choudhary's Capital a/c 4,000 Vishal's Capital a/c 2,000 (Amount of profit on appropriation)

Profit and Loss Appropriation Account for the year ended December 31,2001 Dr. Cr.


Ajit's Salary 12,000 Net profit as per profit 35,660 Choudhary's Commission 5,000 and loss account

Interest on Capital: Interest on Drawings :

Ajit's Capital 3,000 Ajit's Capital 270

Choudhary's Capital 2,400 Choudhary's capital 180

Vishal's Capital 1,800 7,200 Vishal's Capital 90 540 Capital Accounts -

Share of Profit:

Ajit's Capital 6,000

Choudhary's Capital 4,000

Vishal's Capital 2,000 12,000


Ajit's Capital Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.)

Drawings 6,000 Cash 50,000 Interest on Drawings 270 Salary 12,000 Balance c/f 64,730 Interest on Capital 3,000 Profit and Loss

Appropriation

(Share of profit) 6,000


Choudhary's Capital Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount

2001 (Rs.) 2001 (Rs.) Drawings 4,000 Cash 40,000 Interest on Drawings 180 Commission 5,000 Balance c/f 47,220 Interest on Capital 2,400 Profit and Loss

Appropriation



Vishal's Capital Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount

2001 (Rs.) 2001 (Rs.)

Drawings 2,000 Cash 30,000 Interest on Drawing 90 Interest on Capital 1,800 Balance c/f 31,710 Profit and Loss

Appropriation



Illustration 4 (Distribution of profit) Pawan and Purna are partners in a firm sharing profits in the ratio of 3:2. The balance in their

capital and current accounts as on January1, 1998 were as under :

Pawan Purna (Rs.) (Rs.)

Capital Account 30,000 20,000

Current Account (Cr.) 10,000 8,000 The partnership deed provided that Pawan is to be paid salary @ Rs. 500 p.m. whereas Purna

is to get commission of Rs. 4,000 for the year.

Interest on capital is to be allowed @ 6% p.a. The drawings of Pawan and Purna for the

year were Rs. 3,000 and Rs. 1,000, respectively. Interest on

drawings for Pawan and Purna works out at Rs. 75 and Rs. 25, respectively. The net profit of

the firm before making these adjustments was Rs. 24,900.

Prepare the Profit and Loss Appropriation Account and the partners' capital and current

accounts. Solution

Books of Pawan and Purna Profit and Loss Appropriation Account for the year ended Dec. 31,1998

Dr. Cr.


Pawan's Salary 6,000 Net profit as per Profit and 24,900 Purna's Commission 4,000 Loss account

Interest on Capital: Interest on drawings :

Pawan's current 1,800 Pawan's current a/c 75

Purna's current 1,200 3,000 Purna's current a/c 25 100 Capital accounts

(Share of Profit):

Pawan's current 7,200

Purna's current 4,800 12,000


Partners' Capital Account

Dr. Cr.

Date Particulars J. Pawan Purna Date Particulars J. Pawan Purna 1998 F. Rs. Rs. 1998 F. Rs. Rs.

Balance c/f 30,000 20,000 Balance b/f 30,000 20,000

Partners' Current Account

Dr. Cr. Date Particulars J.F. Pawan Purna Date Particulars J.F. Pawan Purna 1998 Rs. Rs. 1998 Rs. Rs.

Drawings 3,000 1,000 Balance b/f 10,000 8,000 Interest on 75 25 Salary 6,000 -- Drawing Commission -- 4,000 Balance c/f 21,925 16,975 Interest on 1,800 1,200 Capital

Share of profit 7,200 4,800

Total 25,000 18,000 Total 25,000 18,000

Calculation of Interest on Capital If the partnership agreement specifically provides for the payment of the interest on the

capital contributed by the partners, the same has to be allowed. Interest to be allowed on

capital is to be calculated with respect to the time, rate and amount. Generally, following

points are to be borne in mind while calculating the interest on capital: 1. Normally, interest on the opening balance at the beginning of the year is allowed for the

whole accounting year. 2. If additional capital is invested during the year, interest for the relevant period is

calculated. 3. If part of the capital is withdrawn during the year, interest on the part of the capital that

was invested for the whole year, interest is calculated for the whole year and it is added

with the amount of interest that is calculated on the remaining capital that was invested

for the relevant period. For example, Anmol has Rs. 30,000 as balance in his capital

account at the beginning of the year. In the middle of the year he withdrew Rs.10,000

from his capital. He is entitled for interest @ 10% p.a.

In this case, interest will be calculated in the following manner:

(20,000 × 10/100) + (10,000 × 10/100 × 1/2) = Rs. 2,500;

Alternatively, we can calculate interest on capital with respect to the amount

remained invested for the relevant period. In the above example, the interest may also be

calculated as follows:

(30,000 × 10/100 × 1/2) + (20,000 × 10/100 × 1/2) = Rs. 2,500.

Illustration 5 (Interest on Capital) Mansoor and Reshma are partners in a firm. Their capital accounts showed the balance

on Jan 1, 2000 as Rs. 20,000 and Rs. 15,000 respectively.During the year, Mansoor

introduced additional capital of Rs.10,000 on May 1, 2000 and Reshma brought in further

capital of Rs.15,000 on July 1, 2000. Reshma withdrew Rs. 5,000 from her capital on

October 1, 2000. Interest is allowed @ 6% p.a. on the capitals. Calculate the interest to be

paid on the capital.

Solution

Statement showing calculation of interest

Particulars Mansoor Reshma Rs. Rs.

1. Interest on capital balance on Jan 1, 2000:

Mansoor – (20,000×6/100) 1,200

Reshma – (15,000×6/100) 900 2. Add interest on additional capital:

Mansoor – (10,000×6/100×8/12) 400

Reshma – (15,000×6/100×6/12) 450 3. Less: Interest on capital withdrawn

by Reshma (5000×3/12×6/100) (75)

Total Interest Payable 1,600 1,275

Calculation of Interest on Drawings Interest on drawings is to be charged from the partners, if the same has been specifically

provided in the partnership deed. Interest on drawings is to be calculated with reference to the

time period for which the money was withdrawn. Following may be the possibilities requiring

the different calculations of interest when:

(1) Amount, rate of interest and date of withdrawal is given:

Suppose, Johnson is a partner who withdrew Rs. 20,000 on October 1, 2002. Interest on

drawings is charged @ 10% per annum. The calculation of interest will be as follows:

Rs. 20,000 10 3 Rs. 500

12

100

(2) Amount and rate of interest are given but date of withdrawal is not specified:

Suppose, Ahmed is a partner who withdraws Rs. 20,000 and interest on drawings is

charged @ 10% per annum. The calculation of interest will be as follows:

Rs. 20,000 10 6 Rs. 1,000

12

100

Here, it is noted that in the absence of any particular date of withdrawal, it is assumed

that withdrawals are made evenly throughout the year. Hence, interest is charged for the

average of the period of the year, i.e., six months. (3) Fixed amount is withdrawn every month:

In this case, there may be three possibilities and accordingly the interest for that period

will be charged: a) If amount is withdrawn during the month (implicitly assumed to be in the middle

of month), interest is calculated for six months; b) If the withdrawal is made in the beginning of the month, interest is calculated for

6½ months (six and a half months), and c) If withdrawal is made at the end of the month, interest is calculated for 5 ½

months (five and a half months). (4) If amount is withdrawn at each quarter:

(a) If amount is withdrawn in the beginning of each quarter, in this case the interest is

calculated on total drawings for a period of seven and a half months, and

(b) If amount is withdrawn at the end of each quarter, the amount of interest is

calculated on total drawings for a period of four and a half months.

(5) Different amounts are withdrawn at different intervals: In this case, the sum of the product of amount withdrawn and the time is calculated and

then the rate of interest is applied for a period of one month. For example, Sonu

withdraws Rs. 1,000 on March 1; Rs. 2,000 on 30th June; Rs. 1,000 on 1st November

and Rs. 2,000 on 31st December. Interest on drawings is charged at 10% per annum. In

this case, interest on drawings will be calculated as follows :

Statement of Calculation of Interest on Drawings

(1) (2) (3) (4) (5)

Date Amount(Rs.) Time Period Product Interest*(Rs.)

(2×3)

March 1 1000 10 Months 10,000 10,000 × 10/100 × 1/12 = 83.33 June 30 2000 6 Months 12,000 12,000 × 10/100 × 1/12 = 100 Nov.1 1000 2 Months 2,000 2,000 × 10/100 × 1/12 = 16.67 Dec.31 2000 0 0 0

Total 24,000 200*

* Instead of this cumbersome calculation, the same result can be obtained by calculating the Interest on the sum of

product for a period of one month = Rs. 24,000 × 10/100 × 1/12 = Rs. 200

Illustration 6 (Interest on Drawings) Rajesh is a partner in a firm. He withdrew the following amounts during the year 2000 :

Rs.

January 31 6,000

March 31 4,000

June 30 8,000

September 30 3,000

October 31 5,000

The interest on drawings is to be charged @ 6% p.a. Assuming the accounting year

closes on December 31each year, interest on drawings to be debited to Rajesh shall be worked

out as follows :

1 2 3 4

Date Amount(Rs.) Period Months Product(Rs.)

(2×3)

Jan 31 6,000 11 66,000

March 31 4,000 9 36,000

June 30 8,000 6 48,000

Sept 30 3,000 3 9,000

Oct 31 5,000 2 10,000

Total 26,000 1,69,000

Interest on drawings for one month on the sum of products :

Rate of interest sum of products 1

100 12

= 6/100 × Rs. 1,69,000 × 1/12

= Rs. 845

Alternatively, interest can be calculated separately for each amount for the period

involved and then totalled. In that case also, we shall arrive at the same amount of interest. Illustration 7 (Interest on drawings) Amit and Sonu are partners sharing profits equally. Amit withdrew Rs. 1,000 p.m. regularly

on the first day of every month for personal expenses. If interest

on drawings is to be charged @ 5% p.a., calculate the interest on the drawings of Amit. Solution

Calculation of Interest on Drawings

(1) (2) (3) (4) Date Amount of drawings(Rs.) Period for which money has Product(Rs.)

2001 been used (2 × 3)

Jan 1 1,000 12 12,000

Feb 1 1,000 11 11,000

Mar 1 1,000 10 10,000

Apr 1 1,000 9 9,000

May 1 1,000 8 8,000

June 1 1,000 7 7,000

July 1 1,000 6 6,000

Aug 1 1,000 5 5,000

Sept 1 1,000 4 4,000

Oct 1 1,000 3 3,000

Nov 1 1,000 2 2,000

Dec 1 1,000 1 1,000

Total 12,000 78,000

Interest on Drawings = Rate of Interest/100 × 1/12 × Sum of the product = 5/100 × 1/12 × 78,000

= Rs. 325

It may be noted that when a fixed amount is drawn at regular intervals, the interest on

drawings can also be calculated on the basis of the average period. The calculation of the

average period depends upon the fact whether the fixed amount is withdrawn on the first day

of every month or the last day of every month.

If the fixed amount is withdrawn on the first day of every month, the average period will

be calculated with the help of following formula :

Average period = (Total period in months + 1)/2

If the fixed amount is withdrawn on the last day of every month, the average period will

be calculated by the following formula : Average period = (Total period in months – 1)/2

In illustration 6, the partners withdrew a fixed amount on the first day of every month.

Hence, the interest on drawings can also be calculated by applying the average period

formula.

Average period = (Total period in months + 1)/2

= (12 +1)/2 = 6.5 Months

Interest on drawings for 6.5 months @ 5% p.a.

= 12000 5

13

1

100 2 12

= Rs. 325

Illustration 8 (Interest on Drawings) Maneesh and Mohan are partners in a firm. The partnership deed provided that interest on

drawings will be charged @ 6% p.a.. During the year ended, December 31, 2002, Maneesh

withdrew Rs.5,000 in the beginning of each quarter and Mohan withdrew Rs. 5,000 at the end

of each quarter. Calculate interest on the partners' drawings.

Solution

Maneesh's total drawings = Rs.5,000 × 4 = Rs.20,000

Mohan's total drawings = Rs.5,000 × 4 = Rs.20,000

Interest on Maneesh's Drawings :

Number of months for which interest will be charged = 12 3

7.5 months

2

Interest = Rs. 20,000 6 15

1 Rs. 750

2

100 12

Interest on Mohan's drawings :

Number of months for which interest will be charged = 12 − 3 4.5 months

2

Interest = Rs. 20,000 6 9 1

Rs. 450

2 12

100

1.4 Guarantee of Profit to a Partner

Guarantee is an assurance that a partner will not get as his share of profit less than the

guaranteed amount. There may be two situations : (a) Guarantee to one partner by (others) the firm, (b) Guarantee to a partner by another partner individually. (a)

Guarantee to one partner by (others) the firm

Sometimes, a partner is guaranteed a minimum amount by way of his share in the profits

of the firm. Such a guarantee may be given to an existing partner or to a new partner at

the time of admission. Such guaranteed amount shall be paid to partner when his share

of profit, as calculated, according to his profit sharing ratio is less than the guaranteed

amount. The deficiency of such guaranteed amount will be borne by the other partner's

in their profit sharing or agreed ratio as the case may be.

Example, Soni and Mita are partners and they decide to admit Mary into the partnership

firm. The profit sharing ratio is agreed as 3:2:1 with a guaranteed amount of Rs. 5,000 to

Mary. For the year ended 2001, the business earns a profit of Rs. 24,000. Mary's share

works out to Rs. 4,000 (1/6 of Rs. 24,000). This is Rs. 1,000 less than the guaranteed

amount of Rs. 5,000. Hence, Mary will get Rs. 4,000 as her share of the profit in the

profit sharing ratio and the deficiency of Rs.1,000 (i.e. the amount by which Rs. 4,000

falls short of the guaranteed amount) shall be transferred to the credit of Mary by

transfer from Soni and Mita in their profit sharing ratio, i.e. 3:2.

Illustration 9 (Guarantee of Profit) Mouse, Keyboard and Monitor are partners. They admit Printer as a partner with a guarantee

that his share of profits shall not be less than Rs. 20,000 p.a. Profits are to be shared in the

proportion of 4:3:3:2. The total profits for the year ended 2002 were Rs. 96,000. Prepare the

profit and loss appropriation account showing the division of the profits for the year.

Solution Books of Mouse, Key Board and Monitor

Profit and Loss Appropriation Account

for the year ended........2002

Dr. Cr.


Mouse 30,400 Net Profits 96,000 Keyboard 22,800

Monitor 22,800

Printer 20,000


Notes to Solution :

Printer's share = Rs. 96,000 × 2/12 = Rs. 16,000. Since Printer has been guaranteed a minimum amount of Rs. 20,000, therefore, he will given Rs.

20,000 and remaining amount i.e., Rs. 20,000 – Rs.16,000 = Rs. 4,000 will be borne by Mouse,

Keyboard and Monitor in the ratio of 4:3:3.

Mouse's share = Rs. 96,000 × 4/12 = Rs. 32,000

Less :

contribution to Printer (Rs. 4,000 × 4/10) = Rs. 1,600 Rs. 30,400

Keyboard's share = Rs. 96,000 × 3/12 = Rs. 24,000 Less:


Monitor's share = Rs. 96,000 × 3/12 = Rs. 24,000 Less:


(b) Guarantee to a partner by another partner individually

The guarantee to an existing or incoming partner may be given by all the old partners or

any of them in their new profit sharing ratio or an agreed basis. In illustration 9, all the

three partners have agreed to guarantee Printer for the minimum share of profit. Hence,

these three divided the Printer's share in the ratio of 4:3:3. Suppose Mouse alone agrees

to guarantee Printer then profit distribution will be as follows :

Mouse's share Rs. 96,000 × 4/12 = Rs. 32,000 Less : Printer's share Rs. 4,000 Final share of Mouse Rs. 28,000 In other words Keyboard and Monitor will get full share, i.e. Rs.24,000 each.

Illustration 10 (Guarantee of Profit) Kim and Lal are partners in a firm sharing profit in the ratio of 2:1. They decide to admit

Mohit with 1/4th share in profits with a guaranteed amount of Rs. 25,000. Kim undertook to

meet the liability arising out of the guaranteed amount to Mohit. The profit sharing ratio

between Kim, Lal and Mohit will be 2:1:1. The firm earned profit of Rs. 76,000 for the year

ended March 31, 2001.

You are required to prepare Profit and Loss Appropriation Account and show the

distribution of profit amongst the partners. Solution The Profit and Loss Appropriation Account will be prepared as follows :

The Profit and Loss Appropriation Account for the

year ended March 31, 2001 Dr. Cr.


Share of Profit Net Profit as per profit 76,000 Kim and loss account

(2/4 of 76,000) 38,000

Less: Mohit's

deficiency

(2/3 of 9,000) 6,000 32,000

Lal

(1/4 of 76,000) 19,000

Mohit (1/4 of 76,000) 19,000

Add: deficiency

borne by Kim 6,000 25,000


Notes to the Solution :

The minimum guaranteed amount to Mohit is Rs. 25,000 whereas, his share of profit as per the profit

sharing ratio works out to be Rs. 19,000 only. Hence, there is a shortfall of Rs 6,000. This amount will

be borne by Kim. Past Adjustments Sometimes, after the final accounts have been prepared and the partners' capital account are

closed, it is found that certain items have been omitted by

mistake or have been wrongly treated. Such omissions and commissions usually relate to the

interest on capital, interest on drawings, salary to partners, etc. In such a situation, necessary

adjustments have to be made in the partners' capital account through an account called Profit

and Loss Adjustment Account. The following procedure may be helpful in recording

necessary adjustments : 1. If, interest on capital is one of the items of omissions, then first ascertain the partners'

capital at the beginning. This can be done by deducting partners' share of current year's

profit from their capitals at the end and adding their drawings thereto.

2. Work out the amounts of omitted items that are to be credited to partners' capital

accounts such as interest on capital, salaries to partners, etc. The following journal entry

for the adjustment is recorded :

Profit and Loss Adjustment a/c Dr. Partners' Capital a/c (individually)

3. Work out the amounts of omitted items which are to be debited to Partners' Capital

Accounts such as interest on drawings and record the following adjustment entry are

recorded :

Partners' Capital (individually) a/c Dr. Profit and Loss Adjustment a/c

4. Work out the balance of the Profit and Loss Adjustment Account. The credit balance of

the Profit and Loss Adjustment Account reflects the profit and the debit balance, the

loss. This is to be distributed among the partners. 5. The balance of the Profit and Loss Adjustment Account as worked out in point 4 above

be transferred to the partners' capital accounts in their profit sharing ratio. Thus, the

Profit and Loss Adjustment Account will stand closed. It will involve the following

journal entry :

If it is a credit balance (profit)

Profit and Loss Adjustment a/c Dr. Partners' Capital (individually) a/c

If it is a debit balance (loss)

Partners' Capital (individually) a/c Dr.

Profit and Loss Adjustment a/c

The adjustment can also be made directly in the Partners' Capital Accounts without

preparing a Profit and Loss Adjustment Account. In such a situation,

we shall prepare a statement to find out the net effect of omissions and commissions and then

to debit the capital account of the partner who had been credited in excess and credit the

capital account of the partner who had been debited in excess. Illustration 11 (Past adjustments) Asha and Bony are partners in a firm sharing profits equally. Their capital accounts as on

December 31, 2000 showed balances of Rs. 60,000 and Rs. 50,000 respectively. After taking

into account the profits of the year 2000, which amounted to Rs 20,000, it was subsequently

found that the following items have been left out while preparing the final account of the year

ended 2000.

(i) The partners were entitled to interest on capitals @ 6% p.a. (ii) The drawings of Asha and Bony for the year 2000 were Rs.8,000 and Rs.6,000

respectively. The interest on drawings was also to be charged @ 5% p.a.

(iii) Asha was entitled to salary of Rs.5,000 and Bony, a commission of Rs.2,000 for the

whole year.

It was decided to make the necessary adjustments to record the above omissions. Give

the necessary journal entries and prepare the profit and loss adjustment account and Partners'

capital accounts. Solution (1) Partners capital at the beginning Asha Bony (Rs.) (Rs.)

Capital at the end 60,000 50,000 Less: Share of Profit (10,000) (10,000)

(Rs. 20,000 shared equally) 50,000 40,000 Add: Drawings 8,000 6,000

Capital at the beginning 58,000 46,000

(2) Interest on Capital

For Asha : 58,000 × 6/100 = Rs. 3,480 For Bony : 46,000 × 6/100 = Rs. 2,760

(3) Interest on Drawings For Asha : on Rs. 8,000 @ 5% p.a. for 6 months.

8,000

5 6

Rs. 200

100

12

For Bony : on Rs. 6,000 @ 5% p.a. for 6 months

6,000

5 6

Rs . 150

100

12

Books of Asha and Bony

Journal

Date Particulars L.F. Debit Credit

Amount Amount

2000 (Rs.) (Rs.)

Dec 31 Profit and Loss Adjustment a/c Dr. 6,240

Asha's Capital a/c 3,480

Bony's Capital a/c 2,760

(Amount of interest on capital )

,, Asha's Capital a/c Dr. 200

Bony's Capital a/c Dr. 150

Profit and Loss Adjustment a/c 350

(Amount of interest on drawings )

,, Profit and Loss Adjustment a/c Dr. 5,000


(Amount of salary )

,, Profit and Loss Adjustment a/c Dr. 2,000

Bony's Capital a/c 2,000

(Amount of commissions )

,, Asha's Capital a/c Dr. 6,445

Bony's Capital a/c Dr. 6,445

Profit and Loss Adjustment a/c 12,890

(Amount of loss on adjustment )

Profit and Loss Adjustment Account for the year ended December 31, 2000

Dr. Cr.


Capital (Interest on capital) Capital ( Interest on Drawings ) Asha 3,480 Asha 200

Bony 2,760 6,240 Bony 150 350 Asha's capital (Salary) 5,000 Capital (Loss on adjustments)

Bony's capital (Commission ) 2,000 Asha 6,445

Bony 6,445 12,890


Partners' Capital Account Dr. Cr.

Date Particulars J.F. Asha's Bony's Date Particulars J.F. Asha's Bony's 2000 Rs. Rs. 2000 Rs. Rs.

Dec31 Profit and Loss Dec 31 Balance b/f 60,000 50,000 Adjustment: 200 150 Profit and Loss

(interest on Adjustment: 3,480 2,760 drawings) (Interest on

Profit and Loss capital)

Adjustment: 6,445 6,445 Profit and Loss

(Loss on Adjustment: 5,000

Adjustment) (Salary)

Balance c/f 61,835 48,165 Profit and Loss

Adjustment: 2,000 (Commission)

68,480 54,760 68,480 54,760

Balance b/f 61,835 48,165

For a Single adjustment entry an analysis table to find out the amount to be debited or

credited to the capital accounts of the partners individually.

Analysis Table

Particulars Asha Bony

(Rs.) (Rs.)

Amount credited 8,480 4,760 (Interest on capital, salary and commission)

Amount debited 6,645 6,595 (Interest on drawings and share of loss)

Cr. 1,835 Dr. 1,835

Journal Entry

Bony's Capital a/c Dr. 1,835


Alternatively: A detailed statement can be prepared as follows :

Statement of Adjustment

Particulars Amount already Amount as should Adjustment recorded have been recorded

Dr. (Rs.) Cr. (Rs.) Dr. (Rs.) Cr. (Rs.) Dr./Cr (Rs.)

Asha's Capital : -- -- --

Interest on Capital -- -- 3,480

Interest on Drawings -- -- 200

Salary -- -- 5,000 Share of Profit 10,000 3,555

200 12,035

NET 10,000 -- 11,835 Cr. 1,835

Bony's Capital :

Interest on Capital -- -- -- 2,760

Interest on Drawings -- -- 150 --

Commission -- -- -- 2,000 Share of Profit -- 10,000 -- 3,555

150 8,315

NET 10,000 -- 8,165 Dr. 1,835

Direct Adjustment Entry Bony's Capital a/c Dr. 1,835

Asha's Capital a/c Note : Share of Profit has been worked out as under :

Profit and Loss Appropriation Account for the

year ended December 31, 2000 Dr.

1,835

Cr. Particulars Amount Particulars Amount

(Rs.) (Rs.)

Interest on Capital Profit as per Profitand Loss a/c 20,000 Asha 3,480 Interest on Drawings :

Bony 2,760 6,240 Asha's 200 Asha's Capital (Salary) 5,000 Bony's 150 350 Bony's Capital (Commission) 2,000

Share of Profit :

Asha 3,555

Bony 3,555 7,110


Goodwill

Goodwill is also one of the special aspects of partnership accounts which requires adjustment

at the time of a change in the profit sharing ratio, the admission of a partner or the retirement

or death of a partner. Meaning of Goodwill Over a period of time, a well-established business develops an advantage of good name,

reputation and wide business connections. This helps the business to earn more profits as

compared to a newly set up business. In accounting, the monetary value of such advantage is

known as 'goodwill'.

It is regarded as an intangible asset. In other words, goodwill is the value of the

reputation of a firm in respect of the profits expected in future over and above the normal

profits. It is generally observed that when a person pays for goodwill, he/she pays for

something, which places him in the position of being able to earn super profits as compared to

the profit earned by other firms in the same industry.

In simple words, goodwill can be defined as ''the present value of a firm's anticipated

excess earnings'' or as "the capitalized value attached to the differential profit capacity of a

business". Thus, goodwill exists only when the firm earns super profits. Any firm that earns

normal profits or is incurring losses has no goodwill.

Factors giving rise to Goodwill The main factors helping the creation of goodwill are as follows : 1. Nature of Business : A firm that produces high value added products or having a stable

demand is able to earn more profits and therefore has more goodwill.

2. Location : If the business is centrally located or is at a place having heavy customer

traffic, the goodwill tends to be high. 3. Efficiency of Management : A well-managed concern usually enjoys the advantage of

high productivity and cost efficiency. This leads to higher profits and so the value of

goodwill will also be high. 4. Market situation : The monopoly condition or limited competition enables the concern

to earn high profits which leads to higher value of goodwill. 5. Special Advantages : The firm that enjoys special advantages like import licences, low

rate and assured supply of electricity, long-term contracts for supply of materials, well-

known collaborators, patents, trade marks, etc. enjoy higher value of goodwill.

Need for Valuation Normally, the need for valuation of goodwill arises at the time of the sale of a business. But,

in case of a partnership firm it may also arise in the following circumstances:

1. Change in the profit sharing ratio amongst the existing partners; 2. Admission of a new partner; 3. Retirement of a partner; 4. Death of a partner; 5. Dissolution of a firm which involves sale of business as a going concern; and 6. Amalgamation of firms.

Methods of Valuation of Goodwill The important methods of valuation of goodwill are as follows : 1. Average Profits Method : Under this method, the goodwill is valued at agreed number of

'years' purchase of the average profits of the past few years. It is based on the

assumption that a new business will not be able to earn any profits during the first few

years of its operations. Hence, the person who purchases a running business must pay in

the form of goodwill a sum which is equal to the profits he is likely to receive for the

first few years. The goodwill, therefore, should be calculated by multiplying the past

average profits by the number of years during which the anticipated profits are expected

to accrue.

For example, if the past average profits of a business works out at Rs. 20,000 and it is

expected that the same profits will be available in future, the value of goodwill will be

Rs. 60,000 (Rs. 20,000 × 3), if three years, purchase of the past average profits

constitute the basis of valuation of the goodwill.

Illustration 12 (Goodwill) The profit for the last five years of a firm were as follows year 1999 Rs. 4,00,000; year 2000

Rs. 3,98,000; year 2001 Rs. 4,50,000; year 2002 Rs. 4,45,000 and year 2003 Rs. 5,00,000.

Calculate goodwill of the firm on the basis of 4 years purchase of 5 years average profits. Solution Year Profit

Rs. Rs.

1999 4,00,000

2000 3,98,000

2001 4,50,000

2002 4,45,000

2003 5,00,000

Total 21,93,000

Average Profit = Total profit of last 5 years

= Rs. 21,93,000 Rs. 4,38,600

No. of years

5

Goodwill = Average Profits × No. of years purchased

= Rs. 4,38,600 × 4 = Rs. 17,54,400

Illustration 13 (Goodwill) Compute the value of goodwill on the basis of four years' purchase of the average profits

based on the last five years.

The profits for the last five years were as follows :

Year Rs.

1999 40,000 2000 50,000 2001 60,000 2002 50,000 2003 60,000

Solution

Calculation of Average Profits

(Profits) Year Rs.

1999 40,000 2000 50,000 2001 60,000 2002 50,000 2003 60,000

Total 2,60,000

Average Profits = 2,60,000/5 = Rs. 52,000

Goodwill = Rs. 52,000 × 4 = Rs. 2,08,000

Illustration 14 (Goodwill) The following were the profits of a firm for the last three years.

Year ending Profit (Rs.)

March 31

2000 4,00,000 (including an abnormal gain of Rs. 50,000) 2001 5,00,000 (after charging an abnormal loss of Rs. 1,00,000) 2002 4,50,000 (excluding Rs. 50,000 payable on the insurance of plant and machinery )

Calculate the value of firm's goodwill on the basis of two years purchase of the average

profits for the last three years. Solution Calculation of average maintainable profits.

Year ended Profit (Rs.)

2000 (4,00,000 – 50,000) 3,50,000 2001 (5,00,000 + 1,00,000) 6,00,000 2002 (4,50,000 – 50,000) 4,00,000

Total 13,50,000

Average profit = Rs.13,50,000

Rs. 4,50,000

3

Goodwill at 2 years purchase of Average Profit = Rs.

4,50,000 × 2 = Rs. 9,00,000

The above calculation of goodwill is based on the assumption that no change in the

overall situation of profits is expected in the future. 1. Weighted Average Profit Method : This method is a modified version of the earlier

method. Under this method each year's profit is multiplied by the respective number of

weights i.e. 1,2,3,4 etc., in order to find out value of product and the total of products is

then divided by the total of weights in order to ascertain the weighted average profits.

Thereafter, the weighted average profit is multiplied by the agreed number to find out

the value of goodwill.

Weighted Average Profit = Total of Products of Profits

Total of Weights

Goodwill = Weighted Average Profits × Agreed

Number of years'(Purchase)

Weighted average profit method of valuation of goodwill is better than the simple

average profit method because it gives weightage to latest profit,which is likely to be

maintained in the future by the firm. It is applicable when the profit shows a rising or

falling trend.

Illustration 15 (Goodwill) The profits of a firm for the year ended 31st March for the last five years were as follows :

Year Profit (Rs.)

1999 20,000

2000 24,000

2001 30,000

2002 25,000

2003 18,000

Calculate the value of goodwill on the basis of three years' purchase of weighted

average profits after weights 1,2,3,4 and 5 respectively to the profits for 1999, 2000, 2001,

2002 and 2003. Solution

Year Profit

ended 31 March Rs. Weight Product

1999 20,000 1 20,000 2000 24,000 2 48,000 2001 30,000 3 90,000 2002 25,000 4 1,00,000 2003 18,000 5 90,000

Total 15 3,48,000

Weighted Average Profit 3,48,000

Rs. 23,200

15

Goodwill = 23,200 × 3 = Rs. 69,600

Illustration 16 (Goodwill) Calculate goodwill of a firm on the basis of three years' purchase of the weighted average

profits of the last four years. The profit of the last four years were : 2000 Rs. 20,200; 2001 Rs.

24,800; 2002 Rs.20,000 and 2003 Rs. 30,000. The weights assigned to each year are : 2000-1;

2001- 2; 2002- 3 and 2003-4. You are supplied the following information : (i) On September 1, 2002 a major plant repair was undertaken for Rs. 6,000 which was

charged to revenue. The said sum is to be capitalized for goodwill

calculation subject to adjustment of depreciation of 10% p.a. on reducing balance

method. (ii) The closing stock for the year 2001 was overvalued by Rs. 2,400. (iii) To cover management cost an annual charge of Rs. 4,800 should be made for the

purpose of goodwill valuation. Solution

Calculation of adjusted 2000 2001 2002 2003 profit Rs. Rs. Rs. Rs.

Given Profits 20,200 24,800 20,000 30,000

Less Management Cost 4,800 4,800 4,800 4,800 15,400 20,000 15,200 25,200 Add Capital expenditure

charged to revenue - - 6,000 - 15,400 20,000 21,200 25,200 Less unprovided

depreciation - - 200 580 15,400 20,000 21,000 24,620 Less over valuation of

closing stock - 2,400 - - 15,400 17,600 21,000 24,620 Add over value of opening - - 2,400 - stock

Adjusted Profit 15,400 17,600 23,400 24,620

Calculation of weighted average profits :

Year Profit Weight Product Rs.

2000 15,400 1 15,400 2001 17,600 2 35,200 2002 23,400 3 70,200 2003 24,620 4 98,480

Total 10 2,19,280

Weight Average Profit = 2,19,280

Rs. 21,928

10

Goodwill = 21,928 × 3 = Rs. 65,784

Notes to the Solution (i) Depreciation of 2002 = 10% of Rs. 6,000 for 4 months

= 6,000 × 10/100 × 4/12 = Rs. 200 (ii) Depreciation of 2003 = 10% of Rs. 6,000 – Rs. 200 for one years

= 5,800 ×10/100 = Rs. 580 (iii) Closing stock of 2001 will become opening stock of 2002. 2. Super Profits Method : The basic assumption in the average profits method of

calculating goodwill is that, if a new business is set up, it will not be able to earn any

profits during the first few years of its operations. Hence, the person who purchases an

existing business has to pay in the form of goodwill a sum equal to the total profits he is

likely to receive for the first 'few years'.

It is also contended that the buyer's real benefit does not lie in total profits; it is limited

to such amounts of profits which are in excess of the normal return on capital employed in

similar business. Therefore, it is desirable to value, goodwill on the basis of the excess profits

and not the actual profits. The excess of actual profits over the normal profits is termed as

super profits. Normal profits can be ascertained as follows :

Capital Employed Normal Rate of Return Normal Profits

100

Suppose an existing firm earns Rs. 18,000 on the capital of Rs. 1,50,000 and the normal

rate of return is 10%. The Normal profits will work out at Rs.15,000 (1,50,000 × 10/100). The

super profits in this case will be Rs. 3,000 (Rs. 18,000 – 15,000).

The goodwill under the super profits method is ascertained by multiplying the super

profits by certain number of years' purchase. If, in the above example, it is expected that the

benefit of super profits is likely to be available for 5 years in future, the goodwill will be

valued at Rs. 15,000 (3,000 × 5). Thus, the steps involved under the method are :

1. Calculate the average profit, 2. Calculate the normal profit on the capital employed on the basis of the normal rate of

return, 3. Calculate the super profits by deducting normal profit from the average profits, and

4. Calculate goodwill by multiplying the super profits by the given number of years'

purchase.

Illustration 17 (Goodwill) The books of business showed that the capital employed on December 31,2001, Rs. 5,00,000

and the profits for the last five years were: 1997-Rs. 40,000; 1998-Rs. 50,000; 1999-Rs.

55,000; 2000-Rs. 70,000 and 2001-Rs. 85,000. You are required to find out the value of

goodwill based on 3 years purchase of the super profits of the business, given that the normal

rate of return is 10%. Solution

Normal Profit Capital Employed Normal Rate of Return

100

5,00,000 10

= Rs. 50,000

100

Average Profits :

Year Profit

Rs.

1997 40,000

1998 50,000

1999 55,000

2000 70,000

2001 85,000

Total Profit Rs. 3,00,000

Average Profit = Rs. 3,00,000/5 = Rs. 60,000 Super Profit = Rs. 60,000 – Rs. 50,000 = Rs. 10,000 Goodwill = Rs. 10,000 × 3 = Rs. 30,000 Illustration 18 (Goodwill) Capital employed in a business on March 31, 2003 was Rs. 20,00,000 and the profits for the

last five years were as follows :

Year ending Profit 31st March Rs.

1999 2,60,000 2000 2,80,000 2001 2,70,000 2002 2,50,000 2003 2,10,000

Calculate the value of goodwill on the basis of 3 years' purchase of the super profits of

the business. The normal rate of return is 10%.

Solution

Normal Profit

Average Profit Super Profit

Goodwill

Capital Employed Normal Rate of Return 100

Rs. 20,00,000 10 Rs. 2,00,000

100

Rs. 2,60,000 2,80,000 2,70,000 2,50,000 2,10,000 5

= Rs.12,70,000

Rs. 2,54,000 5 = Average Profit – Normal Profit = 2,54,000 – 2,00,000 = Rs. 54,000 = Super Profit × No. of years purchase = 54,000 × 3 = Rs. 1,62,000

Illustration 19 (Goodwill) The capital of the firm of Anu and Benu is Rs. 1,00,000 and the market rate of interest is

15%. Annual salary to partners is Rs. 6,000 each. The profits for the last 3 years were Rs.

30,000; Rs. 36,000 and Rs. 42,000. Goodwill is to be valued at 2 years purchase of the last 3

years' average super profits. Calculate the goodwill of the firm. Solution

Interest on capital = 1,00,000 15 Rs. 15,000 (i)

100

Add partner's salary = Rs. 6,000 × 2 = Rs. 12,000 ..................... (ii)

Normal Profit (i + ii) = Rs. 27,000

Average Profit = Rs. 30,000 + Rs. 36,000 + Rs. 42,000 = Rs. 1,08,000

3

= Rs. 36,000

Super Profit = Average Profit – Normal Profit

= Rs. 36,000 – Rs. 27,000 = Rs. 9,000

Goodwill = Super Profit × No of years' purchase = Rs. 9,000 × 2

= Rs. 18,000

3. Capitalization Method : Under this method the goodwill can be calculated in two ways :

(a) by capitalizing the average profits, or (b) by capitalizing the super profits.

(a) Capitalization of Average Profit : In this method, the value of goodwill is

ascertained by deducting the actual capital employed (net assets) in the business

from the capitalized value of the average profits on the basis of normal rate of

return. This involves the following steps :

(i) Ascertain the average profits based on the past few years' performance.

(ii) Capitalize the average profits on the basis of the normal rate of return as

follows :

Average Profits × 100/Normal Rate of Return

This will give the total value of business.

(iii) Ascertain the actual capital employed (net assets) by deducting outside

liabilities from the total assets (excluding goodwill).

Capital Employed = Total Assets (excluding goodwill) – outside liabilities

(iv) Compute the value of goodwill by deducting net assets from the total value

of business, i.e. (ii) – (iii). Illustration 20 (Goodwill) A business has earned average profits of Rs. 1,00,000 during the last few years and the

normal rate of return in a similar type of business is 10%. Ascertain the value of goodwill by

capitalization method, given that the value of net assets of the business is Rs. 8,20,000. Solution Capitalized Value of Average Profits

Rs. 1,00,000 100

= Rs 10,00,000 10

Goodwill = Capitalized Value – Net Assets

= 10,00,000 – 8,20,000

= Rs. 1,80,000

(b) Capitalization of Super Profits : Under this method following steps are involved :

(i) Calculate Capital employed of the firm, which is equal to total assets minus

outside liabilities.

(ii) Calculate required profit on capital employed by using the following

formula :

Profit = Capital Employed × Required Rate of Return/100

(iii) Calculate average profit of past years, that is, 3 to 5 years.

(iv) Calculate super profits by deducting required profits from average profits.

(v) Multiply the super profits by the required rate of return multiplier, that is,

Goodwill = Super Profits × 100/Normal Rate of Return

In other words, goodwill is the capitalized value of super profits.

Illustration 21(Goodwill) Calculate Goodwill if : (i) The goodwill of a firm is estimated at three years' purchase of the average profits of the

last five years which are as follows :

Years: 1998 1999 2000 2001 2002

Profits (Loss): Rs.10,000 15,000 4,000 (5,000) 6,000 (ii) If in the firm total capital employed is Rs.1,00,000 and normal rate of return is 8%, the

average profit for last 5 years is Rs. 12,000 and goodwill is estimated at 3 years'

purchase of super profits, remuneration to partners Rs. 3000.

(iii) Rama Brothers earn a net profit of Rs. 30,000 with a capital of Rs. 2,00,000. The normal

rate of return in the business is 10%. Use capitalization of super profits method to value

the goodwill. Solution (i) Total Profit = Rs. 10,000 + 15,000 + 4,000 + 6,000 – 5,000 = Rs. 30,000

Average Profit = Rs. 30,000/5 = Rs. 6,000 Goodwill = Average Profit × 3 = Rs. 6,000 × 3 = Rs. 18,000.

(ii)

Average Profit = Rs. 12,000 Remuneration to Partners = Rs. 3,000 Average actual profit = Rs. 12,000 – Rs. 3,000 = Rs. 9,000 Normal Profit = Rs. 1,00,000 × 8/100 = Rs. 8,000 Super Profit = Average Profit – Normal profit = Rs. 9,000 – 8,000

= Rs. 1,000 Goodwill = Super Profit × 3 = 1,000 × 3 = Rs. 3,000

(iii) Normal Profit = Rs. 2,00,000 × 10/100 = Rs. 20,000

Super Profit = Average Profit – Normal Profit = Rs. 30,000 – 20,000 = Rs. 10,000

Goodwill = Super Profit × 100/Normal Rate of Return = 10,000 × 100/10 = Rs. 1,00,000

4. Present Value of Super Profits : Under this method, goodwill is estimated as the present

value of the future super profits. This requires following steps :

(i) Calculate the future super profits for next 5 to 7 years depending upon the business

potential.

(ii) Choose the required rate of return.

(iii) Calculate present value factors.

(iv) Multiply present value factors with future super profits.

(v) The sum of product of present value factors and super profits is the value of

goodwill. Illustration 22 (Goodwill)

A firm has the forecasted profits for the coming 5 years as follows :

Year I II III IV V

Profits (Rs.) 1,00,000 1,20,000 90,000 1,00,000 1,50,000 The total assets of the firm are Rs. 10,00,000 and outside liabilities are Rs. 2,00,000. The

present value factor at 10% are as follows :

Year I II III IV V

PVF 0.9091 0.8264 0.7513 0.6830 0.6209 Calculate the Value of goodwill.

Solution

Year I II III IV V

Profits (Rs.) 1,00,000 1,20,000 90,000 1,00,000 1,50,000

Normal Profit 80,000 80,000 80,000 80,000 80,000

Super Profit 20,000 40,000 10,000 20,000 70,000

PVF 0.9091 0.8264 0.7513 0.6830 0.6209

Present Value 18,182 33,056 7,513 13,660 43,463 of Super Profits

Value of Goodwill = Rs. 18,182 + 33,056 + 7,513 + 13,660 + 43,463

= Rs. 1,15,874

Change in Profit Sharing Ratio

Sometimes, the partners of a firm may agree to change their existing profit sharing ratio. As a

result of this, some partners will gain in future profits while others will lose. In such a

situation, the partner who gains by the change in the profit sharing ratio must compensate the

partner who has made the sacrifice because this effectively amounts to one partner buying the

share of profits from another partner. For example, Anu and Benu are partners in a firm

sharing profits in the ratio of 3:2. They decide to have an equal share in profits in future. In

this case, Anu looses 1/l0th (3/5 – 1/2) share of profits and Benu gains this 1/l0th. Hence,

Benu must compensate Anu for her loss in the share of future profits.

The amount of compensation will be equal to the proportionate amount of goodwill.

Suppose, the total value of goodwill is ascertained as Rs. 50,000/-, then Benu must pay 1/10

of Rs. 50,000/-, i.e. Rs. 5,000 to Anu. Alternatively, Benu's Capita1 Account be debited by Rs

5,000 and Anu's Capital Account credited with Rs. 5,000. The entry, thus, will be :

Benu's Capital a/c Dr. 5,000

Anu's Capital a/c 5,000

Alternatively, if the amount is paid privately by the gaining partner to the other partner,

then no entry is made in the books of the firm.

Apart from the payment of compensation for goodwill, the change in profit sharing ratio

may also necessitate adjustment in the partners' capital accounts with regard to reserves,

revaluation of assets and liabilities, etc. These are

similar to those made at the time of the admission or retirement of a partner. All these aspects

will be discussed in details in chapter dealing with admission of a partner.

Joint Life Policy

A life assurance policy obtained jointly on the lives of the members of a partnership firm is

called a joint life policy. Since the firm has an insurable interest in the lives of its members,

hence to make finances available for payment to the retiring partner on his retirement or to the

legal heirs of the deceased partner, it obtains a joint life policy. The payment for the policy

may be made either privately by the partners or by the firm. The joint life policy matures on

the death of any one of the partners or on the expiry of the time for which it is obtained.

Maturity of the policy means that the insurance company becomes liable to pay the sum

assured to the firm either on the death of a partner or on the expiry of the time whichever

happens earlier. Accounting Treatment The premium on the joint life policy may be paid either privately by the partners or by the

firm. When the premium is paid privately by the partners then no accounting treatment is

required in the books of the firm. But when the premium is paid out of the firms cash then the

transactions relating to joint life policy will be shown in the books of the firm. The treatment

of joint life policy in the books of the firm will depend upon the fact whether the premium

paid has been considered as revenue expenditure or capital expenditure.

When premium paid is considered by the firm as a revenue expenditure then it opens in

its books an account called 'Joint Life Policy Premium Account'. Premium paid annually is

debited to this account and credited to cash account. At the end of the year the premium paid

is transferred to joint life policy account. These two entries of payment of premium and its

writing off to profit and loss account are recorded every year. On maturity of the policy the

maturity amount received from the insurance company is credited to the capital accounts of

all the partners including the retiring/deceased partner in their profit sharing ratio.

When premium paid is considered as a capital expenditure then the firm opens in its

books 'Joint Life Policy Account' which is an asset account.

Premium paid is debited to this account and credited to bank account. At the end of the year the 'Joint Life

Policy Premium Account' is reduced to surrender value by debiting the difference between the premium

paid and surrender value. Surrender value is that amount of money which the insurance company pays to

the policy holders in the event of surrendering the policy to the insurance company before the date of its

maturity. At the time of maturity of the policy a joint life policy account is credited with an amount which

is equal to the claim receivable from the insurance company. Afterwards the joint life policy account is

closed by transferring its balance to the capital accounts of all the partners in their profit sharing agreement.

