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FOUNDATION PROGRAMME
FUNDAMENTALS OF
ACCOUNTING AND
AUDITING
PAPER 4
ICSI House, 22, Institutional Area, Lodi Road, New Delhi 110 003
tel 011-4534 1000, 4150 4444 fax +91-11-2462 6727
email [email protected] website www.icsi.edu
i
THE INSTITUTE OF COMPANY SECRETARIES OF INDIA
TIMING OF HEADQUARTERS
Monday to Friday
Office Timings 9.00 A.M. to 5.30 P.M.
Phones
41504444, 45341000
Fax
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Website
www.icsi.edu
E-mail
[email protected]
ii
FOUNDATION PROGRAMME IMPORTANT NOTE
The study material has been written in lucid and simple language and conscious efforts have been made to
explain the fundamental concepts and principles of accounting and auditing. This study material is divided into
two main parts
There is computer based examination for the Foundatian Programme. Where Student are required to answer
multiple choice questions.
For supplementing the information contained in the study material, students may refer to the economic and
financial dailies, commercial, legal and management journals, Economic Survey (latest), CS Foundation Course
e-Bulletin, Suggested Readings and References mentioned in the study material and relevant websites.
The objective of the study material is to provide students with the learning material according to the syllabus of
the subject of the Foundation Programme. In the event of any doubt, students may write to the Directorate of
Academics in the Institute for clarification at [email protected]
Although due care has been taken in preparing and publishing this study material, yet the possibility of errors,
omissions and/or discrepancies cannot be ruled out. This publication is released with an understanding that the
Institute shall not be responsible for any errors, omissions and/or discrepancies or any action taken on the basis
of contents of the study material.
Should there be any discrepancy, error or omission noted in the study material, the Institute shall be obliged if
the same are brought to its notice for issue of corrigendum in the e-Bulletin CS Foundation Course.
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SYLLABUS
1. Theoretical Framework
Meaning and Scope of Accounting; Accounting Concepts; Accounting Principles, Conventions and
Standards Concepts, Objectives, Benefits; Accounting Policies; Accounting as a Measurement
Discipline Valuation Principles, Accounting Estimates
2. Accounting Process
Documents & Books of Accounts: Invoice, Vouchers, Debit & Credit Notes, Day books, Journals,
Ledgers and Trial Balance
Capital and Revenue: Expenditures and Receipts; Contingent Assets and Contingent Liabilities
Rectification of Errors
3. Bank Reconciliation Statement
Meaning; Causes of difference between Bank Book Balance and Balance as per Bank Pass Book /
Bank Statement; Need of Bank Reconciliation Statement; Procedure for Preparation of Bank
Reconciliation Statement
4. Depreciation Accounting
Methods, Computation and Accounting Treatment of Depreciation; Change in Depreciation Methods
5. Preparation of Final Accounts for Sole Proprietors
Preparation of Profit & Loss Account, Balance Sheet
6. Partnership Accounts
Goodwill
Nature of and Factors Affecting Goodwill
Methods of Valuation: Average Profit, Super Profit and Capitalization Methods
Treatment of Goodwill
Final Accounts of Partnership Firms
Admission of a Partner
Retirement/Death of a Partner
Dissolution of a Partnership Firm
7. Introduction to Company Accounts
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Issue of Shares and Debentures; Forfeiture of Shares; Re-Issue of Forfeited Shares; Redemption of
Preference Shares
8. Auditing
Concepts and Objectives
Principles of Auditing
Types of Audit
Evidence in Auditing
Audit Programmes
9. Audits and Auditors Reports
Internal Audit
Statutory Auditor: Appointment, Qualification, Rights and Duties
Secretarial Audit: An Overview
Cost Audit: An Overview
Auditors Report:Meanings, Contents, Types, Qualifications
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LIST OF RECOMMENDED BOOKS*
PAPER 4 : FUNDAMENTAL OF ACCOUNTING AND AUDITING
READINGS
1. M. C. Shukla, Advanced Accounts Vol. I, S. Chand & Company Ltd., Ram Nagar, New Delhi-55.
T. S. Grewal &
S. C. Gupta
2. R. L. Gupta & Financial Accounting, Sultan Chand & Sons, New Delhi - 2.
V. K. Gupta
3. J. R. Monga Financial Accounting Concepts & Applications; Mayoor Paperbacks, A-95, Sector
5, Noida (U.P.)