CHAPTER - 2

ADMISSION OF A PARTNER

Kapil and Krish are running a partnership firm dealing in toys. They are

one of the most successful businessmen in the locality. They now decide

to start manufacturing toys that are electronically operated to diversify

their busmess. For this they need more capital and also technical expertise.

Mohit; their friend is an electronic engineer and has capital also. They

have persuaded him to join their firm. In case, he joins the partnership

firm, this will be a case of admission of a partner. As a result, he may need

to bring in capital and share of goodwill. In this lesson, you will learn

about goodwill and other ajustments at the time of admission of a partner.

Mohit will bring in capital and share of goodwill. Some changes in the

value of some assets and liabilities of the existing firm are need to bring

them at their realistic value, on his admission. There may be other issues

involing finance on his admission. All this need accounting treatment. In

this lesson you will learn accounting treatment and adjustments to be

made on the admission of a partner. After studying this lesson, you will be able to :

l state the meaning of admission of a partner;

l calculate new profit sharing ratio and sacrificing ratio;

l state the meaning and factors affecting goodwill;

l explain the methods of valuation of goodwill;

l describe accounting treatment of goodwill;

l explain the need for revaluation of assets and reassessment of liabilities;

40illustrate the accounting treatment of changes arising from revaluation

of assets and reassessment of liabilities;

4. describe accounting treatment of undistributed profits and reserves;

5. explain the treatment of various adjustments in partners‘ capitals ;

6. prepare Revaluation Account, Partners‘ Capital Accounts and balance sheet of the reconstituted firm.

ADMISSION OF A PARTNER Meaning, New Profit Sharing Ratio and Sacrificing Ratio Meaning An existing partnership firm may take up expansion/diversification of the

business. In that case it may need managerial help or additional capital. An

option before the partnership firm is to admit partner/partners, when a

partner is admitted to the existing partnership firm, it is called admission

of a partner.

According to the Partnership Act 1932, a person can be admitted into partnership only with the consent of all the existing partners

unless otherwise agreed upon.

On admission of a new partner, the partnership firm is reconstituted with a

new agreement. For example, Rekha and Nitesh are partners sharing profit

in the ratio of 5:3. On April 1, 2006 they admitted Nitu as a new partner

with 1/4th share in the profit of the firm. In this case, with the admission

of Nitu as partner, the firm stands reconstituted. On the admission of a new partner, the following adjustments become necessary: (i) Adjustment in profit sharing ratio; (ii) Adjustment of Goodwill; (iii) Adjustment for revaluation of assets and reassessment of liabilities; (iv) Distribution of accumulated profits and reserves; and (v) Adjustment of partners‘ capitals.

Adjustment in Profit sharing Ratio When a new partner is admitted he/she acquires his/her share in profit from

the existing partners. As a result, the profit sharing ratio in the new firm is

decided mutually between the existing partners and the new partner. The

Admission of a Partner

incoming partner acquires his/her share of future profits either incoming

from one or more existing partner. The existing partners sacrifice a share

of their profit in the favour of new partner, hence the calculation of new

profit sharing ratio becomes necessary. Sacrificing Ratio At the time of admission of a partner, existing partners have to surrender

some of their share in favour of the new partner. The ratio in which they

agree to sacrifice their share of profits in favour of incoming partner is

called sacrificing ratio. Some amount is paid to the existing partners for

their sacrifice. The amount of compensation is paid by the new partner to

the existing partner for acquiring the share of profit which they have

surrendered in the favour of the new partner. Sacrificing Ratio is calculated as follows:

Sacrificing Ratio = Existing Ratio – New Ratio Following cases may arise for the calculation of new profit sharing ratio and sacrificing ratio: (i) Only the new partner’s share is given In this case, it is presumed that the existing partners continue to share the

remaining profit in the same ratio in which they were sharing before the

admission of the new partner. Then, existing partner‘s new ratio is calculated

by dividing remaining share of the profit in their existing ratio. Sacrificing

ratio is calculated by deducting new ratio from the existing ratio.

Illustration 1 Deepak and Vivek are partners sharing profit in the ratio of 3 : 2. They

admit Ashu as a new partner for 1/5 share in profit. Calculate the new profit sharing ratio and sacrificing ratio. Solution: Calculation of new profit sharing ratio: Let total Profit = 1 New partner‘s share = 1/5 Remaining share = 1 – 1/5 = 4/5 Deepak‘s new share = 3/5 of 4/5 i.e. 12/25

142


Vivek‘s new share = 2/5 of 4/5 i.e. 8/25

Ashu‘s Share = 1/5 The new profit sharing ratio of Deepak, Vivek and Ashu is : = 12/25 : 8/25 : 1/5 = 12 : 8 : 5/25 = 12 : 8 : 5

So Deepak Sacrificed = 3/5 – 12/25 = 15 – 12/25 = 3/25

Vivek Sacrificed = 2/5 – 8/25 = 10 – 8/25 = 2/25

Sacrificing Ratio = 3 : 2 Sacrificing ratio of the existing partners is same as their existing ratio. l The new partner purchases his/her share of the profit from the

Existing partner in a particular ratio. In this case : the new profit sharing ratio of the existing partners is to be

ascertained after deducting the sacrifice agreed from his share. It means

the incoming partner has purchased some share of profit in a particular

ratio from the existing partners. Illustration 2 Neha and Parteek are partners, sharing profit in the ratio of 5 : 3. They

admit Nisha as a new partner for 1/6 share in profit. She acquires this

share as 1/8 from Neha and 1/24 share from Parteek. Calculate the new

profit sharing ratio and sacrificing ratio. Solution Neha‘s and Parteek existing ratio is 5 : 3 Neha‘s new share = 5/8-1/8 = 4/8 or 12/24

Parteek‘s new share = 3/8-1/24 = 8/24

Nisha‘s share = 1/8+1/24 =4/24 The new profit sharing ratio of Neha, Parteek and Nisha is

12/24 : 8/24 : 4/24

= 12 : 8 : 4 = 3 : 2 : 1 (ii) Sacrifice ratio = 1/8 : 1/24 or 3 : 1

l Existing partners surrender a particular portion of their share in favour of a new partner.

In this case, sacrificied share of the each partner is to be ascertained. This ascertained by multiplying the existing partner share in the ratio of their

sacrifice. The share sacrificed by the existing partners should be deducted

from his existing share. Therefore, the new share of the existing partners is

determined. The share of the incoming partner is the sum of sacrifice by

the existing partners. Illustration 3 Him and Raj shared profits in the ratio of 5:3. Jolly was admitted as a

partner. Him surrendered 1/5 of his share and Raj 1/3 of his share in favour of Jolly. Calculate the new profit sharing ratio. Solution : Him surrenders 1/5 of his share, i.e., = 1/5 of 5/8 = 1/8 Raj surrenders 1/3 of his share, i.e., = 1/3 of 3/8 = 1/8 So, sacrificing ratio of Him and Raj is 1/8 : 1/8 or equal. Him‘s new share = 5/8 – 1/8 = 4/8

and Raj‘s new share = 3/8 – 1/8 = 2/8

Jolly‘s New share = 1/8 + 1/8 = 2/8 New profit sharing ratio of Him‘s, Raj‘s and Jolly‘s is

= 4/8 : 2/8 : 2/8 or 4 : 2 : 2 or 2 : 1 : 1. 144


GOODWILL : MEANING, FACTORS AFFECTING GOODWILL AND VALUATION

Meaning of Goodwill Over a period of time, a business firm develops a good name and reputation

among the customers. This help the business earn some extra profits as

compared to a newly set up business. In accounting capitalised value of this

extra profit is known as goodwill. For example, your firm earns say Rs 1200

and the normal profit was expected from your firm Rs 700. The rate of return

is @ 10%. In this case goodwill is ascertained as under : Step 1 : Excess profit = Actual profit – Desired normal profit

1200 – 700 = 500

Step 2 : Goodwill = 500 100

= Rs 5000

10

In other words, goodwill is the value of the reputation of a firm in respect

of the profit earned in future over and above the normal profit. It may also

be defined as the present value of the capacity to earn future profits. This

means that a firm can be said to have goodwill only if it has capacity to

earn profit in future. A firm earning only normal profits like similar firms

cannot claim to have any goodwill.

Factors affecting the Goodwill The factors affecting goodwill are as follows: 1. Location : If the firm is located at a central place, resulting in good

sale, the goodwill tends to be high. 2. Nature of Business : A firm that produces high value products or

having a stable demand is able to earn more profits and therefore has more goodwill.

3. Efficient management : A well managed firm earns higher profit and

so the value of goodwill will also be high. 4. Quality : If a firm is known for the quality of its products the value of

goodwill will be high. 5. Market Situation : The monopoly condition to earn high profits

which leads to higher value of goodwill. 6. Special Advantages : The firm has special advantages like importing

licenses, long term contracts for supply of material, patents, trademarks, etc. enjoy higher value of goodwill.


Methods of valuation of Goodwill The methods of valuation of goodwill are generally decided by the

partners among themselves while preparing partnership deed. The following are the important methods of valuing the goodwill of a firm : (i) Average Profit Method (ii) Super Profit Method (iii) Capitalisation Method Let us learn about these methods. 1. Simple Average Profit Method : Under this method, average of the

profits of certain given years is calculated. The value of the goodwill is

calculated at an agreed number of years purchase of the average profit.

Thus the goodwill is calculated as follows :

Value of goodwill = Average Profit × Number of year of purchase

For example, the average profits of a firm of say 3 years and the goodwill

is to be calculated at 2 years purchase of the average profits works out at

Rs.25,000 and it is assumed that the same profits will be the value of the

goodwill will be Rs.50,000[Rs.25,000 × 2]. Thus the goodwill is

calculated as goodwill = average profits × Number of years purchase.

Illustration : 4 The profit for the last five years of a firm were as follows Year 2001 Rs.

1,20,000: Year 2002 Rs.1,50,000: Year 2003 Rs.1,70,000: Year 2004

Rs.1,90,000: Year 2005 Rs.2,00,000. Calculate goodwill of the firm on the

basis of 3 years purchases of 5 years average profits. Solution :

Year Profit (Rs.)

2001 1,20,000

2002 1,50,000

2003 1,70,000

2004 1,90,000

2005 2,00,000

Total 8,30,000

146


Average Profit = Total Profit/No. of Years

= Rs.8,30,000/5 = Rs.1,66,000

Goodwill = Average Profits × No. of years purchased

Rs.1,66,000 × 3 = Rs.4,98,000 * Super Profit Method : Super profits is the excess of actual profit over

the normal profits. If a new business earns certain percentage of the

capital employed, it is called ‗normal profit‘. The value of the

goodwill is calculated at an agreed number of years purchase is

multiplied by the Super profit. Normal profit is that profit which is,

earned by other business unit of the same business. Normal profit will

be calculated as follows:

Normal profit = Capital employed × normal rate of return/100

Actual Profit : These are the profit earned during the year or it is also

taken as the average of the last few years profit.

Super Profit = Actual Profit – Normal Profit

For example, A firm earns profit of Rs.65,000 on a capital of

Rs.4,80,000 and the normal rate of return in similar business is 10%.

Then the normal profit is Rs.48,000[10% of the Rs.4,80,000]. The

actual profit is Rs.65,000. Thus,

Super profit = Actual profit – Normal profit

= Rs.65,000 – Rs.48,000

= Rs.17,000

If value of Goodwill is calculated by 3 years‘ purchase of super profit then goodwill is equal to Rs.51,000[ Rs.17,000 × 3].

(b) Weighted average method : This method is a modified version of

average profit method. In this method each year profit is assigned a

weight i.e. 1, 2, 3, 4 etc. Thereafter each year profit is multiplied by

the weight and find product. The total of products is divided by the

total of weight. As a result we find the weighted average profit. After

this the value of goodwill is calculated to multiplied the weight

average profit into the agreed number of year‘s purchase. Thus the

goodwills calculated as follows

Total product of profit Weighted average profit =

Total of weights


Value of goodwill = Weighted average profit × number of year of purchase (Note : This method is used when we observe that there is a tendency to increase the annual profits. Latest year profit is assigned the highest weight. Illustration : 5 The profit of firm for past years were as follow :

Profit Rs.

2002 80,000

2003 85,000

2004 90,000

2005 1,00,000

2006 1,10,000 The weight to be used are 1, 2, 3, 4, and 5 for the years from 2002- 2006. Calculate the value of goodwill on the basis of two year‘s purchase of weighted average profit. Solution

Year Profit Weight Products

2002 80,000 1 80,000

2003 85,000 2 170000

2004 90,000 3 270000

2005 1,00,000 4 400000

2006 1,10,000 5 550000

15 1470000

Weighted Average Profit = 14,70,000

= Rs 98,000

15

Goodwill = Rs 98000 × 2 = Rs 1,96,000

Illustration : 6 A firm earned the following net profits during the last 4 years

148


Rs.

2003 90,000

2004 1,20,000

2005 1,60,000

2006 1,80,000

Capital employed in the firm is Rs.10,00,000. The normal rate of profit is 10%. Calculate the value of the goodwill on the basis of 4 year purchase. Solution:

Total profit of 4 years = Rs. 90,000 + Rs. 1,20,000 + Rs. 1,60,000 + Rs.

1,80,000

= Rs.5,50,000

Average annual profit = Rs.5,50,000/4

= Rs.1,37,500

Normal Profit = Rs.10% of Rs.10,00,000 = Rs.10,00,000

× 10/ 100

= Rs.1,00,000

Super profit = Rs. 1,37,500 – Rs. 1,00,000

= Rs.37,500

Value of goodwill at = Rs. 37,500 × 4 = Rs. 1,50,000

4 years‘ of purchase

(ii) Capitalisation Method : In this method, goodwill is the amount of

capital saved. Normally businessmen invest capital to operate business

activities, and earn profit with the efficient utilisation of capital. If the

business earns more profit by investing lesser amount of capital as

compared to other business, who earned same amount of profit with

more amount of capital, the saved amount is assumed to be goodwill.

Under this method, the Goodwill is calculated in two ways:

Capitalisation of Average profit

Capitalisation of Super profit


1. Capitalisation of Average profit In this method, the value of goodwill is assumed to be excess of the capital value of average profit over the actual capital employed. Following formula is applied for Calculation of capital employed:

Capital employed = Total assets – outsider liabilities

Following formula is applied for calculation of capitalised value of profit:

Capitalised value of profit = Average Profit × 100/ Normal rate of profit

Goodwill = Capitalised value of profits – Capital cimployed

Illustration : 7 A firm earned average profit during the last few years is Rs.40,000 and the normal rate of return in similar business is 10%. The total assets is Rs.3,60,000 and outside liabilities is Rs.50,000. Calculate the value of goodwill with the help of Capitalisation of Average profit method. Solution: Capital employed = Total assets - Outside liabilities

= Rs.3,60,000 - Rs.50,000

= Rs.3,10,000 Capitalised value of average profit = Average Profit × 100/ Normal rate of profit

= Rs. 40,000 × 100/10

= Rs. 4,00,000

Goodwill = Capitalised value – Capital employed

5. Rs. 4,00,000 – Rs. 3,10,000

6. Rs. 90,000 Illustration : 8 The capital invested in a firm is Rs.4,60,000 and the rate of return in the similar business is 12%. The firm earns the following profit in the last 4 years:

2003 Rs. 60,000 2005 Rs. 80,000

2004 Rs. 70,000 2006 Rs. 90,000 Calculate the value of goodwill by Capitalisation method.

150


Solution Total Profit = Rs.60,000 + Rs.70,000 + Rs.80,000 + Rs.90,000/4 Average Profit = Rs.3,00,000/4

= Rs.75,000 Capitalised Value = Average profit × 100/12

= Rs.75,000x100/12

= Rs.6,25,000 Goodwill = Capitalised value – Capital employed

= Rs.6,25,000 – Rs.4,60,000

= Rs.1,65,000 2. Capitalisation of Super profit In this method, the value of goodwill is calculated on the basis of super

profit method. Following formula is applied for Calculation of capital employed:

Goodwill = Super profit × 100/normal rate of profit Illustration : 9 A firm earns a profit of Rs.26,000 and has invested capital amounting to

Rs.2,20,000. In the same business normal rate of earning profit is 10%.

Calculate the value of goodwill with the help of Capitalisation of super

profit method. Solution Actual profit = Rs. 26,000 Normal profit = Rs. 2,20,000 x 10/ 100 = Rs.22,000 Super Profit = Actual Profit – Normal Profit

6. Rs. 26,000 – Rs.22,000

7. Rs. 4,000 Goodwill = Super profit × 100/normal rate of profit

4. Rs. 4,000 × 100/10

5. Rs. 40,000


TREATMENT OF GOODWILL The new partner acquires his/her share profit from the existing partners.

This will result in the reduction of the share of existing partners.

Therefore, he/she compensates the existing partners for the sacrifices.

He/she compensates them by making payment in cash or in kind. The

payment is equal to his/her share in the goodwill.

As per Accounting Standard 10(AS-10) that goodwill should be

recorded in the books only when some consideration in money

has been paid for it. Thus, if a new partner does not bring

necessary cash for goodwill, no goodwill account can be raised in

the books. He/she should pay for goodwill in addition to his/her

contribution for capital.

If, he/she does not pay for goodwill, then amount equal to his/her share of

goodwill will be deducted from the capital. The amount brought in by him/

her as goodwill or amount of goodwill deducted from his/her capital and 152

divided between the existing partners in their sacrificing ratio. At the time

of admission of a new partner any goodwill appearing in the books, will be

written off in existing ratio among the existing partners. There are different situations relating to treatment of goodwill at the time of admission of a new partner. These are discussed as under: 1. When the amount of goodwill is paid privately by the new partner. 2. When the new partner brings his/her share of goodwill in cash. 3. When the new partner does not bring his/her share of goodwill in cash. 1. The amount of goodwill is paid privately by the new partner

If the amount of goodwill is paid by the new partner to the existing partner privately, no journal entries are made in the books of the firm.

2. The new partner brings his/her share of goodwill in cash and the

amount of goodwill is retained in the Business:

When, the new partner brings his/her share of goodwill in cash. The

amount brought in by the new partner is transferred to the existing

partner in the sacrificing ratio. If there is any goodwill account in the

balance sheet of existing partner, it will be written off immediately in

existing ratio among the partners. The journal entries are as follows:

* The existing goodwill in the books of the firm will be written off in existing profit ratio as;

Existing Partners Capital A/c Dr. [individually]

To Goodwill A/c

(Existing goodwill written off)

(ii) For bringing cash for Capital and goodwill

Cash/Bank A/c Dr.

To Premium for Goodwill A/c

To New partner‘s Capital A/c

(Cash brought in for capital and goodwill)

= For amount of goodwill transferred to existing partner capital

account:

Premium for Goodwill A/c Dr.

To Existing Partner‘s Capital/current A/c [individually]

(The amount of goodwill credited to existing partner‘s capitals in sacrificing ratio)


Illustration : 10 Tanaya and Sumit are partners in a firm sharing profit in the ratio 5 : 3.

They admitted Gauri as a new partner for 1/4th share in the profit. Gauri

brings Rs. 30,000 for her share of goodwill and Rs.1,20,000 for capital.

Make journal entries in the books of the firm after the admission of Gauri.

The new profit sharing ratio will be 2 : 1 : 1. Solution :

Books of Tanaya, Sumit and Gauri

Date Particulars LF Debit Credit Amount Amount (Rs) (Rs)

1. Bank A/c Dr. 1,50,000

To Premium for Goodwill A/c 30,000

To Gauri‘s Capital A/c 1,20,000

(cash brought by Gauri for her share of goodwill and capital)


To Tanaya‘s Capital A/c 30,000

To Sumit‘s Capital A/c 15,000

(Goodwill transferred to existing partners 15,000 capital account in their profit sharing ratio)

Working Note: Calculation of sacrificing ratio [existing ratio – new ratio]

Partners Existing ratio New ratio Sacrifice Sacrificing ratio

Tanaya 5/8 2/4 5/8 – 2/4 = 1/8 Tanaya : Sumit

Sumit 3/8 1/4 3/8 – 1/4 = 1/8 1 : 1

The amount of goodwill is withdrawn by the existing partners: (iv) Existing Partners Capital/current A/c Dr. [individually]

To Cash/Bank A/c

(The amount of goodwill withdrawn by the existing partners) It is to be noted that sometimes partner‘s withdraw only 50% or 25%

amount of goodwill. In such a case, entry will be made for the withdrawn

amount only. 154

I1lustration : l1 In previous illustration, it is assumed that the full amount of goodwill is

withdrawn by the Tanaya and Sumit . Make journal entry in the books of the firm. Solution:

Books of Tanaya, Sumit and Gauri

Date Particulars LF Debit Credit amount amount Rs Rs

Tanaya‘s Capital A/c Dr. 15,000

Sumit‘s Capital A/c Dr. 15,000

To Bank A/c 30,000

(Amount of Goodwill is withdrawn

by them)

3. New partner does not bring his/her share of goodwill in cash: When the goodwill of the firm is calculated and the new partner is not able to

bring his/her share of goodwill in cash, goodwill will be adjusted through new

partner‘s capital accounts. In this case new partner‘s capital account is

debited for his/her share of goodwill and the existing partner‘s capital

accounts are credited in their sacrificing ratio. The journal entry is as under:

New Partner‘s Capital A/c Dr.

To Existing Partner‘s Capital A/c [individually in sacrificing ratio]

(New partner‘s share in goodwill credited to exisitng partner‘s in sacrificing ratio) Goodwill appears in the books of the firm and new partner does not bring his/her share of goodwill in cash: If the goodwill account appears in the books of the firm, and the new

partner is not able to bring goodwill in cash. In this case, the amount of

goodwill existing in the books is written off by debiting the capital

account of existing partners in their existing profit sharing ratio. Illustration 12 Ashmita and Sahil are partners sharing profit in the ratio of 3 : 2. They agree

to admit Charu for 1/5 share in future profit. Charu brings Rs. 2,50,000 as

capital and enable to bring her share of goodwill in cash, the goodwill of

Notes

the firm to be valued at Rs. 1,80,000. At the time of admission goodwill

existed in the books of the firm at Rs.80,000. Make necessary journal entries in the books of the firm. Solution:

Books of Ashmita, Sahil and Charu

Date Particulars LF Debit Credit amount amoun Rs Rs

Bank A/c Dr. 2,50,000

To Charu‘s Capital A/c 2,50,000

[Cash brought by Charu for her capital]

Ashmita‘s Capital A/c Dr. 48,000

Sahil‘s Capital A/c Dr. 32,000

To Goodwill A/c 80,000

[Goodwill written off before Charu‘s admission]

Charu‘s Capital A/c Dr. 36,000

To Ashmita‘s Capital A/c 21,600

To Sahil‘s Capital A/c 14,400

[Existing partners capital a/c credited for goodwill on Charu‘s admission in

sacrificing ratio]

Working Note : Ashmita and Sahil sacrifice their profit in favour of Charu in their existing profit sharing ratio i.e. 3 : 2. Therefore, the sacrificing ratio is 3 : 2. Value of Goodwill = Rs.1,80,000 Charu‘s share in Profit = 1/5 Charu‘s share of Goodwill = Rs. 1,80,000 × 1/5 = Rs. 36,000 New partner brings in only a part of his share of goodwill When new partner is not able to bring the full amount of his/her share of goodwill in cash and brings only a part of cash. In this case, the amount

156


of goodwill brought by him is credited to goodwill account. At the time of

goodwill transferred to capital account of existing partner‘s, new partner‘s

capital account is debited with his unpaid share of goodwill besides

debiting goodwill account with the amount of goodwill is paid by him.

The journal entries is as

Bank A/c Dr.

To Premium for Goodwill A/c

[Part Amount of goodwill brought by new partnerI


New Partner‘s Capital A/c Dr.

To Existing Partner‘s Capital A/c [individually in sacrificing ratio]

[Credit given to sacrificing partner by new partner‘s in full share of goodwill] Illustration 13 Tanu and Puneet are partners sharing profit in the ratio of 5 : 3. They

admit Tarun into the firm for 1/6 share in profit which he takes 1/ 18 from

Tanu and 2/ 18 from Puneet. Traun brings Rs.9,000 as goodwill out of his

share of Rs. 12,000. No goodwill account appears in the books of the firm.

Make necessary journal entries in the books of the firm. Solution:

JOURNAL Date Particulars LF Debit Credit Amount Amount Rs Rs

Bank A/c Dr 9,000

To Premium for Goodwill

A/c 9,000

[A part of his share of goodwill brought in by Tarun]

Premium for Goodwill A/c Dr. 9,000

Tarun Capital A/c Dr. 3,000

To Tanu‘s Capital A/c 4,000

To Puneet‘s Capital A/c 8,000

[Goodwill credited to Tanu and Puneet

in their sacrificing ratio i.e 1 : 2]

REVALUATION ACCOUNT

On admission of a new partner, the firm stands reconstituted and consequently

the assets are revalued and liabilities are reassessed. It is necessary to show the

true position of the firm at the time of admission of a new partner. If the values of the assets are raised, gain will increase the capital of the existing partners.

Similarly, any decrease in the value of assets, i.e. loss will decrease the capital of

the existing partners. For this purpose a‗Revaluation Account‘ is prepared. This account is credited with all increases in the value

of assets and decrease in the value of liabilities. It is debited with decrease

on account of value of assets and increase in the value of liabilities. The

balance of this account shows a gain or loss on revaluation which is

transferred to the existing partner‘s capital account in existing profit

sharing ratio The following journal entries made for this purpose are: (i) For increase in the value of assets:

Asset A/c Dr. (individually)

To Revaluation A/c (ii) For decrease in the value of Asset

Revaluation A/c Dr. (individually)

To Asset A/c

[Decrease in the value of assets] (iii) For increase in the value of Liabilities:

Revaluation A/c Dr. (individually)

To Liabilities A/c

[Increase in the value of Liabilities] (iv) For decrease in the value of Liabilities:

Liabilities A/c Dr.

To Revaluation A/c

[Decrease in the value of Liabilities] (v) For unrecorded Assets

Asset A/c [unrecorded] Dr.

To Revaluation A/c

[Unrecorded asset recorded at actual value] (vi) For unrecorded Liability :

Revaluation A/c Dr.

To Liability A/c [unrecorded]

[Unrecorded Liability recorded at actual value] (vii) For transfer of gain on revaluation:

Revaluation A/c Dr.

To Existing Partner‘s Capital/Current A/c

[Profit on revaluation transferred to capital account in existing ratio]

159


(viii)For transfer of loss on revaluation:

Existing Partner‘s Capital/Current A/c Dr.

To Revaluation A/c

[Loss on revaluation transferred to capital account in existing ratio] Proforma of Revaluation account is given as under:

Revaluation account Dr. Cr.


Assets Assets

[decrease in value] [Increase in value]

Liabilities Liabilities

[increase in value] [Decrease in value]

Liabilities[unrecordcd] Assets [unrecorded]

Profit transferred to Loss transferred to

Capital A/c Capital A/c

[Individually in existing [Individually in existing

ratio] ratio]

Illustration 14 Karan and Tarun are partners sharing profit and losses in the ratio of 2 : 1. Their Balance Sheet was as follows:

Balance Sheet of Karan and Tarun as on December 31,2006

Liabilities Amount (Rs.) Assets Amount (Rs.)

Creditors 10,000 Cash in hand 7,000

Bills payable 7,000 Debtors 26,000

Building 20,000

Capitals: Investment 15,000

Karan 40,000 Machinery 13,000

Tarun 30,000 Stock 6,000

70,000

87,000 87,000

160


Nikhil is admitted as a partner and assets are revalued and liabilities reassessed as follows: (i) Create a Provision for doubtful debt on debtors at Rs.800. (ii) Building and investment are appreciated by 10%. (iii) Machinery is deprecated at 5% (iv) Creditors were overestimated by Rs.500. Make journal entries and Prepare revaluation account before the admission of Nikhil. Solution

Journal

Date Particulars LF Debit Credit Amount Amount (Rs.) (Rs.)

Revaluation A/c Dr. 800

To Provision for Doubtful Debts 800

[Provision made for doubtful debts]

Building A/c Dr.

Investment A/c Dr. 2,000

To Revaluation A/c 1,500

[Increase in the value of Building & 3,500

Investment]

Revaluation A/c Dr. 650

To Machinery A/c 650

[Decrease in the value of machinery]

Creditor A/c Dr. 500

To Revaluation A/c 500

[Value of creditors reduced by Rs.500]

Revaluation account

Dr. Cr.

Particulars Amount (Rs.) Particulars Amount (Rs.)

Provision for Building 2,000

Doubtful Debts 800 Investment 1,500

Machinery 650 Creditors 500

Profit transferred to

Karan‘s Capital 1,700

Tarun‘s Capital 850

2,550

4,000 4,000

161


Accumulated Profit or Reserve appearing in the Balance Sheet

19.7 ADJUSTMENTS OF RESERVES AND A 19.8 Any accumulated profit or reserve appearing in the balance sheet at

the time of admission of a new partner, is credited in the existing partner‘s capital account in existing profit sharing ratio. If there is

any loss, the same will be debited to the existing partner in the existing ratio. For this purpose the following journal entries are

made as: (i) For distribution of undistributed profit and reserve.

Reserves A/c Dr

Profit & Loss A/c(Profit) Dr.

To Partner‘s Capital A/c [individually]

[Reserves and Profit & Loss (Profit) transferred to all partners capitals A/c in existing profit sharing ratio]

(ii) For distribution of loss

Partner‘s Capital A/c Dr. [individually]

ToProfit and Loss A/c [Loss]

[Profit & Loss (loss) transferred to all partners capitals A/c in existing profit sharing ratio]

Illustration 15 Rohit and Soniya are partners sharing profit in the ratio of 4:3. On lst

April 2006 they admit Meena as as new partner for 1/4 shares in profits.

On that date the balance sheet of the firm shows a balance of Rs.70,000 in

general reserve and debit balance of Profit and Loss A/c of Rs.21,000.

make the necessary journal entries.

Solution Journal


General Reserve Dr 70,000

To Rohit‘s Capital A/c 40,000

To Soniya‘s Capital A/c 30,000

[Transfer of general reserve to the existing partner‘s capital accounts]

Rohit‘s Capital A/c Dr. 12,000

Soniya‘s Capital A/c Dr. 9,000

To Profit & Loss A/c 21000

[transfer of accumulated Loss to

existing partner‘s capital A/c]

162


Illustration : l6 Bhanu and Etika are partners sharing profit and losses in the ratio of 3:2 respectively. Their Balance Sheet as on March 31, 2006 was as under: Balance Sheet of Bhanu and Etika as on December 31,2006



Capitals: Cash at Bank 23,000

Bhanu 70,000 Debtors 19,000

Etika 70,000 1,40,000 Buildings 65,000

Furniture 15,000

Machinery 13,000

Stock 30,000

1,68,000 1,68,000

On that date, they admit Deepak into partnership for 1/3 share in future profit on the following terms: (i) Furniture and stock are to be depreciated by 10%. (ii) Building is appreciated by Rs.20,000. (iii) 5% provision is to be created on Debtors for doubtful debts. (iv) Deepak is to bring in Rs.50,000 as his capital and Rs.30,000 as

goodwill. Make necessary ledger account and balance sheet of the new firm. Solution :

Revaluation account

Dr. Cr.


Provision for Doubtful 950 Building 20,000

Debts

Furniture 1,500

Stock 3,000


Bhanu‘s Capital A/c 8,730

Etika‘s Capital A/c 5,820 14,550

20,000 20,000

163


Capital account Dr. Cr.

Particulars Bhanu Etika Deepak Particulars Bhanu Etika Deepak (Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

Balance c/d 96,730 87,820 50,000 Balance b/d 70,000 70,000 — (closing) (closing)

Revaluation 8,730 5,820 —

(Profit)

Bank A/c — — 50,000

Premium for Goodwill

A/c 18,000 12,000 —

96,730 87,820 50,000 96,730 87,820 50,000

Balance Sheet of Bhanu , Etika and Deepak

as on December 31, 2006



Capitals: Cash at Bank 1,03,000

Bhanu 96,730 Debtors 19,000

Etika 87,820 Less Provision 950 18,050

Deepak 50,000 2,34,550 Stock 27,000

Furniture 13,500

Machinery 13,000

Building 85,000

2,62,550 2,62,550

Illustration: 17 Ashu and Pankaj are partners sharing profit in the ratio of 3 : 2, their Balance sheet on March 31, 2007 was as follows:

Balance Sheet of Ashu and Pankaj as on March 31,2007



Bills Payable 40,000 Cash at Bank 62,000

Salaries outstanding 5,000 Debtors 58,000

Profit & Loss 40,000 Stock 85,000

Capitals: Machinery 1,45,000

Ashu 1,50,000 Goodwill 38,000

Pankaj 1,30,000 2,80,000

4,03,000 4,03,000


They admitted Gurdeep into partnership on the following terms on March 31, 2007. (a) New profit sharing ratio is agreed as 3 : 2 : l. (b) He will bring in Rs.1,00,000 as his shared capital and Rs.30,000 as

his share of goodwill. (c) Machinery is appreciated by 10% (d) Stock is valued at Rs. 87,000. (e) Creditors are unrecorded to the extent of Rs.6,000. (f) A provision for doubtful debts is to be created by 4% on debtors. Prepare Revaluation account, Capital Accounts, Bank account and Balance Sheet of the new firm after admission of Gurdeep. Solution



Provision for Doubtful Debts 2,320 Machinery 14,500

Creditors 6,000 Stock 2,000


Ashu‘s Capital A/c 4,908

Pankaj‘s Capital A/c 3,272 8,180

16,500 16,500

Capital account

Dr. Cr.

Particulars Ashu Pankaj GurdeepParticulars Ashu Pankaj Gurdeep (Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

Goodwill A/c 22,800 15,200 — Balance b/d 1,50,000 1,30,000 —

Balance c/d 1,74,108 1,46,072 1,00,000 Profit & 24,000 16,000 — Loss A/c

Revaluation 4,908 3,272 A/c (Profit)

Bank A/c — — 1,00,000

Premium for Goodwill

A/c 18,000 12,000 —

1,96,908 1,61,272 50,000 1,96,908 1,61,272 1,00,000

S Admission of a Partner

Balance Sheet of Ashu Pankaj and Gurdeep

as on March 31,2007



Bills Payable 40,000 Cash at Bank 1,92,000

Salaries outstanding 5,000 Debtors 58,000

Capitals: Less Provision (2,320)

Ashu 1,74,108 of doubtful debts 55,680

Pankaj 1,46,072 Stock 87,000

Gurdeep 1,00,000 4,20,180 Machinery 1,59,500

5,09,180 5,09,180

Bank account Dr Cr

Particulars Amount

Amount Particulars

(Rs} (Rs)

Balance b/d 62,000 Balance c/d 1,92,000

Gurdeep‘s Capital A/c 1,00,000

Goodwill A/c 30,000

1,92,000 1,92,000

Working Note: Sacrificing Ratio = Existing Ratio – New Ratio Partners Existing ratio New ratio sacrifice Sacrificing ratio

Ashu 3/5 3/6

18-15

30 Ashu:Pankaj 12 − 10 2

Pankaj 2/5 2/6 3 : 2

30 30

166


19.8 ADJUSTMENT OF PARTNER’S CAPITAL Sometime, at the time of admission, the partners‘ agree that their capitals

be adjusted in proportion to their profit sharing ratio. For this purpose, the

capital accounts of the existing partners are prepared, making all

adjustments, on account of goodwill, general-reserve, revaluation of assets

and resettlement of liabilities. The actual capital so adjust will be

compared with the amount of capital that should be kept in the business

after the admission of the new partner. The excess if any, of adjusted

actual capital over the proportionate capital will either be withdrawn or

transferred to current account and vice versa.

The partners may decide to calculate the capitals which are to be

maintained in the new firm either on the basis of new Partner‘s Capital

and his profit sharing ratio or on the basis of the existing partner‘s capital

account balances. 1. Adjustment of existing partner’s capital on the basis of the capital

of the new partner:

If the capital of the new partner is given, the entire capital of the new firm

will be determined on the basis of the new partner‘s capital and his profit

sharing ratio. Therefore the capital of other partners is ascertained by

dividing the total capital as per his profit sharing ratio. If the existing capital of the partner after adjustment is in excess of his

new capital, the excess amount is withdrawn by partner or transferred to

the credit of his current account. If the existing capital of the partner is less

than his new capital, the partner brings the short amount or makes transfer

to the debit of his current account. The journal entries are made as under: (i) when excess amount is withdrawn by the partner or transferred to

current account.

Existing Partner‘s Capital A/c Dr.

To Bank A/c or Partner Current A/c

(Excess amount is withdrawn by the partner or transferred to current account]

(ii) For bringing in the Deficit amount or Balance transferred to current

account.

Bank A/c or Partner Current A/c Dr.

To Existing Partner‘s Capital A/c

(Bringing the Deficit amount or Balance transferred to current account)

170


Illustration 19 Asha and Boby are partners sharing profit in the ratio of 5:3 with capital of

Rs.80,000 and Rs.70,000 respectively. They admit a new partner Nitin.

The new profit sharing ratio of Asha, Boby and Nitin is 5:3:2 respectively.

Ntin brings Rs.40,000 as capital. The profit on revaluation of assets and

reassessment of liabilities is Rs.6,400. it is agreed that capitals of the

partner‘s should be in the new profit sharing ratio. Calculate new capital

of each partner. Solution:

Actual Capital of Asha and Boby

Asha Boby

(Rs.) (Rs.)

Balance in Capital A/c 80,000 70,000

Add Profit on Revaluation (5 : 3) 4,000 2,400

Capital after Adjustment 84,000 72,400

Calculation of new capital of the firm and existing partner’s capital Nitin‘s Share in the firm = 2/10 Nitin‘s brings 40,000 for 2/10 Share Total capital of the new firm in terms of Nitin‘s capital

= 40,000 × 10/2

= Rs.2,00,000 Asha‘s share in New Capital = 2,00,000 × 5/10 = Rs.1,00,000 Boby‘s share in New Capital = 2,00,000 × 3/10 = Rs.60,000 On comparing Asha‘s adjusted capital with the new capital we find that the Asha brings Rs.16,000 [Rs.1,00,000 - Rs.84,000] or the amount may be debited to her current account. On comparing the Boby‘s adjusted capital with the new capital, we find that the Boby is to withdraw Rs. 12,400 [Rs.72,400 - Rs.60,000] or the amount may be credited to his current account. 3. When the capital of the new partner is calculated in proportion to

the total capital of the new firm. Sometimes the capital of the new partner is not given. He/she is required to bring an amount proportionate to his/her share of profit. In such a case,

171


new partner‘s capital will be calculated on the basis of adjusted capital of the existing partners. For example, the capital account of Sumit and Anu show the balance after

all adjustments and revaluation are Rs.90,000 and Rs.60,000 respectively. They admit Rohit as a new partner for 1/4 share in the profits. Rohit‘s capital is calculated as follows: Total share = 1 Rohit‘s share in the profit = 1/4 Remaining share = 1 – 1/4 = 3/4 3/4 share of profit combined capital of Sumit and Anu

= Rs.90,000+Rs.60,000 = Rs.1,50,000 Total Capital of the firm = Rs.1,50,000 × 4/3

= Rs.2,00,000 Rohit‘s capital for 1/4 share of profits = Rs.2,00,000 × 1/4 = Rs.50,000 Rohit brings in Rs.50,000 as his Capital

Illustration : 20

Manoj and Hema are partner sharing profit and losses in the ratio of

7 : 3. On March 31,2006, their Balance Sheet was as follows:

Balance Sheet of Manoj and Hema

as on March 31,2006


Capital : Bank 12,000

Manoj 88,00 Sundry Debtors 45,000

Hema 64,00 1,52,000 Bills Receivable 30,000

Sundry creditors 32,000 Stock 35,000

Bills Payable 38,000 Investment 13,000

Reserve 18,000 Machinery 40,000

Building 45,000

Goodwill 20,000

2,40,000 2,40,000

They admit Tarun into partnership on the following terms: (i) Stock is revalued at Rs.40,000.

172


5. Building, Machinery and Investment are depreciated by 12%. 6. Prepaid Insurance is Rs. 1,000. 7. Tarun brings Rs.40,000 as his capital and Rs. 12,000 for goodwill for

1/6 share of profit of the firm. 8. Capital of the partners shall be proportionate to their profit sharing

ratio. Adjustment of Capitals to be made by Cash. Prepare Revaluation Account, Partners‘ Capital Account , Cash Account

and Balance Sheet of the new firm. Solution:


Particulars Amount Particulars Amount

(Rs.) (Rs.)

Building 5,400 Stock 5,000

Machinery 4,800 Prepaid Insurance 1,000

Investment 1,560 Loss transferred to

Manoj‘s Capital 4,032

Hema‘s Capital 1,728 5,760

11,760 11,760

Capital account

Dr. Cr.

Particulars Manoj Hema Tarun Particulars Manoj Hema Tarun (Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

Goodwill 14,000 6,000 — Balance b/d 88,000 64,000 —

Revaluation 4,032 1,728 — General 12,600 5,400 — A/c (loss) Reserve

(loss)

Premium for Goodwill A/c 8,400 3,600

Bank A/c — 5,272 — Bank A/c — — 40,000

Balance c/d 1,40,000 60,000 40,000 Bank A/c 49,032 — — (Profit)

1,58,032 73,000 90,000 1,58,032 73,000 90,000


Balance Sheet of Manoj, Hema and Tarun as on March 31, 2006


Bills Payable 38,000 Bank 1,07,760

Sundry creditors 32,000 Bills Receivable 30,000

Capitals A/c: Sundry Debtors 45,000

Manoj 1,40,000 Stock 40,000

Hema 60,000 Investment 11,440

Tarun 40,000 2,40,000 Prepaid Insurance 1,000

Machinery 35,200

Building 39,600

3,10,000 3,10,000

Bank account Dr Cr

Particulars Amount Particulars Amount (Rs) (Rs)

Balance b/d 12,000 Hema‘s Capital A/c 5,272

Manoj‘s Capital A/c 49,032 Balance c/d 1,07,760

Goodwill A/c 12,000

Tarun‘s Capital A/c 40,000

1,13,032 1,13,032

Working Note:

= Calculation of New profit Sharing Ratio:

Total Profit = 1

Tarun gets = 1/6

Remaining Profit = 1 – 1/6 = 5/6 share by Manoj and Hema in their existing profit sharing ratio.

Manoj‘s new share = 5/6 × 7/10 = 7/12

Hema‘s new shares = 5/6 × 3/10 = 3/12

New profit sharing ratio of Manoj, Hema and Tarun =

7/12 : 3/12 : 1/6 or 7 : 3 : 2.

174


= Adjustment of Capital:

Tarun brought capital for 1/6 share = Rs.40,000

Total Capital of the firm = Rs. 40,000 × 6/1 = Rs.2,40,000

Manoj‘s Capital = Rs. 2,40,000 × 7/12 = Rs. 1,40,000

Hema‘s Capital = Rs. 2,40,000 × 3/12 = Rs.60,000 Tarun‘s

Capital = Rs. 2,40,000 × 2/12 = Rs.40,00

TOPICS COVERED UNDER ABOVE MENTIONED

CHAPTER ARE :

Admission of a partner – Meaning When a partner so admitted to the existing partnership firm, it is called admission of a partner. On the admission of a new partner, the following adjustments become necessary: 4. Adjustment in profit sharing ratio; 5. Adjustment of Goodwill; 6. Adjustment for revaluation of assets and reassessment of liabilities; 7. Distribution of accumulated profits and reserves; and 8. Adjustment of partners‘ capitals. Adjustment in Profit sharing Ratio When new partner is admitted he/she acquires his/her share in profit from

the existing partners. As a result, the profit sharing ratio in the new firm is decided mutually between the existing partners and the new partner. Sacrificing Ratio At the time of admission of an incoming partner, existing partners have to surrender some of their share in favour of the new partner. The ratio in which they surrender their profits is known as sacrifice ratio.


Meaning of Goodwill: A established firm develops wide business connections. This helps the firm to earn more profits as compared to a new firm. The monetary value of such advantage is known as ―Goodwill‖.

Methods of valuation of Goodwill (i) Average Profit Method (ii) Super Profit Method (iii) Capitalisation Method

Revaluation of assets and liabilities On admission of a new partner, the firm is reconstituted and the assets are revalued and liabilities are reassessed. It is necessary to show the true position of the firm at the time of admission of a new partner.

Adjustments of reserves and accumulated profit or losses Any accumulated profit or reserve appearing in the balance sheet at the time of admission of a new partner, are credited in the existing partner‘s capital account in existing profit sharing ratio. If there is any loss, the same will be debited to the existing partner in the existing ratio.

Adjustment of partner’s capital Sometime, at the time of admission, the partners‘ agreed that their capitals are adjusted to the

proportionate to their profit sharing ratio. The partners may decide to calculate the capitals

which are to be maintained in the new firm either on the basis of new Partner‘s Capital and his

profit sharing ratio or on the basis of the existing partner‘s capital accounts.

TERMINAL QUESTIONS

CHAPTER-3

RETIREMENT AND DEATH

OF A PARTNER

If you look around, you must have noticed people in your relation and in your

neighbourhood running business in partnership. You must have seen people

quitting partnership firm or a person dies while in partnership. These are the

events that take place during the lifetime of a partnership firm. Some issues

arise on the happening of these events involving finance. Some assets and

liabilities may need revaluation, goodwill is to be treated and amount of joint

life policy is distributed and soon accounting adjustment are required to be

made. Whenever such events take place, the firm has to calculate the dues of

a partner leaving the firm or that of the deceased. In this lesson you will learn

the accounting treatment in the books of the firm in these two cases i.e.

retirement of a partner and death of a partner.