4. S. N. Maheshwari & Advanced Accounting, Volume I; Vikas Publishing House (Pvt.) Ltd., Jangpura,
S. K. Maheshwari New Delhi-14.
5. S. P. Jain & Advanced Accounting, Volume I; Kalyani Publishers, Daryaganj, New Delhi - 2.
K. L. Narang
6. Ashok Sehgal & Advanced Accounting (Financial Accounting); Taxmanns, New Delhi.
Deepak Sehgal
7. Aruna Jha Students Guide to Auditing & Assurance, Taxmann Publications Pvt. Ltd., New
Rohtak Road, New Delhi.
8. S. D. Sharma Auditing Principles & Practice, Taxmann Publications Pvt. Ltd., New Rohtak Road,
New Delhi.
9. Anand G. Srinivasan Auditing, Taxmann Publications Pvt. Ltd., New Rohtak Road, New Delhi.
10. S. Sundharababu, A Handbook of Practice Auditing, S. Chand, S. Sundharsanam, B.N. Tondon &
Company, New Delhi
REFERENCES
1. T. P. Ghosh, A. Banerjee Principles and Practice of Accounting, Galgotia Publishing Company, New Delhi-5.
& K.M. Bansal
2. P. C. Tulsian Financial Accounting, Sultan Chand & Company, New Delhi.
3. R. Narayanaswamy Financial Accounting A Managerial Prospective; PHI Learning Pvt. Ltd.
4. Ashish K. Bhattacharyya Essentials of Financial Accounting; PHI Learning Pvt. Ltd.
*This study material sufficient from the point of view of syllabus. The students may refer latest edition of these books for further knowledge
and study of the subject.
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CONTENTS
PART A: FUNDAMENTALS OF ACCOUNTING
Lesson 1
THEORETICAL FRAMEWORK
Page
Accounting 3
Review Questions 5
Book Keeping 5
Systems of Accounting 6
Accounting as Information System 7
Role of Accountant 8
Accounting Principles, Concepts and Conventions 9
Accounting Standards 12
Accounting Policies 13
Accounting A Measurement Discipline 13
Accounts and its Classification 13
Review Questions 15
Double Entry System 15
Rules of Debit and Credit 16
Accounting Equation 18
LESSON ROUND UP 18
GLOSSARY 19
SELF-TEST QUESTIONS 19
LESSON 2
ACCOUNTING PROCESS-I (RECORDING OF TRANSACTIONS)
Accounting Cycle 24
Journal 24
Ledger 29
Subsidiary Books of Accounts 33
Purchases Book 34
Sales Book 34
Purchases Returns Book 34
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Page
LESSON 3
ACCOUNTING PROCESS-II (RECTIFICATION OF ERRORS)
Errors 60
Classification of Errors 60
Errors Disclosed by Trial Balance 61
Errors Not disclosed by Trial Balance 62
Review Questions 62
Steps to locate Errors 63
Rectification of Errors 63
Before the preparation of Trial Balance 63
After the preparation of Trial Balance but before the preparation of Final Accounts 67
In the next accounting period 70
LESSON ROUND UP 78
GLOSSARY 78
SELF-TEST QUESTIONS 78
LESSON 4
ACCOUNTING PROCESS-III (CAPITAL AND REVENUE ITEMS)
Capital Expenditure 82
Revenue Expenditure 82
Deferred Revenue Expenditure 82
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Page
LESSON 5
BANK RECONCILIATION STATEMENT
Introduction 92
Review Questions 93
Causes of difference between Bank Balance as per Cash Book and Pass Book 93
Significance of Bank Reconciliation Statement 94
Procedure of preparing Bank Reconciliation Statement 94
Preparation of Bank Reconciliation Statement when overdraft balances are given 96
Preparation of Bank Reconciliation Statement when extracts of cash book and pass book are given 98
Illustrations 98
LESSON ROUND UP 108
GLOSSARY 108
SELF-TEST QUESTIONS 109
LESSON 6
DEPRECIATION ACCOUNTING
Introduction 114
Accounting Concept of Depreciation 116
Review Questions 117
Methods of Providing Depreciation 118
Uniform Charge Methods 118
Fixed Instalment Method or Straight Line Method 118
Depreciation Fund (Sinking Fund) Method 120
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Page
LESSON 7
PREPARATION OF FINAL ACCOUNTS FOR SOLE PROPRIETORS
Introduction 142
Trading Account 142
Profit & Loss Account 143
Review Questions 144
Balance Sheet 145
Review Questions 146
Classification of Assets 146
Classification of Liabilities 146
Adjustment Entries 148
Closing Entries 157
Manufacturing Account 158
Limitations of Financial Statements 159
Illustrations 160
LESSON ROUND UP 172
GLOSSARY 172
SELF-TEST QUESTIONS 172
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Page
LESSON 8
PARTNERSHIP ACCOUNTS
Basic Concepts of Partnership 180
Goodwill 182
Methods of Valuation of Goodwill 183
Preparation of Final Accounts of Partnership 185
Profit & Loss Appropriation Account 185
Reconstitution of Partnership 195
Change in Profit Sharing Ratio 195
Admission of a Partner 197
Retirement of a Partner 217
Death of a Partner 232
Dissolution of Partnership Firm 239
LESSON ROUND UP 254
GLOSSARY 255
SELF-TEST QUESTIONS 256
LESSON 9
INTRODUCTION TO COMPANY ACCOUNTS
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Page
LESSON 10
CONCEPT OF AUDITING
Introduction 321
Evolution of Auditing 321
Meaning and Definitions of Auditing 321
Features of Auditing 322
Objectives of Auditing 322
Basic Principles Governing an Audit 323
Principal Aspects to be Covered in Auditing 324
Benefits of Audit 325
Limitations of Audit 325
Review Question 326
Investigation 326
Difference between Auditing and Investigation 326
LESSON ROUND UP 327
GLOSSARY 327
SELF-TEST QUESTIONS 328
Lesson 11
Types of Audit
Introduction 330
Types of Audit 330
Audit under the Companies Act, 2013 330
Statutory Audit 330
Internal Audit 331
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Page
Lesson 12
Tools of Auditing
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Page
Lesson 13
Auditor and Related Provisions
xiv
PART A
FUNDAMENTALS OF ACCOUNTING
LESSONS
LEARNING OBJECTIVES
In todays business world, accounting is
1. Theoretical Framework
considered as the universal language of
business, because it is the vehicle for reporting
2. Accounting Process I financial information about a business entity to
(Recording of Transactions) users such as shareholders and managers. A
proper accounting system is essential to any
business, whether big or small, in order to
3. Accounting Process II
manage its daily functions and run it successfully.
(Rectification of Errors)
The main obligation of any business is to
maximize profits, minimize losses and at the
4. Accounting Process III same time maintain its position as a responsible
(Capital and Revenue Items) entity within the society.
So, in the current business world, everybody
5. Bank Reconciliation Statement should have the knowledge of accounting
discipline irrespective of the job one is doing. Due
to the rapid advancement in business activities
6. Depreciation Accounting
due to industrialization and globalization, the
need for people having knowledge of accounts
7. Preparation of Final Accounts for Sole have increased manifold. It is impossible to
Proprietors survive in todays advanced business
environment without adequate knowledge of
basic accountancy.
8. Partnership Accounts
Especially all business students should have
some background in accounting to understand
9. Introduction to Company Accounts
and interpret and present the results of business.