OBJECTIVES

After studying this lesson, you will be able to:

state the meaning of retirement/death of a partner;

calculate new profit sharing ratio and gaining ratio;

make adjustments relating to goodwill, accumulated reserves and

undistributed profits at the time of retirement/death of a partner;

explain the need for revaluation of assets and reassessment of

liabilities at the time of retirement/death;

prepare the revaluation account relating to retirement/death of a partner;

illustrate the various methods of settling the claim of retiring partner

and the related accounting treatment;

illustrate the accounting treatment of partners capital and its

adjustment; ascertain profit up to the date of death of a partner;

prepare the account of the deceased partner‘s executor. 180

Retirement and Death of a Partner

RETIREMENT – MEANING, CALCULATION OF NEW

PROFIT SHARING RATIO AND GAINING RATIO When one or more partners leaves the firm and the remaining partners

continue to do the business of the firm, it is known as retirement of a

partner. Amit, Sunil and Ashu are partners in a firm. Due to some family

problems, Ashu wants to leave the firm. The other partners decide to allow

him to withdraw from the partnership. Thus, due to some reasons like old

age, poor health, strained relations etc., an existing partner may decide to

retire from the partnership. Due to retirement, the existing partnership

comes to an end and the remaining partners form a new agreement and the

partnership firm is reconstituted with new terms and conditions. At the

time of retirement the retiring partner‘s claim is settled. A partner retires either : 6. with the consent of all partners, or 7. as per terms of the agreement; or 8. at his or her own will. The terms and conditions of retirement of a partner are normally provided

in the partnership deed. If not, they are agreed upon by the partners at the

time of retirement. At the time of retirement the following accounting

issues are dealt : (a) New profit sharing ratio and gaining ratio. (b) Goodwill (c) Adjustment of changes in the value of Assets and liabilities (d) Treatment of reserve and accumulated profits. (e) Settlement of retiring partners dues, (f) New capital of the continuing partners.

New profit sharing ratio and gaining ratio As soon as a partner retires the profit sharing ratio of the continuing

partners get changed. The share of the retiring partner is distributed

amongst the continuing partners. In the absence of information, the

continuing partners take the retiring partner‘s share in their profit sharing

ratio or in an agreed ratio. The ratio in which retiring partner‘s share is

distributed amongst continuing partners is known as gaining ratio. It is

Gaining Ratio = New Ratio – Existing Ratio

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Various cases of new ratio and gaining ratio are illustrated as follows:

(i) Retiring partner’s share distributed in Existing Ratio : In this case, retiring partner‘s share is distributed in existing ratio amongst

the remaining partners. The remaining partners continue to share profits

and losses in the existing ratio. The following example illustrates this : Tanu, Manu and Rena are partners sharing profits and losses in the ratio of

= 4 : 3 : 2. Tanu retires and remaining partners decide to take Tanu‘s share

in the existing ratio i.e. 3 : 2. Calculate the new ratio of Manu and Rena. Existing Ratio between Manu and Rena = 3/9 and 2/9 Tanu‘s Ratio (retiring partner) = 4/9 Tanu‘s share taken by the Manu and Rena in the ratio of 3 : 2 Manu‘s gets = 4/9 × 3/5 = 12/45 Manu‘s New Share = 3/9 + 12/45 = 27/45 Rena‘s gets = 4/9 × 2/5 = 8/45 Rena‘s New Share = 2/9 + 8/45 = 18/45 New ratio between Manu and Rena is 27/45 : 18/45 = 27 : 18 = 3 : 2. Gaining Ratio = New Ratio – Existing Ratio Manu Gain = 27/45 – 3/9 = 12/45 Rena Gain = 18/45 – 2/9 = 8/45 12/45 : 8/45

3 : 2

You may note that the new ratio is similar to existing ratio that existed

between Manu and Rena before Tanu‘s retirement. Note: In absence of any information in the question, it will be presumed

that retiring partner‘s share has been distributed in existing ratio.

(ii) Retiring partner’s share distributed in Specified proportions: Sometimes the remaining partners purchase the share of the retiring partner in

specified ratio. The share purchased by them is added to their old share and

the new ratio is arrived at. The following example illustrates this:

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A B and C are partners in the firm sharing profits in the ratio of 3 : 2 : 1. B

retired and his share was divided equally between A and C. Calculate the

new profit sharing ratio of A and C. B‘s Share = 2/6 B‘s share is divided between A and C in the ratio of 1 : 1. A gets 1/2 of 2/6 = 2/6 × 1/2 = 1/6

A‘s New Share = 3/6 + 1/6 = 4/6

C‘s gets 1/2 of 2/6 = 2/6 × 1/2 = 1/6

C‘s New share = 1/6+1/6 = 2/6

Gaining Ratio

Gaining Ratio = New Ratio – Existing, Ratio Gain of A = 4/6 – 3/6 = 1/6 Gain of C = 2/6 – 1/6 = 1/6 1/6 : 1/6

1 : 1 i.e, equal.

(iii) Retiring Partner’s share is taken by one of the partners The retiring partner‘s share is taken up by one of the remaining partners. In

this case, the retiring partner‘s share is added to that of partner‘s existing

share. Only his/her share changes. The other partners continue to share profit

in the existing ratio. An example illustrating this point is given below: Anuj, Babu and Rani share profit in the ratio of 5 : 4 : 2. Babu retires and

his share is taken by Rani, So Rani‘s share is 2/11 + 4/11 = 6/11, Anuj

share will remain unchanged i.e, 5/11. Thus, the new profit sharing ratio of

Anuj and Rani is 5 : 6.

Illustration 1 Neru, Anu and Ashu are partners sharing profit in the ratio of 4 : 3 : 2.

Ashu retires. Find the new ratio of Neru and Anu if terms for retirement

provide the following : (i) ratio is not given (ii) equal distribution of Ashu‘s share


(iii) Ashu‘s share is taken by Neru and Anu in the ratio of 2 : 1 (iv) Anu take over the share of Ashu. Solution: (i) New profit sharing ratio of Neru and Anu is 4 : 3. (ii) Ashu‘s share = 2/9

Neru gets = 1/2 of 2/9 = 2/9 × 1/2 = 1/9

Neru‘s New share = 4/9 + 1/9 = 5/9 Anu

gets = 1/2 of 2/9 = 2/9 × 1/2 = 1/9 Anu‘s

New Share = 3/9 + 1/9 = 4/9

New profit sharing ratio of Neru and Anu is 5/9 : 4/9 or 5 : 4

Gaining ratio is equal 1/9 : 1/9 = 1 : 1 Mi. e.

(iii) Ashu‘s Share = 2/9

Neru gets = 2/3 of 2/9 = 2/9 × 2/3 = 4/27

Neru‘s new share = 4/9 + 4/27 = 16/27 Anu

gets = 1/3 of 2/9 = 2/9 × 1/3 = 2/27 Anu‘s

new share = 3/9 + 2/27 = 11/27

New profit sharing ratio of Neru and Anu is 16 : 11.

Gaining ratio is 4/27 : 2/27 = 4 : 2 = 2 : 1

(iv) Anu takes over Ashu share fully.

Ashu‘s share = 2/9

Anu gets = 2/9

Anu‘s new share = 3/9 + 2/9 = 5/9

New profit sharing ratio of Neru and Anu is 4 : 5

Only Anu gains.

184


Illustration 2 Ashish, Barmon, and Chander are partners sharing profits and losses in the

ratio of 2 : 1 : 2 respectively. Chander retires and Ashish and Barman decide

to share the profits and losses equally in future. Calculate the gaining ratio. Solution:

Gaining ratio = New Ratio – Existing Ratio

Hence, Ashish gets = 1/2 – 2/5

= 1/10

Barman gets = 1/2 – 1/5

= 3/10 Gaining ratio between Ashish and Barman is 1 : 3

INTEXT QUESTIONS 20.1

TREATMENT OF GOODWILL The retiring partner is entitled to his/her share of goodwill at the time of

retirement because the goodwill is the result of the efforts of all partners

including the retiring one in the past. The retiring partner is compensated

for his/her share of goodwill. As per Accounting Standard 10 (AS-10),

goodwill is recorded in the books only when some consideration in money

is paid for it. Therefore, goodwill is recorded in the books only when it is

purchased and the goodwill account cannot be raised on its own. Therefore, in case of retirement of a partner, the goodwill is adjusted

through partner‘s capital accounts. The retiring partner‘s capital account is


credited with. his/her share of goodwill and remaining partner‘s capital

account is debited in their gaining ratio. The journal entry is made as under:

Remaining Partners‘ Capital A/c Dr. (individually)

To Retiring Partner‘s Capital A/c

(Retiring partner‘s share of goodwill adjusted to

remaining partners in the gaining ratio)

Illustration 3 Mitu, Udit and Sunny are partners sharing profit equally. Sunny retires

and the goodwill of the firm is valued at Rs 54,000. No goodwill account

appears in the books of the firm. Mitu and Udit share future profit in the

ratio of 3 : 2. Make necessary journal entry for goodwill.

Solution:

Journal


Mitu‘s Capital A/c Dr 14,400

Udit‘s Capital A/c Dr. 3,600

To Sunny‘s Capital A/c 18,000

(Sunny‘s share of goodwill adjusted to remaining partners in their gaining

ratio 4 : 1]

Note : Sunny‘s share of goodwill = Rs.54,000 × 1/3 = Rs.18,000

Gaining Ratio = New Ratio – Existing Ratio

Mitu Gains = 3/5 – 1/3 = 9 – 5/15 = 4/15

Udit Gains = 2/5 - 1/3 = 6 – 5/ 15 = 1/15 Gaining Ratio between Mitu and Udit = 4 : 1

When the Goodwill Account already appears in the Books Normally the goodwill is not shown in the books of the firm. If at the time

of retirement/death of a partner, goodwill appears in the Balance Sheet of

the firm, it will be written off by debiting all the partners‘ capital account

186


in their existing profit sharing ratio and crediting the goodwill account. In

such a case, the following journal entry is made:

Partners‘ Capital A/c Dr (including retiring partner‘s capital A/c)

To Goodwill A/c

(Existing goodwill written-off) Illustration 4 Tanu, Priya and Mayank are partners‘ sharing profit in the ratio of 3 : 2 : l.

Priya retires and on the date of Priya‘s retirement goodwill is valued at

Rs.90,000. Goodwill already appears in the books at a value of Rs.48,000.

New ratio of Tanu and Mayank is 3 : 2. Make the necessary journal entries.

Solution:

Journal

Date Particulars LF Debit Credit Amount Arnount (Rs.) (Rs.)

Tanu‘s Capital A/c Dr 24,000

Priya‘s Capital A/c Dr 16,000

Mayank‘s Capital A/c Dr 8,000

To Goodwill A/c 48,000

(Existing goodwill written-off in the books)

Tanu‘s Capital A/c Dr 9,000

Mayank‘s Capital A/c Dr 21,000

To Priya‘s Capital A/c 30,000

(Priya‘s share of goodwill adjusted to remaining partners in their gaining

ratio 3 : 7

Note : Priya‘s share of goodwill = Rs.90,000 × 2/6 = Rs.30,000

Gaining Ratio = New Ratio – Existing Ratio,

Tanu Gains = 3/5 – 3/6 = 18 – 15/30 = 3/30 Mayank Gains = 2/5 – 1/6 = 12 – 5/30 = 7/30

Gaining Ratio between Tanu. and Mayank = 3 : 7


REVALUATION OF ASSETS AND LIABILITIES At the time of retirement of a partner the assets and liabilities of the firm

are revalued and Revaluation Account is prepared in the same way as in

case of admission of a partner. This is done to adjust the changes in value

of assets and liabilities at the time of retirement/death of a partner. Any

profit or loss due to revaluation is divided amongst all the partners

including retiring/deceased in their existing profit sharing ratio. Following

journal entries are made for this purpose : 2. For increase in value of assets: Assets A/c Dr. [Individually]

To Revaluation A/c

(Increase in the value of assets)

(ii) For decrease in value of assets:

Revaluation A/c Dr.

To Assets A/c (Individually)

(decrease in the value of asset)

(iii) For increase in value of Liabilities:

Revaluation A/c Dr.

To Liabilities A/c [Individually]

(Increase in the value of liabilities)

188


(iv) For decrease in value of Liabilities:

Liabilities A/c Dr. [Individually]

To Revaluation A/c

(decrease in the value of liabilities) Revaluation account is prepared to record the change in the value of assets

or liabilities. It will reveal profit or loss on revaluation. This profit or loss

is divided amongst all partners including the retiring/deceased partner in

existing profit sharing ratio. (v) For Profit on Revaluation :

Revaluation A/c Dr. (Individually)

To Partner‘s Capital A/c

(Profit on revaluation divided amongst all

partners in their existing profit sharing ratio) [v] For loss on Revaluation:

Partner‘s Capital A/c Dr. (Individually)

To Revaluation A/c

(Loss on revaluation borne by all partners

in their existing profit sharing ratio)

Illustration 5 Mudit, Mohit and Sonu are partners sharing profit in the ratio 3 : 2 : 1.

Mudit retires from the partnership. In order to settle his claim, the

following revaluation of assets and liabilities was agreed upon: * The value of Machinery is increased by Rs.25,000. * The value of Investment is increased by Rs 2,000. * A provision for outstanding bill standing in the books at Rs. 1,000 is

now not required. * The value of Land and Building is decreased by Rs.12,000. Give journal entries and prepare Revaluation account.


Solution


Machinery A/c Dr. 25,000

Investments A/c Dr. 2,000

Provision for Outstanding Bill Dr. 1,000

To Revaluation A/c 28,000

(Increase in value of Assets i.e. Machinery and investment and reduction in provision)

Revaluation A/c Dr. 12,000

To Land and Building A/c 12,000

(Decrease in value of assets)

Revaluation A/c Dr. 16,000

To Mudit‘s Capital A/c 8,000

To Mohit‘s Capital A/c 5,333

To Sonu‘s Capital A/c 2,667

(Profit on revaluation credited to all partners capital A/c in old profit sharing

ratio i.e. 3 : 2 : 1)

Revaluation account

Dr Cr


Land and Building 12,000 Machinery 25,000

Profit transferred to : Investments 2,000

Mudit Capital 8,000 Provision for 1,000

Mohit Capital 5,333 Outstanding Bill

Sonu Capital 2,667 16,000

28000 28000

Treatment of accumulated reserves and undistributed profit All the balances of Accumulated Reserves, funds and undistributed amount of

Profit or Loss appearing in the balance sheet of the firm on the date of

retirement/death is distributed amongst all partners including retiring/deceased

partner in their old profit sharing ratio, The following entries are made:

190


(iii) For distribution of undistributed profit and reserve.

Reserves A/c Dr

Profit & Loss A/c (Profit) Dr.

To Partners‘ Capital A/c (individually)

(Reserves and Profit & Loss (Profit) transferred to all partners capitals A/c in existing profit sharing ratio)

(ii) For distribution of undistributed loss

Partners‘ Capital A/c Dr. (individually)

To Profit & Loss A/c (Loss)

(Profit & Loss (loss) transferred to all partners Capitals A/c in old profit sharing ratio)

INTEXT QUESTIONS 20.3 SETTLEMENT OF RETIRING PARTNER’S CLAIM The amount due to the retiring partner is paid according to the terms of

partnership agreement. The retiring partners‘ claim consists of (a) The credit balance of Capital Account;


= His/her share in the Goodwill of the firm; = His/her share in the Revaluation Profit: = His/her share in General Reserve and Accumulated Profit; (f) Interest on Capital

But, the following deductions are made from his/her Capital Account on

account of : = His/her share in the Revaluation loss; = His/her Drawings and Interest on Drawings up to the date of retirement

= His/her share of any accumulated losses = Loan taken from the firm.

The total amount so calculated is the claim of the retiring partner. He/she

is interested in receiving the amount at the earliest. Total payment may be

made immediately after his/her retirement. However, the resources of the

firm may not be adequate to make the payment to the retiring partner in

lumsum. The firm makes payment to retiring partner in instalments. (i) Payment in Lump Sum Retiring partners‘ claim is paid either out of the funds available with the

firm or out of funds brought in by the remaining partners. The following journal entry is made for disposal of-the amount payable to

the retiring partner : On payment of cash in lump sum.

Retiring Partner‘s Capital A/c Dr.

To Cash/Bank A/c

(Amount paid to the retiring partner) Illustration 6 Om, Jai and Jagdish are partners sharing profit in the ratio of 3 : 2 : l.

Their balance sheet as on December 31st 2006 is as under :

192


Balance sheet as on December 31st, 2006

Liabilities Amount Assets Amount

(Rs.) (Rs.)

Creditors 80,000 Building 1,80,000

Bills Payable 26,000 Plant 1,40,000

General reserve 24,000 Motor Car 40,000

Capital : Stock 1,00,000

Om 1,60,000 Debtors 63,000

Jai 1,20,000 4,00,000 Less Provision 3,000 60,000.

Jagdish 1,20000 for Bad debts

Cash at Bank

10,000

5,30,000 5,30,000

Jai retires on that date on the following terms: 7. The Goodwill of the firm is valued at Rs.60,000. 8. Stock and Building to be appreciated by 10%. 9. Plant is depreciated by 10% 10. Provision for Bad debts is increased upto Rs.5,000. 11. Jai‘s share of goodwill adjusted through remaining partners capital

account, The amount due to Jai is paid out of the fund brought in by Om and Jagdish

for that purpose in their new profit sharing ratio. Jai is paid full amount. Prepare Revaluation Account and Partner‘s Capital account. Solution : It is assumed that Om and Jagdish gaining ratio remains 3 : l. 3. Gaining ratio = 3 : 1.

Om gets = 2/6 × 3/4 = 1/4

Om‘s new share = 3/6 + 1/4 = 3/4

Jagdish gets 2/6 × 1/4 = 1/12

Jagdish‘s new share = 1/6 + 1/12 = 3/12 = 1/4

New profit sharing ratio between Om and Jagdish is 3/4 : 1/4 = 3 : 1.


(b) Jai‘ Share of goodwill

60,000 × 2/6 = 20,000

Adjusted through the remaining partners capital account:

Om Capital A/c Dr. 15,000

Jagdish Capital A/c Dr. 5,000

To Jai Capital A/c 20,000

(Jai‘s share of goodwill debited to remaining partners‘ capital A/c)

Revaluation Account

Dr. Cr.


Provision for Bad debts 2,000 Stock 10,000

Plant 14,000 Building 18,000


Capital Accounts:

Om 6,000

Jai 4,000

Jagdish 2,000 12,000

28,000 28,000

Capital account

Dr. Cr.

Particulars Om Jai Jagdish Particulars Om Jai Jagdish (Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

Capital 15,000 — 5,000 Balance b/d 1,60,000 1,20,000 1,20,000

Bank 1,52,000 General Reserve 12,000 8,000 4,000

Balance c/d 2,77,000 — 1,59,000 Revaluation (Profit) 6,000 4,000 2,000

Om Capital — 15,000 —

Jagdish Capital — 5,000

Bank 1,14,000 38,000

2,92000 1,52,000 164,000 2,92000 1,52,000 164,000

194


(ii) Payment in instalments In this case the amount due to retiring partner is paid in instalments. Usually,

some amount is paid immediately on retirement and the balance is transferred

to his loan account. This loan is paid in one or more instalments The loan

amount carries some interest. In the absence of any agreement the rule under

Section 37 of the Indian Partnership Act 1932 applies.

According to this rule, if the amount due to him is not paid

immediately on his retirement, he can claim interest @ 6% p.a. on

the amount due. An instalment consists of two parts : (i) Principal Amount of instalment due to retiring partner. (ii) Interest at an agreed rate, Interest due on loan amount is credited to retiring partners‘ loan account.

Instalment inclusive of interest then is paid to the retiring partner as per

schedule agreed upon. (i) On part payment in cash and balance transferred to his/her loan

account.


To Cash/Bank A/c

To Retiring Partner‘s Loan A/c

(Part payment made and balance transferred to loan A/c) (ii) Total amount due transferred to loan A/c


To Retiring Partner‘s Loan A/c

(Total amount due transferred to loan A/c) (iii) For interest due

Interest on loan A/c Dr.

To Retiring Partners‘ Loan A/c

(Interest due on loan) (iv) For payment of instalment

Retiring Partners‘ Loan A/c

To Cash/Bank A/c

(Instalment inclusive of interest paid)


Illustration 7 Taking the figures of the pervious illustration, assuming that he is paid 40% of the amount due

immediately and the balance in three equal yearly instalments. The interest payable is 12% p.a.

Solution: The amount due to Jai = Rs.1,52,000 Amount paid immediately = Rs.1,52,000 × 40/100

= Rs.60,800 Amount of three equal instalments = Rs.1,52,000 – Rs.60,800 × 3

= Rs.91,200 ÷ 3 = Rs.30,400 1st Instalment at the end of 1st Year = Rs.30,400 + Rs. 10,944

= Rs.41,344 Interest @ 12% pa. = Rs.91,200 × 12/100

= Rs.10,944 2nd Instalment at the end of 2nd Year = Rs.30,400 + Rs.7,296

= Rs.37,344 Interest @ 12% pa. = Rs.60,800x1.2/ 100

= Rs.7,296 3rd Instalment at the end of 3rd Year = Rs.30,400 + Rs.3,648

= Rs.34,048 Interest @ 12% pa. = Rs.30,400 × 12/100

= Rs.3,648


196


III. Find the total amount due to Munish, who is retiring as a partner:

1. Credit balance in Munish capital account Rs.20,000.

2. Munish‘s share of goodwill Rs.7,000

3. General reserve balance shown in Balance sheet Rs.10,000

4. Profit on Revaluation of Assets /liabilities Rs.3,000

5. Interest on drawings Rs.5,00.

6. Munish share in the profit of the firm 1/2

ADJUSTMENT OF REMAINING PARTNER’S CAPITAL

ACCOUNT AFTER RETIREMENT After retirement of a partner the remaining partners may decide to adjust

their capital. Often the remaining partners determine the total amount of

capital of the reconstituted firm and decide to keep their respective capital

accounts in proportion to the new profit sharing ratio. The total capital of

the firm may be more or less than the total of their capital at the time of

retirement. The new capitals of the partners are compared with the balance

standing to the credit of respective partner‘s capital account. If there is a

surplus in the capital account, the amount is withdrawn by the concerned

partner. The partner brings cash in case the balance in the capital account

is less than the calculated amount.

Illustration 8 Roopa, Sunder and Shalu are partners sharing profit in the ratio of 5 : 3 : 2.

Roopa retired, when their capitals were: Rs.46,000, Rs.42,000 and

Rs.38,000 respectively after making all adjustments on retirement. Sunder

and Shalu decided to have a total capital of the firm at Rs.84,000 in the

proportion of 7 : 5. Calculate actual cash to be paid or brought in by each

partner and make necessary journal entries.

Solution:

Total Capital of the New firm = Rs.84,000

Sunder‘s share in the new capital = Rs.84,000 × 7/12

= Rs.49,000

Shalu‘s share in the new capital = Rs.84,000 × 5/12

= Rs.35,000


On comparing Sunder‘s share in the new capital of the firm with the

amount standing to the credit of his capital, It is observed that he has to

bring Rs.7,000 the deficit amount (Rs.49,000 – 42,000) in Cash. Similarly, Shalu‘s share in the new capital of the firm is Rs.35,000 while

Rs.38,000 stands credited to her capital account. So she is allowed to

withdraw Rs.3,000, the surplus amount (Rs.38,000 – Rs.35,000) from the

firm so as to make her capital in proportion to her new profit share ratio.

journal


Bank A/c Dr. 7,000

To Sunder‘s Capital A/c 7,000

(The deficit amount brought in by the partner)

Shalu‘s Capital A/c Dr. 3,000

To Bank A/c 3,000

(The surplus amount withdrawn by the partner)

Adjustment of remaining partner’s capital in their profit sharing

ratio, when the total capital of the new firm is not pre-determined. In this case the total amount of adjusted capital of the remaining partners

is rearranged as per agreed proportion in which they share profit of the

reconstituted firm. The following steps may be adopted: 2 Add the balance standing to the credit of the remaining partners‘

capital accounts. 3 The total so obtained is the total capital of the firm. 4 This capital is divided according to the new profit sharing ratio.

Illustration 9 Sumit, Amit and Neha are partners sharing profit in the ratio of 4 : 3 : 1.

when Amit retired , their adjusted capitals were Rs.76,000: Rs.45,000 and

Rs.34,000 respectively. Sumit and Neha decided to have their total capital

of the firm in the ratio of 3 : 2. The necessary adjustments were to be

made in cash only. Calculate actual cash to be paid off or brought in by

each partner. 198


Solution: Total of the adjusted capitals of the remaining partners.

Sumit = Rs. 76,000

Neha = Rs. 34,000

Total = Rs.110,000

Total capital of the firm which is divided in the new ratio of 3 : 2. New capital of Sumit = 1,10,000 × 3/5 = Rs. 66,000

New Capital of Neha = 1,10,000 × 2/5 = Rs.44,000 Sumit‘s share in the new capital of the firm is Rs.66,000 while Rs.76,000

stands credited to his capital account. So he will withdraw Rs.10,000

(Rs.76,000 – Rs.66,000) from the firm so as to make his capital in

proportion to his new profit sharing ratio. Similarly, Neha‘s share in the new capital of the firm is Rs.44,000 while

Rs.34,000 stands credited to her capital account, She has to bring Rs,10,000

(Rs,44,000 – 34,000) in Cash to make up the deficit in the capital account.

Illustration 10 The Balance Sheet of Rohit, Nisha and Sunil who are partners in a firm

sharing profits according to their capitals as on 31st March 2006 was as

under:

Liabilities Amount As.sets Amount (Rs.) (Rs.)

Creditors 25,000 Machinery 40,000

Bills Payable 13,000 Building 90,000

General Reserve 22,000 Debtors 30,000

Capital Less Provision for 1.000 29,000

Rohit 60,000 Bad debts

Nisha 40,000 Stocks 23,000

Sunil 40,000 1,40,000 Cash at Bank 18,000

2,00,000 2,00,000

On the date of Balance Sheet, Nisha retired from the firm, and following

adjustments were made:

19


(i) Building is appreciated by 20%. (ii) Provision for bad debts is increased to 5% on Debtors. (iii) Machinery is depreciated by 10%. (iv) Goodwill of the firm is valued at Rs.56,000 and the retiring partner‘s

share is adjusted. (v) The capital of the new firm is fixed at Rs.1,20,000. Prepare Revaluation Account, Capital Accounts of the partner and Balance

sheet of the new firm after Nisha‘s retirement.

Solution:

Revaluation Account Dr. Cr.

Particulars Amount Particulars Amount

(Rs.) (Rs.)

Provision for Bad debt A/c 500 Building A/c 18,000

Machinery A/c 4,000


Capital Accounts (3 : 2 : 2)

Rohit 5,786

Nisha 3,857

Sunil 3,857 13,500

18,000 18,000

Capital account

Dr. Cr.

Particulars Rohit Nisha Sunil Particulars Rohit Nisha Sunil (Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

Sunil Capital 9,600 — 6,400 Balance b/d 60,000 40,000 40,000

Bank 66,143 General : Reserve 9,428 6,286 6,286

Balance c/d 72,000 — 48,000 Revaluation (Profit) 5,786 3,857 3,857

Rohit Capital — 9,600 —

Sunil Capital 6,400

Bank 6,386 4,257

81,600 66,143 54,400 81,600 66,143 54,400

200


Balance Sheet as on 31st March 2006


(Rs.) (Rs.)

Creditors 25,000 Building 1,08,000

Bank overdraft 37,500 Machinery 36,000

Bills Payable 13,000 Debtors 30,000

Capital: Less Provision for 1,500 28,500

Rohit 72,000

Bad debts

Sunil 48,000 1,20,000 Stock 23,000

1,95,500 1,95,500

Working Notes : (i) (a) Profit sharing ratio is 60,000:40,000:40,000 i.e. = 3:2:2

(b) Gaining Ratio: Rohit = 3/5 – 3/7 = 21/35 – 15/35 = 6/35

Sunil = 2/5-2/7 = 14/35 – 10/35 = 4/35

= 6/35 : 4/35

= 6 : 4 = 3 : 2

(c) Nisha Share of Goodwill = 56,000 × 2/7 = Rs.16,000.

Share of Goodwill in the gaining ratio by the existing partner,

i.e. Rohit = 16,000 × 3/5 = Rs.9,600

Sunil = 16,000 × 2/5 = Rs.6,400

The journal entry is

Rohit‘s Capital A/c Dr 9,600

Sunil‘s Capital A/c Dr 6,400

To Nisha‘s Capital A/c 16,000

(Share of Goodwill divided into gaining ratio}


Bank account Dr Cr


Balance b/d 18,000 Nisha‘s Capital A/c 66,143

Rohit‘s Capital A/c 6,386

Sunil‘s Capital A/c 4,257

Balance c/d 37,500 (Bank overdraft)

66,143 66,143

(ii) Bank overdraft is taken to pay the retiring partner amount. (iv) New Capital of the firm is fixed at Rs.1,20,000. Rohit Sunil

(Rs.) (Rs.)

New Capital (Rs.1,20,000 in the ratio of 3 : 2) 72,000 48,000

Existing Capital (After Adjustments) i.e. partner capitals 65,614 43,743

Cash to be brought by the remaining partners 6.386 4,257 Illustration 11 Chauhan Triphati and Gupta are partners in a firm sharing profit and

losses in the ratio of 1/2, 1/6 and 1/3 respectively. The Balance Sheet on

March 31, 2006 was as follows :


(Rs.) (Rs.)

Sundry Creditors 36,000 Freehold Premises 80,000

Bills Payable 24,000 Machinery 60,000

General Reserve 24,000 Furniture 24,000

Capitals: Debtors 40000

Chauhan 60,000 Less Provision for 2,000 38,000

Triphati 60,000

Bad debts

Gupta 56,000 1,76,000 Stock 44,000

Cash

14,000

2,60,000 2,60,000

202


Gupta retires from the business and the partners agree to the following

revaluation: = Freehold premises and stock are to be appreciated by 20% and 15%.

respectively = Machinery and furniture are to be depreciated by 10% and 7%

respectively = Bad debts reserve is to be increased to Rs.3,000. = On Gupta retirement, the goodwill is valued at Rs.42,000. = The remaining partners have decided to adjust their capitals in their

new profit sharing ratio after retirement of Gupta. Surplus/deficit, if

any in their capital account will be adjusted through cash.

Prepare necessary ledger accounts and Balance Sheet of reconstituted

firm.

Solution:

Revaluation Account Dr. Cr.


Provision for Bad debts 1,000 Freehold Premises 16,000

Machinery 6,000 Stock 6,600

Furniture 1,680


Capital Accounts:

Chauhan 6,960

Triphati 2,320

Gupta 4,640 13,920

22,600 22,600

Capital Account

Dr. Cr.

Particulars Chauhan Triphati Gupta Particulars Chauhan Triphati Gupta (Rs) (Rs) (Rs) (Rs) (Rs) (Rs)

Gupta Capital 10,500 3,500 – Balance b/d 60,000 60,000 56,000

Gupta Loan 82,640 General Reserve 12,009 4,000 8,000

Cash 30,000 Revaluation (Profit) 6,960 2,320 4,640

Balance c/d 98,460 32,820 Chauhan Capital — — 10,500

Tirphati Capital 3,500

Cash 30,000

1,08,960 66,320 82,640 1,08,960 66,320 82,640

203


Balance Sheet as on March 31, 2006 Liabilities Amount Assets Amount

(Rs.) (Rs.)

Creditors 36,000 Freehold Premises 96,000

Bills Payable 24,000 Machinery 54,000

Gupta‘s Loan 82,640 Furniture 22,320

Capital: Debtors 40,000

Chauhan 98,460 Less Provision for 3,000

Tirphati 32.820 1,31,280 Bad debts 37,000

Stock

50,600

Cash 14,000

2,73,920 2,73,920

Working Note: (c) In the absence of agreement, retiring partner‘s capital account is transferred to his loan account. (d) In the absence of agreement, existing ratio of remaining partners is gaining ratio i.e. 3 : 1 (e) Calculation of Cash brought in (or paid off) by remaining partner.

Chauhan Tirphati

3. Total Capital of Chauhan and Tirphati

(Rs.68,460 + 62,820 = Rs.1,31,280 in the

ratio of 3 : 1) 98,460 32,820

Adjusted existing Capital 68,460 62,820

Excess or Deficit (Excess) 30,000 (Deficit) 30,000

INTEXT QUESTION 20.5 204


DEATH OF A PARTNER

On the death of a partner, the accounting treatment regarding goodwill,

revaluation of assets and reassessment of liabilities, accumulated reserves

and undistributed profit are similar to that of the retirement of a partner,

When the partner dies the amount payable to him/her is paid to his/her

legal representatives. The representatives are entitled to the followings : (iv) The amount standing to the credit to the capital account of the

deceased partner (v) Interest on capital, if provided in the partnership deed upto the date of

death: (vi) Share of goodwill of the firm; (vii) Share of undistributed profit or reserves; (viii) Share of profit on the revaluation of assets and liabilities; (ix) Share of profit upto the date of death; (x) Share of Joint Life Policy. The following amounts are debited to the account of the deceased

partner‘s legal representatives: (4) Drawings (5) Interest on drawings (6) Share of loss on the revaluation of assets and liabilities; (7) Share of loss that have occurred till the date of his/her death. The above adjustments are made in the capital account of the deceased

partner and then the balance in the capital account is transferred to an

account opened in the name of his/her executor. The payment of the amount of the deceased partner depends on the

agreement. In the absence of an agreement, the legal representative of a

deceased partner is entitled to interest @ 6% p.a. on the amount due from

the date of death till the date of final payment.

205


Calculation of profit upto the date of death of a partner. If the death of a partner occurs during the year, the representatives of the

deceased partner are entitled to his/her share of profits earned till the date of

his/her death. Such profit is ascertained by any of the following methods: 6. Time Basis 7. Turnover or Sales Basis (i) Time Basis In this case, it is assumed that profit has been earned uniformly through

out the year. For example: The total profit of previous year is Rs. 2,25,000 and a partner dies three

months after the close of previous year, the profit of three months is Rs.

31,250 i.e. 1,25,000 × 3/12, if the deceased partner took 2/10 share of

profit, his/her share of profit till the date of death is Rs. 6,250 i.e. Rs.

31,250 × 2/10

(ii) Turnover or Sales Basis In this method, we have to take into consideration the profit and the total

sales of the last year. Thereafter the profit upto the date of death is

estimated on the basis of the sale of the last year. Profit is assumed to be

earned uniformly at the same rate.

Illustration 12 Arun, Tarun and Neha are partners sharing profits in the ratio of 3 : 2 : 1

Neha dies on 31st May 2006. Sales for the year 2005-2006 amounted to

Rs.4,00,000.and the profit on sales is Rs.60,000. Accounts are closed on

31 March every year. Sales from lst April 2006 to 31st May 2006 is

Rs.1,00,000. Calculate the deceased partner‘s share in the profit upto the date of death.

Solution : Profit from 1st April 2006 to 31st May 2006 on the basis of sales: If sales are Rs.4,00,000, profit is Rs.60,000 If the sales are Rs.1,00,000 profit is : 60,000/4,00,000 × 1,00,000

= Rs.15,000

Neha‘s share = 15,000 × 1/6 = Rs.2,500 206


Alternatively profit is calculated as

Rate of profit = 60000

100 15%

400000

Sale upto date of death = 1,00,000

Profit = 1,00,000 15

= Rs 15000

100

Illustration 13 Nutan, Sumit and Shiba are partners in a firm sharing profits in the ratio

5 : 3 : 2. On 31st December 2006 their Balance Sheet was as under: Liabilities Amount Assets Amount (Rs.) (Rs.)

Creditors 52,000 Building 60,000

Reserve Fund 15,000 Plant 50,000

Capitals : Stock 27,000

Nutan 60,000 Debtors 25,000

Sumit 45,000 Cash 10,000

Shiba 30,000 1,35,000 Bank 30,000

2,02,000 2,02,000

Nutan died on 1 July 2007. It was agreed between her executor and the

remaining partners that: 7. Goodwill to be valued at 2½ years purchase of the average profits of

the last Four years, which were: 2003 Rs. 25,000; 2004 Rs.20,000;

2005 Rs.40,000 and 2006 Rs.35,000. 8. Building is valued at Rs.70,000; Plant at Rs.46,000 and Stock at

Rs.32,000. 9. Profit for the year 2006 be taken as having accrued at the same rate as

that of the previous year. 10. Interest on capital is provided at 9% p.a. 11. On 1 July 2007 her drawings account showed a balance of Rs.20,000. 12. Rs.25,950 are to be paid immediately to her executor and the balance

is transferred to her Executors Loan Account. Prepare Nutan‘s Capital Account and Nutan‘s Executor‘s Account as on

1st July 2007.

Solution (i) Valuation of Goodwill:

Total Profit = Rs.25,000 + Rs.20,000 + Rs.40,000 + Rs.35,000

= Rs. 1,20,000

207


Average Profit = 1,20,000/4 = Rs.30,000

Hence, Goodwill at 2½ year‘s purchase = Rs.30,000 × 2½ =

Rs.75,000 Nutan‘s share of goodwill = 75,000 × 5/10 = Rs.37,500

It is adjusted into the Capital Accounts of Sumit and Shiba in the

gaining ratio of 3 : 2 i.e. Rs 22,500 and Rs 15000 respectively. 2. Share of Profit payable to Nutan [upto the date of death]

Rs.35,000 × 6/12 × 5/10

Rs.8,750 3. Nutan‘s Share of Reserve Fund = Rs.15,000 × 5/10

Rs.7,500 4. Interest on Nutan‘s Capital = 60,000 × 9/100 × 6/12

Rs.2,700

Revaluation account Dr Cr


Plant 4,000 Building 10,000

Profit transferred to Stock 5,000

Nutan Capital 5,500

Sumit Capital 3,300

Shiba Capital 2,200 11,000

15,000 15,000

Nutan’s Capital account

Dr. Cr.


Drawings 20,000 Balance b/d 60,000

Nutan‘s Executor‘s 1,01,950 Reserve fund 7,500

Sumit‘s Capital (Goodwill) 15,000

Shiba‘s Capital (Goodwill) 22,500

Profit & Loss (Suspense) 8,750

Revaluation A/c 5,500

Interest on Capital 2,700

1,21,950 1,21,950

208

Retirement and Death of a Partner Nutan’s Executor’s accounts

Dr. Cr.


Bank 25,950 Nutan‘s Capital 1,01,950

Nutan‘s Executor‘s 76,000 Loan Transfer

1,01,950 1,01,950

CHAPTER-4

DISSOLUTION OF A PARTNERSHIP FIRM

LEARNING OBJECTIVES After studying this chapter you will be

able to : l State the meaning of dissolution of

firm;

l Differentiate between dissolution

of firm and dissolution of

partnership;

l Prepare realization account;

l Settle the claims against the firm;

l Record transactions for closure of

the books and settlement of

partners‘ accounts.

The word Dissolution implies ―the undoing or

breaking of a bond tie‖. In other words,

dissolution implies that the existing state of

arrangement is done away with. Suppose,

certain colour is put into the water, the colour

dissolves into the water because the solid state

of the colour disintegrates through the process

of breaking of bond of chemicals that was the

basis of that solid state. In life, anything

dissolves only by losing its current state, so is

true in the case of the partnership as well. An

existing partnership dissolves whenever the

reconstitution of the existing firm is caused by

admission, retirement or death of a partner.

However, the dissolution of partnership does

not lead to the dissolution of the firm since the

two situations are different. In case of

dissolution of partnership, the firm continues,

only the partnership relation is reconstituted, but

in case of dissolution of firm, not only

partnership is dissolved but the

firm also loses its existence,

implying thereby that the firm

ceases to operate as a partnership firm (Section 39 of the Partnership Act, 1932). After

dissolution of firm, the firm does not remain in business. The only business to be carried out

is akin to its funeral ceremony, i.e., closing ceremony of all existing activities.

Dissolution of a Partnership

The relation of partnership among different partners is changed without changing the

partnership firm. Thus, in case of dissolution of partnership, the economic basis of

relationship of partners is reconstituted without affecting the entity of the firm which

continues to remain in business as ever before. A partnership is dissolved by change of

mutual contract in the following cases : 7. Change in profit sharing ratio among partners; 8. Admission of a new partner; 9. Retirement of a partner, where at least two persons remain as partners; 10. Death of a partner (Section 42); 11. Adjudication of a partner as an insolvent; 12. Completion of a venture if partnership is formed for that; 13. Expiry of the period of partnership if partnership is for a pre-determined period;

14. Merger of one partnership firm into another.

Dissolution of a Firm

Dissolution of a firm takes place in the following cases : 9. Dissolution by agreement : A firm is dissolved in case :

1.2 All the partners give consent to it, or 1.3 As per the terms of partnership agreement.

10. Compulsory dissolution : A firm is dissolved compulsorily in the following cases :

1.2 Where all the partners or all except one partner, become insolvent or insane

rendering them incompetent to sign a contract;

1.3 Where the business becomes illegal;

Where all the partners except one decide to retire from the firm;

Where all the partners or all except one partner dies;

Where the partnership deed includes any provision regarding the happening of the

following :

Expiry of the period for which the partnership was formed;

Completion of the specific venture or project for which the firm was formed.

6. Dissolution by notice : In case of partnership at will, the firm may be dissolved if any of

the partners gives a notice in writing to the other partners signifying his intention of

seeking dissolution of the firm. 7. Dissolution by court : A court, may order a partnership firm to be dissolved (under

Section 44), in case of a suit by a partner in the following situations :

A partner becomes insane;

A partner becomes permanently incapable of performing his duties as a partner;

A partner deliberately and consistently commits breach of agreements relating to

the management of the firm;

A partner‘s conduct is likely to adversely affect the business of the firm;

The partner transfers whole of his interest in the firm to a third party;

The business of the firm cannot be carried on, except at a loss;

The court, on any ground, regards dissolution to be just and equitable.

Distinction between Dissolution of

Partnership and Dissolution of Firm

Basis Dissolution of Partnership Dissolution of Firm

1. Termination of No, the business is not The business of the firm is business terminated. closed.

2. Settlement of as- Assets and liabilities are Assets are sold and realized sets and liabilities revalued and new balance and liabilities are paid off. sheet is drawn.

3. Court‘s Court does not intervene A firm can be dissolved by Intervention because partnership is the court‘s order. dissolved by mutual agreement

and through the process of

reconstitution.

4. Economic Relation- Economic relationship may Economic relationship ship remain and changes. between the partners comes to an end.

5. Closure of books Does not require because the All books of accounts are business is not terminated. closed.

Settlement of Accounts

In case of dissolution of firm, the firm ceases to conduct business and has to settle its

accounts. For this purpose, it disposes off all its assets for making payment to all the

claimants against it.

Section 48 of the Partnership Act provides the following rules for the settlement of

accounts between the partners : l Loss to be paid first out of profits, next out of capital and lastly by the partners

individually in the proportion in which they were entitled to share the profits. In other

words, losses are to be shared by the partners in their profit sharing ratio;

l Assets of the firm are first to be applied in paying off the debts of the firm to the third

parties, next in paying off to each partner proportionately what is due to him from the

firm for advances as distinguished from

capital; and the residue to be divided among the partners in the proportion in which they

were entitled to share profits. In simple words, following is the order of payment from

the proceeds of the sale of the firm :

l Expenses of realization;

l Payment to outside creditors. It is to be noted that secured creditors are to be paid

off first out of the proceeds of secured assets before anything is paid to unsecured

creditors;

l Loans and advances made by partners‘ spouse;

l Loans and advances made by a partner apart form his capital; and

l Final claims of the partners on their capital account.

Debts of firm verses personal debts of partners If assets of the firm are not sufficient to pay off the firm‘s creditors, the partners may be

required to make contributions because of the unlimited nature of the liability of the partner.

In such a case, the partner will have the right to apply his personal assets in paying off his

personal debts first. Thereafter, the remaining surplus of personal assets will be used for

making his contribution to satisfy the unsettled portion of outside creditors. It is to be further

noted that personal assets of the partner are individually owned assets excluding the personal

property of wife (Streedhan).

Accordingly the following steps are taken : l All assets would be disposed off and cash has to be realized; l With the available funds, claims are satisfied in the following order—

1. Payment of expenses for realizing the assets and collection of debts;

2. Payment of outside liabilities of the firm, i.e. creditors, loans, bank overdrafts, bills

payable, advances from partners‘ relatives;

3. Loans and advances made by a partner;

4. Repayment of advances extended by the partners;

5. Repayment of capital contribution to the partner;

6. Any surplus left, is distributed among all partners in their profit sharing ratio.

Accounting Treatment The books of accounts are closed and profit or loss on realizing the assets and discharge of

liabilities has to be computed in the event of dissolution of the firm. For this purpose, a

realization account is prepared for recording the realization of assets and payment of

liabilities. Sale of assets is recorded at the realized value and payment to creditors is recorded

at the settlement value. After recording of all transactions with respect to sale, transfer or

takeover of assets and payment of all external liabilities, the realization account would have a

balance that will either be profit or loss. Profit arises when assets are realized at more than the

book value and/or liabilities are settled at less than book value. In an otherwise situation there

is loss. The profit or loss on realization is transferred to partners‘ capital accounts in their

profit sharing ratio. Journal Entries * For transferring the assets

Transfer to the debit of realization account at their gross book values of all accounts of

assets excluding cash, bank and the fictitious assets.

Realization a/c Dr.

Assets a/c(individually)

It is to be noted that debit balance such as accumulated losses deferred expenses are not

transferred to the realization account. These are transferred to the partners‘ capital

account in their profit sharing ratio by recording the following entry :

Partners‘ capital a/c Dr.

Fictititous assets a/c

(iv) For transferring the liabilities

All external liability accounts including provisions, if any, in respect of assets which

have been transferred to the realization account are closed by transferring them to the

credit of realization account at their book values.

External liabilities a/c(Individually) Dr.

Realization a/c

Partners‘ capital account and loan account of the partner are prepared separately and are

not transferred to realization account.

2. For sale of assets

Bank a/c(realized price) Dr.

Realization a/c 4. For an asset taken over by a partner

Partner‘s capital a/c Dr.

Realization a/c(Agreed price) 5. For payment to creditors

Any amount paid in cash to creditors, realisation account is debited and cash/bank

account is credited.

Realization a/c Dr. Bank a/c

6. Settlement with the creditors through transfer of asset

When a creditor accepts an asset in part payment no entry is recorded. It is because the

liability due to the creditors has already been transferred to the credit of realization

account and the asset taken over by the creditor is appearing on the debit side of the

realization account. Thus, the debit of the asset cancels the credit of the corresponding

liability in the realization account. Sometimes, a creditor may accept part of his payment

in cash and part of his payment by taking over an asset. In this case, the entry will be

recorded for cash payment only. For example, a creditor to whom Rs. 10,000 was due

accepted office equipment worth Rs. 8,000. He will be paid Rs. 2,000 in cash by

recording the following entry :

Realization a/c Dr. Rs. 2,000

Bank a/c Rs. 2,000

Whenever a creditor takes over an asset, there may be two situations :

(a) When a creditor accepts an asset whose value is more than the amount due to him,

he will pay cash. It is recorded as :

Bank a/c Dr. Realization a/c

(b) When a creditor accepts an asset as full and final settlement, no journal entry is

recorded.

(iii) Expenses of realization

(a) When realization expenses are paid by the firm


8. When firm has agreed to pay partner a fixed amount towards realization expenses

irrespective of the actual realization expenses

Realization a/c Dr. Partners‘ capital a/c

6. When the actual expenses are paid by the firm on behalf of a partner, the following

entry will be recorded :

Partners‘ capital a/c Dr. Bank a/c

(2) However, if a partner himself pays and agreed not to get them reimbursed, no

journal entry is recorded.

(3) When the partner agrees to pay the expenses on behalf of the firm, the entry to be

recorded :


(3) When liabilities are paid off


(5) When partner discharges a liability

The liability account is transferred from realization account to partner‘s capital account

by recording the following entry :


10. For realization of any unrecorded assets

Bank a/c Dr. Realization a/c

11. Unrecorded asset taken over by a partner

Partners‘ capital a/c Dr. Realization a/c

12. For settlement of any unrecorded liability


13. Unrecorded liability taken over by a partner

Realization a/c Dr. Partners‘ Capital a/c 14. When the profit (loss) on realization is transferred to partners’ capital account in their

respective profit sharing ratio :

(a) In case of profit on realization

Realization a/c Dr. Partners‘ Capitals a/c(individually)

(b) In case of loss on realization

Partners‘ Capitals a/c (individually) Dr.

Realization a/c 4. For transferring accumulated profits and reserve

All accumulated profits and reserves are transferred to the partners‘ capital account in

their respective profit sharing ratio :

Accumulated profit/reserves Dr. Partners‘ capitals a/c (Individually)

16. Transfer of fictititous assets

All accumulated losses and fictitious assets are debited to the partners‘ capital accounts

in their profit sharing ratio :

Partners‘ capitals a/c (Individually) Dr. Accumulated losses/Fictitious Assets a/c

17. Payment of loans

Any loans due to partners are paid off :

Partner‘s loan a/c Dr. Bank a/c

18. Settlement of capital accounts

3. If the partner‘s capital account shows debit balance, he is to bring in the necessary

cash :

Bank a/c Dr.

Partners‘ capital a/c

(b) In case of partners whose accounts show credit balance, the same is paid off :

Partners‘ capitals a/c Dr.

Bank a/c

It may be noted that the aggregate amount finally payable to the partners must equal to

the amount available in the bank and cash accounts. Thus, all accounts of a firm are closed in

case of dissolution. At times, the Balance Sheet of the firm may not be available on dissolution of partnership

firm. In such a situation, first of all, all the relevant ledger balances are worked out and then

Balance Sheet of the firm on the date of its dissolution is prepared. Thereafter, the process of

dissolution is undertaken in the same manner as discussed above.

Illustration 1(Ascertaining the value of assets) Ram and Shyam share the profits equally. They decided to dissolve their firm. Their liabilities

were : Ram‘s Capital Rs. 25,000; Shyam‘s Capital Rs. 30,000; Creditors Rs. 12,500; Bills

payable Rs.7,500; Assets of the firm realized Rs.1,00,000. Prepare a Realization Account. Solution Books of Ram and Shyam

Realization Account

Dr. Cr.


Sundry assets 75,0001 Bank 1,00,000

Bank: Creditors 12,500 Creditors 12,500 Bills payble 7,500 Bills payable 7,500

Capital Accounts:

Ram 12,500

Shyam 12,500 25,000

Total 1,20,000 Total 1,20,000

Notes to the Solution

Capital + Liabilities = Assets

Capital + Creditors + Bills payable = Assets

Rs. 25,000 + 30,000 + 12,500 + 7,500 = Rs. 75,0001

Illustration 2(When balance sheet at the time of dissolution is not given) Kumar, Yash and Zakir commenced business on January 1, 2001 with capitals of Rs.

1,00,000, Rs. 80,000 and Rs. 60,000 respectively. Profits are shared in the ratio 4:3:3.

Capitals carried interest at 5% p.a. During 2001 and 2002 they made profits of Rs. 40,000 and

Rs. 50,000 (before allowing interest on capitals). Drawings of each partner were Rs. 10,000

per year.

On December 31, 2002 the firm was dissolved. Creditors on that date were Rs. 24,000.

The assets realized Rs. 2,60,000 net. Prepare the necessary accounts to close the books of the

firm. Solution Books of Kumar, Yash and Zakir

Partners’ Capital Accounts

Dr. Cr.

Date Particulars J.F. Kumar Yash Zakir Date Particulars J.F. Kumar Yash Jakir Rs. Rs. Rs. Rs. Rs. Rs.

2001 2001

Dec. 31 Drawings 10,000 10,000 10,000 Jan. 1 Bank 1,00,000 80,000 60,000 Bal. c/f 1,06,200 82,400 61,400 Int. on Capital 5,000 4,000 3,000 Dec. 31 Net profit 11,200 8,400 8,400

1,16,200 92,400 71,400 1,16,200 92,400 71,400

2002 2002

Dec. 31 Drawings 10,000 10,000 10,000 Jan. 1 Bal. b/f 1,06,200 82,400 61,400 Bal. c/f 1,16,510 87,770 65,720 Int. on capital 5,310 4,120 3,070 Net Profit 15,000 11,250 11,250

1,26,510 97,770 75,720 1,26,510 97,770 75,720

Dec. 31 Realization a/c 13,600 10,200 10,200 Jan. 1 Balance b/f 1,16,510 87,770 65,720 Bank 102,910 77,570 55,520

Total 1,16,510 87,770 65,720 Total 1,16,510 87,770 65,720

Balance Sheet

as at December 31, 2002 Liabilities Amount Assets Amount

(Rs.) (Rs.)

Capital : Assets Assets(balancing figure) 2,94,000 Kumar 1,16,510

Yash 87,770

Zakir 65,720 2,70,000

Creditors 24,000

Total 2,94,000 Total 2,94,000

Realization Account

Dr. Cr.


Dec31 Assets 2,94,000 Dec31 Bank (Assets) 2,60,000 Bank (Creditors) 24,000 Creditors 24,000 Loss transferred to:

Kumar‘s Capital 13,600 Yash‘s Capital 10,200 Zakir‘s Capital 10,200

Total 3,18,000 Total 3,18,000

Bank Account

Dr. Cr.


Dec31 Realization 2,60,000 Dec 31 Realization 24,000 (assets) (Creditors)

Capital :

Kumar 1,02,910 Yash 77,570 Zakir 55,520 Total 2,60,000 Total 2,60,000

218 Illustration 3(Preparation of Realization Account) The following is the Balance Sheet of Anju and Manju sharing profits in the ratio of 3:2 as on

December 31, 2003 :

Balance Sheet as at December 31, 2003


(Rs.) (Rs.)

Creditors 19,000 Plant and Machinery 14,000

Loan by Anju‘s brother 5,000 Furniture and Fixtures 2,000 Loan by Manju 7,500 Investment 5,000 General Reserve 1,250 Stock 3,000 Capitals : Debtors 10,000

Anju 5,000 Less: provision 500 9,500 Manju 4,000 9,000 Bank 5,750

Profit and Loss 2,500


The firm was dissolved on March 31, 2003. As a result, * Anju took over investments at an agreed value of Rs. 4,000 and agreed to pay loan taken

from her brother * Realization of assets is as follows : Stock Rs. 2,500, Debtors Rs. 9,250, Furniture and

Fixture Rs. 2,250, Plant and Machinery Rs. 12,500 * Expenses of realization were Rs. 300 * Creditors allowed 2.5% discount in full settlement. Record necessary journal entries and

close the books of the firm.

Solution

Books of Anju and Manju Journal


2003 Amount Amount

(Rs.) (Rs.)

Dec 31 Realization a/c Dr. 34,000

Stock 3,000

Debtors 10,000

Furniture and Fixtures 2,000


Investments 5,000

(Transfer of Sundry assets to realization

account)

Loan by Anju‘s brother a/c Dr. 5,000

Sundry creditors a/c Dr. 19,000

Provision for doubtful debts a/c Dr. 500

Realization a/c 24,500

(Transfer to Sundry Liabilities to

Realization Account)

Bank a/c Dr. 26,500


(Value of assets realized)

Realization a/c Dr. 5,000

Anju‘s capital a/c 5,000

(For adjustment of liabilities

taken over by Anju)

Anju‘s capital a/c Dr. 4,000


(Ajustment of investment taken over by Anju)


Bank a/c 18,525

(Payment to creditors at a discount of 2.5%)


Manju‘s capital a/c Dr. 1,130


(Transfer of loss on realization)

1,500

Anju‘s capital a/c Dr.


Profit and Loss a/c 2,500

(Transfer of accumulated loss to capital

accounts)

General Reserve a/c Dr. 1,250 Anju‘s capital a/c 750 Manju‘ s capital a/c 500 (Transfer of General Reserve to

Capital Account)

Manju‘s loan a/c Dr. 7,500

Bank a/c 7,500 (Loan paid off)



Bank 5,925 (Final payment to partners)

Realization Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2003 (Rs.) 2003 (Rs.) Dec31 Stock 3,000 Dec31 Sundry Creditors 19,000

Debtors 10,000 Provision for 500 Furniture and Fixture 2,000 doubtful debts

Plant and Machinery 14,000 Loan by Anju‘s brother 5,000 Investments 5,000 Bank (assets realized) 26,500 Anju‘s Capital 5,000 Anju‘s capital 4,000 (Anju brother‘s loan) (Investment)

Bank (Expenses) 300 Capitals (loss on

Bank (Creditors) 18,525 realization)

Anju 1,695

Manju 1,130 2,825


Anju’s Capital Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 20.03 (Rs.) 2003 (Rs.)

Dec 31 Realization (loss) 1,695 Dec 31 Balance b/f 5,000 Realization 4,000 Realization 5,000 (Investment) (Anju brother‘s loan)

Profit and Loss 1,500 General Reserve 750 Bank 3,555


Manju’s Capital Account Dr. Cr.


Dec31 Realization (loss) 1,130 Dec 31 Balance b/f 4,000 Profit and Loss 1,000 General Reserve 500 Bank 2,370


Manju’s Loan Account Dr. Cr.


Dec 31 Bank 7,500 Dec 31 Balance b/f 7,500

Bank Account

Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount 2003 (Rs.) 2003 (Rs.)

Dec31 Balance b/f 5,750 Dec 31 Realization : Realization a/c 26,500 Creditors 18,525 (assets realized) Expenses 300 Manju‘s Loan 7,500 Manju‘s Capital 2,370 Anju‘s Capital 3,555


Illustration 4 (Preparation of Balance Sheet at the time of Dissolution) X and Y are partners in a firm with a profit sharing ratio of 3:2 respectively. They decided to

dissolve the partnership on June 1, 2001. On that date their capitals stood as Rs. 20,000 and

Rs. 10,000, respectively. Amount owed by Y to the firm was Rs. 6,400 and there was a loan

by X for Rs. 8,000; Creditors were Rs. 50,000 and cash Rs. 5,400. The remaining assets other

than loan to Y and cash, realized Rs. 59,200. Realization expenses amounted to Rs. 2,000.

Prepare the Balance Sheet of the firm as on June 1, 2001 and necessary ledger accounts

to close the books of the firm.

Solution

Books of X and Y Balance Sheet as at June 1, 2001


(Rs.) (Rs.)

Sundry Creditors 50,000 Cash 5,400 X‘s Loan 8,000 Y‘s Loan 6,400 Capitals: Other Assets 76,200

X 20,000 (Balancing figure) Y 10,000 30,000



Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) June Sundry Assets 76,200 June Creditors 50,000

1 Cash (expenses) 2,000 1 Cash (Assets

Cash (Creditors) 50,000 realised) 59,200 Capitals:

Loss on

realisation :

X 11,400

Y 7,600 19,000

Total 1,28,200 Total 1,28,200

Cash Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) June Balance b/f 5,400 June Realization 2,000

1 Realization 59,200 1 (expenses)

(Assets) Realization 50,000 Y‘s capital 4,000 (Creditors)

X Loan‘s 8,000 X‘s capital 8,600


X’s Loan Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) June 1 Cash 8,000 June 1 Balance b/f 8,000

Capital Accounts

Dr. Cr.

Date Particulars J.F. X Y Date Particulars L.F. X Y 2001 Rs. Rs. 2001 Rs. Rs.

Loan to Y - 6,400 Balance b/d 20,000 10,000 Realization Cash - 4,000 (Loss) 11,400 7,600

Cash 8,600 -

Total 20,000 14,000 Total 20,000 14,000

Illustration 5 (Realization of Assets by a partner) Dinesh, Ramesh and Satish were partners in a firm sharing-profits in the ratio of 5:3:2. They

agreed to dissolve their partnership firm on March 31, 2002. Dinesh was asked to realize the

assets and pay off liabilities. He had to bear the realization expenses for which he was

promised a lump sum amount of Rs. 2,000. Their financial position on that date was as

follows :

Balance Sheet as at March 31, 2002


Creditors 27,500 Plant and Equipment 60,000 Invst. Fluctuation fund 9,000 Investment 30,000 Capitals: Stock 11,000

Dinesh 75,000 Debtors 14,200

Ramesh 30,000 Less Provision for

Doubtful debts 900 13,300 Cash 11,200 Satish‘s Capital 16,000

Total 1,41,500 Total 1,41,500

Dinesh agreed to purchase investments at Rs. 25,000. Ramesh took over stock at Rs.

10,500 and Debtors at Rs. 11,800. Plant and Equipment was sold for Rs. 45,000. Unrecorded

assets realized cash of Rs. 3,000. Actual realization

expenses amounted to Rs. 1,800. Prepare necessary ledger accounts on the dissolution of

firm. Solution Books of Dinesh, Ramesh and Satish

Realization Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2002 (Rs.) 2002 (Rs.) Mar. Plant and Equip. 60,000 Mar. Creditors 27,500

31 Stock 11,000 31 Provision for 900 Investment 30,000 doubtful debts

Debtors 14,200 Investment 9,000 Dinesh‘s Capital 2,000 fluctuation fund

(expenses) Dinesh‘s Capital 25,000 Cash (Payment to 27,500 (Investments)

Creditors) Ramesh‘s Capital 10,500 (Stock)

Ramesh‘s Capital 11,800 (Debtors)

Cash (Plant and 45,000 Equipment)

Cash (Unrecorded 3,000 assets)

Capitals :

(Loss on realization)

Dinesh 6,000

Ramesh 3,600

Satish 2,400 12,000

Total 1,44,700 Total 1,44,700



Balance b/f 11,200 Realization (Creditors) 27,500 Equipment 45,000 Dinesh‘s Capital 46,000 Realization 3,000 Ramesh‘s Capital 4,100 (Unrecorded asset)

Satish‘s Capital 18,400 Total 77,600 Total 77,600

Partner’s Capital

Dr. Cr.

Date Particulars J.F. Dinesh Ramesh Satish Date Particulars J.F. Dinesh Ramesh Satish Rs. Rs. Rs. Rs. Rs. Rs.

Balance b/f - - 16,000 Balance c/d 75,000 30,000 - Realization 6,000 3,600 2,400 Cash - - 18,400 (Loss) Realization 2,000

Realization 25,000 - - (Expenses)

(Investments)

Realization - 10,500 -

(Stock)

Realization - 11,800 -

(Debtors)

Cash 46,000 4,100 -

Total 77,000 30,000 18,400 Total 77,000 30,000 18,400

Illustration 6 (Preparation of ledger accounts) A, B and C are running a hardware shop sharing profits equally. Their financial position is as

under :

Balance Sheet as at March 31, 2003


(Rs.) (Rs.)

Accounts Payable 20,000 Land and Buildings 50,000

Bank Loan 7,000 Office Equipment 5,000

B‘s Loan 20,000 Stock 40,000

Joint Life Policy Accounts Receivable 30,000 Reserve 18,000 Joint Life Policy 18,000

Capitals : Bank 6,000 A Rs. 27,000

B Rs. 34,000

C Rs. 23,000 84,000

Total 1,49,000 Total 1,49,000

Partners agreed to dissolve the firm on that date. You are given the following

information regarding dissolution : = The Joint Life Policy was surrendered to the insurance company. The company paid a

sum of Rs. 11,500 after deducting an amount of Rs. 6,500 towards loan and interest

thereon by B against the policy.

= Office equipment was accepted by a Accounts Payable for Rs. 7,000 at Rs. 3,500 and

the balance was paid to him by cheque. = Bankers accepted stock worth Rs. 5,000 and the balance in cash. = The firm purchased 200 convertible debentures of a leasing company in 2001. After

sometime the investment was treated as bad and was written off. These debentures were

found to be having a market value of Rs. 8,000 and were accepted by a creditor at this

value. = Assets realized in the following manner :

Land and Buildings Rs. 2,00,000

Stock Rs. 30,000

Accounts Receivable Rs. 20,000 (f) All the liabilities were paid off. Accounts Payable allowed a discount of Rs. 200.

(g) Realization expenses amounted to Rs. 1,800.

You are required to prepare the realization account, bank account and capital accounts

of the partners. Solution Books of A, B and C



Mar31 Land and Buildings 50,000 Mar31 Accounts payable 20,000 Office equipments 5,000 Bank Loan 7,000 Stock 40,000 Joint Life Policy 18,000 Accounts Receivable 30,000 Reserve

Joint Life Policy 18,000 Bank :

Bank 20,000 Joint Life 11,500 (Accounts Policy

Payable) Land 2,00,000

Less: and

Office Equip. 7,000 Building Debentures 8,000 Stock 30,000

Discount 200 Accounts 20,000 2,61,500 15,200 4,800 Receivable

Total c/f 1,47,800 Total c/f 306,500

Total b/f 1,47,800 Total b/f 306,500 Bank 7,000 B‘s Capital 6,500 (Bank Joint Life Policy

Overdraft)

Less: Stock 5,000 2,000

Bank (Realization 1,800

Expenses)

Capitals-Gain on

Realization

A Rs. 53,800

B Rs. 53,800

C Rs. 53,800 1,61,400

Total 3,13,000 Total 3,13,000

Bank Account

Dr. Cr.


Mar Balance b/f 6,000 Mar Realization 4,800 31 Realization : 31 (Accounts

Joint Life Policy 11,500 Payable)

Land and Buildings 2,00,000 Realization 2,000 Stock 30,000 (Bank

Accounts 20,000 Overdraft)

Receivables Realization 1,800 Realization (Expenses)

Accounts B‘s Loan 20,000 Receivable Capital :

A 80,800

B 81,300

C 76,800 2,38,900

Total 2,67,500 Total 2,67,500

A’s Capital Account

Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount 2003 (Rs.) 2003 (Rs.) Mar Bank 80,800 Mar Balance b/f 27,000 31 31 Realization (Gain) 53,800


B’s Capital Account Dr. Cr.


Mar Realization (JLP) 6,500 Mar Balance b/f 34,000 31 Bank 81,300 31 Realization (Gain) 53,800


C’s Capital Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2003 (Rs.) 2003 (Rs.) Mar Bank 76,800 Mar Balance b/f 53,800 31 31 Realization (Gain) 23,000


Illustration 7 ( Preparation of ledger accounts) R and K are equal partners. They decided to dissolve their firm as on December 31, 2000.

Their Balance Sheet on that day stood as under :

Balance Sheet of R and K as at December 31, 2000


(Rs.) (Rs.)

Sundry Creditors 10,000 Land and Buildings 20,000 Bills Payables 20,000 Furniture and Fittings 14,000 Capitals : Lorry 10,000

Ram 15,000 Stock 5,000 Krishan 15,000 30,000 Debtors 6,000

Cash 5,000


They decided to take up liabilities : R : Sundry Creditors and K : Bills Payable. Assets

realized – Debtors Rs. 4,000; Furniture – Rs. 10,000; Stock Rs. 4,000; Lorry Rs.15,000 and

Land and Buildings Rs. 35,000. Expenses on realization amounted to Rs. 500.

Record necessary journal entries for the above transactions and prepare realization

account, cash account and capital accounts of partners. Solution

Books of R and K

Journal

Date Particulars L.F. Debit Credit Amount Amount

2000 (Rs.) (Rs.)

Dec 31 Realization a/c Dr. 55,000 Debtors 6,000 Furniture and Fittings 14,000 Stock 5,000 Lorry 10,000 Land and Building 20,000 (Asset Accounts Closed)

Sundry Creditors Dr. 10,000 Bills Payable Dr. 20,000

Realization a/c 30,000 (Transfer of Liability)

Cash a/c Dr. 68,000 Realization a/c 68,000 (Assets realised)

Realisation a/c Dr. 500 Cash a/c 500 (Expense on Realization paid off)


R 10,000 K 20,000 (Liabilities taken over by partners

R – Sundry creditors, K –

Bills payable)


R 6,250 K 6,250 (Profit credited)

R Dr. 31,250

K Dr. 41,250

Cash a/c 72,500 (Final payment to partners)

Realization Account


Mar31 Sundry Debtors 6,000 Mar31 Sundry creditors 10,000 Furniture 14,000 Bills Payable 20,000 and Fittings Cash : Assets 68,000 Stock 5,000 Realized

Lorry 10,000

Land and 20,000

Buildings

R (Creditors) 10,000

K (Bills 20,000

Payable)

Cash – (Expenses 500

on Realization)

Capital – (Gain on

Realization):

R 6,250

K 6,250 12,500



Date Particulars J.F. Amount Date Particulars J.F. Amount 2000 (Rs.) 2000 (Rs.) Dec31 Balance b/f 5,000 Dec31 Realisation – 500

Realization - 68,000 Expenses

Assets Capitals –

R 31,250

K 41,250 72,500


R’s Capital Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2000 (Rs.) 2000 (Rs.) Dec31 Balance c/f 31,250 Dec31 Balance b/f 15,000 Realization 10,000 Creditors

Realization(Gain) 6,250 Total 31,250 Total 31,250

Krishan’s Capital Account


Dec31 Balance c/f 41,250 Dec31 Balance b/f 15,000

Realization 20,000 (Bills Payable)

Realization– Profit 6,250


Illustration 8 (Unrecorded assets and liabilities) Lata, Geeta and Neeta were partners sharing profits in the ratio of 5:3:1. They decided to

dissolve the partnership on March 31, 2001 and their balance sheet was as under.

Balance Sheet Lata, Geeta and Neeta as at March 31, 2001


(Rs.) (Rs.)

Sundry creditors 16,600 Plant and Machinery 40,000

Bills payable 3,400 Stock 10,000

Mortgage loan 15,000 Debtors 25,000 General reserve 4,500 Less : provision 5,000 20,000 Capital accounts : Cash at bank 19,500

Lata 22,000

Geeta 18,000

Neeta 10,000 50,000


There was a typewriter written off which realised Rs. 500. They had a joint life policy of

Rs. 20,000 which was surrendered for Rs. 5,000. Goodwill was sold for Rs. 5,000. Other

assets realized – stock Rs. 6,700; debtors 50%; plant and machinery 10% less than its book

value. Creditors were paid Rs. 16,000. But an outstanding bill of Rs. 400 for repairs was to be

paid off. Expenses on realization amounted to Rs. 620.

Give journal entries to record the above transactions and also prepare necessary

ledger accounts.

Solution

Books of Lata, Geeta and Neeta Journal


Amount Amount

2001 (Rs.) (Rs.)

Mar 31 Realization a/c Dr. 70,000

Stock 10,000

Sundry Debtors 20,000


( All assets transferred to realization account)

Sundry Creditors a/c Dr. 16,600

Bills Payable a/c Dr. 3,400

Mortgage loan a/c Dr. 15,000


( All external liabilities transferred

realization account)

Realisation a/c Dr. 16,000

Bank a/c 16,000

( Payment made to creditors)

Realization a/c Dr. 400

Bank a/c 400

(Outstanding bill of repairs paid off)

Bank a/c Dr. 5,500


(Unrecorded assets – a typewriter and

J.L.P Surrender value realized Rs. 500 and

Rs. 5,000 respectively)

Bank a/c Dr. 52,700


(Assets realized at the time of dissolution)


Bank a/c 15,400

( Bills payable and mortgage paid off)

Realization a/c Dr. 620

Bank a/c 620

(Realization expenses paid off)

Lata‘s capital a/c Dr. 5,400

Geeta‘s capital a/c Dr. 3,240

Neeta‘s capital a/c Dr. 1,080


(Transfer of loss to partner‘s capital account)

4,500

General Reserve a/c Dr.

Lata‘s capital a/c 2,500

Geeta‘s capital a/c 1,500

Neeta‘s Capital a/c 500

(General reserve distributed among partners)

19,100

Lata‘s Capital a/c Dr.

Geeta‘s Capital a/c Dr. 16,260

Neeta‘s Capital a/c Dr. 9,420

Bank a/c 44,780

(Final payment to partners after dissolution)

Bills Payable Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) Mar31 Realization 3,400 Mar31 Balance b/f 3,400

Mortgage Loan Account

Dr. Cr.


Mar31 Realisation 15,000 Mar31 Balance b/f 15,000

General Reserve Account

Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) Mar31 Capitals : Mar31 Balance b/f 4,500 Lata 2,500

Geeta 1,500

Neeta 500


Stock Account

Dr. Cr.


Mar31 Balance b/f 10,000 Mar31 Realization 10,000

Debtors Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) Mar31 Balance b/f 25,000 Mar31 Realization 25,000

Provision for Bad and Doubtful Debts Account Dr. Cr.

Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) Mar31 Realization 5,000 Mar31 Balance b/f 5,000

Creditors Account Dr. Cr.


Mar31 Realization a/c 16,600 Mar31 Balance b/f 16,600

Plant and Machinery Account Dr. Cr.


Mar31 Balance b/f 40,000 Mar31 Realization 40,000

Realization Account

Dr. Cr. Date Particulars J.F. Amount Date Particulars J.F. Amount 2001 (Rs.) 2001 (Rs.) Mar31 Stock 10,000 Mar31 Provision for 5,000

Debtors 25,000 bad debts

Plant and Machine 40,000 Sundry creditors 16,600 Bank : Bills payable 3,400 Sundry Mortgage loan 15,000 creditors 16,000 Bank – assets

Bills realized :

payable 3,400 Stock 6,700

Mortgage 15,000 34,400 Debtors 12,500

loan Plant and 36,000

Bank : (repairs 400 Machinery 55,200 outstanding) Bank – unrecorded

Realization 620 assets realised –

expenses Goodwill 2,500

Typewriter 500

Joint

life policy 2,500 5,500 Partner Capitals –

Loss :

Lata : 5,400

Geeta : 3,240

Neeta : 1,080 9,720 Total 1,10,420 Total 1,10,420

Capital Account

Dr. Cr. Date Particulars J.F. Lata Geeta Neeta Date Particulars J.F. Lata Geeta Neeta 2001 Rs. Rs. Rs. 2001 Rs. Rs. Rs.

Mar31 Realization 5,400 3,240 1,080 Mar31Balance b/f 22,000 18,000 10,000 (Loss) General

Bank 19,100 16,260 9,420 Reserve 2,500 1,500 500 Total 24,500 19,500 10,500 Total 24,500 19,50010,500

Bank Account Dr. Cr.


Mar31 Balance b/f 19,500 Mar31 Realization 34,400 Realization (liabilities)

(Assets Realization 400 Realized) 55,200 (unrecorded

Realization 5,500 liabilities)

(Unrecorded Realization 620 assets) (Expenses)

Capitals :

Lata 19,100

Geeta 16,260

Neeta 9,420 44,780

Total 80,200 Total 80,200 Illustration 9(Preparation of ledger accounts) Following is the Balance Sheet of Raman and Ramesh on June 30, 2002.


(Rs.) (Rs.)

Sundry creditors 20,000 Goodwill 10,000

Bills payable 20,000 Building 25,000

Bank overdraft 10,000 Plant and fittings 25,000

Mrs. Raman‘s loan 20,000 Investment 15,300

Ramesh‘s loan 10,000 Stock 8,700

Investment fluctuation 2,800 Debtors 17,000

fund Less provision 2,000 15,000

Employee‘s provident 1,200 for bad debts

fund Bills receivable 10,000

General reserve 2,000 Cash at bank 13,000

Raman‘s capital 20,000 Profit and loss 4,000

Ramesh‘s capital 20,000

Total 1,26,000 Total 1,26,000

The firm was dissolved on June 30, 2002 and following was the position : 4. Raman agreed to pay off his wife‘s loan. 5. Debtors realized Rs. 12,000. 6. Ramesh took away all the investments at Rs. 12,000. 7. Other assets realized as follows :

Plant and Fittings 20,000

Building 50,000

Goodwill 6,000 4. Sundry creditors and Bills payable were settled at 5% discount. 5. Raman accepted stock at Rs 8,000 and Ramesh took over bills receivable at 20%

discount. 6. Realization expenses amounted to Rs. 2,000.

Record journal entries and also prepare various ledger accounts. Solution

Books of Raman and Ramesh Journal

Date Particulars L.F. Debit Credit 2002 Amount Amount

(Rs.) (Rs.)

June 30 Realization a/c Dr. 1,11,000 Investments 15,300 Stock 8,700 Bills receivable 10,000 Debtors 17,000 Plant and fittings 25,000 Buildings 25,000 Goodwill 10,000 (Sundry asset accounts closed by

transferring to Realization accounts)

‗‘ Provision for bad and doubtful debts a/c Dr. 2,000 Sundry creditors Dr. 20,000 Bills payable Dr. 20,000 Bank overdraft Dr. 10,000 Mrs. Raman‘s loan Dr. 20,000 Employees provident Dr. 1,200 Investment fluctuation fund Dr. 2,800 Realization a/c 76,000 (Sundry external liabilities transferred to Realization account)

‗‘ Realization a/c Dr. 38,000 Bank a/c 38,000 (Payment to creditors and bills payable)

Realization a/c Dr. 11,200 Bank a/c 11,200 (Payment of bank overdraft and

employees‘ provident fund)

Realization a/c Dr. 2,000 Bank a/c 2,000 (Payment of realization expenses)

Realization a/c Dr. 20,000 Raman‘s Capital a/c 20,000 (Mrs. Raman‘s loan paid off by Raman)

Bank a/c Dr. 88,000 Realization a/c 88,000 (Assets realized)

Ramesh‘s Capital a/c Dr. 20,000 Raman‘s Capital a/c Dr. 8,000

Realization a/c 28,000 (Bills receivable taken over by Ramesh

and investments and stock taken over

by Raman)

Realization a/c Dr. 9,800 Ramesh‘s Capital a/c 4,900 Raman‘s Capital a/c 4,900 (Profit on realization)

Ramesh‘s loan a/c Dr. 10,000 Ramesh‘s Capital a/c 10,000 (Ramesh‘s loan transferred to his capital)

General Reserve a/c Dr. 2,000 Ramesh‘s Capital a/c 1,000 Raman‘s Capital a/c 1,000 (General reserve distributed)

Raman‘s Capital a/c Dr. 2,000

Ramesh‘s Capital a/c Dr. 2,000 Proft and Loss a/c 4,000 (Transfer of loss to partners‘ capital

accounts)

Raman‘s Capital a/c Dr. 35,900 Ramesh‘s Capital a/c Dr. 13,900

Bank a/c 49,800 (Final payment to partners)

Realization Account


2002 (Rs.) 2002 (Rs.) June Investments 15,300 June Provision for bad 2,000 30 Stock 8,700 30 and Doubtful

Bills receivable 10,000 debts

Debtors 17,000 Sundry creditors 20,000 Plant and fittings 25,000 Bills payable 20,000 Buildings 25,000 Bank overdraft 10,000 Goodwill 10,000 Mrs. Raman‘s loan 20,000 Bank – Employees‘ P.F. 1,200 Creditors 19,000 38,000 Investment

Bills Payable19,000 Fluctuation 2,800 Bank – Bank 10,000 Fund

Overdraft Bank –

Employee‘s P.F. 1,200 Debtors 12,000

Bank (Realization 2,000 Plant and 20,000

Expenses) Fittings

Raman‘s Capital : 20,000 Building 50,000

(Mrs. Roman‘s loan) Goodwill 6,000 88,000 Capital Account: Ramesh‘s capital–

Raman 4,900 Bills Receivable 8,000 Ramesh 4,900 9,800 Raman‘s Capital–

Stock 8,000 Ramesh‘s Capital-

Investment 12,000

Total 1,92,000 Total 1,92,000

Bank Account Dr. Cr.

Date Particulars J. Amount Date Particulars J. Amount 2002 F. (Rs.) 2002 F. (Rs.) June Balance b/f 13,000 June Realization :

30 Realization : 30 Creditors 19,000

Debtors 12,000 Bills Payable 19,000 38,000 Plant and 20,000 Realization

Fittings : Expense 2,000 Buildings 50,000 Realization –

Goodwill 6,000 88,000 Employees‘ 1,200 Provident fund

Realization –

Bank Overdraft 10,000 Raman‘s Capital 35,900 Ramesh‘s Capital 13,900

Total 1,01,000 Total 1,01,000

Capital Accounts

Dr. Cr.

Date Particulars J.F. Raman Ramesh Date Particulars L.F. Raman Ramesh 2002 Rs. Rs. 2002 Rs. Rs.

June Realization – June Balance b/f 20,000 20,000 30 Investment 12,000 30 Loan – 10,000

Bills receivable 8,000 Mrs. Raman‘s 20,000 – Stock 8,000 loan

Profit and Loss 2,000 2,000 General Reserve 1,000 1,000 Bank - 35,900 13,900 Realization 4,900 4,900 (settlement (Profit)

amount)

Total 45,900 35,900 Total 45,900 35,900

UNIT 2

CHAPTER -1

ISSUE OF SHARES

CTIVES

PROCEDURE OF ISSUE OF SHARES Face value of a share is the par value of the share. It is also known as the

Nominal value or denomination of a share. To issue shares a company

follows a definite procedure which is controlled and regulated by the

Companies Act and Securities Exchange Board of India (SEBI). There are

different ways of issue of shares which may be:

(A) For

considerat

ion other

than cash

(B) For cash (A) Issue of shares

for

consideration

other than cash (iii) Sometimes

shares are issued to the promotors of the company in lieu of the services provided by them during the incorporation of the

Issue of Shares

compnay. The issue price of these shares is normally debited to ‗Goodwill A/c‘ and journal entry is made as follows :

Goodwill A/c Dr

To Share Capital A/c

In case a company does not have sufficient funds for the purchase of fixed

assets or for payment to creditors it may offer and allot its shares to vendors/

creditors in lieu of cash. Any allotment of shares against which cash is not to

be received is called ‗issue of shares for consideration other than cash‘. For

example building is purchased and payment is made by issuing shares. In case of purchase of assets like building, machinery, stock of materials, etc. the following journal entry is made : 1. Assets A/c Dr

To Vendors/Creditors A/c

(Assets purchased)

2. Vendors/Creditors A/c Dr


(Issue of shares of Rs…….each fullly paid up)

(B) Issue of Shares for cash In general, shares are issued for cash. The company may call the share money either in one instalment or in two or more instalments. But company always collects this money through its bankers. (i) Receipt of share money in one instalment The company may receive the share money in one instalment along with application. In this case the following journal entries are made in the books of the company 1. On Receipt of Application Money

Bank A/c Dr

To Share Application A/c

(Application money received on ….shares of Rs…each) 2. On transferring the Application Money

Share Application A/c Dr


(Application money transferred to share capital A/c) 256

Issue of Shares

(ii) Share money received in two or more instalments Instead of receiving payment in one instalment i.e. at the time of

application the company collects it in two or more instalments. The first,

instalment which the appplicants have to pay along with the applications

for shares is known as application money. On the allotment of shares the

allottees are required to pay the second instalment which is termed as

allotment money. If the company decides to call the share money in more

than two instalments the other instalment is/are termed as call money (i.e.

first-call, second call or final call). In the above case the transactions are recorded in journal as given below : (a) On receipt of application money (i) Bank A/c Dr


(Reciept of share application money for …. Shares @ Rs.. per share)

(b) On allotment of shares After receiving the application for shares within the prescribed time, the

Board of Directors of the company proceed to allot shares. On allotment

of shares the applicaion money is transferred to Share Capital A/c. For this

the following journal entry is made :


To Share Capital A/c (Share application for …. Shares @ Rs… per share transferred to share capital A/c)

Allotment Money becoming due and received On the allotment of shares the amount receivable on the next instalment

i.e. on allotment becomes due. The following entry is made for recording

the amount due : (i) Allotment money becoming due

Share Allotment A/c Dr

To Share Capital A/c (Share allotment money due on …. shares @Rs ... per share)

257

Issue of Shares

(ii) Receipt of allotment money On the receipt of share allotment money the following journal entry is made:

Bank A/c Dr

To Share Allotment A/c.

(Receipt of the amount due on allotment of … shares)

Calls on shares After the receipt of application and allotment money the money that remains unpaid can be called up by the company as and when required. Thus a call is a demand made by the company asking the shareholders to remit the called up amount on shares allotted to them. The company may demand the remaining money in more than two

instalments. The amount called after the allotment is known as call money.

There may be one or more calls, depending on the funds requirements of

the company. When only one call is made Call Money is Due :

Share First and Final Call A/c Dr

To Share Capital A/c. (Call money due on …. share @ Rs … per share).

Receipt of call money The following journal entry is made for receipt of call money:

Bank A/c Dr

To Share First & Final call A/c

(call money due on … shares @ Rs ... per share received) Note : If the company makes more than one call the same accounting

treatment is followed for recording the second call or third call money due

and their receipt. The last call made is termed as final call. Illustration 1

Fashion Fabrics Ltd. issued 100000 shares of Rs. 10 each on 1st

April, 2006. The amount payable on these shares was as under:

Rs 2 per share on application.

Rs 3 per share on allotment.

Rs 5 per share on call. Make journal entries and prepare relevant accounts in the books of company.

258

Issue of Shares

Solution :

Fashion Fabrics Ltd. Journal entries

S.No. Particulars L.F Dr Cr Amount Amount

Rs Rs

1. Bank A/c Dr 200000

To Share Application A/c 200000

(Application money received @ Rs 2 per share)

2. Share Application A/c Dr 200000

To Share Capital A/c 200000

(Share application money for 100000 shares transferred to

share capital A/c)

3. Share Allotment A/c Dr 300000

To Share Capital A/c… 300000

(Allotment money made due on 100000 shares @ Rs 3/- per share)

4. Bank A/c Dr 300000

To Share Allotment A/c. 300000

(Allotment money received on 100000 shares @Rs 3 per

share.)

5. Share First & Final call A/c. Dr 500000


(Call money on 1,00,000 shares @ Rs 5 per share made due)

6. Bank A/c Dr 500000

To Share First & Final call A/c. 500000

(Call money received on 1,00,000 shares @ Rs 5 per share)

Note : Although shares may be equity shares or preference shares but if

the term shares is used it means equity shares)

259

Issue of Shares

Relevant Accounts

Bank A/c Dr Cr

Date Particulars JF Amount Date Particulars JF Amount Rs Rs

Share Application A/c 200000 Balance cld 1000000

Share Allotment A/c 300000

Share First and Final

call A/c 500000

1000000 1000000

Balance b/d 1000000

Share Application A/c Dr Cr


Share Capital A/c 200000 Bank A/c 200000

200000 200000

Share Capital A/c Dr Cr


Balance cld 1000000 Share Applicaiton 200000 A/c

Share Allotment 300000 A/c

Share First and

Final call A/c 500000 1000000 1000000

Balance b/d 1000000

Share Allotment A/c

Dr Cr



300000 300000

260

Issue of Shares

Share First and Final Call A/c Dr Cr



500000 500000

INTEXT QUESTIONS 23.1 23.2 FULL, UNDER AND OVER SUBSCRIPTION

A company decides to issue number of shares to raise capital. It invites public to buy these shares. Now there may be three situations : I. Full Subscription

Company may receive applications equal to the number of shares

company has offered to people. It is called full subscription. In case of

full subscription the journal entries will be made as follows :

(a) On receipt of application money

Bank A/c Dr


(Application money received for ......... shares)

(b) On allotment of shares



(Application money of shares transferred to capital A/c on their allotment)

261

Issue of Shares

(iii)The company does not receive application equal to the number of shares offered for subscription, there may be two situations :

under subscription

over subscription

(i) Under subscription The issue is said to have been under subscribed when the company

receives applications for less number of shares than offered to the public

for subscription. In this case company is not to face any problem regarding

allotment since every applicant will be alloted all the shares applied for.

But the company can proceed with allotment provided the subscription for

shares is at least equal to the minimum required number of shares termed

as minimum subscription. (ii) Over Subscription When company receives applications for more number of shares than the

number of shares offered to the public for subscription it is a case of over

subscription. A company cannot allot more shares than what it has offered.

In case of over subscription, company has the following options : Option I (i) Rejection of Excess Applications and Money Returned

The company may reject the applications for shares in excess of the shares

offered for issue and a letter of rejection is sent to such applicants. In this

case the application money received from these applicants is refunded to

them in full. The journal entry made is as follows:


To Bank A/c

(Application money on … shares refunded to the applicants) l Excess application money adjusted towards sums due on

allotment. Journal entry made is :

Shares Application A/c Dr

To Share Allotment A/c

(Excess application money adjusted towards sums due on allotment) 262

Issue of Shares

If the application money received on partially accepted applications is

more than the amount required for adjustment towards allotment money,

the excess money is refunded. However, if the Articles of the company so

authorise, the directors may retain the excess money as calls in advance to

be adjusted against the call/calls falling due later on and the following

entry is made :


To Call-in-advance A/c (The adjustment of excess share application money retained as call-in-advance in respect of ... shares). Option II Partial acceptance of Applications.

In some cases the company accepts the applications for subscription

partially. It means that the company does not allot the full number of

shares applied for. For example if an applicant has applied for 5000 shares

and is allotted only 2000 shares, then the applications is said to have been

partially accepted. The company may evolve some formula of accepting

applications partially or making proportionate allotment/ the Prorata

allotment which means that the applicants are allotted shares

proportionately. In such a case the company adjusts the excess share

money received on application towards share allotment money due on

partially accepted applications. The journal entry recording the adjustment

of application money towards share allotment money, is as under :


To Share Allotment A/c

(Share application money transferred to Share Allotment Account in respect of ... shares).

Illustration 2 The Full Health Care Ltd has offered to public for subscription 20000

shares of Rs 100 each payable as Rs 30 per share on application, Rs 30 per

share on allotment and the balance on call. Applications were received for

30000 shares. Applications for 5000 shares were rejected all together and

applicaiton money was returned. Remaining applicants were alloted the

offered shares. Their excess application money was adjusted towards some

due on allotment. Calls were made and duly received. Make journal

entries in the books of the company.

263

Issue of Shares

Solution

Full Health Care Ltd. Journal entries S.No. Particulars L.F Dr Cr Amount Amount Rs Rs

1. Bank A/c Dr 900000


(Application money received for

30000 shares @ Rs 30 per share)



To Bank A/c 150000

To Share Allotment A/c 150000

(Application money of 20000 shares

transferred to share capital A/c on their

allotment. That of 5000 shares returned

and of 5000 shares adjusted towards sum

due on allotment. 3. Share Allotment A/c Dr 600000

To Share Capital A/c… 600000

(Allotment money due)

4. Bank A/c Dr 450000

To Share Allotment A/c. 450000

(Allotment money received)

5. Share First and Final call A/c. Dr 800000


(Call money due)

6. Bank A/c Dr 800000

To Share First and Final call A/c. 800000

(Call money received) 264

Issue of Shares


ISSUE OF SHARES AT PREMIUM A company can issue its shares at their face value. When company issues

its shares at their face value, the shares are said to have been issued at par.

Company can also issue its shares at more than or less than its face value

i.e, at ‗Premium‘ or at ‗Discount‘ respectively. When shares are issued at

premium or at discount an accounting treatment different from shares

issued at par is required. Let us discuss issue of shares at premium.

Issue of shares at premium If a company issues its shares at a price more than its face value, the

shares are said to have been issued at Premium. The difference between

the issue price and face value or nominal value is called ‗Premium‘. If a

share of Rs 10 is issued at Rs 12, it is said to have been issued at a

premium of Rs 2 per share. The money received as premium is transferred

to Securities Premium A/c. A company issues its shares at premium only

when its financial position is very sound. It is a capital gain to the

company. The Premium money may be demanded by the company with

application, allotment or with calls. The Companies Act has laid down certain restrictions on the utilisation of the amount of premium.

According to Section 78 of this Act, the amount of premium can be utilised for :

5.4.1 Issuing fully-paid bonus shares;

5.4.2 Writing off preliminary expenses, discount on issue of shares,

underwriting commission or expenses on issue;

5.4.3 Paying premium on redemplion of Preference shares or Debentures.

265

Issue of Shares

Further, the company may demand the total amount of premium in more

than one instalment. In case the company doesn‘t specify the particular

call with which Securities Premium is to be paid it is supposed to be called

at the time of Allotment.

Accounting Treatment of premium on Issue of Shares Following is the accounting treatment of Premium on issue of shares : (a) Securities premium collected with share Application money :

If the Securities premium is collected on application and the company has taken decision about the allotment of shares, the following journal

entry is made :

Share Application A/c. Dr

To Securities Premium A/c

(The amount of Securities premium received on application of the alloted shares is transferred to Securities Premium A/c)

(b) Premium collected with Allotment money or Calls.