Lesson 1
Theoretical Framework
LESSON OUTLINE
LEARNING OBJECTIVES
Accounting
Accounting is a very old concept as old as
Definition
Stages of Accounting money. A description of proper keeping of
Branches of Accounting
accounts is also found in Arthashastra written
Functions of Accounting
Advantages of Accounting by Kautilya. However, it has developed with the
Limitations of Accounting passage of time to meet the requirements and
Review Questions
Book Keeping challenges of ever growing society. The
The system of book keeping by double entry is, perhaps the most beautiful one in the wide domain
of literature or science.
Edwin T. Freedley
Lesson 1 Theoretical Framework 3
ACCOUNTING
Accounting is used by business entities for keeping records of their monetary or financial transactions. A
businessman who has invested money in his business would like to know whether his business is making a
profit or incurring a loss, the position of his assets and liabilities and whether his capital in the business has
increased or decreased during a particular period.
Definition
The definition given by the American Institute of Certified Public Accountants (AICPA) clearly brings out the
meaning of accounting. According to it, accounting is the art of recording, classifying and summarizing in a
significant manner and in terms of money, transactions and events which are, in part at least, of a financial
character and interpreting the results thereof. The definition brings out the following as attributes of
accounting :
(i) Accounting is an art. Accounting is classified as an art, as it helps us in attaining our aim of
ascertaining the financial results, that is, operating profit and financial position through analysis and
interpretation of financial data which requires special knowledge, experience and judgment.
(ii) It involves recording, classifying and summarizing. Recording means systematically writing down the
transactions and events in account books soon after their occurrence. Classifying is the process of
grouping transactions or entries of the same type at one place. This is done by opening accounts in a
book called ledger. Summarizing involves the preparation of reports and statements from the classified
data (ledger), understandable and useful to management and other interested parties. This involves
preparation of final accounts namely profit and loss account and balance sheet.
(iii) It records transactions in terms of money. All transactions are recorded in terms of common measure
i.e. money which increases the understanding of the state of affairs of the business.
(iv) It records only those transactions and events which are of financial character. If an event has no
financial character then it will not be capable of being measured in terms of money ; it will not be,
therefore, recorded.
(v) It is the art of interpreting the results of operations to determine the financial position of the enterprise,
the progress it has made and how well it is getting along.
Stages of Accounting
Accounting has the following stages:
(i) The transactions of a business that have, at least in part, a financial character are identified and
recorded.
(ii) The recording is done in a manner which identifies the different classes and types of transactions.
(iii) The resulting records are summarized in such a way that the owners or other interested parties in the
business can see the overall effects of all the transactions. The statements prepared by the
summarizing process are known as financial statements which will show the profit or loss made by the
business over a period of time and the total capital employed in the business. Such financial
statements are used by management to make business decisions.
Branches of Accounting
Accounting has three main forms or branches viz. financial accounting, cost accounting and management
accounting.
(i) Financial Accounting: It is concerned with record-keeping directed towards the preparation of trial
balance, profit and loss account and balance sheet.
4 FP-FA&A
(ii) Cost Accounting: Cost accounting is the process of accounting for costs. It is a systematic procedure
for determining the unit cost of output produced or services rendered. The main functions of cost
accounting are to ascertain the cost of a product and to help the management in the control of
cost.
(iii) Management Accounting: Management accounting is primarily concerned with the supply of
information which is useful to the management in decision-making, increasing efficiency of business
and maximizing profits.
Functions of Accounting
The following are the main functions of accounting:
(i) Keeping Systematic Records: Accounting is done to keep a systematic record of financial transactions.
(ii) Protecting and Controlling Business Properties: Accounting helps to see that there is no unauthorized
use or disposal of any assets or property belonging to the firm, because proper records are
maintained. Accounting will furnish information about money due from various persons and money due
to various parties. The firm can see that all amounts due to it are recovered in due time and that no
amount is paid unnecessarily.
(iii) Ascertaining the Operational Profit/Loss: Accounting helps to determine the results of the activities in a
given period, usually a year, i.e. to show how much profit has been earned or how much loss has been
incurred. This is done by keeping a proper record of revenues and expenses of a particular period and
then matching the revenues with the corresponding costs.