If the company decides to demand the premium with share Allotment or/and share call money, the journal entry made is:


Or/and

Share Call A/c Dr


(Adjustment of share premium due on……shares @Rs…….per share.)

Illustration 3 Luxuary Cars Ltd. issued 100000 shares of Rs 10 each at a premium of Rs 5 per share, payable as: On application Rs. 4 (including Rs 2 premium) per share

On allotment Rs 8 (including Rs 3 premium) per share

On call Rs. 3 per share Applications were received for 100000 shares and allotment was made to all. Make journal entries.

266

Issue of Shares

Solution:

Books of Luxury Cars Ltd. Journal entries

S.No. Particulars L.F Dr Cr Amount Amount Rs Rs

1. Bank A/c Dr. 400000


(Amount received for 1,00,000 shares)



To Securities Premium A/c 200000

(Share application money transferred to share capital A/c and securities

Premium A/c)

3. Bank A/c Dr 800000


(Share allotment money is received on 1,00,000

shares @ Rs 8 per share)




(Share allotment money made Due)

5. Share First and Final Call A/c Dr 300000


(Share call money made due on 1,00,000 shares @

Rs 3 per share.)

6. Bank A/c Dr 300000

To Share First and Final Call A/c 300000

(Share call money received on 1,00,000 shares @ Rs 3 per

share.)

267

Issue of Shares

INTEXT QUESTION23.4 ISSUE OF SHARES AT ISISSUE

ISSUE OF SHARES AT DISCOUNT When the issue price of share is less than the face value, shares are said to

have been issued at discount. For example if a company issues its shares

of Rs 100 each at Rs. 90 each, the shares are said to be issued at discount.

The amount of discount is Rs 10 per share (i.e. Rs 100 – Rs 90). Discount

on shares is a loss to the company. Section 79 of Companies Act 1956 has laid down certain conditions subject to which a company can issue its shares at a discount. These conditions are as follows :

(i) At least one year must have elapsed from the date of commencement of business;

(ii) Such shares are of the same class as had already been issued;

(iii) The company has sanctioned such issue by passing a resolution in

its General meeting and the approval of the court is obtained.

(iv) Discount should not be more than 10% of the face value of the share and if the company wants to give discount more than 10%, it will have to obtain the sanction of the Central Government.

Accounting Treatment of Shares Issued at Discount The amount of discount is generally adjusted towards share allotment money and the following journal entry is made:


Discount on issue of shares A/c Dr

To Share Capital A/c Allotment money due on….shares @Rs ……per share after allowing discount @Rs ……….per share.

268

Issue of Shares

Illustraion 4 Sri Krishna Agro Chemical Ltd. was registered with a capital of Rs

5000000 divided into 50000 shares of Rs 100 each. It issued 10000 shares at discount of Rs 10 per share, payable as : Rs 40 per share on application Rs 30 per share on allotment Rs 20 per share on call. Company received applications for 15000 shares. Applicants for 12000

shares were allotted 10000 shares and applications for the remaining

shares were sent letters of regret and their application money was returned.

Call was made. Allotment and call money was duly received. Make

journal entries in the books of the company. Solution

Sri Krishna Agro Chemicals Ltd

Journal entries


1 Bank A/c Dr. 6,00,000

To Share Application A/c 6,00,000

(Application money received for 15000 shares @ Rs 40 per

Share)

2. Share Application A/c Dr 4,00,000

To Share Capital A/c 4,00,000

(Application money of 10000

shares transferred to share Capital A/c on their allotment)

3. Share Application A/c Dr 2,00,000

To Share Allotment A/c 80,000

To Bank A/c 1,20,000

(Application money of 3000 shares

returned and of 2000 shares adjusted

towards sum due on allotment)

4. Shares Allotment A/c Dr 3,00,000

Share discount A/c Dr 1,00,000

To Share Capital A/c. 4,00,000

(Allotment money due)

5. Bank A/c Dr 2,20,000

To Share Allotment A/c 2,20,000


6. Share First & Final Call A/c Dr 2,00,000

To Share Capital A/c 2,00,000

Amount due on call

7. Bank A/c Dr 2,00,000

To Share First & Final Call A/c 2,00,000

(Call money received)

INTEXT QUESTIONS 23.4 CALLS IN ADVANCE AND CALLS IN ARREARS

If a shareholder pays any amount to company before it is demanded, it is

called Call-in-Advance. This amount is put in a separate account known as

Calls-in-Advance A/c. This amount is not shown as capital of the

company, till such time the company makes a demand from all the

shareholders. Call-in-Advance A/c is shown on the liabilities side of the

Balance Sheet. For example if a company issued shares of Rs 10 on which

it has already called Rs 5. Against the uncalled portion of Rs 5 per share

the company makes a call Rs 3 per share, the entry for call money due will

be made only for Rs 3 per share. Now suppose a shareholder pays Rs 5

270

Issue of Shares

per share including the uncalled amount of Rs 2 per share along with the

call money, it means he has paid Rs 2 per share in advance, which will be

credited to calls in Advance A/c. The company is required to pay interest

on this amount @ 6% till the date of its appropriation. Accounting teatment Following journal entry is made for calls-in-advance.

Bank A/c Dr

To Calls-in-Advance A/c

(Calls in advance received on…….shares @ Rs …….per share) Appropriation of calls-in-Advance A/c say in the final call

Journal entry will be :

Calls-in-Advance A/c Dr

To Share Final call A/c

(Calls in advance amount adjusted) For interest given on Calls-in-Advance

Journal entry will be

Interest on calls-in-Advance A/c Dr

To Bank A/c

(Interest paid on the amount of Call-in-Advance) Illustration 5 India Software Ltd. offered 50000 shares of Rs 10 each to the public payable as:

Rs 2 on application

Rs 3 on allotment

Rs 2 on First call and the balance as and when required. All the shares were applied for and duly allotted but Mukesh a shareholder holding 200 shares paid the entire balance on allotment. Make necessary journal entries.

271

Issue of Shares

Solution India Software Ltd.

Journal entries

Date Particulars L.F Dr Cr Amount Amount Rs Rs

Bank A/c Dr. 100000

To Share Application A/c. 100000

(Share application money received for 50000

shares @ Rs 2 per share)

Share Application A/c Dr 100000


(Share application money transferred to share capital

A/c on allotment.)

Share Allotment A/c Dr 150000


(Share allotment money made due on 50000 shares @

Rs 3 per share.)

Bank A/c. Dr 151000


To Calls-in-Advance A/c 1000

(Amount received on allotment @ Rs 3 per share

and advance for 200 shares

@ Rs 5 per share.)

Share First Call A/c Dr 100000


(Share first call money due on 50000 shares @ Rs 2 per share.)

Bank A/c Dr 99600

Call-in-Advance A/c Dr 400

To Share First call A/c 100000

(First call money is received on 49800 shares and on 200 shares

call in advance is adjusted.)

272

Issue of Shares

Calls in arrears When the company sends notice to the shareholders to pay allotment and

/or call money, it has to be paid by them within the specified time period.

If it is not paid by any one or more of the shareholders, the unpaid amount

becomes arrears due from them. Such arrears are transferred to an account

termed as Calls-in-Arrears A/c. The company is authorised to charge

interest on calls-in-Arrears @ 5% p.a. for the intervening peroid. (The

period between date of non-receipt of the due amount and the date of

actual receipt of the due amount).

Accounting Treatment The following jounal entry is made to record Calls-in-Arrears:

Calls-in-Arrears A/c Dr

To Share Allotment/Call A/c

(Share allotment/ Call money not received on …. shares) When the unpaid balance is received later on the following journal entry is made:

Bank A/c Dr

To Calls in Arrears A/c (Amount due on allotment/ call remaining unpaid now received on…… shares.) The company may charge interest on the amount of calls in arrears at a given rate from the date of amount due till it is paid journal entry will be

Bank A/c Dr

To Interest on calls in arrears A/c

Illustration 6 X Ltd. made its first call of Rs 20 per share on 1st July 2006. Zahir holding

200 shares failed to pay the call money. He could pay the money only on 31st

December, 2006. Company charged interest @12% per annum. Make necessary journal entry for the interest charged by the company.

Solution

Amount of interest due 4000 12 6

240

100 12

273

Issue of Shares

Journal entry

S.No.Particulars L.F Dr Cr Amount Amount Rs Rs

Bank A/c Dr. 240

To Interest on call in Arrears A/c 240

(Receipt of interest on calls in arrears)

Illustration 7 ABC Ltd issued 20000 shares of Rs 10 each payable as Rs 2 per share on

application, Rs 5 (including premium of Rs 2 per share) on allotment, Rs 3 per share on first call and the balance on Final Call. All the money were received except the first call money on 400 shares; which was received later on with final call. Make necessary journal entries. Solution :

Journal entries


1 Bank A/c Dr. 40000


(Application money received for 20000 shares @ Rs 2 per

Share.)



(Application money of 20000 shares transferred to share Capital A/c

on allotment)




(Allotment money make due with premium @ Rs 5 (3+2) per

share on 20000 shares.)

274

Issue of Shares

4. Bank A/c Dr 100000


(Share allotment money received)

5. Shares First Call A/c .Dr 60000

To Share Capital A/c. 60000

(Share first call money is due on 20000 shares @ Rs 3 per share.)

6 Bank A/c Dr 58800

Calls-in-Arrears A/c Dr 1200

To Share First Call A/c 60000

(First call money received on 19600 shares @ Rs 3 per share.)

7. Share Final Call A/c Dr 40000


(Final Call money due on 20000

shares @ Rs 2 per share.)

8. Bank A/c Dr 41200

To Share Final Call A/c 40000

To Calls-in-Arrears A/c 1200

(Final Call money received

on 20000 shares @ Rs 2 per

share along with arrears of

first call on 400 shares.

Illustration 8 The progressive Industries Limited was registered with a capital of Rs

5000000. It issued 20000 equity shares of Rs 100 each payable as Rs 25

on application, Rs 25 on allotment and balance on 1st and final call and

10000 9% preference shares of Rs 50 each payable as Rs 50 on application

and allotment and the balance on two calls of Rs 25 each. All the shares

were applied for and allotted. All money was duly received. Make

necessary journal entires in the books of the company :

275

Issue of Shares

Solution

Progressive Industries Ltd

Journal entries


1 Bank A/c Dr. 10,00,000

To Equity Share Application A/c 5,00,000

To 9% Preference Share Application

and Allotment A/c 5,00,000

(Application money received

for 2000 equity shares @ Rs 25 per

Share and 10000 9% preference shares

@ Rs 50 per share)

2. Equity Share Application A/c Dr. 500000

9% Preference Share Applicaiton & Allotment A/c Dr. 500000

To Equity Share Capital A/c 500000

To 9% Preference Share Capital A/c 500000

(Applicaiton money transferred to capital accounts)

3. Equity Share Allotment A/c Dr. 500000

To Equity share Capital A/c 500000

(Allotment money due on 20000 equity shares at Rs 25 per share

4. 9% Preference share 1st call A/c Dr 250000


(1st call money due on 10000 9% preference shares at Rs 25 pershare

5. Bank A/c Dr 750000

To Equity Share Allotment A/c 500000

To 9% Preference Share 1st call A/c 250000

(Equity share allotment money and 9% preference share 1st call money

received)

276

Issue of Shares

6. Equity Share First & Final Call A/c Dr 10,00,000

9% Preference Share Cinal Call A/c Dr 250000

To Equity Share Capital A/c 1000000


First & Final call on equity shares and Final call on 9% preference shares due

7. Bank A/c Dr 1250000

To Equity Share First & Final Call A/c 1000000

To 9% Preference Share Fianl Call A/c 250000

Equity share 1st and final call and 9%

Preference share final call money received.


.

CHAPTER--2

ISSUE OF DEBENTURES

share capital is the main source of finance of a joint stock company. Such

capital is raised by issuing shares. Those who hold the shares of the

company are called the shareholders and are owners of the company.

Company may need additional amount of money for a long period. It

cannot issue shares every time. It can raise loan from the public. The

amount of loan can be divided into units of small denominations and the

company can sell them to the public. Each unit is called a ‗debenture‘ and

holder of such units is called Debenture holder. The amount so raised is

loan for the company. In this lesson we shall learn about issue of

debentures and its accounting treatment.

OBJECTIVES

DEBENTURE AND ITS TYPES

A Debenture is a unit of loan amount. When a company intends to raise

the loan amount from the public it issues debentures. A person holding

debenture or debentures is called a debenture holder. A debenture is a

document issued under the seal of the company. It is an acknowledgment

of the loan received by the company equal to the nominal value of the

debenture. It bears the date of redemption and rate and mode of payment

of interest. A debenture holder is the creditor of the company.

As per section 2(12) of Companies Act 1956, ―Debenture includes

debenture stock, bond and any other securities of the company

whether constituting a charge on the company‘s assets or not‖.

Types of debentures Debenture can be classified as under : B From security point of view

(A) Secured or Mortgage debentures : These are the debentures

that are secured by a charge on the assets of the company. These

are also called mortgage debentures. The holders of secured

debentures have the right to recover their principal amount with

the unpaid amount of interest on such debentures out of the

assets mortgaged by the company. In India, debentures must be

secured. Secured debentures can be of two types :

First mortgage debentures : The holders of such debentures

have a first claim on the assets charged.

Second mortgage debentures : The holders of such

debentures have a second claim on the assets charged.

Unsecured debentures : Debentures which do not carry any

security with regard to the principal amount or unpaid interest are

called unsecured debentures. These are called simple debentures. l On the basis of redemption

Redeemable debentures : These are the debentures which are

issued for a fixed period. The principal amount of such

debentures is paid off to the debenture holders on the expiry of

such period. These can be redeemed by annual drawings or by

purchasing from the open market.

Non-redeemable debentures : These are the debentures which are

not redeemed in the life time of the company. Such debentures are

paid back only when the company goes into liquidation.

Issue of Debentures

3. On the basis of Records

(i) Registered debentures : These are the debentures that are

registered with the company. The amount of such debentures is

payable only to those debenture holders whose name appears in

the register of the company.

(ii) Bearer debentures : These are the debentures which are not

recorded in a register of the company. Such debentures are

transferrable merely by delivery. Holder of these debentures is

entitled to get the interest. 4. On the basis of convertibility

(i) Convertible debentures : These are the debentures that can be

converted into shares of the company on the expiry of

predecided period. The term and conditions of conversion are

generally announced at the time of issue of debentures.

(ii) Non-convertible debentures : The debenture holders of such

debentures cannot convert their debentures into shares of the

company. 5. On the basis of priority

(i) First debentures : These debentures are redeemed before other

debentures.

(ii) Second debentures : These debentures are redeemed after the

redemption of first debentures. 314

Issue of Debentures


ISSUE OF DEBENTURES By issuing debentures means issue of a certificate by the company under

its seal which is an acknowledgment of debt taken by the company. The procedure of issue of debentures by a company is similar to that of the

issue of shares. A Prospectus is issued, applications are invited, and letters

of allotment are issued. On rejection of applications, application money is

refunded. In case of partial allotment, excess application money may be

adjusted towards subsequent calls. Issue of Debenture takes various forms which are as under : (v) Debentures issued for cash (vi) Debentures issued for consideration other than cash (vii) Debentures issued as collateral security. Further, debentures may be issued (i) at par, (ii) at premium, and (iii) at discount Accounting treatment of issue of debentures for cash 1. Debentures issued for cash at par : Following journal entries will be made : (i) Application money is received

Bank A/c Dr

To Debentures Application A/c

(Application money received for Debentures)

315

Issue of Debentures

7. Transfer of debentures application money to debentures account

on their allotment

Debentures Application A/c Dr

To Debentures A/c

(Application money transferred to debenture account on allotment)

(iii) Money due on allotment

Debentures Allotment A/c Dr

To Debentures A/c

(Allotment money made due) (iv) Money due on allotment is received

Bank A/c Dr

To Debentures Allotment A/c

(Receipt of Debenture allotment money) (v) First and final call is made

Debentures First and Final call A/c Dr

To Debentures A/c

(First and Final call money made due on ............... debentures) (vi) Debentures First and Final call money is received

Bank A/c Dr

To Debentures First and Final call A/c

(Receipt of Amount due on call) Note : Two calls i.e. first call and second call may be made Journal entries will be made on the lines made for first and final call.

Illustration 1 Shining India Ltd. issued 5000 8% Debentures of Rs 100 each payable as

follows Rs 20 on Application

Rs 30 on Allotment Rs. 50 on First and Final call

316

Issue of Debentures

All the debentures were applied for and allotted. All the calls were duly

received. Make necessary journal entries in the books of the company. Solution :

Shining India Ltd. Dr Cr S.No. Particulars LF Amount Amount Rs Rs

1. Bank A/c ... Dr 100000

To Debentures Application A/c 100000

(Application money received for 5000 debentures)

2. Debentures Application A/c Dr 100000

To 8% Debentures A/c 100000

(Application money transferred to Debentures A/c on allotment)

3. Debentures Allotment a/c Dr 150000


(Allotment money due on 5000 debentures @ Rs 30 per debenture)

4. Bank A/c Dr 150000

To Debentures Allotment A/c 150000


5. Debentures First and Final call A/cDr 250000


(Debentures first and final call money made due @ Rs 50 per debenture)

6. Bank A/c Dr 250000

To Debentures First and Final call A/c 250000

(Receipt of Debentures first and final call money)

Over subscription Company if receives applications for number of debentures that exceed the

number of debentures offered for subscription, it is called over

subscription. There can be following treatment of the excess application

money received :

317

Issue of Debentures

(iv) The total amount of excess number of applications is refunded in case

the applications are totally rejected. (v) The amount of excess application money is totally adjusted towards

amount due on allotment and calls

— in case partial allotment is made,

— the excess amount is adjusted towards sums due on allotment and

rest of the amount is refunded. Journal entries in the above cases will be as follows : For refund of money if the applications are rejected


To Bank A/c

(Refund of money on rejected applications) For adjustment of excess application money adjusted towards sum due on

allotment


To Debentures Allotment A/c

(Excess application money adjusted)

Illustration 2 ABC Ltd issued 5000 10% Debentures of Rs 100 each payable as Rs 40

on application and Rs 60 on allotment. Applications were received for

6000 debentures. Applicants for 500 debentures were sent letter of regret

and money was returned. Allotment was made proportionately to the

remaining applicants. Over subscription was applied to the amount due on

allotment. All money was duly received. Make journal entries for the above transactions in the books of the company. Solution : Journal entries Dr Cr Date Particulars LF Amount Amount Rs Rs

1. Bank A/c Dr 240000


(Application money received for 6000

debentures @ Rs 40 per debenture) 318

Issue of Debentures



To Bank A/c 20000


(Debenture application money of 5000

debentures transferred to debenture A/c

on their allotment of 500 debentures

returned and balance of 500 adjusted

towards allotment) 3. Debentures Allotment A/c Dr 300000


(Allotment money due on 5000 debentures @ Rs 60 per debenture)

4. Bank A/c Dr 280000




ISSUE OF DEBENTURES AT PREMIUM AND AT DISCOUNT

Debentures are said to be issued at premium when these are issued at a

value which is more than their nominal value. For example, a debenture of

Issue of Debentures

Rs 100 is issued at Rs 110. This excess amount of Rs 10 is the amount of

premium. The premium on the issue of debentures is credited to the

Securities Premium A/c as per section 78 of the Companies Act, 1956. Journal entry will be as follows :


To Debentures Account


(Amount due on allotment alongwith premium of Rs ....)

Illustration 3 A company has issued 5000 10% Debentures of Rs 100 each at a premium

of 20% payable as Rs 60 on application Rs 60 on allotment (including premium) All the debentures were subscribed for and money was duly received.

Make journal entries.

Solution

Journal entries Dr Cr Date Particulars LF Amount Amount Rs Rs

1. Bank A/c Dr 300000


(Application money received)



(Application money transferred to Debenture A/c)

3. Debentures Allotment A/c 300000



(Amount due on allotment along with premium)

4. Bank A/c Dr 300000



Issue of Debentures

Issue of Debentures at Discount When debentures are issued at less than their nominal value they are said to

be issued at discount. For example, debenture of Rs 100 each is issued at Rs

90 per debenture. Companies Act, 1956 has not laid down any conditions for

the issue of debentures at a discount as have been laid down in case of issue

of shares at discount. However, there should be provision for issue of such

debentures in the Articles of Association of the Company. Journal entry for issue of debentures at discount (at the time of allotment)


Discount on issue of debentures A/c Dr

To Debentures A/c

(Allotment money due. The amount of discount is @ Rs .... per debenture)

Illustration 4 A company has issued 2000 9% debentures of Rs 100 each at a discount of

10% payable as Rs 40 on application Rs 50 on allotment Make necessary journal entries. Solution Dr Cr Date Particulars LF Amount Amount Rs Rs

1. Bank A/c Dr 80000


(Application money received)



(Application money transferred to debenture A/c)

3. Debentures Allotment A/c Dr 100000

Debentures Discount A/c Dr 20000

To 9% Debenture A/c 120000

(Amount due on allotment, along with discount amount

Rs 10 per debenture)

4. Bank A/c Dr 100000

To Debentures Allotment 100000

(Receipt of allotment money)

Issue of Debentures for consideration other than cash When a company purchases some assets and issues debentures as a

payment for the purchase, to the vendors it is known as issue of debentures

for consideration other than cash. Debentures can be issued to vendors at

par, at premium and at discount

Accounting Treatment : 1. Purchase of Assets

Sundry Assets A/c Dr

(Individually)

To Vendors A/c

(Purchase of assets) (v) Allotment of debentures

At par

Vendors' A/c Dr

To Debentures A/c

(issue of debentures at par to vendors)

(ii) At discount

Vendors' A/c Dr

Debentures Discount A/c Dr

To Debentures A/c

(Issue of debentures to vendors at a discount of

Rs ... per debenture)

322

(iii) At premium

Vendors‘ A/c Dr

To Debentures A/c


(issue of debentures to vendors at a premium

of Rs .... per debenture)

Illustration 5 M.B. Electronics Ltd. purchased machinery for Rs 198000 and issued 9%

debentures of Rs 100 each to the vendors. Make journal entries if the

debentures were issued (a) at par (b) at a premium of Rs 10 (c) at a discount of Rs 10 Solution : Dr Cr

S.No. Particulars Amount Amount Rs Rs

(a) Machinary A/c ...Dr 198000

To Vendors A/c 198000

(Machine purchased)

(b) Vendors A/c Dr 198000


1980 debentures of Rs 100 each issued to vendors

(c) Vendors A/c Dr 198000



(1800 debentures issued at a premium of

Rs 10 per debenture)

323

Issue of Debentures

Working notes

Amount due = Rs 198000

Value of debenture including Rs 10 for premium = Rs 110

Rs 198000

No. of denentures to be issue = = 1800

Rs 110

∴ Debenture amount (Nominal value) = 1800 × 100 = Rs 180000

Securities Premium Amount = 1800 × Rs 10 = Rs 18000

(c) Vendors A/c Dr 198000

Discount on Issue of Debentures A/c Dr 22000


(Issue of 2200 9% debentures of Rs 100 each at a

discount of Rs 10 per debenture)

Working notes

Amount due to vendor = Rs 198000

Value of one debenture at a discount of Rs 10 = Rs 90

No. of denentures to be issued = Rs 198000 ÷ Rs 90 = 2200

Debentures amount (Nominal value) = 2200 × Rs 100 = Rs 220000

Discount on issue of Debentures = 2200 × Rs 10 = Rs 22000

Issue of Debentures with conditions Stipulated to their Redemption

(Journal entry) (i) Issued at par redeemable at par

Bank A/c Dr

To Debentures Account

(Issue of debentures of Rs .... at par) (ii) Issued at discount and redeemable at par

Bank A/c Dr

Discount on issue of Debentures A/c Dr

To Debentures A/c

(Issue of debentures of Rs ... at a discount of Rs ....) (iii) Issued at premium redeemable at par

Bank A/c Dr

324

Issue of Debentures

To Debentures A/c


(Issue of ... debentures of Rs .... at a premium of Rs ....) (iv) Issue at par, redeemable at premium

Bank A/c Dr

Loss on Issue of Debentures A/c Dr

To Debentures A/c

To Premium on Redemption of Debenture A/c

(Issue of ... debentures of Rs ... a redeemable at a premium of Rs ...) (v) Issued at discount and redeemable at premium

Bank A/c Dr

Discount on Issue of Debentures A/c Dr

Loss on Issue of Debentures A/c Dr

To Debentures A/c

To Premium on Redemption of Debenture A/c

(issue of ... debentures of Rs ... at a discount of

Rs ... redeemable at a premium of Rs ....)

Illustration 6 Make journal entries if 200 debentures of Rs 500 each have been issued as

:

= Issued at Rs 500, redeemable at Rs 500

= Issue at Rs 450; redeemable at Rs 500

= Issued at Rs 550; redeemable at Rs 500

= issued at Rs 500; redeemable at Rs 550

= Issued at Rs 450; redeemable at Rs 550 Solution : Journal Dr Cr Date Particulars LF Amount Amount Rs Rs

(i) Bank A/c Dr 100000

To Debentures A/c 100000

(Issue of 200 debentures @ of Rs 500 each)

325

(ii) Bank A/c Dr 90000



(Issue of 200 debentures of Rs 50 each at Rs 450)

(iii) Bank A/c Dr 110000



(Issue of 200 debentures of Rs 500 each at Rs 550)

(iv) Bank A/c Dr 10000

Loss on Issue of Debentures A/c Dr 10000


To Premium on redemption of 10000 debentures A/c

(Issue of 200 debentures of Rs 500 each at Rs 500 repayable at Rs 550)

(v) Bank A/c Dr 90000

Loss on Issue of Debentures A/c Dr 10000



To Premium on Redemption of 20000 Debentures A/c

(Issue of 2000 Debentures of Rs 500 each at Rs 45 repayable at Rs 550)

Issue of

s

ISSUE OF DEBENTURES AS COLLATERAL SECURITY Collateral security means security given in addition to the principal

security. It is a subsidiary or secondary security. Whenever a company

takes loan from bank or any financial institution it may issue its

debentures as secondary security which is in addition to the principal

security. Such an issue of debentures is known as ‗issue of debentures as

collateral security‘. The lender will have a right over such debentures only

when company fails to pay the loan amount and the principal security is

exhausted. In case the need to exercise this right does not arise debentures

will be returned back to the company. No interest is paid on the debentures

issued as collateral security because company pays interest on loan. In the accounting books of the company issue of debentures as collateral

security can be credited in two ways. (i) No journal entry to be made in the books of accounts of the company : Debentures are issued as collateral security. A note of this fact is given on

the liability side of the balance sheet under the heading Secured Loans and

Advances.

Balance Sheet ...... Co. Ltd.

Capital & liabilities Amount Assets Amount

Rs Rs Rs

Debentures (.... debentures

of Rs .... per debenture

issued as collateral security

Loan

(Secured by the issue of ....

debentures of Rs .... each

issued as collateral security

(ii) Entry to be made in the books of account the company A journal entry is made on the issue of debentures as a collateral security,

Debentures suspense A/c is debited because no cash is received for such

issue.

327

Issue of Debentures

Following journal entry will be made

Debenture Suspense A/c Dr

To Debentures A/c

(.....Debentures of Rs .... each issued as

collateral security to ..... ) In the Balance sheet of the issuing company it will be shown as udner :

Balance Sheet of ...... Co. Ltd.

Capital & Liabilities Amount Assets Amount Rs Rs Rs

Bank

Debenture Debenture suspense A/c

(.....debenture of Rs .... each (Debenture issued as collateral issued as collateral security security for loan as per contra)

as per contra)

Loan

Illustration 7 Sky Rocketing Company Ltd issued 6000 10% debentures of Rs 100 each

to the bank as collateral security against a loan of Rs 500000 taken from

the bank. Record the issue of debentures in the books of the company and

show the issued Debentures in the Balance Sheet of the Company.

Solution (i) No journal entry is required

Balance Sheet (Relevant) of Sky Rocketing Co. Ltd

Capital & Liabilities Amount Assets Amount

Rs Rs Rs

Secured Loan 500000 Current Assets & loans and Advance

Bank loan Cash at Bank 500000

(Secured by 6000 10%

debentures of Rs 100 each

issued as collateral security)

328

Issue of Debentures

(ii) Journal Dr Cr

Date Particulars LF Amount Amount Rs Rs

Debentures Suspense A/c Dr 600000

To Debenture A/c 600000

(Issue of 6000 10% debentures of Rs 100 each issued as collateral

security to bank)

Balance Sheet (Relevant) of Sky Rocketing Co. Ltd.

Capital & Liabilities Amount Assets Amount Rs Rs

Secured Loan Current Assets

Bank loan 500000 Cash at Bank 500000

Miscellaneous expenditure Debenture suspense A/c 600000

(6000 Debentures of Rs 100 each issued as collateral

security as per contra)

Debentures 600000

(6000 10% debentures issued as collateral security)

DISCOUNT ON ISSUE OF DEBENTURES AND LOSS ON

ISSUE OF DEBENTURES In case company issues debentures on discount the total amount of discount is

not charged to profit and Loss Account of the company in the accounting

Issue of Debentures

year in which this discount is allowed. The amount of such discount is

very heavy and to the company gets benefit from the loan by issuing

debentures over a number of years. Hence some part of the amount of

discount is written off every year. Generally it is written off prior to the

redemption of these debentures. As the amount of discount on issue of debentures is treated as a capital

loss, it is shown on the asset side of the balance sheet of the company

under the head ―Miscellaneous Expenditure‖ until and by the amount it is

not written off.

The amount of debenture discount can be written off in two ways : JJJ. All debentures are to be redeemed after a fixed period.

When the debentures are to be redeemed after a fixed period, the

amount of discount will be distributed equally within the number of

years spreaded between the issue of debentures and their redemption.

The amount of discount on issue of debentures to be written off each

year is calculated as

Amount of discount to be written off annually

TotalRs100000amount of Discount Number5= of years

Illustration 8 A company issues 1000 debentures of Rs 1000 each at a discount of 10%

for a period of 5 years i.e. to be redeemed after 5 years. Calculate the

amount of discount to be written off each year and prepare on issue of

debentures discount account.

Solution

b1000 Rs1000g 10 Amount of discount = = Rs 100000

100

Amount to be written off each year = = Rs 20000

Accounting Treatment Journal entry to write off debenture discount each year

330

Issue of Debentures

Dr. Cr.

Profit and Loss A/c ...Dr 20000

To Discount on Issue of Debentures A/c 20000

(Amount of Discount on Issue of Debentures written off) Discount on Issue of Debentures Account till the amount of discount is written off, is shown as under :

Discount on Issue of Debentures A/c Dr. Cr.

Date Particulars Amount Date Particulars Amount

Rs Rs

1st year 1st year

Jan 1 Debenture A/c 100000 Dec 31 Profit & Loss A/c 20000

Dec 31 Balance cld 80000

100000 100000

2nd year

2nd year

Jan 1 Balance b/d 80000 Dec. 31 Profit & Loss A/c 20000

Dec.31 Balance cld 60000

80000 80000

3rd year

3rd year

Jan 1 Balance b/d 60000 Dec 31 Profit & Loss A/c 20000


60000 60000

4th year

4th year



40000 40000

5th year

5th year


20000 20000

Issue of Debentures

2. Debentures are redeemed in instalments

Debentures may also be redeemed in instalments but over a fixed

period. In that case the amount of debenture discount will be written

off each year in proportion to the amount of debentures redeemed.

Illustration 9 A company has issued 2000 9% debentures of Rs 1000 each at a discount

of 10%. If the debentures are to be redeemed in five equal annual

instalments, calculate the amount of Discount on Issue of Debentures to be

written off each year and prepare Discount on Issue of Debentures A/c.

Solution Calculation of Amount of Discount on Issue of Debentures Account Total amount of Discount on Issue of Debentures A/c

= = Rs 200000

Year end Outstanding amount Ratio Amount of Discount

of debenture 5 written off

Rs b2000 Rs1000g 10 Rs Rs

300000

15

10

1st 3000000 5 = 100000

2nd 2400000

4

300000 4

= 80000

15

3rd 1800000

3

300000 3

= 60000

15

4th 1200000

2

300000 2

= 40000

15

5th 600000

1

300000 1

= 20000

15

15

Journal entry

Dr. Cr.

1st year Profit and Loss A/c ...Dr 100000

To Debenture Discount A/c 100000

(Discount on issue of debenture

written off)

332 ACCOUNTANCY

Issue of Debentures

Similarly entry will be made every year with the respective amount of

discount. Discount on issue of Debentures account till the amount of discount is

written off will be shown as under.

Discount on Issue of Debentures A/c Dr. Cr.


Rs Rs

1st year 1st year

Jan 1 Debentures A/c 300000 Dec 31 Profit & Loss A/c 100000


300000 300000

2nd year

2nd year

Jan 1 Balance b/d 200000 Dec. 31 Profit & Loss A/c 80000

Dec.31 Balance cld 120000

200000 200000

3rd year

3rd year



120000 120000

4th year

4th year



60000 60000

5th year

5th year


20000 20000

Loss on Issue of Debentures You have learnt that a company may issue debentures with the stipulation

that the repayment of the debentures on maturity will be made at premium.

The amount of the premium payable is debited to Loss on Issue of

33

Issue of Debentures

Debentures A/c at the time of issue of debentures. This amount will also

be written off in the same manner as is done in case of writing off

Discount on Issue of Debentures. This is illustrated as under : (i) All Debentures are redeemed after fixed period

Journal Entry

Amount of Loss on Issue of Debentures written off each year

Profit and Loss A/c Dr

To Loss on Issue of Debentures A/c

(Loss on Issue of Debentures written off)

Same journal entry will be made each year till the whole amount of the

Loss on issue of Debentures is written off. Calculation of the amount to be written off Total Amount of Loss on Issue of Debentures/No. of years. Illustration 10 A company issues 1000 10% Debentures of Rs 1000 each on 1st Jan, 2006

payable at a premium of 10% after 5 years. Make journal entries and open Rs100000

Loss on Issue of Debentures A/c for the year ending 31st December 2006. 5

Solution

1000 Rs1000 10

Amount of Loss on issue of Debentures =

= Rs 100000

100

Amount to be written off each year = = Rs 20000

Loss on issue of Debentures A/c

Dr. Cr.


Rs Rs

2006 2006

Jan 1 10% Debentures A/c 100000 Dec 31 By Profit & Loss A/c 20000

Dec 31 By Balance cld 80000

100000 100000

2007

Jan 1 Balance b/d 80000

334

Journal Entry

2006 Profit and Loss A/c Dr 20000

Dec 31 To Loss on Issue of Debentures A/c 20000

(Loss on Issue of Debentures transferred

to Profit and Loss A/c)

(ii) Debentures are Redeemed in Instalments

The amount of Loss on Issue of Debentures to be written off each year

is calculated in the manner it is calculated in case of Discount on Issue

of Debentures and accounting treatment is also the same.

Illustration 11 Refer Illustration No. 10. A company decides to redeem its debentures in

five equal instalments beginning from the end of first year. Make journal

entry for the writing off and show Loss on Issue of Debentures A/c for

first year. Solution Amount of Loss on Issue of Debentures =

1000 = Rs 100000

Rs1000 10

Calculation of amount to be written off each year 100

Year end Amount Outstanding Ratio Amount of Loss to be

written off each year

1st 1000000 5

100000 5

= 33333

15

2nd 800000 4

100000 4

= 26667

15

3rd 600000 3

100000 3

= 20000

15

4th 400000 2

100000 2

= 13333

15

5th 200000 1

100000 1

= 6667

15

15

Journal Entry

2006 Profit and Loss A/c Dr 33333

Dec 31 To Loss on Issue of Debentures A/c 33333

(Amount of Loss on Issue of Debentures

written off for 2006)

335

Issue of Debentures

Loss on Issue of Debentures A/c Dr. Cr.


Rs Rs

2006 2006

Jan 1 10% Debentures A/c 100000 Dec 31 Profit & Loss A/c 33333


100000 100000

2007

Jan 1 Balance b/d 66667

Interest on Debentures If you have seen an advertisement in newspaper regarding issue of

debentures by a company, you must have noticed that ‗Debenture‘ is

always prefixed by a certain percentage say 9% Debentures or 12%

Debentures. Have you ever thought what meaning does this prefix carry. It

is the rate of interest per annum that will be paid to the debenture holders.

Companies generally pay interest on its debentures after every six months.

Journal entries that are made in the books of the company are as follows; (i) Payment of Interest on Debentures

Debenture Interest A/c Dr

To Bank A/c

(Interest on ....% Debentures paid for six months ending ...@ ....% pa) (ii) Transfer of Debenture Interest to Profit and Loss A/c

Profit and Loss A/c Dr

To Debenture Interest A/c

(Debenture Interest transferred to Profit and Loss A/c) Illustration 12 X Ltd has issued 5000 9% Debentures of Rs 1000 each, on 1st April, 2006

Interest is payable after every six months. Make journal entries for the

interest paid for the first six months after the date of issue.

336

Solution. Calculation of Interest payable at six monthly intervals :

Amount of Debentures 9 6

100 12

Amount of Debentures = 5000 × Rs 1000 = Rs 5000000 Interest on Debentures for six month ending 30th September, 2006

= Rs 5000000 9 6 = Rs 225000

12

100

Journal Entry

2006 Dr. Cr.

30th Sept. Debentures Interest A/c Dr 225000

To Bank A/c 225000

(Interest on 5000 9% Debentures @ Rs 1000

per debenture paid for 6 months ending

30th Sept 2006)

2007

31st Mar Profit and Loss A/c Dr 225000

To Debentures Interest A/c 225000

(Debenture Interest transferred

to profit and Loss A/c)


CHAPTER- 3

FINAL ACCCOUNTS OF COMPANY

Introduction :

As per the companies act it is a stationary obligation to prepare final accounts

of companies along with Profit and Loss A/C with in a stipulated time. Preparation of Profit & Loss Account:-

The Principle for preparation of Profit & Loss a/c is same as it is a firm or

company, modified by the special provisions laid down in the companies act. It consists

of Trading Account to show Gross Profit, Profit & Loss a/c to determined net profit, and

Profit & Loss appropriation a/c to give a view about the manner in which Profits are

disposed.

No form for Profit & Loss a/c has been prescribed in the Companies act as it has

been prescribed for Balance Sheet, but requirement as to Profit and Loss a/c are given

in Part II of Schedule VI.

. Certain items Appearing in Profit & Loss A/c:-

The following are the some of the important items appearing in Profit &

Loss A/c and their treatment if it is given in Trail Balance and Adjustment.

(v) Dividends & Interest received:- It relates to income of the company

and appears credit side of Profit & Loss a/c.

19.9 Provision for Taxation:- It should be credited to Profit & Loss a/c. If it is

given in adjustment, it is debited to Profit & Loss A/c and second time on the

Liabilities side of Balance sheet.

19.10 Income tax Paid:- It is treated as advance tax is paid so it appears on Asset

side of “Loan & Advances” head.

19.11 Preliminary Expenses:- It appears Asset side of Balance Sheet. If

adjustment is there, the (adjustment appears) written off amount debited Profit &

Loss A/c, and the same deducted from the item in Balance Sheet.

19.12 Discount & Expenses on issue of shares / Debentures:- It is appears on

the Assets side of Balance Sheet. If adjustment is there on these items, the

written off amount appears on debit side of Profit & Loss A/c and the same

deducted from the respective items, in Asset side of Balance sheet.

19.13 Interest on Debentures:- If it is given in Trail balance it is debited to

Profit & Loss A/c. If it is given in adjustment it appears both side of Profit &

Loss A/c Debit and Liabilities side of Balance sheet.

Proforma of Trading & Profits and Loss A/C of a Company is titled as

Profit & Loss A/c of ____________Co. Ltd., as on ___________.

Dr Cr

Particulars Amount

Particulars Amount

(Rs) (Rs)

To Opening Stock Xxxxx By Sales xxxxx

To Purchases xxxxx (-) Returns xxx Xxxxx

(-) Returns xxx Xxxxx By Closing Stock Xxxxx

To Carriage inwards Xxxxx

To Productive wages Xxxxx

To Freight Xxxxx

To Gross Profit Xxxxx

(Transferred to Profit & Loss

A/c) Xxxxxx xxxxxx

To Salaries xxxxx By Gross Profit

(-) Out standing xxx Xxxxx (Transferred from Trading xxxxx

To Insurance xxxxx A/c)

(-) Prepaid xxx Xxxxx By Discount received xxxxx

To Bank expenses Xxxxx By Share Transfer fees xxxxx

To Director fees Xxxxx By Interest on Investments xxxxx

To General expenses Xxxxx By Interest on defence bonds

To Discount paid Xxxxx By Net Loss (if arises) xxxxx

To Bad debts Xxxxx (Transferred to Profit & Loss xxxxx

To Advertisement Xxxxx Appropriation A/c)

To Commission paid Xxxxx

To Interest on Debentures xxxx

(+) Out standing xxx Xxxxx

To Preliminary Expenses written

off (Adj) Xxxxx

To Depreciation (on Assets) Xxxxx

To Provision for Income tax Xxxxx

To Net Profit (Transferred to

Profit & Loss Appropriation Xxxxx

A/c)

xxxxxx

xxxxxx

Profit and Loss Appropriation Account

A company has to prepare the Profit and Loss Appropriation

Account in addition to the profit and loss account. It shows the

appropriation of Profit and is popularly known as below the line the

splitting of the Profit and Loss A/C into three section (i.e. trading A/C,

Profit and loss A/C and profit and loss appropriation A/C) is not forbidden

by the companies Act. It is desirable to split the profit and loss A/C into

three sections so that gross profit, Net profit and surplus carried to the

balance sheet may be ascertained. It is prepared as follows.

Profit and loss appropriation Account

Dr Cr

Particulars Amount

Particulars Amount

(Rs) (Rs)

To Transfer to Reserves Xxxxx By Last year’s Balance b/d Xxxxx

To Income tax for Previous Year By Net Profit for the year Xxxxx

not provided for Xxxxx By Amount withdrawn from

To Interim dividend Xxxxx General Reserve/other

To Surplus (balancing figure reserve Xxxxx

carried to Balance Sheet) Xxxxx By Provision( Income tax

provision not required) Xxxxx

xxxxx xxxxx

Illustration: -

The following are the particulars of J.S.Co., Ltd., Tirupathi as 31-12-05.

Particulars Dr Cr

Opening Stock 75,000

Sales 3,50,000

Purchases 2,50,000

Wages 50,000

Discount 5,000

Salaries 7,500

Rent 5,000

Sundry Expenses 7,000

Profit & Loss Appropriation A/c1-1-06 15,000

Dividend Paid 9,000

Plant & Machinery 30,000

Adjustments:- Closing stock valued Rs.80,000, Depreciate Plant & Machinery

@ 10/-. You are required to Prepare Profit & Loss A/c for the year ended 31-12-

06.

J.S.Co.,Ltd.,Profit & loss A/c for the year ended 31-12-05.

Dr Cr

Particulars Amount

Particulars Amount

(Rs) (Rs)

To Opening stock 75,000 By Sales 3,50,000

To Purchases 2,50,000 By Closing stock 80,000

To Wages 50,000

To Gross Profit C/d 55,000

4,30,000 4,30,000

To Salaries 7,500 By Gross Profit B/d 55,000

To Rent 5,000 By Discount 5,000

To Sundry Expenses 7,000

To Depreciation on Plant &

Machinery 3,000

To Net Profit C/d 37,500

60,000 60,000

To Dividend Paid 9,000 By Balance B/d 15,000

To Balance C/d (Carried forward 43,500 By Net Profit Current year 37,500

to Balance sheet)

52,500 52,500

Illustration 2:-

PremRaj Ltd had a nominal Capital of Rs.6, 00,000 dividend in to shares of Rs.10/-each.

The Balances as per Ledger of the Company as at Dec.31, 2005 was as follows: -

Particulars Rs Particulars Rs

Calls in arrear 7,500 Premises 3,00,000

Plant & Machinery 3,60,000 Interim Dividend Paid 7,500

Purchases 1,85,000 Preliminary Expenses 5,000

Freight 13,100 Directors’ Fees 5,740

Bad debts 2,110 6% Debentures 3,00,000

P. & L.A/c (Cr) 14,500 Sundry Creditors 50,000

General Reserves 25,000 4% Govt.Securities 60,000

Stock (1st

Jan.2005) 75,000 Fixtures 7,200

Sundry Debtors 87,000 Good will 25,000

Cash in Hand 750 Cash at Bank 39,900

Wages 84,800 General Expenses 16,900

Salaries 14,500 Provision for Bad debts 3,500

Debentures Interest Sales 4,15,000

Share Capital (fully called) 4,60,000 Bills Payable 38,000

Prepare the Final Accounts and the Balance sheet relating to 2005 from

the figures given above after taking in to account the following:-

(ii) Depreciate Plant & Machinery by 10 % and Fixtures by 5%; (iii) Write off1/5 of Preliminary Expenses; (iv) Rs.10, 000 of wages were utilized in adding rooms to the Premises; no entry

has as yet been made for it (v) Leave Bad Debts Provision at 5% of the Sundry Debtors; (vi) Provide a final dividend @5% (vii) Transfer Rs.10,000 to General Reserve; and (viii) Make a Provision for Income Tax to the extent of Rs.25, 000.

(ix) The stock on 31st

December 2005 was Rs.1, 01,000.

Trading and Profit & loss A/c of the Prem Raj Co., Ltd., for the year

ended 31-12-2005.

Dr Cr

Figures Figures for

Figures Figures for

relating

relating

the Current

the Current

to 31st

Expenses

to 31st

Incomes

Year

Year

Dec

Dec

Rs.

Rs.

2005

2005

To Stock 75,000 By Sales 4,15,00

To Purchases 1,85,000 By Stock 1,01,000

To Wages 84,800

Less Charged to

Premises 10,000 74,800

To Freight 13,100

To Gross Profit C/d 1,68,100

5,16,000

5,16,000

To General Expenses

To salaries 16,900

To Debenture Interest* 14,500

Paid 9,000

Add out

Standing 9,000

_______ 18,000

To Directors’ Fees 5,740

To Preliminary

Expenses 1,000

To Depreciation- Plant

& Machinery 36,000

Fixtures 360

______ 36,360

To Provision for Bed

Debts-

Required 4,350

Add Bad

Debts 2,110

______

6,460

Less Existing

Provision 3,500

_______ 2,960

To Provision for

Income Tax 25,000

To Net Profit c/d 50,040

1,70,500

By Gross Profit

b/d 1,68,100

By Interest due

on Govt.

Securities

(4% on

Rs.60,0000) 2,400

1,70,500

Balance Sheet of the Quick Ltd. as at December 31, 2005

(not in prescribed form)

Liabilities Amount

Assets Amount

Rs.

Rs.

Share Capital: Fixed Assets:

Authorised – 60,000 Good will

Shares of Rs. 10 each Premises 25,000

Issued 6,00,000 Plant and 3,10,000

Subscribed & paid – up Machinery 3,60,000

Capital : Less Depre-

46,000 Shares Citations 36,000

of Rs.10 each _________

fully called 4,60,000 Fixtures 7,200 3,24,000

Less Calls in Less Depre-

Arrear 7,500 4,52,500 Citations 360

6,840

Reserves and Surplus: Current Assets:

General Reserve 35,000 Investments

P.& L., A/c 24,415 Interest Due 60,000

Stock 2,400

Secured Loans : Sundry Debtors 87,000 1,01,000

6% Debentures 3,00,000 Less Provision

Interest Outstanding 9,000 For Bad Debts 4,350

Current Liabilities: Cash in Hand

Bills Payable 38,000 Cash in Bank 82,650

Sundry Creditors 50,000 Preliminary Expenses 750

Provision for Income Tax 25,000 39,900

Proposed Dividend 22,625 4,000

9,56,540

9,56,540

Alternatively, the Trading and Profit and Loss Account and the Profit and

Loss Appropriation Account may be merged together and presented as

follows: -

Trading and Profit & loss A/c of the Prem Raj Co., Ltd., for the year

ended 31-12-2005.

Dr Cr

Figures Figures for

Figures Figures for

relating

relating

the Current

the Current

to 31st

Expenses to 31st

Incomes

Year Year

Dec

Dec

Rs.

Rs.

2005

2005

To Stock 75,000 By Sale 4,15,000

To Purchases 1,85,000 By Stock 1,01,000

To Wages 74,800 By Interest on

To Freight 13,100 Government.

To General Expenses 16,900 Securities 2,400

To Salaries 14,500

To Debenture interest 18,000

To Director’s Fees 5,740

To Preliminary

Expenses 1,000

To Depreciation – Plant

& Machinery 36000

Fixtures 360 36,360

To Provision for Bad

Debts:

Required 4350

Add Bad Debts 2110

6460

Less Existing

Provision 3500 2,960

To Provision for Income

– Tax 25,000

To General Reserve 10,000

To Interim Dividend 7,500

To Proposed Dividend 22,625

To Balance of Profit 9,915

5,18,400 5,18,400

Balance Sheet:-

It must be drawn up in such a form and should have such contents as will

give affairs. For this purpose it should be drawn up as far as possible in

conformity with the form set out in Part –I of schedule VI of the companies

Act. Section 210 of the companies Act requires that at every annual

general meeting of the shareholders, the Board of Directors of the

Company shall lay before the company a Balance Sheet at the end of

each trading period.

Certain important items in Balance Sheet:-

The following are some of the important items appearing in Balance

Sheet.

(iii) Call in Arrears: This amount is deducted from the called up share capital. (iv) Call in advance: The amount received in advance. Son it is

shown separately from the called up capital on the liabilities side. (v) Share premium: It is shown on the liabilities of Balance sheet under the

head Reserve and surplus. (vi) Forfeited shares: It is to be added to the paid up capital on the liability

side of Balance sheet. (vii) Fixed deposits: It can accepts from public it is shown under

unsecured Loan on the liability side of Balance sheet. (viii) Unclaimed dividend: Dividend which are not en cashed by the

share holders are called unclaimed dividends. This item is shown under current liabilities.

(ix) Secured Loan: In case of each secured loan the nature of security given by the company should be indicated.

(x) Unsecured Loans: Interest occurred and due on unsecured loans must be shown as an addition to the respective loans.

(xi) Fixed Assets: Full details of fixed assets their additions, Total depreciations should be clearly shown.

(xii) Current Assets: Closing stock, debtors, Bills Receivable etc., comes under this head.

(xiii) Miscellaneous Expenditure: Not written off expenditure comes

under this head. Ex: Preliminary Expenditure.

The form of the Balance sheet as given in Part I of Schedule VI of the Companies Act is given below. Schedule VI (Section 211) Part – I Form of Balance Sheet

Balance Sheet of __________________ as on _________________

Figure Figur Figure Figu Figu

s for es for s for res res

the the the for for

Previo Liabilities

Curre Previo Assets

the the

us nt us

Curr Prev

Year Year Year ent ious

Rs. Rs. Rs. Year Year

Rs. Rs.

1 2 3 4 5 6 7

Share Capital: Fixed Assets:

Authorised _______ Good will

Shares of _____ each. Land

Issued ____ Shares of Buildings

Rs._______ each. Leaseholds

Subscribed____ Railway sidings

shares of Rs. Each Plant and Machinery

_____ Shares of Furniture & Fittings

Rs.____ per share Development of

called up. Property

Less: Calls unpaid Patents, trade marks

1) by directors and designs

2) by others Livestock

Add: Forfeited Shares

Vehicals, etc.

of the above shares Investments:

____ shares are

Showing nature of

allotted as fully paid up

pursuant to a contract investments and

without payments mode of valuation,

being received in cash e.g., cost or market

of the above ____ value:

shares are allotted as a) Investments in

fully paid up by way of Government or

bonus shares. Trust Securities.

b) Investments in

shares,

Reserves and debentures or

Surplus: bonds.

Immovable

Capital Reserve Properties.

Capital Redemption

Reserve Current Assets,

Share Premium Loans and

Account Advances

Other Reserve A) Current Assets

Less: Debit Balance in Interest accrued

Profit and Loss on Investments

Account, if any. Stores &

Surplus, i.e., balance in Spare parts

Profit and Loss Loose Tools

Account after providing Stock – in – Trade

for proposed Work-in-Progress

allocations, namely,

Dividend, Bonus, etc. Sundry Debtors

Proposed additions to

a) Debts

Reserves, Sinking

Funds out standing for a

period exceeding

Secured Loans six months

Debentures b) Other debts

Loans & Advances Less: Provision

from Banks

Cash balance in

Loans & Advances

from Subsidiaries hand Bank Balances:

Other Loans & a)With Scheduled

Advances Banks

Unsecured Loans

B) With others

Fixed Deposits B) Loans&

Loans & Advances Advances

from Subsidiaries Advances and Loans

Short term loans and to Subsidiaries

advances: Advances and Loans

a) from Banks to partnership firms in

b) from others which the company

or any of its

Current Liabilities subsidiaries is a

and Provisions partner

a) Current Liabilities

Bills of Exchange

Acceptances

Sundry Creditors

Advances

Advance payments

and unexpired recoverable in cash

discounts or in kind or for value

Unclaimed to be received, e.g.,

dividends, other Rates, Taxes,

Liabilities (if any) Insurance, etc.

Interest Accrued but Balance with

not due on loans Customs, Port Trust

etc. (Where payable

B) Provisions on demand)

Provision of

Taxation Proposed Miscellaneous

Dividends For Expenditure

contingencies (To the extent not

For Provident Fund write off or adjusted)

Scheme Preliminary

For Insurance, Expenses Expenses

Pension and similar including commission

staff other provisions or brokerage on

Contingent Liabilities underwriting or

(A foot note to the subscription of

balance sheet is shares or debentures

added to show Interest paid out of

separately and these capital during

are not included in construction (also

the total) stating the rate of

Claims against the

interest)

Development

company not

acknowledged as expenditure not

debts uncalled liability adjusted

on shares partly paid Other items

Arrears of fixed (specifying nature)

cumulative dividends

Estimated amount of Profit and Loss

contracts remaining to Account

be executed on capital (Show here the debit

account and not balance of profit and

provided for other Loss Accountant

moneys for which the carried forward, after

company is deduction of the

contingently liable. uncommitted

reserves, if any.)

Summing up:

Companies have to prepare final Accounts as per the provisions of

the companies Act 1956 Every profit and loss A/C and Balance sheet

must disclose a true and fair view of the profit or loss and financial state of

the affairs of the company. Balance sheet is to be prepared in prescribe

form is part I of schedule VI. The Profit and loss A/C must company with

the requirements of part II of the schedule VI.

Glossary :

Dividend: Amount paid to the shareholders out of the profits.

Preliminary Expenses: It is incurred in connection with the formation of

the company.

Profit & Loss appropriation A/C: It shows the appropriation out of profits.

Illustration: The following was the Trail balance of Sri. Nagi Reddy Textiles of Kurnool

as on 31-12-05.

Trail Balance

Particulars Debit Rs. Credit Rs.

Call in Arrears 5,000

Land & Building 5,00,000

Machinery 4,00,000

Purchases & Sales 4,00,000 9,00,000

Preliminary Expenses 1,00,000

Wages 10,000

Director fees 2,000

Bad debts 3,000

Profit & Loss A/c 1,00,000

Sundry Debtors & Creditors 1,00,000 50,000

General Reserve 50,000

1-1-05 Stock 50,000

Cash in hand 10,000

Cash at Bank 50,000

Salaries 20,000

Share Capital 4,00,000

Bills Payable 1,50,000

16,50,000 16,50,000

Adjustments:- (v) Depreciate Machinery @10 % (vi) Write off ¼ Preliminary Expenses. (vii) Transfer Rs.5000 to General Reserve (viii) Closing stock 1,00,000.

You are required to Prepare final Accounts.

Profit & loss A/c of the Nagi Reddy Textiles for the year ended 31-12-

2005.

Dr Cr

Figures Figures for

Figures Figures for

relating

relating

the Current

the Current

to 31st

Expenses to 31st

Incomes

Year Year

Dec

Dec

Rs.

Rs.

2005

2005

To Stock 1-1-05 50,000 By Sales 9,00,000

To Purchases 4,00,000 By Closing Stock 1,00,000

To Wages 10,000

To Gross Profit C/d 5,40,000

10,00,000 10,00,000

To Salaries 20,000 By Gross Profit 5,40,000

To Director fees 2,000 B/d

To Bad debts 3,000

To Preliminary

Expenses1/4 25,000

To Depreciation on 40,000

machinery 10%

To Net Profit C/d 4,50,000

5,40,000 5,40,000

Profit & loss Appropriation A/c.

Dr Cr

Figures Figures for

Figures Figures for

relating

relating

the Current

the Current

to 31st

Expenses to 31st

Incomes

Year

Year

Dec

Dec

Rs.

Rs.

2005

2005

To General Reserve 5,000 By Balance B/d 1,00,000

To Surplus 5,45,000 By Net Profit for 4,50,000

Current Year

5,50,000 5,50,000

Sri Nagi Reddy Textiles Balance Sheet as on 31-12-05

Liabilities Amount Rs Assets Amounts RS

1. Share Capital 1. Fixed Assets 5,00,000

Authorised Land & Building

Issued Called up & Machinery 4,00,000

Paid up 4,00,000 (-) Depreciation 4,000 3,60,000

(-)Call in Arrears 5,000 3,95,000 2. Investments --------

2. Reserves & Surplus 3. Current Assets Loan

General Reserve 50,000 Advances

(+)Addition 5,000 55,000 Closing Stock 1,00,000

P & L A/c Sundry Debtors 1,00,000

3. Secured Loans 5,45,000 Cash in hand 10,000

4.Unsecured Loans -------- Cash at Bank

5. Current Liabilities & -------- 4. Miscellanies

Provisions Expenditure 50,000

Bills Payable 1,50,000 Preliminary

Sundry Creditors 50,000 Expenses 1,00,000

6. Contingent Liabilities -------- (-) Written off 25,000 75,000

11,95,000 11,95,000

UNIT -- 3 Consignment—What is it?

Quite often it happens that a manufacturer or a wholesale dealer who does not find ready market in

his own place becomes desirous of seeking a good market elsewhere. Even when there is a good market

for his goods in his own place, he is often anxious to make his goods popular elsewhere. For this purpose

the merchant employs a leading dealer at the place where he wants to push his goods to act as his agent

and sell goods on his behalf and risk as agent on commission. Goods so sent to a person are known

as Consignment. The person who sends such goods is known as the Consignor and the person to whom

the goods are sent is known as the consignee. Such goods sent to the Consignee remain the property of

the Consignor. The Consignee to whom the goods are sent does not buy them, but, merely undertakes

to sell them on behalf of the consignor. He is not responsible for any loss or damage to the goods, if such

loss or damage is caused for no fault of the Consignee.

Such a shipment of the goods by the Consignor cannot be treated as ordinary sale and such transactions

require special treatment in the books of accounts. Difference between a Sale and a Consignment

1. When goods are sold by one to another, the property in the goods immediately passes to the

buyer, whereas when goods are sent on Consignment, the property in the goods remains with

the consignor. Only the possession is transferred to the consignee.

2. When goods are sold by one to another, it becomes a relationship of a buyer and seller or a

Debtor and a Creditor between the two persons, whereas when goods are Consigned by one

to another, it becomes a relationship of a Principal and an Agent between the Consignor and

the Consignee.

3. When goods are sold, the buyer cannot return the goods to the seller whereas when goods are

sent on Consignment the goods are returnable, if they remain unsold.

4. The risk in the goods is not transferred to the consignee despite the transfer of possession of

goods. Any damage or loss to the goods is therefore borne by consignor. But in the case of sale,

the risk is immediately transferred to the buyer even when the goods are still in the possession

of the seller.

5. The expenses, in respect of freight, cartage, insurance, etc. are met by the consignor in a

consignment transaction, but in the case of sale the expense are borne by the purchaser unless

otherwise provided in the agreement.

6. The transfer of possession (i.e. delivery of goods) is essential in a consignment transaction. In

a sale, however, the goods may be delivered at a later date.

The consignee will be treated as a debtor only when goods or part of them have been sold by him.

But if goods remain unsold, the consignee will send them back to the Consignor and the Consignor will

pay the Consignee all the expenses he has incurred in keeping the goods in safety and in attempting to

push the goods in the market.

*Note:— Strictly speaking the term consignment implies the despatch or shrpping of goods to an

agent in a foreign country for sale on commission basis. In business circles, however, the term is used

for despatch of goods to an agent in different parts of the same country as well.

Commission or Consignee’s Remuneration

When the goods are sold by the consignee, he is paid a commission for his services at a fixed rate

on the proceeds of the goods sold by him. In addition to this commission, he is to be reimbursed for all

expenses incurred by him in connection with the consignment sales. Usually these expenses are in the

nature of dock charges, custom duties, carriage, godown rent, advertisement, insurance of the goods while

in his possession etc.

Del Credere Commission. Usually the consignor advises the consignee to sell the goods consigned

to him for cash only, because if such goods are sold on credit by the consignee and if any amount becomes

irrecoverable from the debtors the loss will fall upon the consignor. As the consignee acted as an agent

only in effecting the sales, he does not become responsible for any debts. But sometimes an arrangement

is made between the consignor and the consignee whereby the later guarantees payment and undertakes

responsibility for bad debts. For this the consignee receives an additional commission known as ‗‗Del

Credere Commission‘‘ on the total sales. When del-credere commission is given to the consignee, the

consignee will make payment to the consignor, whether he himself receives the payment or not from the

purchaser(s).

Over-riding Commission : This type of commission is allowed to the consignee in addition to the

normal commission (as distinct from Del credere commission). The idea seems to be to provide addition

incentive to the consignee for the purpose of creating market for new products.

Proforma Invoice :

When goods are despatched, the consignor makes out a ‗Pro-Forma Invoice‘ giving indication of the

price of the goods at which the consignee ought to sell the goods. Pro-Forma Invoice is a statement which

is similar to that of an invoice, but it is called proforma because it does not make the consignee responsible

to pay the amount named therein.

The consignor generally mentions a higher price than his cost so that consignee does not know the

profit of the consignor.

Advance against Consignment :

Until the goods are sold by the consignee, he is not indebted to the consignor and is not expected to

pay for them. This results in a part of the consignor's Capital being locked up for a period. To overcome

his difficulty, the consignee often remits a sum of money in advance to the consignor. This may be done

in the form of an acceptance of a Bill of Exchange drawn by the consignor on the Consignee or a simple

bank draft. An advance is readily sent against consignment by the consignee to the consignor when the

consignment goods have become popular in the consignee‘s place.

Account Sales :

Periodically, the consignee will send statements of sales and expenses incurred, commission earned

and the consequent amount due to the consignor. Such a statement is made in a form known as ‗‗Account

Sales‘‘. An Account Sales may be defined as a ‗‗statement prepared and sent by the consignee to the

consignor at periodical travels, say three months or six moths detailing therein the goods payable and the

net amount due from the consignee after deducting the advances, if any, paid already.‘‘ The following is

a specimen :—

Accounts Sales

Account Sales of 65 cases of Fancy goods ex. S.S. Vikram sold by Messers A. Dutt & Co., Colombo,

Ceylon on account and risk of Messers Thankers & Co., Delhi, India.

Accounting treatment

Entries in the Books of the Consignor

1. On Despatch of Goods : Rs. Rs.

Consignment Outward A/c Dr. ?

or

Consignments to such and such

Person or Place A/c Dr.

To Goods sent on Consignment A/c ?

(With either the cost of the goods consigned

or with the amount of the higher price charged

Consignment.)

Here Sales Account is not credited because sending goods on consignment does not mean actual

sales. These goods are returnable by the Consignee if it cannot effect sale. Hence a new account ‗‗Goods

sent on Consignment‘‘ is opened.

2. On Paying Expenses (by the Consignor) :

Consignment Outward A/c Dr.

To Case (or bank) A/c

(For amount spent on carriage, freight, insurance, etc., at the time of despatching the goods.)

3. (On Receipt of an Advance from the Consignee :

Case (or Bank or Bills Receivable) a/c Dr.

To Consignee‘s Personal A/c

(An advance of rs....received against consignment from the Consignee).

4. If the Advance is in the form of a Bill Receivable and the same is discounted by the

Consignor :

Cash (or bank) A/c Dr.

*Discount A/c Dr.

To B/R A/c

(No further entry is made in the books of the Consignor till an Account Sales is received from

the Consignee.)

5. On Receipt of Account Sales :

(i) Consignee‘s Personal A/c Dr.

To Consignment Outward A/c

(With the gross proceeds of the Account sales.)

(ii) Consignment Outward A/c Dr.


(With the expenses incurred by the Consignee plus commission payable to the Consignee as per

Account Sales.)

6. On Receipt of Remittance from the Consignee :

Cash (or Bank or Bills Receivable) A/c Dr.


7. For unsold Stock (if any) with the Consignee

Stock on Consignment A/c Dr.

To Consignment outward A/c

8. Entry for Profit & Loss :

If all the goods dent have been sold, and the cosignment account to such and such person or place

was debited with the cost price of the goods, the Consignment Outward Account will now reflect profit

or loss. In case it results in a profit, the entry will be :


To Profit and Loss A/c

(The profit earned on Consignment to such and such place transferred to Profit & Loss A/c.)

In case the consignment deal results in loss, the entry will be reverse, i.e.,

Profit & Loss A/c Dr.


(The loss of Consignment A/c transferred to Profit & Loss A/c.)

Adjustment of Proforma Invoice Price :

But if the goods were consigned at a price in excess of cost and the Consignment Outward Account

was debited and Goods sent on Consignment A/c credited at the excess price, then an adjustment entry

will have to be made, before ascertaining the profit or loss on Consignment. The adjustment entry will

be :

Goods sent on Consignment A/c Dr.


(With the amount of excess price charged on Consignment A/c)*

*Note:— The discount charge is financial expense and discount acount therefore is transferred to

profit and loss account and not to consignment account.

Lastly, the ‗‗Goods sent on consignment A/c‘‘ will be transferred to the Purchase or Trading A/c. The

journal entry will be ;

Goods sent on Consignment A/c Dr.

To Trading A/c

Unsold Stock of Consignment Goods : Its Valuation :

If a part of the goods sent to the Consignee has remained unsold, the unsold stock with the Consignee

must be valued and brought into the books before profit or loss can be ascertained. This unsold stock is

valued at cost price or market price, whichever is lower of the two. The cost price here should not mean

merely the cost at which the goods were invoiced but should include such proportionate expenses

as normally increase the value of the goods consigned. Such expenses are freight, custom duties, dock

dues, insurance-in-transit, loading and unloading charges, etc. It does not matter whether these expenses

are paid by the Consignor himself or by the Consignee. But the expenses incurred by the Consignee in

effecting sales, such as advertisement, travellers commission, storage, insurance against fire or theft, are

not included in determining the cost price of the unsold stock. In other words it can be said that all direct

expense or all expenses made whether by the consignor or by the consignee in placing the goods in a

saleable condition (all expenses till the goods reach the godown of the consignee) will be taken into

account while valuing the closing stock.

Example : Suppose the Consignor sends to the Consignee, 1,00 units at Rs.25 per unit and pays costa

duty, Rs.1,000; marine insurance, Rs.500. The Consignee pays, at the time of taking delivery, unloading

charges of Rs.250. The Consignee also pays godown rent Rs.550 and advertisement Rs.250.

If 200 units (1/5th of the total goods) remain unsold. They will be valued as :— Rs.P.

1/5th of 1000 units, i.e., 200 Radios @ Rs.25

1/5th of Rs.500, Marine Insurance

1/5th of Rs.250, unloading charges paid by the Consignee

Total value of unsold Stock

..... 5,000.00

..... 100.00

..... 50.00

5,350.00

The rule regarding valuation is cost or market price whichever is lower.

In the market price of the unsold stock is more than Rs.5,350, it will be valued at Rs.5,350. If however,

the market price is less than Rs.5,350, it will be valued at the market price. Any loss or depreciation

of stock should be duly taken into account.

The unsold stock valued in the above manner will now be brought into books by passing an entry, as

Stock on Consignment A/c Dr.

To Consignment Outward A/c ?

Note : If the proforma invoice was made out at a price higher than the cost, stock will also be valued

at invoice and not at cost. But it is wrong to show unsold stock in Balance Sheet at a figure higher than

the cost. Hence for the difference (i.e., difference between value of stock at invoice price and value of

stock at cost) reserve must be created, Entry is :


To Stock Reserve A/c ?

The Stock on Consignment will appear as an asset in Balance Sheet of the Consignor.

Entries in the Books of the Consignee :

As has already been pointed out, the Consignee receives the goods of the Consignor as an agent and

sells them on behalf of the principal. These goods do not belong to him, so he is not to make any entry

*Note:— This entry is the everse of the ntry paswsed at the time when goods ae sent on Consignment

to the Consignee.

till he incurs expenditure on them and sells them at his place. But he must keep a detailed note of the

receipt of these goods, otherwise they are mixed with his own goods.

The Entries are

1. On Receipt of Goods :

No Entry. Only a detailed note is maintained.

2. Expenses of the Consignee :

Consignor‘s Personal A/c Dr.

To Cash (or Bank) A/c

(Custom-duty, dock charges, unloading charges

at the time of receiving the goods and later on,

advertisement, godown rent, etc., paid)

3. When (and if) an Advance is given :

Consignor‘s Personal A/c Dr.

To Cash (r Bank or Bills Payable) A/c

4. When goods are sold :

(i) For Cash .......... (i) Cash (or bank) A/c..... Dr.

Consignor‘s Personal A/c

(ii) On Credit ....... (ii) Debtors A/c ........ Dr.

To Consignor‘s Personal A/c

(iii) If Purchased by the.... (iii) Purchase A/c..... Dr.

Consignee himself To Consignor‘s Personal A/c

5. For Commission Earned :

Consignor‘s Personal A/c....... Dr.

To Commission A/c.

6. On Settling the account of the Consignor :

Consignor‘s Personal A/c ........ Dr.

To Cash (or Bank or B/P) A/c

Det Credere Commission :

Sometimes the consignor allows a special commission to the consignee, called the Del Credere

Commission, by which the loss arising on bad debts on credit sales is borne by the Consignee. Thus if

the Consignee is paid Del Credere Commission and if any amount due from Debtors (to whom Consignment

goods have been sold on credit) becomes irrecoverable, the bad debts will be Consignee‘s loss. The entry

then will be :

Commission A/c........ Dr.

To Bad Debts A/c

The Balance of Commission earned will then be transferred to the Profit and Loss Account.

Thus :

Commission A/c....... Dr.

To Profit and Loss A/c*

Illustration-1

D. Dogra of Delhi sent to his agent, M. Monga of Madras, 500 articles costing Rs.15/- per article

at an invoice price of Rs.20 per article. The following payments were made by D. Dogra in this

connection: freight and carriage Rs. 450, miscellaneous exp. Rs. 50. M. Monga sent a bank draft for

Rs.3,000 as an advance against the Consignment M. Monga sold 300 articles at a flat rate of Rs.28 per

article and sent an Account Sales showing deduction for storage charges Rs.550 insurance Rs.550 and

his Commission of 3% plus 2% Del Credere on gross sale proceeds, and remitted the amount due on

consignment. M. Monga also informed D. Dogra that 50 articles were damaged in transit and thus they

were valued at Rs.550

Record the above transactions in the books of the consignor and consignee.

\

Solution : (Entries made on Cost Price Basis)

Books of D. Dogra (Consignor)

Journal

Dr. Cr.

(1) Consignment to madras A/c

To Goods sent on Consignment A/c

(500 articles sent to M. Monga, Agent, Cost being Rs.15 per article).

Rs.

7,500

500

3,000

8,400

570

4,830

350

2,850

Rs.

7,500

500

3,000

8,400

570

4,830

350

2,850

(2) Consignment to Madras A/c

To Bank Account

(Expenses incurred on the Consignment)

Freight & Carriage Rs. 450

Miscellaneous Exp. Rs. 50

500

(3) Bank Account

To M. Monga

(Advance received from the Agent in the form of Bank Draft.)

(4) M. Monga

To Consignment to Madras A/c

(Sales affected by M. Monga as per Account Sales.)

(5) Consignment to Madras A/c Dr.

To M. Monga

(Expenses incurred by M. Monga Rs.150 and Commission due to

him, Rs.550 (5% of Rs.8,400).

(6) Bank Account Dr.

To M. Monga

(Amount due from the consignee received.)

(7) P & Loss A/c Dr.


(Abnormal Loss on 50 damaged Articles)

(8) Stock on Consignment A/c Dr.


(Value of stock unsold at Madras) Rs.

150, goods articles, @ Rs.20 2,250

Add: Expenses Rs.150 150

50 damaged articles 450

2,850

130

(9) Consignment to Madras A/c Dr.

To Profit & Loss Account

(Profit on consignment transferred to Profit & Loss Account)

3030

7,500

3030

7,500

(10) Goods sent on Consignment A/c Dr.

To Trading Account

(Goods sent on consignment A/c closed by transfer to trading

Account)

Note—(Figures in brackets denote sequence of entries

Ledger

Consignment to Madras Accountt to Madras Account

Dr. Cr.


To bank A/c (expenses)

To M. Monga

Expenses 150

Commission 430

To P & L A/c (Transfer)

Rs.

7,500

500

570

3,030

By M. Monga

(Sale proceeds)

By Stock on

Consignment A/c

By Profit & Loss A/c

(Abnormal Loss)

Rs.

8,400

2,850

350

11,600

11,600

M. Monga

To Consignment to madras A/c

Rs.

8,400

By Bank A/c

By Cosignment to

Madras A/c

By Bank A/c

Rs.

3,000

570

4,830

8,400

8,400

Bank Account

Dr. Cr.

To M. Monga

Rs.

3,000

By Consignment to Madras A/c

Rs.

500

Goods sent on Consignment Account

To Trading A/c Transfer

Rs.

7,500

By Consignment to Madras A/c

Rs.

7,500

Profit & Loss A/c


Rs.

350

By Consignment to

Madras A/c

Rs.

3,030

Books of M. Monga (Consignee)

Journal

Dr.

Cr.

D. Dogra

To Bank Account

(Advance sent to the Consignor against consignment)

Rs.

3,000

150

8,400

420

4,830

Rs.

3,000

150

8,400

420

4,830

D. Dogra

To Bank Account

(Expenses incurred on the Consignment on behalf of D. Dogra

Storage 50

Insurance 100

150

Bank Account

To D. Dogra

(Sale of 300 articles @ Rs.28 each out of the Consignment.)

D.Dogra

To Commission Account

(5% Commission on Sales made on half of D. Dogra; 3% Commission

+ 2% Del Credere Com.)

D. Dogra

To Bank Account

(Amount due to D. Dogra remitted).

Ledger

D.Dogra

Dr. Cr.

To Bank A/c (Advance)

To Bank A/c (Expenses)

To Commission A/c

To Bank A/c (amount remitted)

Rs.

3,000

150

420

4,830

By Bank A/c (Sale proceeds)

Rs.

8,400

8,400

8,400

Bank Account

To D. Dogra

Rs.

8,400

By D. Dogra

By D. Dogra

By. D. Dogra

Rs.

3,000

150

4,830

Commission Account

By D. Dogra 420

Entries made on Invoice Price basis. If it is desired to make entries on the basis of invoice price,

the following will be the changes as compared to the solution given above :

Instead of entry No. 1 there will be the following entry ;

1. Consignment to Madras A/c To Goods sent on consignment A/c

(500, articles consigned at an invoice price of Rs.20 each (cost Rs.15)

Rs.

10,000

Rs.

10,000

Entries No.(2) to (6) will remain unchanged. The following will be other entries—No.(7) onwards :

7. Stock on Consignment A/c To Consignment to Madras A/c

Value of Stock at Madras Rs.

150 goods articles @ Rs.20 3,000

proportionate expenses 150

50 damaged articles 450

3,600

Rs.

3,600

2,500

750

3030

7,500

Rs.

3,600

2,500

750

3030

7,500

8. Goods sent on Consignment a/c To Consignment to Madras A/c

(Excess amount included in invoice price of articles sent to Madras

(Rs.5 each) credited on consignment A/c)

9. Consignment to Madras A/c

To Stock Reserve Account (Reserve credited equal to excess amount above cost (Rs.5 per

articles) included in valuation of stock)

10. Consignment to Madras A/c

To Profit and Loss Account

(Transfer of Profit on Consignment)

11. Goods sent on Consignment A/c

To Trading Account

(Goods sent on Consignment A/c closed by transfer to Trading A/c)

The Ledger Accounts relating to M. Monga, bank and Profit and Loss will be same as shown already.

The other accounts will now appear as under :—

Dr. Consignment to Madras Account Cr


To Bank A/c (expenses)

To M. Monga

To Stock Reserve A/c


Rs.

10,000

500

570

750

3,030

By M. Monga

by Stock on Consignment

Account

By Goods sent on Consignment

A/c (Loading)


(Abnormal Loss)

Rs.

8,400

3,600

2,2500

350

14,850

14,850

Dr. Goods sent on Consignment Account Cr.


To Trading A/c

Rs.

2,500

7,500

Rs.

By Consignment to

Madras A/c

10,000

10,000

10,000

Dr. Stock on Consignment Account Cr.

To Consignment to Madras a/c

Rs.

3,600

Dr. Stock on Consignment Account Cr.

By Consignment to Madras Account

Rs.

750

In the Balance Sheet the stock on consignment will be shown at Rs.2,850 i.e., Rs.3,000 minus the

reserve of Rs.750.

Abnormal Loss. In the illustration, it has been mentioned that 50 articles have been damaged and

have been valued at Rs.450 Had there been no damage, the value (at cost) would have been Rs.800.

Cost @ Rs.15 Rs.750

Proportionate Expenses Rs.50

Rs.800

Thus, there is a loss of Rs.350, i.e., Rs.800 less Rs.450 In the absence of such loss, the profit on

consignment would have been Rs.2,680 + Rs.350, i.e., Rs.3,030 This is a better measure of the profit on

consignment. To ensure that the Consignment Account shows true consignment profit, such a loss would

be recorded by means of the following entry ;

Profit and Loss Account Dr. 350

To Consignment Account 350

This entry will no doubt increase the profit shown y the consignment account ut will not inflate profits

because the amount concerned is being debited in the Profit and Loss Account. Loss of Stock

In case the goods sent on consignment are lost or damaged in transit or otherwise, the loss is that

of the consignor and not of the consignee. Accordingly the consignor will have to make the entries for

such loss. There may be two types of losses viz. Normal loss and Abnormal loss.

Normal Loss:—Normal loss is natural, unavoidable and inherent in the nature of goods or commodities

or articles sent on consignment. This type of loss is a part of the cost of the consignment, so the consignor

does not make separate entry for such a loss. However, the normal loss has to be taken into consideration

while valuaing the unsold consignment stock in the hand of the consigne.

The accounting treatment of normal loss is to charge the total cost of the goods to the remaining goods

after the normal loss. In other words, the value of the unsold stock is calculated in proportion to the total

cost of the goods consigned.

Value of unsold stock = Total Cost of the goods sent

Total quantity sent – quantity of normal loss

Suppose 10,000 tones of coal are despatched. The cost of 1 tonne of coal is Rs.80 and the freight

incurred is Rs.36,000. To the Consignor the total cost comes to rs.8,35,000. In the nature of coal some

shortage is unavoidable. Suppose the Consignee receives only 9,500 tonnes. It is legitimate to say that the cost is Rs.8,36,000 for 9,500 tonnes.

In that case the Consignor can properly say that the cost of 1 tonne of coal is

Rs.8,36,000

9,500

or Rs.88. If 2,000 tonnes of coal are left unsold with the Consignee, the value of stock will e 2,000 ×

88 i.e. Rs.1,76,000.

Illustration 2 :

Mr. Datta Consigned to hatt 10,000 kgs of flour, costing Rs.33,000. He spent Rs.550 as forwarding

charges. 12% of the Consignment was lost in weighning and handling. Mr. Bhatta sold 8,200 kgs. of flour

at Rs.6 per kg, his selling expenses being Rs.3,300 and Commission 5% on sales. Prepare the Consignment

Account.

Solution :

Ledger of Mrs. Datta

Consignment Account

To Goods sent on Consignment Account

To Bank (forwarding Charges)

To Consignee‘s A/c

Rs.

Selling Expenses 3,300

Commission

@5% on Rs.49,200 2,460


Rs.

3,3000

880

5,760

11,870

By Bhatt (Sales) (8,200×6)

By Stock on

Consignment*

Rs.

49,200

2,310

51,510

51,510

unsold quantity

Working Notes :

(i) Calculation of Closing Stock :

Total Quantity of Flour Consigned

Less : Normal Loss 12%

Sales

1,200 kgs.

8,200 kgs.

10,000 kgs.

9,400 kgs.

Closing Stock 600 kgs.

*(ii) Valuation of Closing Stock:

Total Cost of the goods sent The non recurring exp ensses

Units of Goods sent – Normal losses (units)

Rs.33,000 Rs.880

10,000 1,200

= 33,880

600 = 2,310

Abnormal loss:- It arises due to abnormal factors or circumstances such as fire, theft Pilferage,

sabotage etc. In case of abnormal loss the price is not inflated at all. This loss is calculated y adding

proportionate direct expenses incurred by the consignor and the consignee as the case may be to the

original cost of the goods.

The accounting Entry is :

Debit Abnormal Loss A/c

Credit Consignment A/c

In case the stock is insured, the amount of claim admitted by the insurance company should be

reduced from the Abnormal loss and only the net loss amount should be debited to Abnormal loss or P&L

A/c.

The entry will be :

Debit : Insurance Company A/c (with the amount of claim admitted)

Debit : Profit and Loss (Abnormal Loss A/c) (with the amount of loss)

Credit: Consignment A/c (with the amount of Total Abnormal loss)

The procedure for calculating the Abnormal loss and the valuation of the remaining stock is

summarised as under :

(i) Calculation of Abnormal loss :

Add

Less

(ii) Valuation of Closing Stock

Cost of goods Lost

Proportionate Expenses of the goods lost

any amount of claim

(if any received from the insurance company)

(1) Cost of the goods – Closin g Stock

Total goods consigned

× Cost of total goods consigned

ClosingStock (units)

= 600

8,800

Add. Proportionate Non-recurring (direct) expenses incurred before the loss –

closin g stock

Total goods consigned

Add: Proportionate expenses (Direct only)

× Expenses incurred before the loss

incurred after the loss : (Total quantity sent goods Lost)

× Expenses incurred after the loss.

Illustration 3 :

Philips Radio of Calcutta despatched 1,000 transistors at Rs.700 each to Mohan Bros. of Delhi, the

consignors paid freight Rs.7,500, cartage Rs.500 and insurance Rs.2,500 Mohan Bros. received only 900 sets and incurred he following expenses.

Octroi and other Expenses

Cartage

Sales expenses

Rs.

1,00,000

5,000

6,000

The consignee sold 600 sets only. You are required to calculate the value of closing stock.

Solution :

Calculation of the value of unsold stock

Sets received 900-sets sold 600 = unsold stock 300

(i) Cost of unsold stock 300 × 700

(ii) Add: Proportionate Expenses Paid by consignor

Rs.

= 2,10,000

(7500 + 500 + 2500)10

× 10,500 = 3,150

(iii) Add: Proportionate Expense

paid by consignee

Octroi

Cartage

1,00,000

5,000

1, 05, 000 300 = 35,000

2,48,150

Illustration 4 :

S of Bombay consigned 10,000 kg. of oil to D of Calcutta. The cost of oil was Rs.2 per kg. S paid

Rs.5,000 as freight and insurance. During transit 250 kg were accidentally destroyed for which the

insurers paid directly to the consignors Rs.450 if full settlement of the claim.

D reported that 7,500 kg were sold @ Rs.3 per kg. The expenses being on godown rent Rs. 200 on

advertisement Rs.1,000 and on salesman salary Rs.2,000 D. is entitled to a commission of 3% plus 1.5%

del credere. D reported a loss of 100 kg. due to leakage. D. settled the accounts by bank draft. Prepare

the accounts is the books of S.

quantity unsoid

3

900

Consignment to Calcutta A/c

Dr. Cr.

Rs. Rs.

To Goods on Consignment A/c

To Bank—Freight & Insurance

To D—Expenses

To D—Commission

Rs.

Ordinary 3% 675

Del Credere 1.5% 338

20,000

5,000

3,200

1,013

By Bank (Ins. Co.)

By P & L A/c (abnormal loss

By D—(Sale proceeds)

By Consignment Stock A/c

By P & L A/c—Loss

450

175

22,500

5,431

657

29,213

29,213

Goods Sent on Consignment A/c

Dr. Dr.

To Trading A/c

Rs.

20,000

By Consignment to Calcutta A/c

Rs.

20,000

Consignment Stock A/c

Dr. Dr.

To Consignment Calcutta A/c

Rs.

5,431

By Balance c/d

Rs.

5,431

D

Dr. Dr.

To Consignment to Calcutta A/c

—(sale proceeds)

Rs.

22,500


(Exp.)


(commission)

By Bank

Rs.

3,200

1,013

18,287

22,500

22,500

Working Notes :

(A) Cost of Goods destroyed Rs.

Cost of 10,000 [email protected] 20,000

Freight 5,000

Total cost of 10,000 kg. 25,000

(B) Value of Stock still unsold Kg.

Quantity received by D =

Less Normal leakage =

9,750 (excluding accidental loss)

100

9,650

Cost of 9,650 kg = Rs.25,000-625 = Rs.24,375

Cost of 2,150 kg. = 1 25

2150 = Rs.5,431

Illustration 5 (Valuation of Stock):

A company sends 300 bales of cotton to its consignee at profit 20% on sale. The cost of each

bale to company is Rs.600 per bale. The following are the expenses incurred in connection with this

consignment :

(a) Rs.900 paid by the consignor for despatching goods.

(b) Rs.2,000 paid by the consignee by way of freight, duty and landing charges.

(c) Rs.1,000 paid by the consignee by way of godown rent, salaries of salesman.

Required :

The Valuation of stock at the end (at invoice price) if the consignee sells away 2/3rd of the consignment.

Solution :

Total bales sent 300

Less bales sold 2/3rd or 300 200

Bales unsold 100

Cost price of 100 ales at Rs.550 per bale 60,000

Add Profit at 20% on sale or 25% on cost 15,000

Add 1/3rd direct expenses : 75,000

Expenses paid by Consignor 900

Expenses paid by Consignor 2,000

1/3rd thereof 2,900 967

Stock at the end (at Invoice Price) 75,967

Note : In the consignment account, stock reserve account will appear at Rs.15,000 on the debit side.

Illustration 6 (Calculation of Stock at the end) :

Deepak sold goods on behalf of Geep Sales Corporation on consignment basis. On 1 January 2002

he had with him a stock of Rs.20,000 on consignment. During the year he received goods worth

Rs.2,00,000.

Deepak had instructions to sell goods at cost plus 25% and was entitled to a commission of 4% on

sales in addition to 1% del credere commission.

During the year ended 31 December 2002 cash sales were Rs.1,20,000; credit sales Rs.1,05,000;

Deepak‘s expenses relating to consignment Rs.3,000 being salaries and insurance bad debts amounted to

Rs.3,000.

Prepare necessary accounts in the books of Geep Sales Corporation.

1 00

Solution :

Dr.

In the books of Geep Sales Corporation

Consignment Account

Cr.

To Consignment Stock b/d

To Goods sent on Consignment Account

To Deepak (Commission)

To Deepak (Commission)

To Deepak (expenses)


Profit)

Rs.

20,000

2,00,000

9,000

2,250

3,000

30,750

By Deepak

Cash Sales 1,20,000

Credit Sales 1,05,000

By Consignment Stock c/d

Rs.

2,25,000

40,000

2,65,000

2,65,000

Deepak’s Account

Dr. Cr.

To Consignment account (Sales)

Rs.

2,25,000

By Consignment account

(Commission)

By Consignment Account

(Commission)


(Exp.)

By Balance c/d

Rs.

9,000

2,250

3,000

2,10,750

2,25,000

2,25,000

Working Notes :

(1) Calculation of Consignment Stock

Sale Price = 100 + 25 = 125

Cost of Sales = Sales × 125

= 2,25,000 ×125

= Rs.1,80,000

Cost of the goods available for sale = Rs. 20,000 + Rs.2,00,000 = Rs.2,20,000

Hence stock at the end = Rs.2,20,000 - Rs.1,80,000 = Rs.40,000

(2) Since Deepak is paid del-credere commission, bad debts of Rs.3,000 would be borne by him.

Illustration 7 :

Messrs. Sundar & Company consigned 1,000 tins of Ghee costing Rs.60 per tin to their agents, Bansal

Stores, at Calcutta. The agents sold 400 tins at Rs.80 per tin for cash, 400 tins at Rs.82 per tin on credit

and they took over the balance to their own stock at Rs.82 per tin. Messrs. Sundar & Company paid

freight and carraige Rs.500 and miscellaneous expenses Rs.200. They drew on Bansal Stores at 3 Months

for Rs.45,000, which was duly accepted by the later. The expenses incurred by the Bansal Stores were :

100 100

Carriage Rs.50

Octroi Rs.40

Storage Rs.110

Miscellaneous Rs.100

They were entitled to 5% commission and 2% del credere commission on total gross sale proceeds.

They sent their account sales to their principal showing as a deduction there from their commission and

the various expenses incurred by them a month later. All the debtors except one who owed Rs.200 paid

cash and the bansal Stores remitted the amounts due on consignment.

Show the journal entries in the books of the consignor and the consignee‘s account and consignment

account in the consignor‘s ledger. Show also the entries relating to consignment inwards and the consignor‘s

personal accounts at it would appear in the consignee‘s ledger.

Journal Entries

(In the books of Consignor)

Rs. Rs.

(1) Consignment Account Dr.

To Goods sent on consignment account

(being the goods sent on consignment)

60,000

700

300

81,200

5,684

14,516

60,000

45,000

60,000

700

300

81,200

5,684

60,000

45,000

(2) Consignment Account Dr.

To Bank Account

(being the expenses incurred by consignor on account of consignment)

(3) Consignmet Account Dr.

To Bansal stores account

(being the expenses incurred by consignee on account of consignment)

(4) Bansal store account Dr.

To Consignment account

(being the sale effected by the consignee)

(5) Consignment account Dr.

To bansal stores account

(being the commission on sales)

(6) Consignment account Dr.

To Profit & Loss account

(being the profit on consignment transferred to profit ad loss account)

(7) Goods sent on consignment account Dr.

To Purchase account

(being the value of goods sent on consignment)

(8) Bills Receivable account Dr.

To Bansal stores account

(being the bill drawn on consignment)

Ledger

Consignment of Calcutta Account

Rs. Rs.

To Goods sent on consignment account

To Bank-Expenses

To Bansal store account-Expenses

To Bansal stores account—Commission

To profit & Loss A/c

60,000

700

300

5,684

14,516

By Bansal store :

Cash sales

(400 × 80) = 32,000

Credit sales

(400 × 82) = 32,800

Balance of stock taken

(200 × 82)

32,000

32,800

16,400

81,200

81,200

Illustration 8 (Abnormal Loss) :

On January 1, 2002, A of delhi sent on consignment to B of Bombay 200 packets of coffee costing

Rs.80 each invoiced pro forma at Rs.100 each. The freight and other charges paid by A amounted to

Rs.640. A sent the documents through Bank and drew upon B a bill for Rs.10,000 and discounted the

same with the Bank for Rs.9,800. The bill was met on maturity.

On march 15, B sent Account sales (together with the amount due) showing that 150 packets had

realised Rs.100 each and 25 packets Rs.110 each and 25 packets were shown as unsold stock. B incurred

Rs.400 as expenses for the entire consignment. B is entitled to a commission of 6%.