(iv) Ascertaining the Financial Position of the Business: Balance sheet is prepared to ascertain the
financial position of the firm at the end of a particular period. It shows the values of the assets and the
liabilities of the business entity.
(v) Facilitating Rational Decision Making: Accounting facilitates collection, analysis and reporting of
information at the required point of time to the required levels of authority in order to facilitate rational
decision making.
Advantages of Accounting
The following are the advantages of accounting:
(i) Maintenance of Business Records: All financial transactions are recorded in a systematic manner in
the books of accounts so that there is no need to depend upon on memory. It is impossible to
remember the business transactions which have grown in size and complexity.
(ii) Preparation of Financial Statements: Proper recording of transactions facilitates the preparation of
financial statements i.e. the trading and profit and loss account and balance sheet.
(iii) Comparison of Results: Accounting information when properly recorded can be used to compare the
results of one year with those of earlier years so that the significant changes can be analyzed.
(iv) Decision Making: Accounting information helps the management to plan its future activities by
preparing budgets and coordination of various activities in different departments.
(v) Evidence in Legal Matters: Properly recorded accounting information can be produced as evidence in
a court of law.
(vi) Provides Information to Interested Parties: Interested parties like owners, creditors, management,
employees, customers, government, etc. can get financial information about the organisation.
(vii) Helps in Taxation Matters: Income tax and/sales tax authorities depend for taxation matter on the
accounts maintained by the business.
(viii) Valuation of Business: When the business is to be sold, the accounting information can be utilized to
determine the proper value of business.
Lesson 1 Theoretical Framework 5
Limitations of Accounting
The following are the limitations of accounting:
(i) Accounting information is expressed in terms of money: The accountant measures only those events
that are of financial nature i.e. capable of being expressed in terms of money. Non-monetary items or
events which cannot be measured are not recorded in accounting.
(ii) Accounting information is based on estimates: Some accounting data are based on estimates and
some estimates may be inaccurate.
(iii) Accounting information may be biased: Accounting information is not without personal influence or
bias of the accountant. In measuring income, accountant has a choice between different methods of
inventory valuation, deprecation methods, treatment of capital and revenue items etc. Hence, due to
the lack of objectivity income arrived at may not be correct in certain cases.
(iv) Fixed assets are recorded at the original cost: The values of fixed assets change over time and so
there may be a great difference between the original cost and current replacement cost. Balance sheet
may not show true and fair view of the financial position on a particular date.
(v) Accounting can be manipulated: Accounting information may not be used as the only test of
managerial performance as profits can be manipulated or misrepresented.
(vi) Money as a measurement unit changes in value: The value of money does not remain stable. Unless
price level changes are considered in measurement of income, the accounting information will not
show true financial results.
REVIEW QUESTIONS
BOOK-KEEPING
Book-keeping is mainly concerned with recording of financial data relating to the business operations in a
significant and orderly manner. It is concerned with the permanent record of all transactions in a systematic
manner to show its financial effect on the business. It covers procedural aspects of accounting work and
includes record keeping function. It is the science and art of correctly recording in books of account all those
business transactions that result in the transfer of money or moneys worth. It is mechanical and repetitive.
This work of bookkeeping is of clerical nature and usually entrusted to junior employees of accounts section
of a business house. Now-a-days, most of the book-keeping work is done through computers and other
electronic devices. In fact, accounting is based on a systematic and efficient book-keeping system. The main
purpose behind book-keeping is to show correct position regarding each head of income and expenditure as
well as assets and liabilities. Further, book-keeping is meant to show the effect of all the transactions made
during the accounting period on the financial position of the business.
Book-keeping Accounting
(i) It is concerned with the recording of (i) It is concerned with the summarizing of the
transactions. recorded transactions.
(ii) The work of book-keeping is mainly routine (ii) The work of accountant requires higher
and clerical in nature and is increasingly being level of knowledge, conceptual
done by computers. understanding and analytical skill.