On March 31 B informed A that 15 packets were damaged due to bad packing and it was estimated

that the selling price of the damaged packets would be about Rs.20 per packet.

Both A and B close their books on March 31. Prepare ledger accounts in the books of A and B.

Solution :

Books of A, Delhi

Consignment of BOmbay Account

2002 Jan. 1

To Goods sent on consignment

To Bank (Expenses)

To B. Exp.

To B (Commission)

To Stock Reserve Account


Rs.

20,000

640

400

1,065

200

1,725

2002 March 15

By B (sales)

By Goods sent on consignment (loading)

March 31

By Abnormal Loss (1)

By Stock on Consignment (2)

By Stock of damaged goods

Rs.

17,750

4,000

648

1,032

600

24, 030

24,030

B’s Account

2002 March 15

To Consignment Account Sales

March 31

To Balance c/d

Rs.

17,750

500

2002 Jan. 1Rs.

By Bills Receivable

March 15

By Consignment Account-Expenses

By Consignment Account-Commission

March 31

By Bank

April 1 By Balance b/d

10,000

400

1,065

6,785

18,250

18,250

500

Goods sent of Consignment Account

2002 March 31 Rs.

To Consignment account Loading 4,000

To Purchase Account Transfer 16,000

20,000

2002 Jan. 1 Rs.

By Consignment Account 20,000

20,000

Books of B

2202 Jan. 1

To Bills Payable

To bank-Expenses

March 15

To Commission Account

March 31

To Bank

April 1 To Balance b/d

Rs.

10,000

400

1,065

6,785

2002 March 15

By Bank

By Balance c/d

Rs.

17,750

500

18,250

18,250

500

Note:

(i) Stock at the end (At Invoice Price) Rs.

10 Packets @ Rs.100 (Invoice Price) 1,000

Add Proportionate expenses incurred by A i.e. 1/20th of Rs.640 32

1,032

(ii) Abnormal Loss

Cost of 15 packets damaged 1,200

Add Proportionate expenses 200

15 48

1,248

Less Value of 15 packets @ Rs.20 Per Packet

600

648

640

(iii) Since 10 Packets are still in the stock-in-hand, advance to that extent has not been adjusted.

Hence Rs.500 is carried forward i.e.

10,000 × 200

Illustration 9 (Normal and Abnormal Loss) :

Vegetables Oils Ltd., Pune, consigned 10,000 kg. of Ghee costing Rs.20 per Kg. to Ramesh and

Company of Madras on 1st January 2002. Oils Ltd. paid Rs.50,000 as freight and insurance. 250 Kgs.

of ghee were destroyed on 10-1-2002 in transit. The insurance claim was settled at Rs.4,500 and was

paid directly to the consignors.

Ramesh and Co. took delivery of the consignment on 20th January 2002 and accepted a bill drawn

upon them by Oils Ltd. for Rs 1,00,000 for 3 months. On 31st March 2002 Ramesh and co. reported as Follows.

(i)

(ii)

(iii)

7,500 Kg. were sold at Rs.30 per Kg.

Other expenses were : godown rent Rs.2,000; Wages Rs.20,000 Printing and Stationary including

advertising Rs.10,000

250 Kg. were lost due to leakage.

Ramesh and Co. are entitled to a commission of 4.5% on all the sales affected by them. They paid

the amount due in respect of consignment on 31st March itself.

Show the consignment account, the account of Ramesh and Co. and loss-in-transit account in the

books of consignor for the year ended 31st March 2002. Solution :

Books of Oils Ltd., Pune.

Consignment to Madras Account

2002 Jan 1

To Goods sent on Consignment

Account

To Bank-Expenses

March 31

To Ramesh and Co. Account

Expenses and Commission

(2,000+20,000+10,000+10,125)

Rs.

2,00,000

50,000

42,125

2002 Jan. 10

By Loss-in-transit

March 31

By Ramesh and Co.—Sale

By Stock on Consignment A/c

By Profit & Loss Account (Loss)

Rs.

6,250

2,25,000

51,316

9,559

2,92,125

2,92,125

Loose-in-Transit Account

2002 Jan.10

To Consignment Account

Rs.

6,250

2002 March 31

By Insurance Co.

By Profit & Loss Account

Rs.

4,500

1,750

6,250

6,250

10

Ramesh and Co.

2002 March 31

To Consignment account

To Balance c/d

Rs.

2,25,000

20,000

2002 Jan. 20

By Bill Receivable

March 1


Expenses and Commission

By Bank

Rs.

1,00,000

42,125

1,02,875

2,45,000

2,45,000

Working Notes :

(1) Cost of ghee destroyed in transit

Cost of 10,000 Kg. of ghee @ Rs. 20

Freight and Insurance

Total cost of 10,000 Kg.

Rs.

2,00,000

50,000

2,50,000

Cost of 250 Kg. (2,50,000 250)

10,000

6,250

Cost of 9,750 k.g. of ghee

(2) Value of stock at the end

Quantity of ghee received by the consignee

Less : Quantity lost through leakage (Normal Loss)

Quantity Available for sale

Total Cost of 9,500 Kg.

9,750 Kg.

250 Kg.

9,500 Kg.

2,43,750

2,43,750

Cost of 2,000 Kg.

2,43,750 2,000

9,500

51,316

(3) Since 2000 Kg. of ghee has not been sold.

Proportionate amount of advance is (100,000×1/5) is Rs.20,000 will not be adjusted.

Exercise :- Shah sends goods on consignment to Rao. The terms are that Rao will receive 10%

commission on the invoice price (which is cost plus 25%) and 20% of any price realised above the invoice

price. Rao will meet his expenses himself, goods to be sent freight paid.

Shah sent goods costing Rs.1,60,000 and septum Rs.15,000 on freight forwarding etc. Rao accepted

a bill of exchange for Rs.1,60,000 immediately on receiving the consignment. His expenses were Rs.2,000

as rent and Rs.1,000 as insurance. Rao sold 3/4 of the goods for Rs.1,95,000. Half of the sales were on

credit and one customer failed to pay Rs.4000.

Give consignment account and Rao‘s Account in the books of Shah and important ledger accounts

in the books of Rao.

INLAND BRANCH ACCOUNTS

A firm, having branches, would like to know the profits earned or losses incurred at each branch. The

system of accounting adopted by the firm (known as Head Office) will will depend on the type of branch.

The branches may be classified as under :

(i) Branches receiving goods only from the head office, selling goods only for cash, remitting all

cash received to the head office, expenses being met out of remittance from the head office.

(ii) The branches similar to (i) above, except that the goods are sold both for cash and credit.

(iii) The branches similar to (ii) except that the head office sends to the branches goods at invoice

price.

(iv) Branches functioning as an autonomous unit.

(v) Foreign Branches.

Accounts for the first three types of branches are kept by the head office. The last two types of

branches maintain an independent set of books of account.

Under the category (iii) the goods are invoiced to the branch at selling price (invoice price) by the

H.O. To ascertain correct profit, necessary adjusting entries are recorded to reduce the selling price to

cost price. Similarly closing stock is valued at invoice price. Now for reducing closing stock, stock reserve

is created. Thus the following journal entries will be passed in the books of H.O.

(i) Branch a/c

To goods sent to Branch A/c

(ii) Branch A/c

To Bank A/c

(iii) Bank A/c

To Branch A/c

(iv) Branch Stock A/c

Branch Debtors A/c

To Branch A/c

(v) Goods Sent to Branch A/c

To Branch A/c

(vi) Branch A/c

To Branch Stock Reserve A/c

(vii) Branch A/c


(viii) Goods sent to Branch A/c

To Trading A/c

Dr. Invoice value of goods sent.

Dr. Cash sent for expenses.

Dr. Cash remitted by the branch to the H.O.

(Cash consists of sales and receipts from Drs.)

Dr. Branch stock (at invoice Price) and branch

Dr. debtors at the end of the year.

Dr. Invoice price on goods sent to branch adjusted.

(Loading on the goods sent)

Dr. Invoice value of closing stock adjusted.

Dr. Profit at branch

Dr. Goods sent to Branch Transferred.

Take an example. A new branch is opened and goods costing Rs.40,000. are sent to it. Further,

Rs.5,000 are sent by the H.O. to the branch for expenses. The branch remits Rs.51,000. as sale proceeds

194

to the H.O. All the goods sent by H.O. has been sold by the branch. Thus it is clear that the branch has

made a profit of 51,000-45,000 = Rs.6,000. This will be recorded in the books of H.O. as follows (without

narrations)

Rs. Rs.

Branch A/c Dr.

To Goods Sent to Branch A/c

40,000

5,000

51,000

6,000

40,000

5,000

51,000

6,000

Branch A/c Dr.

To Bank

Bank A/c Dr.

To Branch A/c

Branch A/c Dr.

To P & L A/c

In the above example, there was no unsold stock. If there is closing stock, it should be valued on the

basis of well-accepted principle, i.e. Cost or market Price, whichever is lower of the two. The journal

entry of the unsold stock will be :

Branch Stock A/c Dr.

To Branch A/c

In case, the branch sells goods on credit, the entry for closing debtors will be :

Branch Debtors A/c Dr.

To Branch A/c

The closing stock and closing Debtors will be shown in the Balance Sheet and transferred to the

Branch A/c next year. It should further noted that Branch is credited when it remits Cash to H.O. This

cash consists of Cash sales and collected from debtors. Branch accounts should not be debited.

Illustration-1 : A Limited opened a branch at Shimla in 2002. Goods were invoiced at cost plus 25%.

From the following prepare ledger accounts in the books of A Limited.

Rs.

Goods sent to Simla (Invoice Price) 40,000

Sales at Simla :

Cash Sales 21,000

Credit Sales 16,000

Cash collected from debtors 14,500

Discount allowed 200

Cash sent to Branch for expenses 4,000

Stock at Branch, 31st Dec.2002 (Invoice Price) 3,200

195

Solution

Dr.

A. Ltd’s Books

Shimla Branch A/c

Cr.

2002

Dec.31

To Goods sent to

Branch A/c

To Bank (Expenses)

To Bank stock

Reserve A/c

To P & L A/c

transfer

Rs.

40,000

4,000

640

3,360

2002

Dec.31

By Bank (Remittance)

Cash sales 21,000

Cash Form Drs. 14,500

By Branch Stock A/c

By Branch Debtors A/c

By Goods sent to Branch A/c

(loading)

Rs.

35,500

3,200

1,300

8,000

48,000

48,000

Goods sent to Branch A/c

2002

Dec.31

To Shimla Branch A/c

(Loading)

To Trading A/c

(transfer)

Rs.

8,000

32,000

2002

By Shimla Brach A/c

Rs.

40,000

40,000

40,000

Branch Debtors A/c

2002

To Sales A/c

Rs.

16,000

2002

By Cash

By Discount

By Balance c/d

Rs.

14,500

200

1,300

16,000

16,000

Branch Stock A/c

2002

Dec.31

2003

Jan.1


To Balance b/d

Rs.

3,200

2002

Dec.31

By Balance c/d

Rs.

3,200 3,200

Branch Debtors A/c

2002

Dec.31

2003

Jan.1


To Balance b/d

Rs.

1,300

2002

Dec.31

By Balance c/d

Rs.

1,300

1,300

196

Branch Stock Reserve A/c

2002

Dec.31

To Balance c/d

Rs.

640

2002

Dec.31

2000

Jan.1

By Shimla Branch A/c

By Balance

Rs.

640

640

Stock and Debtors System :

When goods are sent by head office to branch at an invoice price, then this system can be used to

ascertain profit or loss of the branch. Under this system, the following ledger account are opened :

(1) Branch Stock Account

(2) Branch Debtors Account

(3) Branch expenses Account

(4) Branch Adjustment Account, Or

Branch Profit and Loss Account

The Head Office keeps branch assets‘ account as usual.

Entries to be made by the Head Office.

(1) When goods are sent by Head Office to branch at Invoice price.

S.No.

Particulars

L.F.

Rs.

Rs.


To Goods Sent to Branch A/c

(Goods sent to branch at an invoice price)

(2) If goods are returned by the branch then

Goods Sent to Branch A/c Dr.

To Brach Stock A/c

(Goods returned by the branch)

(3) When branch expenses are paid by the head office.

Branch Expenses A/c Dr.

To Cash A/c

(Branch expenses paid by head office)

(4) Sales of goods by branch

Cash A/c Dr.

To Branch Stock A/c

(Cash sales at branch)

197

(5) In case of credit sales by the branch

Branch Debtors A/c Dr.

To Branch stock A/c

(Credit sales at branch)

(6) Cash receipts from branch debtors

Cash A/c Dr.

To Branch debtors A/c

(Cash received form branch debtors)

(7) When any amount is spent or discount etc. is allowed on debtors of the branch.

Branch Expenses A/c Dr.

Branch Discount A/c Dr.

To Branch Debtors A/c

(Expenses on branch debtors)

(8) If there is shortage/loss of stock, then

Branch adjustment A/c Dr.

To Branch Stock A/c

(Loss in Stock at branch)

(9) Entry for difference in price i.e. invoice price and cost relating to opening stock at branch goods

sent to branch.


Goods Sent to branch A/c Dr.

To Branch adjustment A/c

(Difference in value passed)

(10) In case of closing stock at branch, reverse entry of the above is to be passed i.e.

Branch Adjustment A/c Dr.

To Branch Stock A/c

(Difference in value passed)

(11) Branch expenses are transferred to branch adjustment account i.e.


To Branch Expenses A/c

(Branch expenses transferred)

198

(12) Transfer of balance of branch adjustment account to general profit and loss account, then


To General Profit & Loss A/c

(Balance being profit transferred)

Note : In case of loss at branch, reverse entry to be passed.

(13) Goods sent to branch is transferred to Purchases account if it is a trading concern and in Trading

account if it is a manufacturing concern.

Illustration-2

A Ltd. has a branch in Calcutta. Goods are invoiced at cost plus 25%.

Opening Balance 2002

Stock 3,200

Debtors 1,300

Goods sent to Branch (Invoice price) 75,000

Sales at Calcutta

Cash Sales 32,000

Credit Sales 38,000

Cash collected from Debtors 33,400

Discount allowed 400

Bad Debts written off 250

Cash sent to Branch for expenses 5,500

Stock at end 7,900

Branch Stock A/c

2002

Jan.1

To Balance b/d

To goods sent to

Branch A/c

3,200

75,000

2002

To Cash Sales

By Branch Debtors

By Branch Adjustment A/c

By Balance c/d

32,000

38,000

300

7,900

78,200

78,200

Goods sent to Branch A/c

2002

Dec.31

To br. Adjustment

A/c (loading)

To Trading A/c

(Transfer)

15,000

60,000

2002

By Br. Stock A/c

75,000

75,000

75,000

199

Branch Stock Reserve A/c

2002

Dec. 31

To Br. Adjustment A/c

To balance c/d

640

2002

Jan.1

Dec.31

By Balance b/d

By Branch Adj. A/c

640

1,580

1,580

Branch Debtors Account

2002

Jan.

To Balance b/d

To Branch Stock

(cr. Sales)

1,300

38,000

2002

by Cash

Dec.31

33,400

By Branch Exp. A/c

Discount 400

Bad Debts 250

By Bal. c/d

650

5,250

39,300

39,300

Branch Adjustment A/c

2002

Dec.31

To Be Stock Reserve

(closing stock) A/c

To br. Stock A/c

(shortage)

To Br. Exp. A/c

To P & L A/c

1,580

300

7,150

6,610

2002

Dec.31

By Stock Reserve

(opening stock)

By Goods sent to br. A/c

640

15,000

15,640

15,640

Branch Expenses A/c

2002

To Cash

To branch Dr.s A/c

Discount 400

Bad Debts 250

6,500

650

2002

Dec.31


7,150

7,150

7,150

* This is the balancing figure.

Illustration-3

Agra head office supplies goods to its branch at Alwar at invoice price which is cost plus 50%. All

Cash received by the branch is remitted to Agra and all branch expenses are paid by the head office.

From the following particulars related to Alwar Branch for the year 2006, prepare Branch debtors account

200

Branch stock account and Branch Adjustment Account in the books of the head office so as to find out

the gross profit and net profit made by the branch.

Stock with Branch on 1.1.2006 (at invoice price)

Branch Debtors on 1.1.2006

Petty cash balance on 1.1.2996

Goods received from head office (at invoice price)

Goods returned to Head Office

Credit Sales

Sales Returns

Allowance to customer on selling price

(already adjusted while invoicing)

Cash received from debtors

Discount allowed to debtors

Expenses (cash paid by Head Office)

Rent

Salaries

Petty Cash

Cash Sales

Stock with Branch on 31.12.2006 (at invoice price

Petty Cash balance on 31.12.2006

Rs.

66,000

22,000

500

2,04,000

6,000

87,000

3,000

2,000

93,000

2,400

Rs.

2,400

24,000

2,000 28,400

1,06,000

69,000

100

[Delhi B.Com. (Pass) 2001]

Solution

Dr.

In the books of Agra Head Office

Alwar branch debtors accounts

Cr.

Particulars

To Balance b/d

To Branch stock A/c

(credit sales)

Rs.

22,000

87,000

Particulars

By Branch Cash A/c

By Branch Expenses A/c

(Discount allowed to Debtors)

By Sales Returns

By Balance c/d

Rs.

93,000

2,400

3,000

10,600

1,09,000

1,09,000

201

Dr. Alwar Branch Stock Account Dr.

To balance b/d

To Goods sent to Branch A/c

To Branches Debtors A/c

Sales Return

66,000

2,04,000

3,000

By branch A/c-cash sales

By Branch Debtors A/c-credit sales


Allowance to customer

On selling price (already

Adjusted while invoicing)

By Goods sent to branch A/c

Returns to H.O.

By Shortage-in-stock A/c

By Balance c/d

1,06,000

87,000

2,000

6,000

3,000

69,000 2,73,000

2,73,000

Alwar Branch Adjustment Account

Dr.

To Stock reserve A/c

To Goods sent to Branch A/c

(6000 × 50/150)

To Branch stock A/c

To Shortage (Load)

To Gross profit c/d

To Branch expenses A/c

Rent 2,400

Salaries 24,000

Petty exp. 2,400

(500 + 2000 - 100)

To Branch debtors A/c discount

To Shortage (cost)

To Net profit

23,000

2,000

2,000

1,000

62,000

By stock reserve A/c

(66,000 × 50/150)

By Goods sent to Branch A/c

(2,04,000 × 50/150)

By Gross profit b/d

Cr.

22,000

68,000

90,000

90,000

28,800

2,400

2,000

28,800

62,000

62,000

62,000

Illustration-4

Delhi Head Office supplies goods to its branch at Kanpur at Invoice Price which is cost plus 50%.

All Cash received by the branch is remitted to Delhi and all branch expenses are paid by the head office.

From the following particulars related to Kanpur branch for the year 2006 prepare :

(i) Branch Account, and

(ii) Branch Stock Account, Branch Debtors Account, Branch expenses A/c and Branch Adjustment

account in the books of the head office so as to find out the gross profit and net profit made

by the branch.

202

Stock with branch on 1.1.06 (at invoice price)

Branch Debtors on 1.1.06


Goods received from head office (at invoice price)

Goods returned to head office

Credit sales less returns

Allowances to customer at selling price

(already adjusted while invoicing)

Cash received from Debtors

Discount allowed to Debtors

Expenses (Cash paid by head office):

Rent 2,400

Salaries 24,000

Petty Cash 1,000

Rs.

60,000

12,000

10

1,86,000

3,000

84,000

2,000

90,000

2,400

27,400

Cash sales 1,04,000

Stock with Branch on 31.12.06 (at invoice price)


54,000

100

[Delhi, B.Com. (Hons.) 1 Yr. 1889]

[Delhi, B. Com. (Pass), 1997]

Branch Debtors Accounts

Dr. Cr.

Particulars

Rs.

Particulars

Rs.

To Balance b/d

To Credit Sales

12,000

84,000

By Cash Received

By Discount Allowed

By balance c/d

90,000

2,400

3,600

96,000

96,000

Branch Stock Account

Dr. Cr.

To Balance b/d

To Goods Sent to Branch

60,000

1,86,000

By Cash Sales

By Credit sales

By Goods Sent to H,P. (Returned)

By Shortage (Loss)

By balance (Given)

1,04,000

84,000

3,000

1,000

54,000

2,46,000

2,46,000

203

Kanpur Branch Account

Dr. Cr.

Particulars

Rs.

Particulars

Rs.

To Stock

To Branch Cash

To Petty Cash

To Goods Sent to Branch

To Reserve for returns (1/3 of

3,000)

To Stock Reserve (1/3 of

54,000)

To Branch Expenses

To Cash (Petty expenses)

To Profit transferred to Gen.

P & L A/c

60,000

12,000

10

1,86,000

1,000

18,000

27,400

90

32,200

By Cash-Remittance

Cash Sales 1,04,000

Cash from Debtor 90,000

By Goods Sent to H.O. (Returns)

By Stock Reserve (1/3 of 60,000)

By Reserve for Goods Sent (1/3 of 1,86,000)

By Stock at Branch (Given)

By Branch debtors A/c

By Petty Cash

1,94,000

3,000

20,000

62,000

54,000

3,600

100

3,36,700

3,36,700

Branch Adjustment Account

Dr. Cr.

Particulars

To Reserve for returns

To Stock reserve

To Shortage

To Profit transferred to P & L A/c

Rs.

1,000

18,000

333

62,667

Particulars

By Stock Reserve

By Reserve for Goods Sent

Rs.

20,000

62,000

82,000

82,000

Branch Expenses Account

Dr. Cr.

Particulars

Rs.

Particulars

Rs.

To Cash

27,310


27,310

Branch Profit and Loss A/c

Dr. Cr.

Particulars

To Branch Expenses

To Branch debtors (Discount A/c)

To Loss (Shortage)

To Net Profit

Rs.

27,400

2,400

667

32,200

Particulars


Rs.

62,667

62,667

62,667

204

UNIT -- 4

JOINT VENTURES

Joint Venture What is it?

A Joint venture is a contract between two or more persons who agree to do a small piece of

commercial undertaking jointly. It is a temporary partnership, without the use of a firm name limited or

restricted to a particular venture in which the two or more persons agree to contribute a specific amount

of capital and to share profits or losses either in equal proportions or in any other agreed proportion.

Nature of Joint Venture

A Joint venture may be in connection with a joint cosignment of goods, and under-writing* of shares

or debentures of a new joint stock company, speculation in shares, the construction of a building jointly,

the purchase and sale of a particular plot of land or any other similar temporary or seasonal business

enterprise. Once the joint undertaking is complete and over; the joint venture or limited partnership ends

and no liability will then attach to any party.

Advantages of a Joint Venture

Sometimes a party may be in a position to buy goods at a much lower cost and on far better terms

than others. a second party may be in a position to sell the same at an exceptionally good price. Or, it

may so happen that merchandise is bought cheap at one place by one party and when sent to another

place it can be sold at a higher price by the second party. A third party may have financial resources but

may not be in a position either to buy at lower price or to sell at higher price. A combination of all these

parties in a common venture may result in a successful and remunerative business.

Consignment VS. Joint Venture

The points of difference between the two may be stated as under :—

Points of Difference

Consignment

Joint Venture

1. Relationship

The Consignor is principal-

while the consignee is

agent.

Relationship between

Coventures is that of the

Partners.

2. Nature of Business

Agent is not necessarily a

partner, hence it is not a

partnership.

It is a partnership (Though

temporary) since Co-venturers

are partners.

3. Powers

Consignee being an agent

is simply a servant and has

to obey the instructions of

the Principal

Co-ventures enjoy full

powers as to sale and pur-

chase of goods and collec-

tions of dues etc.

*Underwritng means undertaking the responsibility that shares or debentures issued by company will

be taken up by the public. If the public does not take them, the underwriters agree to take up the shares

or debentures.

4. Scope

Consignment is concerned

Joint Venture may be

only with the sale of

movable goods.

undertaken for any type of

legal business e.g. construc-

ction of roads, building etc.

in addition to purchase and

sale of goods.

5. Finance

Consignor (Principal) provides

the funds.

Funds are provided by the

Co-Ventures.

6. Profits and commission

The Consignee is entitled

to receive only commission

and reimbursement of his

expenses. No share in the

profits or liability for losses.

Profits (or losses) are

shared by the Co-ventures

in the predetermined ratios

or equally in the absense of

an agreement. Commission

may or may not be granted to

Co-ventures.

7. Number of Persons

There are normally two

parties namely the principal

and the agent.

The number of Co-venturers

will be at least two though it

may be more than two with

equal status i.e. that each is

a principal and agent at the

same time like partners.

Record of Transactions

No Separate sets of Books :

It may be arranged that one of the parties will alone manage the joint venture, that is he alone will

look after the buying and the selling on joint account. He may, for this service, be allowed certain

commission by other parties to the joint venture. Under such a circumstance he will open a Joint Venture

Account with such and such person‘‘ in his books. The Joint venture account will be debited with the cost

of goods and with expenses incurred by him, his cash account will be credited. If he is entitled to a

commission, joint venture account will be debited and commission account will be credited. When he sells

goods on joint account, joint venture account will be credited and cash or debtor‘s account will be debited.

Each party may remit his proportion of cost, which will be placed to the credit of the party‘s account.

This amount plus the share of profit will then be repaid to that party. The joint venture account will then

be balanced. The balance of this account will represent either profit or loss which proportionately be

credited or debited respectively to the other party‘s account. The amount due to other parties will then

be remitted to them by the party recording account of joint venture dealings.

But it may so happen that each party to the joint venture might effect transactions independent of

others. Under such a case each party would record in his own books the transaction that has entered into

on joint account. That it has own book, each will open one, ‗‗Joint Venture Account with such and such

person.‘‘ He will debit the joint venture account and credit cash for goods purchase and expenses incurred

by him on joint venture. If he supplies goods from his own stock, he will debit joint venture account and

credit goods or sales account. When the venture is complete each party will sent to the other details of

the transactions effected by him and as they appear in the joint venture account in his own books. On

receipt of such a statement the other party will make suitable entries indicated below.

The joint venture account in each party‘s books, will be debited with the cost of the goods purchased

and expenses incurred by the other party or parties, the corresponding credit being given to the personal

account of the other party or parties. Similarly, the other party‘s account will be debited with sale proceeds

received by him, the corresponding credit being given to the joint venture account. The joint venture

account will not be closed in each party‘s books the balance indicating either profit or loss which will be

credited or debited proportionately to the other party‘s personal account and to his own profit and loss

account (his share). The balance on the personal accounts of the other parties will then indicate their

relative position with each other.

Where No Separate Set of Books is Maintained

(A) Recording in the Books of Each Party?

Under this method Co-Venture will prepare two accounts namely (i) Joint Venture Account and (ii)

The Personal Account of other Co-Ventures.

Notes : (a) Joint Venture account, being a nominal account, is prepared to find out profit of loss of

the Venture. Personal account(s) of the other Co-Venture‘s) is prepared to find out the amount due from

or amount due to him.

(b) It must be made clear that each Co-Ventures has his own separate business and these

transactions are in addition to what he records in respect of his independent business.

A summary of accounting entries in respect of joint venture transactions in the books of any co-

venture is given below :—

(a) Transaction of the person recording the same.

1. Cash Contributed or Goods Purchased in Cash for Joint Venture :

Joint Venture Account Dr.

To Cash/Bank Account

2. Goods Supplied from own stock for Joint Venture


To Purchase Account

Note : If the goods are supplied at a price other than cost price, then Sales Account will be

credited.

3. For Paying Expenses


To Cash/Bank Account

4. For Sale of Goods for Cash

Cash Account Dr.

To Joint Venture Account

5. For Sale on Credit

Debtor‘s Account Dr.


6. Cash received from Debtors

Cash/Bank Account Dr.

To Debtors Account

7. Discount allowed or bad debts


to Debtors account

8. Cash or Bills Receivable received from other Co-Venturer(s)

Cash/Bank/Bills receivable Account Dr.

To (Other) Co-Venture‘s Personal Account

9. Cash or Bills Payable given to Co-Venture

(Other) Co-Venture‘s Personal Account Dr.

To Cash/Bank/Bills Payable Account

10. Commission/Salary etc. Receivable


To Commission/Salary etc. Account

11. Unsold Stock of Joint Venture taken into Stock

Purchase Account Dr.


(b) Transaction of the other Co-Venturer.

12. Cash Contributed or goods contributed or goods purchased for Cash or on Credit

for Joint Venture.


To (Other) Co-Venturer‘s Account

13. Any Expenses paid or discount allowed by him or any bad debts incurred by him

for joint Venture.


To (Other) Co-Venture‘s Account

14. Goods sold for cash or on Credit by other Co-Venturer(s).

(Other) Co-Venturer‘s Account Dr.


15. Commission or Salary payable to Co-Venturer


To (Other) Co-Venturer‘s Account

16. Unsold Stock taken by Co-Venturer(s)

(Other) Co-Venturer‘s Account Dr.


17. Profit or Loss on Joint Venture

(c) (i) For Profit



(For the person recording the transaction)

To (Other) Co-Ventures Account

(For the share of other Co-Venturer)

(ii) For Loss

Profit And Loss Account Dr.

(For the share of self)

(Other) Co-Ventures Account Dr.

(For the share of other co-venturer)


(d) Final Settlement of account

(i)

(ii)

Important :

For Cash or Bill Receivable received

Cash or Bills Receivable Account Dr.

To (Other) Co-Venturers Account

For Cash or Bills Payable Given

(Other) Co-Venturers Account Dr.

To Cash or Bills Payable Account

(a) When any co-venturer receives cash from debtors for credit sales there is no entry in the books

of other Co-Venturers(s).

(b) When one Co-Venturer allows cash discount to and/or incurs bad debts on debtors, the entry

is :


To (other) Co-Venturer‘s Account

(c) The procedure adopted for valuing the closing stock is similar to the valuation of consignment

stock. Accounting treatment for unsold stock is :

(i) When Joint Venture account is only closed (though Joint Venture business is continuing),

closing stock is credited to Joint Venture Account as By balance c/d.

(ii) When Joint Venture Account business is finally closed the unsold stock is taken over by

co-venturer(s) at agreed value. But if the examination problem is silent as to its distribution

by co-ventures at agreed values it should be distributed in the profit sharing ratio by

debiting the purchase account and co-venturer‘s account and crediting the Joint Venture

Account.

Example of a Joint Venture where no Separate Set of Bok’s are Needed :

Illustration-1

A of Ahemdabad and B of Bombay enter into a joint venture to consign 100 bales of cotton to C of

Ceylon to be sol by the latter on the joint risk of A and B, sharing in proportion of 3/5 and 2/5 respectively.

A sends 60 bales at Rs.1,3000 each, paying freight and other charges amounting to Rs.900 B sends 40

bales at Rs.1,250 each and pays for freight and other charges Rs.800. All the bales are sold by the

consignee for rs.1,50,000 out of which he deducts Rs.1,600 for his expenses and his commission at 3 per

cent. He remits a bank draft for rs.70,000 to A and the balance to B in a separate draft.

Give the necessary ledger account to record these transaction in the books of A and B.

A’s Ledger

Dr. Joint Venture account with B Cr.

To Goods A/c

To Cash (Exps.)

To B (Goods)

To B (Expenses)

To B (Profit)

To P & L A/c

Rs.

78,000

900

50,000

800

5,680

8,520

By cash (recd. from C)

By B (recd. from C*)

Rs.

70,000

73,900

1,43,900

1,43,900

*It is never called as B‘s Capital A/c since A and B are not partners.

Dr. B’s A/c Cr.

To Joint Venture A/c

(Cash recd. from C)

To Balance b/d

Rs.

73,900

73,900

By Joint Venture A/c

—Goods

By Joint Venture A/c—exps.

By Joint Venture A/c—Profit

By Balance c/d

Rs.

50,000

800

5,680

17,420

73,900

17,420

Total Sales By C =

Less=his expenses 1,600

Less-his commission 3% of 1,50,000 4,500

Balance

Less amount sent to A

*Amount received by B

Rs.

1,50,000

6,100

1,43,900

70,000

73,900

B’s Ledger

Dr. Joint Venture Account with A Cr.

To Goods A/c

To Cash (Exps.)

To A (Goods)

To A (Expenses)

To A (Profit)

To P & L A/c

Rs.

50,000

800

78,000

900

8,520

5,680

By Cash (received from C)

By A (received from C)

Rs.

73,900

70,000

1,43,900

1,43,900

Dr. A Cr.

To Joint Venture A/c (From C)

To Balance c/d

70,000

17,420

By Joint Venture A/c—Goods

By Joint Venture A/c—Exps.

By Joint Venture A/c—Profit

78,000

900

8,520

87,420

87,420

Alternative Method :

On receipt of details of transactions effected by other parties, each party may prepare, in his books,

a ‗‗Memorandum Joint Venture Account (Memorandum Joint Venture is similar to Joint venture A/c) by

combining all this information received from other parties. The memorandum joint venture account is

prepared only to find out the profit or loss made. It is not a part of accounts. As part of accounts, only

the account of the other party under the style, say, Joint Venture with ‗‗B‘‘ A/c‘‘ is opened. This account

is debited with expenditure incurred venture this account is credited. The share of profit (as ascertained

by the memorandum joint venture account) is debited to this account and credited to Profit and Loss A/

c. This account will then show the amount due to or by the other party and will be closed by remittance

from one to the other party.

The above illustration is now worked out according to this method.

A’s Ledger

Joint Venture with ‘B’ Account

Dr. Cr.

To Goods A/c

To Cash (Exps.)

To Profit & Loss A/c

To balance b/d

Rs.

78,000

900

8,520

By Cash

By Balance c/d

Rs.

70,000

17,420

87,420

87,420

17,420

B’s Ledger

Joint Venture with ‘A’ Account

Dr. Cr.

To Goods A/c

To Cash

To Profit & Loss A/c

To Balance c/d

Rs.

50,000

800

5,680

17,420

By Cash

By balance b/d

Rs.

73,900

73,900

73,900

17,420

Memorandum Joint Venture A/c

To A (goods)

To A (Exp)

To B (goods)

To B Exp.

To Profit A

B

Rs.

78,000

900

50,000

800

8520

5680

By A Cash

By B Cash

Rs.

70,000

73,900

1,43,900

1,43,900

*It is never called as B‘s Capital A/c since A and B are not partners.

Illustration-2

A of delhi and B of Bangalore entered into a Joint Venture for purchases and sales of one lot of

Mopeds. The cost of each Moped was Rs.3,000 and the fixed retail selling price Rs.3,000 The following

were the recorded transactions :

2002

Jan. 1

A Purchase 100 Mopeds paying Rs.72,000 in cash on account.

A raised a loan from Canara Bank for Rs.50,000@ 18% p.a. interest, repayable with interest on

1.3.2002.

A forwarded 80 Mopeds to B incurring Rs.2,880 as forwarding and insurance charges.

Jan.7

B received the consignment and paid Rs.720 as clearing charges.

Feb.1

A sold 5 Mopeds for Cash

B sold 20 Mopeds for Cash

B raised a loan of Rs.1,50,000 from Union Bank repayable with interest at 18% p.a. on 1.3.2002.

B telegraphically transferred Rs.1,50,000 to A incurring charges of Rs.50 A paid balance due for the

Mopeds.

Feb. 26

A sold the balance Mopeds for Cash

B sold the balance Mopeds for Cash

A paid selling expenses Rs.5,000

B paid selling expenses Rs.20,000

March. 1

Accounts settled between the venturers and loans repaid. Profit being appropriated equally.

You are required to show :

(1) The Memorandum Joint Venture Account.

(2) Joint Venture with B Account in A‘s Books.

(3) Joint Venture with A Account in B‘s Books.

You are to assume that each venturer recorded only such transactions concluded by him.

Solution :

Memorandum Joint Venture Account

For the period between Jan 1 to March 2002

To A

Cost of Mopeds

Forwarding and Insurance

Interest on Bank Loan

Selling Expenses

Rs.

3,60,000

2,880

1,500

5,000

By Sales

A (20 × 4,500)

B (80 × 4, 500)

Rs.

90,000

3,60,000

To B

Clearing Charges

Interest on Bank Loan

Sundry Expenses

(Telegraphic transfer Charges)

Selling Expenses

To Net Profit

A 28,800

B 28,800

720

2,250

50

20,000

57,600

4,50,000

4,50,000

Books of ‘A’

Joint Venture with B Account

To Bank (Part payment of Cost)

To Bank (Forwarding Charges)

To Bank (Balance cost of purc-

hase)

To Bank (Selling expenses)

To Bank (Interest on Bank Loan)


(Share of profit)

72,000

2,880

2,88,000

5,000

1,500

28,800

By Bank (Sale proceeds)

By Bank (Remittance from B)

By Bank (Sale proceeds)

By Bank (Cash recovered

in settlement)

22,500

1,50,000

67,500

1,58,180

3,98,180

3,98,180

Books of ‘A’

Joint Venture with A Account

To Bank (Clearing Charges)

To Bank (Remittance plus telegraphics

transfer charges)

To bank (Selling expenses)

To Bank (Interest on Bank Loan)


(Share of profit)

To Bank (payment in settlement)

720

1,50,050

20,000

2,250

28,800

1,58,180

By Bank (Sale

proceeds 20 Mopeds)

By bank (Sale proceeds of

60 Mopeds)

90,000

2,70,000

3,60,000

3,60,000

Separate Books for Joint venture :

A complete set of separate books is opened to record the joint venture transactions when buying and

selling on account of joint venture is managed by one of the parties and all the transactions are recorded

at the place of business. In this case the recorded of transactions does not differ in any way from ordinary

partnership transactions. The parties to the joint venture usually contribute their share of money to carry

out the joint venture dealings. This money is put in a joint banking account. The parties‘ personal accounts

are credited and the joint banking account debited. The joint venture account will be debited with the cost

of goods purchased, and expenses incurred and for this the joint banking A/c will be credited. Joint banking

account is debited. The joint venture account will be debited with the cost of goods purchased, and

expenses with the sale proceeds and the joint venture A/c will be credited. Finally, if any stock remains

unsold, it may be taken over by one of the parties. The party‘s A/c will then be debited and the joint

venture A/c will be credited with the agreed value. The joint venture A/c will then be balanced and the

profit or loss will be transferred to the parties‘ personal accounts. The amount due to each will be paid

out from the joint bank A/c and thus the books of account will be closed.

‘‘Summary of Journal Entries’’

(1) Amount contributed or invested by the Co-Venturers.

Joint Bank Account Dr.

To Co-Venturer‘s Capital Accounts (Individual)

(2) Goods or any other item contributed by a co-venturer or expenses paid by him.


To Co-Venturer‘s Capital Account

(3) For purchase of goods for cash.


To Joint Bank Account

(4) For purchase of goods on Credit.


To Creditor‘s (Suppliers) Accounts

(5) For expenses on Joint Venture.



(6) For good sold (Cash).

Joint Bank Account Dr.


(7) Sale on Credit

Debtor‘s (Consumers) Account Dr.


(8) Payment to creditors in cash or issue Bills payable.

Creditors Account Dr.


To Bills Payable Account

(9) Cash or Bills Receivable received from debtors.

Joint bank Account Dr.

Bills Receivable account Dr.

To Debtor‘s Account

(10) Any Commission, salary, interest etc. payable to any Co-Venturer.


To Co-Venturer‘s Account

(11) Part of the stock taken by Co-Venturer

Co-Venturer‘s Account Dr.

To Joint venture Account

(12) For profit on joint venture.


To Co-Venturer‘s Account

(13) For loss on joint venture.


To Joint venture Account

(14) Settlement of the account of each party.



Note: Discount received should be Debited to Creditor‘s account and Credited to Joint Venture

Account. Similarly discount allowed and bad debts should be Debited to Joint Venture Account and

Credited to Debtor‘s Account.

Illustration-3 (Construction of a building)

A and B entered into a joint Venture to construct a building for a newly started Tools India. Ltd.

The Contract price was fixed at Rs.20 Lakhs to be settled as follows :—

Rs.8 lakhs in cash

Rs. 2 lakhs in fully paid preference shares.

A joint bank account is opened in which A and B deposited Rs.2,50,000 and rs.1,50,000 respectively.

The profit or loss is to be shared in the ratio of 2 : 1 after providing for interest on Capital at 10%.

The details of their transaction are :

Plant Purchased

Wages Paid

Material Purchased

Material supplied by A from his own stock

Material supplied by B from his own stock

Architect‘s fees paid By A

2,00,000

1,00,000

7,00,000

50,000

40,000

20,000

The contract was completed and the price was received as stipulated. Half of the plant was taken

over by A for Rs.80,000 and half was sold for Rs.1,10,000.

Joint Venture Account was closed by A taking up all the shares at an agreed valuation of Rs.1,60,000

and B taking up the stock of material at an agreed valuation of Rs.30,000 separate books were maintained

for the Joint Venture. Give ledger accounts.

Solution

Joint Venture Account

To Joint Bank (Plant)

To Joint Bank (Wages)

To Joint Bank (materials)

To A (Stock)

To B (Stock)

To A (Architect‘s fees)

To A (Interest)

To B (Interest)

To Share‘s Account (Loss)

To A (2/3 Share of profit)

To B (1/3 Share of profit)

2,00,000

1,00,000

7,00,000

50,000

40,000

20,000

25,000

15,000

40,000

20,000

10,000

By Joint Bank Account

(Contract Price)

By Share Account

(Contract Price)

By A (1/2 Plant takeover)


(1/2 Plant sold)

By B (Materials tekenover)

8,00,000

2,00,000

80,000

1,10,000

30,000

12,20,000

12,20,000

Joint Bank Account

To A‘s Account

To B‘s Account


(Contract Price)


(Sale of Plant)

2,50,000

1,50,000

8,00,000

1,10,000

By Joint Venture Account

(Plant)

By Joint venture Account

(Wages)

By Joint Venture Account (Materials)

By A (Refund of Capital)

By B (Refund of Capital)

2,00,000

1,00,000

7,00,000

1,25,000

1,85,000

13,10,000

13,10,000

A’s Account

To Joint Venture

(Plant taken over)

To Shares

To Joint bank

80,000

1,60,000

1,25,000

By Joint Bank (Capital)

By Joint Venture (Stock)

By Joint Venture (Architects‘s

fees)

By Joint Venture (Interest)

By Joint venture (Profit)

2,50,000

50,000

20,000

25,000

20,000

3,65,000

3,65,000

B’s Account

To Joint Venture (Material)

To Joint bank

30,000

1,85,000

By Joint bank

By Joint Venture (Stock)

By Joint Venture (Interest)

By Joint Venture (Profit)

1,50,000

40,000

15,000

10,000

2,15,000

2,15,000

In the books of ‘A’

Joint Venture Investment Account

To Cash (Capital)

To Cash (Architect‘s fees)

To Stock

To Interest

To Profits

2,50,000

20,000

50,000

25,000

20,000

By Bank Account

By Shares

By Plant taken over

1,25,000

1,60,000

80,000

3,65,000

3,65,000

In the books of ‘B’

Joint Venture Investment Account

To Cash

To Stock

To Interest

To Profits

1,50,000

40,000

15,000

10,000

By Materials taken over

By Bank

30,000

1,85,000

2,15,000

2,15,000

Notes : (1) Joint Venture transactions are recorded in a separate set of books meant for Joint Venture

and not in the books of either of the co-venturers.

(2) Though plant is an asset it is simply transferred to Joint Venture Account to be used for Joint

Venture. The depreciation value of the plant is recorded on the credit side of the Joint Venture Account.

However, in this illustration since half of the plant is taken over by Co-Venturer (A) and the other half

is sold, the amounts are credited to Joint Venture account, and A‘s Account and Joint bank Account are

debited respectively.

(3) Interest on Capital is calculated @ 10% for one year.

Construction of Building, Bridges, Roads etc.

Such works are usually undertaken for joint stock companies which become contractee. Price is

usually received partly in cash and partly in the form of shares and debentures. The joint venturers have

to sell these shares/debentures in order to determine the overall profits/loss of the Venture. The shares/

debentures may be either sold in the market or one or more co-venturers may take them at an agreed

price. The additional entries, then are made as follows :

(1) For Contract price

becoming due

(2) On receipt of contract

price

(3) On Sale of shares/

debentures

(4) For profit on sale of

shares/debentures

(5) For Loss on sale of

shares/debentures

Contractee‘s (Company‘s) Account


Joint Bank Account

Shares Account

To Contractee (Company)

Joint Bank Account

Co-Venturers Account

To Shares/Debentures Account

Shares/Debentures Account



To shares/Debentures Account

Dr.

Dr. (for cash)

Dr. (for shares/debentures

Dr.

Dr.

Dr.

Dr.

Illustration-4 (Construction of a Building)

A, B and C enter into a joint venture for supervision of the construction of a multistory building for

a joint stock company for a contract price of Rs.1,00,000.

Incidental expenses might have to be paid by the Venturers but as per agreement they are entitled

to be re-imbursed to the extent of actual such expenditure or Rs.5,000 whichever is less. In this way A

spends Rs.4,000; B Rs.5,000 and C Rs.6,000. The Venturers are to share profits and losses equally but

C being a technical person, is entitled to a special commission of 10% of the profit of the venture after

charging such commission. They open a joint bank account to which A contributes Rs.20,000, B Rs.15,000

and C Rs.15,000. B also gives his own plant to the venture for which he charges Rs.8,000. Materials are

purchased for Rs.20,000 and wages amount to Rs.30,000.

At the end of the Venture the company paid the agreed contract price (keeping Rs.10,000 as retention

money) to the extent of Rs.30,000 in cash and the balance in equity shares of the company of Rs.10 at

an agreed value of Rs.12 per share. The shares are subsequently sold in the market @ Rs. 13 per share.

Unused materials costing Rs.2,000 are taken over by A at Rs.1,000. The plant is taken back by B at an

agreed value of Rs.2,000 C takes up the retention money at Rs.7,000.

Show necessary ledger accounts in the books of the venturer.

Solution :


To A

B

C

To B (Plant)


Materials

Wages

To C (Commission)

10% of Rs.

1/11 of Rs.

To Net Profit :

A

B

C

4,000

5,000

5,000

Rs.