(iii) Book-keeping constitutes the base for (iii) Accounting starts where book keeping
accounting. ends.
(iv) Book-keeping is done in accordance with (iv) The methods and procedures for
basic accounting concepts and conventions. accounting for analysis and interpretations
for financial reports may vary from firm to
firm.
(v) Financial statements do not form part of book- (v) Financial statements are prepared in
keeping. accounting process from the book-keeping
records.
(vi) Financial position of the business cannot be (vi) Financial position of the business is
ascertained through book-keeping records. ascertained on the basis of accounting
reports.
SYSTEMS OF ACCOUNTING
Basically there are two systems of accounting:
Cash System of Accounting: It is a system in which accounting entries are made only when cash is received or
paid. No entry is made when a payment or receipt is merely due. In other words, it is a system of accounting in
which revenues and costs and assets and liabilities are reflected in the accounts in the period in which actual
payments or actual receipts are made in cash. It may not treat any revenue to have been earned or even sales to
have taken place unless cash is actually paid by customers. It has no relevance whether the receipts pertain to
previous period or future period. Similarly, expenses are restricted to the actual payments in cash during the
current year and it is immaterial whether the payments have been made for previous period or future period.
Cash basis of accounting is incompatible with the matching principle of income determination. Hence, the
financial statements prepared under this system do not present a true and fair view of operating results and
financial position of the organization. However, cash system of accounting is suitable in the following cases:
(i) Where the organization is very small or in the case of individuals, where it is difficult to allocate small
amounts between accounting periods; and
(ii) Where credit transactions are almost negligible and collections are uncertain e.g. accounting in case of
professionals i.e. doctors, lawyers, firms of chartered accountants/company secretaries. But while
recording expenses, they take into account the outstanding expenses also. In such a case, the
financial statement prepared by them for determination of their income is termed as Receipts and
Expenditure Account.
Accrual System of Accounting: This is also known as mercantile system of accounting. It is a system in
which transactions are recorded on the basis of amounts having become due for payment or receipt. Accrual
basis of accounting attempts to record the financial effects of the transactions, events, and circumstances of
an enterprise in the period in which they occur rather than recording them in period(s) in which cash is
Lesson 1 Theoretical Framework 7
received or paid by the enterprise. It recognizes that the buying, selling and other economic events that affect
enterprises performance often do not coincide with the cash receipts and payments of the period. The
purpose of accrual basis accounting is to relate the revenue earned to cost incurred so that reported net
income measures an enterprises performance during a period instead of merely listing its cash receipts and
payments. Accrual basis of accounting recognizes assets, liabilities or components of revenues and expenses
received or paid in cash in past and expected to be received or paid in cash in the future. The following are
the essential features of accrual basis:
Revenue is recognized as it is earned irrespective of whether cash is received or not;
Costs are matched against revenues on the basis of relevant time period to determine periodic
income, and
Costs which are not charged to income are carried forward and are kept under continuous review. Any
cost that appears to have lost its utility or its power to generate future revenue is written off as a loss.
ROLE OF ACCOUNTANT
The role of accountant may be summarized as under:
(i) Maintenance of Books of Accounts: The primary role of an accountant is to offer his services for
maintaining systematic records of financial transactions in order to ascertain the net profit or loss for
the accounting period and the financial position as on a particular date.
(ii) Statutory Audit: Every limited company is required to appoint a chartered accountant as an auditor
who is statutorily required to report each year whether the financial statements have been prepared in
accordance with the generally accepted accounting principles, accounting standards and legal
requirements and that they show a true and fair view of the financial position and profit and loss.
(iii) Internal Audit: In addition to statutory audit, a big company employs its own staff to conduct internal
audit to ensure that the transactions are recorded, classified and summarized in accordance with the
established accounting procedures to ensure that instructions of the management are being followed
throughout the company.
(iv) Budgeting: Budgeting means the planning of business activities before they occur. On completion of
the actual activities for a given period, the planned activities are compared with the actual activities to
find out the variation, if any.