14,000

8,000

50,000

3,000

30,000


By Shares Account

By Shares Account

(Profit on sale)

By A (Unused materials)

By B (Plant

By C (Retention money)

Rs.

30,000

60,000

5,000

1,000

2,000

7,000

20,000

30,000

3,000

30,000

33,000

10,000

10,000

10,000

1,05,000

1,05,000

A’s Account

To Joint Venture

(Unused materials)


1,000

33,000

By Joint Venture

(Incidental expenses)

By Joint Bank

By Joint Venture—Profits

Rs.

4,000

20,000

10,000

34,000

34,000

B’s Account

To Joint venture (Plant)

To Joint Bank

2,000

36,000

By Joint Venture

(Incidental expenses)


By Joint Venture Plant

By Joint Venture-Profit

5,000

15,000

8,000

10,000

38,000

38,000

C’s Account

To Joint Venture (Retention

money)


7,000

26,000

By Joint Venture (Incidental

expenses)

By Joint Venture

(Commission)

By Joint bank Account

By Joint Venture-profits

5,000

3,000

15,000

10,000

33,000

33,000

Joint Bank Account

To A

To B

To C

To Joint Venture (Contract Price)

To Shares Account (sale of shares)

20,000

15,000

15,000

30,000

65,000

By Joint Venture

Materials 20,000

Wages 30,000

By A 33,000

By B 36,000

By C 26,000

50,000

95,000

1,45,000

1,45,000

Illustration-5 (Development of land state)

A and B enter into a joint venture to purchase and develop certain lands as Industrial Estate. For that

purpose, a Joint bank Account was opened wherein A deposited Rs.60,000 and B deposited Rs.40,000.

A piece of land measuring 18,000 sq. meters was purchased at Rs.3 per sq. meter. The following

expenses were paid from the Joint Bank Account :

Rs.

Cost of earth filling to level land 14,000

Compensation paid to a human dweller for vacating possession 5,000

Municipal Taxes 2,000

Cost of barbed fire fence 3,000

Architect‘s fees for plans 1,000

Stamp duty and Solicitor‘s fees 6,000

General expenses 2,000

Income from sale of timber 2,000

It was decided to sell land in smaller plots of 500 sq. metres each. One sixth of the area was left

over for public lands. 10 plots were sold at Rs.20 per sq. metre through the brokers who were paid 2%

brokerage on the sale price of land.

A retained one plot for his personal use at an agreed price of Rs.3,000 The remaining plots were sold

at a consolidated price of Rs.76,200 directly. A and B shared profits (or losses) of the Joint Ventures in

the proportion of the amounts invested by them. All transactions have been effected through the bank.

Prepare joint venture account, joint bank account and accounts of A and B assuming that all accounts

are settled. Solution :

Total land purchased

Less: 1/6th left for public roads

land available for sale of 30 plots.

Each plot measures 500 sq. metres

18,000 sq. meters

3,000 sq. meters

15,000 sq. meters

hence, there are 15,000

= 30 plots.

(2) Sales

(a) 10 plots i.e. 10 × 500 sq. metres

= 5,000 sq. metres @ Rs.20 per sq. metre

= Rs. 60,000 less 2% of this as brokerage

= 60,000—1,200 58,800

(b) One plot to A for Rs. 5,000

(c) Remaining 19 plots sold for 76,200

1,40,000


To Joint Bank :

Cost of land 54,000

Cost of levelling 14,000

Compensation 5,000

Municipal taxes 2,000

Cost of fence 3,000

Architect‘s fees 1,000

Stamp duty etc. 6,000

General expenses 2,000

To A‘s Account—(3/5 profit)

To B‘s Account—(2/5 profit)

Rs.

87,000

33,000

22,000

To Joint Bank :

Sale of timber

By Joint bank :

Sale of 10 plots

less brokerage

By Proceeds of 19 plots

By A‘s Account-plot taken over

Rs.

2,000

58,800

76,200

5,000

1,42,000

1,42,000

500

Joint Bank Account

To A

To B

To Joint Venture-sales

To Joint Venture-sale

Rs.

60,000

40,000

1,35,000

2,000


(cost of land and other

expenses)

By A

By B

Rs.

87,000

88,000

62,000

2,37,000

2,37,000

A

To Joint Venture-cost of plot

To Joint Bank (Settlement)

5,000

88,000

By Joint Bank (Investment)

By Joint Venture (Profit)

60,000

3,000

93,000

93,000

B

To Joint bank (settlement)

Rs.

62,000

By Joint Bank (Investment)

By Joint Venture (profits)

Rs.

40,000

22,000

62,000

62,000

Under writing of Shares :

When the co-venturers agree to under write the share of a limited company, they become entitled to

underwriting commission which may be received partly in cash and partly in shares. As per the nature

of the underwriting business the underwriters will have to take up the shares received as commission and

the shares not subscribed by the public. The shares are ultimately sold or taken over by co-venturers at

an agreed price in order to calculate the overall profit or loss on joint-venture. The additional entries are

given below :

(1) On receiving the commission

Joint Bank Account

Shares Account

To Joint Venture account

(2) For subscription of shares not taken over by public

Shares Account


To Co-Venturers Account

(3) For sale of shares

Joint Bank Account

Co-Venturers Account

To Shares Account

Dr. (for cash)

Dr. (for shares)

Dr.

Dr.

Dr.

(4) For profit on sale

Shares Account Dr.


Entry No. 4 will be reversed in case of loss.

Illustration - 6

A and B enter into a joint venture for guaranteeing the subscription at par of 1,00,000 shares of Rs.20

each of a joint stock company. They agree to share profits and losses in the ratio of 2 : 3. The terms

with the company are : 4½% commission in cash and 6,000 fully paid up shares of the company.

The public take up 88,000 of the shares and the balance shares of the guaranteed issue are taken

up by A and B who provide cash equally. The commission in cash is taken by the partners in the ratio

4 : 5.

The entire share holding of the Joint Venture is then sold through brokers : 25% at a price of Rs.9;

50% at a price of Rs.8.75; 15% at a price of Rs.8.0 and the remaining 10% is taken over by A and B

equally at Rs. 8 per share.

Prepare a joint venture account and the separate accounts of A and B showing the adjustment of

final balance between A and B. Ignore interest and income tax.


To Share (Loss on sale)

To A‘s Account

To B‘s Account

Rs.

24,750

32,100

48,150

By Joint Bank (Commission)

By Shares (Commission)

Rs.

45,000

60,000

1,05,000

1,05,000

A’s Account

To Joint Bank (Cash Commission)

To Shares

To Joint bank-Final settlement

Rs.

20,000

7,200

64,900

By Joint Bank

(Contribution)

By Joint Venture

(Profit)

Rs.

60,000

32,100

92,100

92,100

B’s Account

To Joint Bank (Cash Commission)

To Shares

To Joint bank) Final Settlement

Rs.

25,000

7,200

75,950

By Joint Bank (Contribution)

By Joint venture (Profit)

Rs.

60,000

48,150

1,08,150

1,08,150

Shares Account

To Joint Bank (Shares purchased)

To Joint Venture (Commission)

Rs.

1,20,000

60,000

By Joint Bank (25%)

By Joint Bank (50%)

By Joint Bank (15%)

By A‘s A/c (5%)

By B‘s A/c (5%)

By Joint Venture (Loss on Sale)

Rs.

40,500

78,750

21,600

7,200

7,200

24,750

1,80,000

1,80,000

Joint Bank Account

To A (Contribution)

To B (Contribution)

To Joint Venture (Commission)

To Shares

25%

50%

15%

Rs.

60,000

60,000

45,000

40,500

78,750

21,600

By Shares (purchased)

By A

By B

By A (Final settlement)

By B (Final settlement)

Rs.

1,20,000

20,000

25,000

64,900

75,950

3,05,850

3,05,850

Illustration-7

X and Y undertake jointly to build for a newly stated joint stock company for a contract price of

Rs.1,000,000 payable as to Rs.80,000 by instalments in cash and Rs.20,000 in fully paid shares of the new

company. A banking account is opened in the joint name, X contributing Rs. 25,000 and Y Rs,15,000. They

have to share profits and losses in the proportion of 2/3 and 1/3 respectively. Their transactions were as follows :

Paid wages

Bought materials

Paid architect‘s fees

Rs.30,000

Rs.79,000 on credit from Z.

Rs.3,000

The contract was completed and the price dully received: Z‘s dues were dully paid off. The joint

venture was closed by X taking up all the shares of the company at an agreed valuation of Rs.16,000

and Y taking up unused stock of materials for Rs.3,000 as mutually valued.

Prepare the necessary accounts to record the above transactions.

Solution :

Dr. Joint Bank Account Cr.

To X (Capital contributed)

To Y (Capital contributed)


(Amount Received from

contractee)

Rs.

25,000

15,000

80,000

By Joint venture A/c—Wages

By Joint Venture A/c—Architect-

fees

By Z

By X (Amount returned)

By Y (Amount returned)

30,000

2,000

79,000

1,000

8,000

1,20,000

1,20,000

Z


Rs.

79,000

By Joint Venture Account

Rs.

79,000


Dr. Cr.

To Joint bank A/c—Wages

To Z—Materials

To Joint Bank A/c (Architect‘s fees)

To Share‘s A/c—Loss

Rs.

30,000

79,000

2,000

4,000

By Joint Bank A/c

(Amount received From-

contractee)

By Share A/c

By Y (Materials Taken over)

By Loss transferred to :

X 2/3 8,000

Y 1/3 4,000

Rs.

80,000

20,000

3,000

12,000

1,15,000

1,15,000

Dr. Shares Account Cr.


Rs.

20,000

By X

By Joint Venture A/c—Loss

Rs.

16,000

4,000

20,000

20,000

X’s A/c


Loss

To Shares a/c

To Joint Bank A/c

8,000

16,000

1,000


25,000

25,000

25,000

Y’s A/c


(Material)

To Joint venture A/c

Loss

To Joint Bank A/c

3,000

4,000

8,000

By Joint venture A/c

15,000

15,000

15,000

Illustration-8

A and B enter into a Joint Venture sharing profit and loss equally. A purchased goods for Rs. 5,000

and B spent Rs.3,000 for freight on 1st jan. 2002. On the same day B bought goods worth Rs.10,000 on

credit. Further expenses were incurred as follows :

On 1-2-2002—Rs.1,500 By B

On 1-3-2002—Rs.500 By A

Sales were made against cash as follows :

15-1-2002—Rs.3,000 By A

31-1-2002—Rs.6,000 By B

15-2-2002—Rs.3,000 By A

1-3-2002—Rs.4,000 By B

Creditors for goods were paid as follows :

1-2-2002—Rs.5,000 By A

1-3-2002—Rs.5,000 By B

On 31st March 2002 the balance stock was taken over by B at Rs.9,000 The accounts between the

venturers were settled by cash payment on this date. The venturers are entitled to interest at 12% per

annum.

Prepare necessary ledger accounts in the books of Venturers. Solution

Memorandum Joint Venture Account

To Cost of goods ;

A

B

To Freight-B

To Expenses-A

B

To Interest-A

To profit—A

B

Rs.

5,000

10,000

1,000

500

1,500

135

3,457

3,458

By Sales A

B

By Interest B

By B-Stock

Rs.

6,000

10,000

50

9,000

25,050

25,050

A’s Ledger

Joint Venture with B Account

2002

Jan.1. To Bank (Purchase)

Feb.1. To bank (Creditors)

Mar.1. To Bank (Expenses)

‘‘ 31 To Interest A/c

To Profit & Loss account-

share of profit

Rs.

5,000

5,000

500

135

3,457

2002

Jan 15 By Bank (sale proceeds)

Feb 15 By bank (sale proceeds

Mar.15 By Bank (amount

received in settlement)

3,000

3,000

8,902

14,092

14,092

B’s Ledger

Joint Venture with A Account

2202

Rs.

2002

Rs.

Jan.1 To bank (freight)

To Creditors (goods

bought- on credit

Feb 1 To bank (expenses)

Mar.31 To Profit & Loss account

(share of profit)

To bank (amount paid to

A in settlement

1,000

10,000

1,500

3,458

8,092

Jan 31

Mar.31

Mar.31

By Bank (sale)

By Creditors

paid by co-venturer

By Bank (sale)

By Stock account

stock taken over

By Interest account

6,000

5,000

4,000

9,000

50

24,050

24,050

Calculation of Interest

Date Amount

Rs.

1-1-2002 5,000

1-3-2002 500

1-2-2002 5,000

Payment by A

Month

3

1

2

Int. Till 31-3-2002

@1% p.m.

Rs.

150

5

100

255

Date

15-1-2002

15-2-2002

Amount received by A

Amount Month

Rs.

3,000 2½

3,000 1½

Int. Till 31-3-2002

@1% p.m.

Rs.

75

45

120

Net Interest due to A 135

Date

1-1-2002

1-2-2002

1-3-2002

Date

31-1-2002

Payment by B

Amount Month

1,000 3

1,500 2

5,000 1

Amount received by B

Amount Month

6,000 2

Int. Till 31-3-2002

@1% p.m.

30

30

50

110

Int. Till 31-3-2002

@1% p.m.

120

1-3-2002 4,000 1 40 160

Net Interest due from B 50

Conversion of Consignment into Joint venture :

Some times the consignor and consignee may decide to convert the consignment into Joint Venture

with retrospective effect i.e. from the date of the original consignment agreement. In such a case the

accounts will have to be prepared both on consignment basis and Joint Venture basis to be paid out :

(i) The amounts due to other party by way of commission on consignment basis; and

(ii) By way of profit on the basis of Joint Venture arrangement.

If the other party is entitled to more under the Joint Venture arrangement the following entry is to

be made :

Profit and Loss account Dr.

To Co-Venturer‘s Personal Account

The above entry will be reversed if the co-venturer has already received more than what is due to

him under Joint Venture arrangement.

Illustration-9 (Conversion of Consignment to Joint Venture)

On the 1st January of 2002 Singh of Amritraj, a manufacturer of sports goods, sent a Consignment

of 100 cricket bats to Bose of calcutta to be sold on consignment basis at a commission of 20%, such

commission to cover the consignee‘s expenses but not the freight charges of the goods to Calcutta. The

cost of each bat is Rs.100 but is invoiced to Bose at Rs.150 each. A case containing 10 cricket bats was

lost against which the consignor lodged a claim and collected from the insurance company Rs.800. The

consignee paid Rs.540 as freight charges and spent a further sum of Rs.400 as sales expenses. Consignor‘s

expenses amounted to Rs.500. The consignee accepted a bill of exchange drawn by Singh for 3 months

(beginning with the date of despatch) for Rs.10,000 which bill was discounted at 6% p.a. with the bankers.

Bose sold 75 bats at Rs.200 each and on 30th June 2002 remitted the balance due from him.

After making up accounts on 30th June 2002 the parties decide to convert their relationship to that

of a Joint Venture on the terms that the cost of a bat would be taken at Rs.350, Singh to get an interest

of 8% p.a. on his investment and Bose to get a commission of 10% on sales. Venturers are to share profit

and losses equally.

Prepare the necessary accounts in the books of Singh and indicate the adjustment entry required on

conversion of the terms of despatch.

Solution :

Consignment to Calcutta Account

To Goods sent on consignment

To Bank (expenses)

To Bose (Freight)

To Stock reserve (15 × 50)

To Bose-Commission


(Profit on consignment)

Rs.

15,000

500

540

750

3,000

3,675

By Bose (Sale proceeds)

By Goods sent on consignment

(Loading)

By bank (Insurance Claim)

By Abnormal loss

By Stock on consignment

Rs.

15,000

5,000

800

250

2,415

23,465

23,465

Notes : (1) It is assumed that freight was paid only on 90 bats.

(2) Valuation of closing Stock at Invoice Price

15 bats @ Rs. 150 each

Proportionate freight 540 15

proportionate Expenses (Consignor)

540 15

100

(3) Abnormal Loss

Cost of bats 10 × 100

Proportionate expenses 500 15

Less : Amount of Claim

Rs. 2,250

Rs. 90

Rs. 75

Rs. 2,415

Rs.

Rs. 1,000

Rs. 50

Rs. 1,050

800

250

90

100

Memorandum Joint venture Account

To Goods sent on Joint Venture

To Expenses : Singh

Bose

To Interest : Investments 8% on Rs.15,000 for 6

months

To Commission (Bose)

Rs.

15,000

500

940

600

1,500

By Sales

By Insurance Claim

By Stock 15 bats

By Loss : Singh 163

Bose 162

Rs.

15,000

800

2,415

325

18,540

18,540

Notes : (1) Interest has been allowed on investment in goods only; the question of expenses and of

claim received cancelling out one another.

(2) For the purpose of Joint Venture no stock reserve is required.

(3) Adjustment is required as under :

Amount already received by Bose (Commission)

Amount receivable by Bose as co-Venturer :

Commission

Expenses

Less : Loss to be debited to him

Entries on Conversion into Joint Venture

(1) Bose


1,500

400

1,900

162

Rs.

Dr. 1,262

Rs.3,000

1,738

1,262

Rs.

1,262

(Amount due to Bose under the Joint Venture Arrangement being Rs.3,000 whereas he previously

received Rs.3,000 amount now adjusted)

(2) Profit and Loss Account Dr. 375

To Stock Reserve 375

(Our share of the unrealised profit on unsold stock 50% of Rs.3,000

Exercise :

(1) Das, Bose and Gupta undertake to erect a five storied mansion for National Housing Trust Ltd.

The contract price is agreed at Rs.25,00,000 to be paid in cash Rs.22,00,000 by four equal instalments

and the balance amount in 13% debentures of the company. They agreed to share equally the profits and

losses. They opened a joint banking account with the cash contributed as stated below :

Das Rs.3,00,000; Bose Rs.3,75,000; and Gupta Rs.2,00,000. Das arranges the preparation of the

building plan etc. and pays Rs.32,000 as architects‘s fees; Bose brings a concrete Mixer and other

implements valued at Rs.80,000 and Gupta brings a Motor Lorry valued at Rs.75,000.

They paid out of joint banking account for the following : Materials Rs.12,26,800; Wages Rs.7,32,200;

Sundry expenses Rs.20,000 and plant Rs.60,000.

On Completion of the venture, concrete mixer is sold for Rs.50,000 and plant and other implements

are sold as scarp for Rs.10,000. Gupta Takes back the Motor Lorry at Rs.40,000. Das took over the

Debentures at a valuation of Rs.2,80,000.

Show the necessary accounts for the joint venture.

(Ans. Profit on joint venture Rs.3,54,000; Final payments: Dass Rs.1,70,000; Bose Rs.5,73,000 and

Gupta Rs.3,53,000.

(2) S and R carrying on a business separately as contractors, jointly take up the work of constructing

a building at an agreed price of Rs.3,50,000 payable in cash Rs.2,40,000 and in fully paid shares of a

company for the balance of Rs.1,10,000. A bank account is opened in which S and R paid Rs.75,000 and

Rs.50,000 respectively. The following costs were incurred in completing the constructions and the contract

price was duly realised :

(i) Wages paid Rs.90,000

(ii) Material purchased for Cash Rs.2,10,000

(iii) Materials supplied by R from his stock Rs.27,000.

(iv) Consulting Engineer‘s fees paid by S. Rs.3,000

The accounts were closed, S taking up all the shares of the company at an agreed valuation of

Rs.48,000, treating loss on shares as joint venture loss and R taking the remaining stock of materials at

Rs.9,000

Prepare and close the joint venture accounts and personal accounts of S and R assuming that a

separate set of books are opened for this purpose and that the net result of the venture is shared by s

and R in ratio of 2 :1.

(Ans. Loss on Joint venture Rs.36,000; Amounts brought in by S. Rs.9,000 and R Rs.56,000)

(3) Shyam took a contract for Rs.1,62,000 for supply of material in connection with tube wells. He

entered into a joint venture contract with Ashok. It was agreed to share profit and losses equally.

Following were the terms of the joint venture :

Shyam will contribute Rs.1,50,000 as capital on which he will get interest at 4% p.a. This amount was

given to Ashok on 1 January 2002 Shyam was entitled to a commission of 2% on the contract price. Ashok

being a technician will be entitled to a salary of Rs.400 per month. He will also get Rs1,500 because his

plant will be used on the contract.

Ashok made the following payments : Raw Materials Rs.50,000; Wages Rs.60,000; Repairs of

Machinery Rs.5,000 and Establishment expenses Rs.4,500.

Contract was complete on 30 September 2002 Shyam received the amount from Ashok.

Open Joint Venture Account, Shaym‘s Account and Cash Account in the books of Ashok.

(Ans. Joint Venture Profit Rs.36,000; Payment to Shyam Rs.1,72,825)

(4) B of Bombay and C of Calcutta enter into a joint venture to consign scrap iron A of agra, to be

sold on their risk. They share profit or losses equally. A is entitled to a commission of 10% of the net

proceeds after charging such commission.

B sends 50 tonnes costing Rs.3,000 per tonne and pays freight and other expenses of Rs.30,000. C

sends 70 tonnes costing Rs.3,000 per tonne and pays freight and other expenses of Rs.40,000.

All the scraps are sold by A @ Rs.10,000 per tonne and he pays selling expenses of Rs.12,000. he

remits Rs.5,00,000 to B and the balance of net proceeds to C by bank draft.

You are required (a) to show accounts in the books of B and C to record their own transactions and

(b) to prepare a Memorandum Joint Venture Account.

(Ans. Profit on Joint venture Rs.4,45,000; final settlement for Rs.32,500)

AMALGAMATION, ABSORPTION &

RECONSTRUCTION

ACCOUNTING FOR AMALGAMATIONS

The following terms are used in this standard with the meanings

specified:

l Amalgamation means an amalgamation pursuant to the

provisions of the Companies Act, 1956 or any other statute

which may be applicable to companies.

l Transferor company means the company which is amalgamated

into another company.

l Transferee company means the company into which a transferor

company is amalgamated.

l Reserve means the portion of earnings, receipts or other surplus

of an enterprise (whether capital or revenue) appropriated by the

management for a general or a specific purpose other than a

provision for depreciation or diminution in the value of assets or

for a known liability.

l Amalgamation in the nature of merger is an amalgamation

which satisfies all the following conditions.

All the assets and liabilities of the transferor company become,

after amalgamation, the assets and liabilities of the transferee

company.

(ii) Shareholders holding not less than 90% of the face value of the

equity shares of the transferor company (other than the equity

shares already held therein, immediately before the

amalgamation, by the transferee company or its subsidiaries or

their nominees) become equity shareholders of the transferee

company by virtue of the amalgamation.

(vi) The consideration for the amalgamation receivable by those

equity shareholders of the transferor company who agree to

become equity shareholders of the transferee company is

discharged by the transferee company wholly by the issue of

equity shares in the transferee company, except that cash may

be paid in respect of any fractional shares.

(vii) The business of the transferor company is intended to be carried

on, after the amalgamation, by the transferee company.

(viii) No adjustment is intended to be made to the book values

of the assets and liabilities of the transferor company when they

are incorporated in the financial statements of the transferee

company except to ensure uniformity of accounting policies.

Amalgamation in the nature of purchase is an amalgamation which

does not satisfy any one or more of the conditions specified in

sub-paragraph (e) above.

l Consideration for the amalgamation means the aggregate of the

shares and other securities issued and the payment made in the

form of cash or other assets by the transferee company to the

shareholders of the transferor company.

l Fair value is the amount for which an asset could be exchanged

between a knowledgeable, willing buyer and a knowledgeable,

willing seller in an arm‘s length transaction.

l Pooling of interests is a method of accounting for amalga-

mations the object of which is to account for the amalgamation

as if the separate businesses of the amalgamating companies

were intended to be continued by the transferee company.

Accordingly, only minimal changes are made in aggregating the

individual financial statements of the amalgamating companies.

Explanation

Types of Amalgamations Generally speaking, amalgamations fall into two broad categories. In the first

category are those amalgamations where there is a genuine pooling not

merely of the assets and liabilities of the amalgamating companies but also of

the shareholders‘ interests and of the businesses of these companies. Such

amalgamations are amalgamations which are in the nature of ‗merger‘ and

the accounting treatment of such amalgamations should ensure that the

resultant figures of assets, liabilities, capital and reserves more or less

represent the sum of the relevant figures of the amalgamating companies. In

the second category are those amalgamations which are in effect a mode by

which one company acquires another company and, as a consequence, the

shareholders of the company which is acquired normally do not continue to

have a proportionate share in the equity of the combined company, or the

business of the company which is acquired is not intended to be continued.

Such amalgamations are amalgamations in An amalgamation is classified as an ‗amalgamation in the nature of merger‘ when all the conditions listed in paragraph 3(e) a re satisfied.

There are, however, differing views regarding the nature of any further

conditions that may apply. Some believe that, in addition to an exchange

of equity shares, it is necessary that the shareholders of the transferor

company obtain a substantial share in the transferee company even to the

extent that it should not be possible to identify any one party as dominant

therein. This belief is based in part on the view that the exchange of

control of one company for an insignificant share in a larger company

does not amount to a mutual sharing of risks and benefits. Other s believe that the substance of an amalgamation in the nature of

merger is evidenced by meeting certain criteria regarding the relationship

of the parties, such as the former independence of the amalgamating

companies, the manner of their amalgamation, the absence of planned

transactions that would undermine the effect of the amalgamation, and the

continuing participation by the management of the transferor company in

the management of the transferee company after the amalgamation.

Methods of Accounting for Amalgamations There are two main methods of accounting for amalgamations:

(a) the pooling of interests method; and

(b) the purchase method.

The use of the pooling of interests method is confined to circumstances

which meet the criteria referred to in paragraph 3(e) for an amalgamation in

the nature of merger. The object of the purchase method is to account for the amalgamation by

applying the same principles as are applied in the normal purchase of

assets. This method is used in accounting for amalgamations in the nature

of purchase. The Pooling of Interests Method Under the pooling of interests method, the assets, liabilities and reserves

of the transferor company are recorded by the transferee company at their

existing carrying amounts. If, at the time of the amalgamation, the transferor

and the transferee companies have conflicting accounting policies, a uniform

set of accounting policies is adopted following the amalgamation. The effects

on the financial statements of any changes in accounting policies are reported

in accordance with Accounting Standard (AS) 5, Net Profit or Loss for the

Period, Prior Period Items and Changes in Accounting Policies. The Purchase Method Under the purchase method, the transferee company accounts for the

amalgamation either by incorporating the assets and liabilities at their

existing carrying amounts or by allocating the consideration to individual

identifiable assets and liabilities of the transferor company on the basis of

their fair values at the date of amalgamation. The identifiable assets and

liabilities may include assets and liabilities not recorded in the financial

statements of the transferor company. Where assets and liabilities are restated on the basis of their fair values, the

determination of fair values may be influenced by the intentions of the transferee company. For example, the transferee company may

have a specialised use for an asset, which is not available to other

potential buyers. The transferee company may intend to effect changes in

the activities of the transferor company which necessitate the creation of

specific provisions for the expected costs, e.g. planned employee

termination and plant relocation costs.

Consideration The consideration for the amalgamation may consist of securities, cash or

other assets. In determining the value of the consideration, an assessment is

made of the fair value of its elements. A variety of techniques is applied in

arriving at fair value. For example, when the consideration includes

securities, the value fixed by the statutory authorities may be taken to be the

fair value. In case of other assets, the fair value may be determined by

reference to the market value of the assets given up. Where the market value

of the assets given up cannot be reliably assessed, such assets may be valued

at their respective net book values. Many amalgamations recognise that adjustments may have to be made to the

consideration in the light of one or more future events. When the additional

payment is probable and can reasonably be estimated at the date of

amalgamation, it is included in the calculation of the consideration. In all

other cases, the adjustment is recognised as soon as the amount is

determinable

Treatment of Reserves on Amalgamation If the amalgamation is an ‗amalgamation in the nature of merger‘, the

identity of the reserves is preserved and they appear in the financial

statements of the transferee company in the same form in which they

appeared in the financial statements of the transferor company. Thus, for

example, the General Reserve of the transferor company becomes the

General Reserve of the transferee company, the Capital Reserve of the

transferor company becomes the Capital Reserve of the transferee

company and the Revaluation Reserve of the transferor company becomes

the Revaluation Reserve of the transferee company. As a result of preserving

the identity, reserves which are available for distribution as dividend before

the amalgamation would also be available for distribution as dividend after

the amalgamation. The difference between the amount recorded as share

capital issued (plus any additional consideration in the form of cash or other

assets) and the amount of share capital of the

Revaluation Reserve of the transferee company. As a result of preserving the

identity, reserves which are available for distribution as dividend before the

amalgamation would also be available for distribution as dividend after the

amalgamation. The difference between the amount recorded as share capital

issued (plus any additional consideration in the form of cash or other assets)

and the amount of share capital of the transferor company is adjusted If the amalgamation is an ‗amalgamation in the nature of purchase‘, the

identity of the reserves, other than the statutory reserves dealt with in

paragraph 18, is not preserved. The amount of the consideration is

deducted from the value of the net assets of the transferor company

acquired by the transferee company. If the result of the computation is

negative, the difference is debited to goodwill arising on amalgamation

and dealt with in the manner stated in paragraphs 19-20. If the result of

the computation is positive, the difference is credited to Capital Reserve. Certain reserves may have been created by the transferor company pursuant

to the requirements of, or to avail of the benefits under, the Income-tax Act,

1961; for example, Development Allowance Reserve, or Investment

Allowance Reserve. The Act requires that the identity of the reserves should

be preserved for a specified period. Likewise, certain other reserves may

have been created in the financial statements of the transferor company in

terms of the requirements of other statutes. Though, normally, in an

amalgamation in the nature of purchase, the identity of reserves is not

preserved, an exception is made in respect of reserves of the aforesaid

nature (referred to hereinafter as ‗statutory reserves‘) and such reserves

retain their identity in the financial statements of the transferee company

in the same form in which they appeared in the financial statements of the

transferor company, so long as their identity is required to be maintained

to comply with the relevant statute. This exception is made only in those

amalgamations where the requirements of the relevant statute for

recording the statutory reserves in the books of the transferee company

are complied with. In such cases the statutory reserves are recorded in the

financial statements of the transferee company by a corresponding debit

to a suitable account head (e.g., ‗Amalgamation Adjustment Account‘)

which is disclosed as a part of ‗miscellaneous expenditure‘ or other

similar category in the balance sheet. When the identity of the statutory

reserves is no longer required to be maintained, both the reserves and the

aforesaid account are reversed.

Treatment of Goodwill Arising on Amalgamation Goodwill arising on amalgamation represents a payment made in anticipation

of future income and it is appropriate to treat it as an asset to be amortised to

income on a systematic basis over its useful life. Due to the nature of

goodwill, it is frequently difficult to estimate its useful life with reasonable

certainty. Such estimation is, therefore, made on a prudent basis.

Accordingly, it is considered appropriate to amortise goodwill over a period

not exceeding five years unless a somewhat longer period can be justified. Factors which may be considered in estimating the useful life of goodwill

arising on amalgamation include:

1. the foreseeable life of the business or industry;

2. the effects of product obsolescence, changes in demand and

other economic factors;

3. the service life expectancies of key individuals or groups of

employees;

expected actions by competitors or potential competitors; and

legal, regulatory or contractual provisions affecting the useful life.

Balance of Profit and Loss Account In the case of an ‗amalgamation in the nature of merger‘, the balance of the

Profit and Loss Account appearing in the financial statements of the

transferor company is aggregated with the corresponding balance appearing

in the financial statements of the transferee company. Alternatively, it is

transferred to the General Reserve, if any. In the case of an ‗amalgamation in the nature of purchase‘, the balance of the

Profit and Loss Account appearing in the financial statements of the

transferor company, whether debit or credit, loses its identity.

Treatment of Reserves Specified in A Scheme of Amalgamation The scheme of amalgamation sanctioned under the provisions of the

Companies Act, 1956 or any other statute may prescribe the treatment to

be given to the reserves of the transferor company after its amalgamation.

Where the treatment is so prescribed, the same is followed. In some cases,

the scheme of amalgamation sanctioned under a statute may prescribe a

different treatment to be given to the reserves of the transferor company

after amalgamation as compared to the requirements of this Standard that

would have been followed had no treatment been prescribed by the

scheme. In such cases, the following disclosures are made in the first

financial statements following the amalgamation:

l A description of the accounting treatment given to the reserves

and the reasons for following the treatment different from that

prescribed in this Standard.

l Deviations in the accounting treatment given to the reserves as

prescribed by the scheme of amalgamation sanctioned under

the statute as compared to the requirements of this Standard

that would have been followed had no treatment been

prescribed by the scheme.

(c) The financial effect, if any, arising due to such deviation.

Disclosure

(a) 24. For all amalgamations, the following disclosures are

considered appropriate in the first financial statements

following the amalgamationnames and general nature of

business of the amalgamating companies;

(b) effective date of amalgamation for accounting purposes;

(c) the method of accounting used to reflect the amalgamation; and

(d) particulars of the scheme sanctioned under a statute.

For amalgamations accounted for under the pooling of interests method,

the following additional disclosures are considered appropriate in the first


description and number of shares issued, together with the

percentage of each company‘s equity shares exchanged to effect

the amalgamation;

the amount of any difference between the consideration and the

value of net identifiable assets acquired, and the treatment

thereof. For amalgamations accounted for under the purchase method, the

following additional disclosures are considered appropriate in the first


consideration for the amalgamation and a description of the

consideration paid or contingently payable; and

the amount of any difference between the consideration and the


thereof including the period of amortisation of any goodwill

arising on amalgamation.

Amalgamation after the Balance Sheet Date When an amalgamation is effected after the balance sheet date but before

the issuance of the financial statements of either party to the

amalgamation, disclosure is made in accordance with AS 4,

‗Contingencies and Events Occurring After the Balance Sheet Date‘, but

the amalgamation is not incorporated in the financial statements. In

certain circumstances, the amalgamation may also provide additional

information affecting the financial statements themselves, for instance, by

allowing the going concern assumption to be maintained

Main Principles

An amalgamation may be either –

an amalgamation in the nature of merger, or

an amalgamation in the nature of purchase.

An amalgamation should be considered to be an amalgamation in the

nature of merger when all the following conditions are satisfied:

(i) All the assets and liabilities of the transferor company become,

after amalgamation, the assets and liabilities of the transferee

company.

Shareholders holding not less than 90% of the face value of the

equity shares of the transferor company (other than the equity

shares already held therein, immediately before the

amalgamation, by the transferee company or its subsidiaries or

their nominees) become equity shareholders of the transferee

company by virtue of the amalgamation.

The consideration for the amalgamation receivable by those

equity shareholders of the transferor company who agree to

become equity shareholders of the transferee company is

discharged by the transferee company wholly by the issue of

equity shares in the transferee company, except that cash may

be paid in respect of any fractional shares.

7. The business of the transferor company is intended to be carried

on, after the amalgamation, by the transferee company.

8. No adjustment is intended to be made to the book values of the

assets and liabilities of the transferor company when they are

incorporated in the financial statements of the transferee

company except to ensure uniformity of accounting policies. An amalgamation shou ld be considered to be an amalgamation in the

nature of purchase, when any one or more of the conditions specified in

paragraph 29 is not satisfied31. When an amalgamation is considered to

be an amalgamation in the nature of merger, it should be accounted for

under the pooling of interests method described in paragraphs 33–35. When an amalgamation is considered to be an amalgamation in the

nature of purchase, it should be accounted for under the purchase method

described in paragraphs 36–39.

The Pooling of Interests Method In preparing the transferee company‘s financial statements, the assets,

liabilities and reserves (whether capital or revenue or arising on revaluation)

of the transferor company should be recorded at their existing carrying

amounts and in the same form as at the date of the amalgamation. The

balance of the Profit and Loss Account of the transferor company should be

aggregated with the corresponding balance of the transferee company or

transferred to the General Reserve, if any. If, at the time of the amalgamation, the transferor and the transferee

companies have conflicting accounting policies, a uniform set of

accounting policies should be adopted following the amalgamation. The

effects on the financial statements of any changes in accounting policies

should be reported in accordance with Accounting Standard (AS) 5 Net Profit or Loss for the Period, Prior Period Items and Changes in The difference between the amount recorded as sha re capital issued

(plus any additional consideration in the form of cash or other assets) and

the amount of share capital of the transferor company should be adjusted

in reserves. The Purchase Method In preparing the transferee company‘s financial statements, the assets and

liabilities of the transferor company should be incorporated at their

existing carrying amounts or, alternatively, the consideration should be

allocated to individual identifiable assets and liabilities on the basis of

their fair values at the date of amalgamation. The reserves (whether

capital or revenue or arising on revaluation) of the transferor company,

other than the statutory reserves, should not be included in the financial

statements of the Any excess of the amount of the consideration over the value of the net

assets of the transferor company acquired by the transferee company

should be recognised in the transferee company‘s financial statements as

goodwill arising on amalgamation. If the amount of the consideration is

lower than the value of the net assets acquired, the difference should be

treated as Capital Reserve. The goodwill arising on amal gamation should be amortised to income

on a systematic basis over its useful life. The amortisation period should

not exceed five years unless a somewhat longer period can be justified. Where the requirements of the relevant statute for recording the statutory

reserves in the books of the transferee company are complied with,

statutory reserves of the transferor company should be recorded in the

financial statements of the transferee company. The corresponding debit

should be given to a suitable account head (e.g., ‗Amalgamation

Adjustment Account‘) which should be disclosed as a part of

‗miscellaneous expenditure‘ or other similar category in the balance

sheet. When the identity of the statutory reserves is no longer required to

be maintained, both the reserves and the aforesaid account should be

reversed. Common Procedures The consideration for the amalgamation should include any non-cash

element at fair value. In case of issue of securities, the value fixed by the

statutory authorities may be taken to be the fair value. In case of other

assets, the fair value may be determined by reference to the market value

of the assets given up. Where the market value of the assets given up

cannot be reliably assessed, such assets may be valued at their respective

net book values.

Where the scheme of amalgamation provides for an adj ustment to the

consideration contingent on one or more future events, the amount of the

additional payment should be included in the consideration if payment is

probable and a reasonable estimate of the amount can be made. In all

other cases, the adjustment should be recognised as soon as the amount is

determinable [see Accounting Standard (AS) 4, Contingencies and Events

Occurring After the Balance Sheet Date].

Treatment of Reserves Specified in A Scheme of Amalgamation Where the scheme of amalgamation sanctioned under a statute prescribes

the treatment to be given to the reserves of the transferor company after

amalgamation, the same should be followed. Where the scheme of

amalgamation sanctioned under a statute prescribes a different treatment

to be given to the reserves of the transferor company after amalgamation

as compared to the requirements of this Standard that would have been

followed had no treatment been prescribed by the scheme, the following

disclosures should be made in the first financial statements following the

amalgamation: (a) A description of the accounting treatment given to the

reserves and the reasons for following the treatment different

from that prescribed in this Standard.

(b) Deviations in the accounting treatment given to the reserves as

prescribed by the scheme of amalgamation sanctioned under

the statute as compared to the requirements of this Standard

that would have been followed had no treatment been

prescribed by the scheme.

(c) The financial effect, if any, arising due to such deviation.

Disclosure For all amalgamations, the following disclosures should be made in the

first financial statements following the amalgamation:

(a) names and general nature of business of the amalgamating

companies;

(b) effective date of amalgamation for accounting purposes;

(c) the method of accounting used to reflect the amalgamation; and

(d) particulars of the scheme sanctioned under a statute. For amalgamations accounted for under the pooling of interests method,

the following additional disclosures should be made in the first financial

statements following the amalgamation: (a) description and number of shares issued, together with the

percentage of each company‘s equity shares exchanged to effect

the amalgamation;

(b) the amount of any difference between the consideration and the


thereof. For amalgamations accounted for under the purchase method, the

following additional disclosures should be made in the first financial

statements following the amalgamation:

(a) consideration for the amalgamation and a description of the

consideration paid or contingently payable; and

(b) the amount of any difference between the consideration and the

value of net identifiable assets acquired, and the treatment thereof including the period of amortisation of any goodwill

arising on amalgamation. Amalgamation after the Balance Sheet Date

When an amalgamation is effected after the balance sheet date but before

the issuance of the financial statements of either party to the

amalgamation, disclosure should be made in accordance with AS 4, ‗Contingencies and Events Occurring After the Balance Sheet Date‘, but

the amalgamation should not be incorporated in the financial statements.

In certain circumstances, the amalgamation may also provide additional

information affecting the financial statement

.

1. Method to calculate Purchase Consideration:

Net Asset method Intansic value method Net payment method

Agreed value of MV of total assets xxx Amalgamation in nature of: -

assets taken over xxx Less: MV of total Liab. xxx Merger: Amount paid to Equity

Less: Agreed value of Net intrinsic value xxx shareholders only in the form of

Liab. taken over xxx equity shares in purchasing

PC xxx

company except cash for

Intrinsic Value = Net Intrinsic value

fraction of shares.

Per share No. of equity share

Purchase: Cash and agreed

value of shares, debentures and

PC= No. of equity shares purchased other assets given by purchasing

company to the liquidator of

X Intrinsic value per share of

vendor company For the

vendor company

Shareholders of vendor

company.

Note: If information about all the three method is given in the question then we should follow Net payment method.

Amalgamation in nature of merger: Amalgamation deemed to be in the nature of merger if following conditions are satisfied: - (BARED)

Business of vendor company must be carried on by the purchasing company. All assets and liabilities of vendor company transferred to purchasing company.

Recorded in new company of assets and liabilities taken over at Book Value of vendor company. (Except to comply with accounting policy) Equity shareholders holding 90% shares (except already held) agree to become

shareholders in new company. Disbursement of Purchase Consideration only in shares except cash for fraction of

shares.

Entries in books of vendor company:

Realisation account: We have to follow the following procedure

Transfer all real assets to debit side at Gross Book Value including goodwill but excluding fictitious assets. Transfer all outside liabilities to credit side at Gross Book Value but excluding

accumulated reserves and surplus. If any asset/liabilities not taken over than any realisation on sale of such asset

or payment on disbursement of such liabilities is credited/debited to realisation

account.

Amount of Purchase Consideration is credited to realisation account. Liquidation expenses debited to realisation account if born by vendor company

Realisation account is balanced and the balance of this account is profit or loss on realisation, which is transferred to Equity Shareholders Account.

Notes: 1. Assets not taken over if transferred to shareholders account: it must be shown on

debit side of shareholders account at Current Value of such asset and a corresponding credit is made to realisation account.

What are outside liabilities: Preference shareholders and Debenture holders are treated outside liabilities. But proposed dividend is not treated outside liabilities.

If against any reserve there is any expected liabilities: then to the extent of that expected liability the amount of reserve is transferred to realisation account and balance to shareholders account as usual. Example: Workmen compensation reserve given in Balance sheet = 8000 Expected liability to workmen =5000. Therefore Rs 5000 will be transferred to the credit side of realisation account and balance Rs 3000 to the credit side of shareholders account.

Any inter company owings or adjustments: is ignored while preparing vendor company books, it is considered only while preparing purchasing company books.

Equity Shareholders Account:

Credit side: Equity Share Capital, Accumulated profits and reserves, balance of realisation account. Debit side: Accumulated losses, Fictitious asset, amount of Purchase

Consideration, balance of realisation account.

Purchasing Company Account:

Credit side: Amount of Purchase Consideration due. Debit side: Discharge of Purchase Consideration.

3. Entries in books of Purchasing Company

a) Three basic entries

For purchase consideration due

Business purchase a/c Dr.

To liquidator of vendor company

For assets and liabilities taken over

Assets taken over Dr.

Goodwill a/c Dr.

To liabilities taken over

To business purchase a/c

To capital reserve a/c For discharge of purchase consideration Liquidator of vendor company a/c Dr.

To equity share capital a/c

To share premium a/c

To debentures a/c To preference share capital a/c To cash

b) For liquidation expenses paid by purchasing company

Goodwill/Capital reserve a/c Dr.

To cash a/c

c) For cancellation of mutual owings

Creditor /Bills payable a/c Dr.

www.caplanet.com To Debtors/Bills receivable a/c

d) For adjustment of unrealised profit

Goodwill/Capital reserve a/c Dr.

To Stock a/c

e) For carry forward of statutory reserves

Amalgamation adjustment a/c Dr.

To Statutory reserve a/c

f) If both capital reserve and goodwill appears in books

Capital reserve a/c Dr.

To Goodwill a/c

Note: Amalgamation in nature of merger: The entries in the case of amalgamation in the

nature of merger is almost similar to the entries given above, the only difference is: In the second basic entry above, instead of opening the Goodwill/Capital reserve

a/c, the difference between purchase consideration paid and book value of the share capital of vendor company is adjusted in general reserve. If general reserve is not sufficient then balance adjusted in profit & loss account. Similarly any difference in actual debenture value and the amount paid to them is also adjusted to general reserve. If general reserve is not sufficient then balance adjusted in profit & loss account.

Where ever Goodwill/Capital reserve a/c is debited or credited in above entries we will have to debit or credit general reserve account.

Following will remain same in both the methods of amalgamation Calculation of Purchase consideration.

Discharge of Purchase consideration.

Entries in books of vendor company.

Inter company holding

Purchasing company held shares Vendor company held shares Both vendor and purchasing in vendor company (P

V) in purchasing company company held shares in each

(V

P) other (P<

V)

Calculation of purchase consideration

PC (Given/calculated) xxx PC (Given/calculated) PC (Given/calculated) xxx Less: % reduction for shares xxx Less: % reduction for shares

Held by purchasing Less: Value of shares Held Held by purchasing

company in vendor by vendor company in company in vendor

company xxx purchasing company company xxx Net PC xxx xxx Less: Value of shares Held

Net PC by vendor company in xxx purchasing company xxx Net PC xxx

www.caplanet.com

% = Shares held by X 100 purch. comp. Total shares of vendor comp.

Value= No of shares held X Intrinsic value per share

Books of Vendor company

Realisation account Realisation account

All assets

WHAT YOU HAVE LEARNT

337

WHAT YOU HAVE LEARNT

77

Issue of Shares

TERMINAL QUESTIONS

278

Issue of Shares

279

Issue of Shares

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