Lesson 1 Theoretical Framework 9
(v) Taxation: An accountant can handle the taxation matters of a business and can represent before the
tax authorities and settle the tax liability under the prevailing statute. He also assists in reducing the
tax burden by proper tax planning.
(vi) Investigation: Accountants are often called upon to carry out investigation to ascertain the financial
position of the business for the information of interested parties.
(vii) Management Advisory Service: An accountant is largely responsible for internal reporting to the
management for planning, controlling, decision-making on matters for long-term plans. He provides
management consultancy services in the areas of management information systems, expenditure
control and evaluation of appraisal techniques.
(viii) Other Activities: Accountants among many other duties perform duties of arbitrator registrars for
settling of disputes, liquidators, cost accountants, etc.
Accounting Concepts
Accounting concepts are defined as basic assumptions on the basis of which financial statements of a
business entity are prepared. They are used as a foundation for formulating various methods and procedures
for recording and presenting the business transactions. The important accounting concepts are given
below:
(i) Business Entity Concept: According to this concept, business is treated as an entity separate from its
owners. It is treated to have a distinct accounting entity which controls the resources of the concern and is
accountable thereof. Accounts are kept for a business entity as distinguished from the person(s) owning it. All
transactions of the business are recorded in the books of the business from the point of view of the business.
Transactions are also recorded between the owner and the business, for instance, when capital is provided
by the owner, the accounting record will show the business as having received so much money and as
owing to the proprietor. This concept is based on the sense that proprietors entrust resources to the
management and the management is expected to use these resources to the best advantage of the firm and
to account for the resources placed at its disposal. Hence, in accounting for every type of business
organization, be it sole tradership or partnership or joint stock company, business is treated as a separate
accounting entity.
The failure to recognize the business as a separate accounting entity would make it extremely difficult to
evaluate the performance of the business since the private transactions would get mixed with business
transaction. The overall effect of adopting this concept is:
Only the business transactions are recorded and reported and not the personal transactions of the
owners.
Income or profit is the property of the business unless distributed among the owners.
The personal assets of the owners or shareholders are not considered while recording and reporting
the assets of the business entity.
(ii) Money Measurement Concept: Money measurement concept holds that accounting is a measurement
10 FP-FA&A
and communication process of the activities of the firm that are measurable in monetary terms. Thus, only
such transactions and events which can be interpreted in terms of money are recorded. Events which cannot
be expressed in money terms do not find place in the books of account though they may be very important for
the business. Non-monetary events like, death, dispute, sentiments, efficiency etc. are not recorded in the
books, even though these may have a great effect. Accounting therefore, does not give a complete account of
the happenings in a business or an accurate picture of the conditions of the business. Thus, accounting
information is essentially in monetary terms and quantified.
The system of accounting treats all units of money as the same irrespective of their time dimension. This has
created doubts about the utility of the accounting data, leading to the introduction of inflation accounting.
(iii) Cost Concept: According to cost concept, the various assets acquired by a concern or firm should be
recorded on the basis of the actual amounts involved or spent. This amount or cost will be the basis for all
subsequent accounting for the assets. The cost concept does not mean that the assets will always be shown
at cost. The fixed asset will be recorded at cost at the time of its purchase but it may systematically be
reduced in its value by charging depreciation. These assets ultimately disappear from the balance sheet when
their economic life is over and they have been fully depreciated and sold as scrap. It may be noted that if
nothing has been paid for acquiring something, it would not be shown in the accounting books as an asset.
Cost concept is not much relevant for investors and other users because they are more interested in knowing
what the business is actually worth today rather than the original cost.
(iv) Going Concern Concept: Business transactions are recorded on the assumption that the business
will continue for a long-time. There is neither the intention nor the necessity to liquidate the particular
business venture in the foreseeable future. Therefore, it would be able to meet its contractual obligations
and use its resources according to the plans and pre-determined goals. It is on this concept that a
clear distinction is made between assets and expenses. Transactions are recorded in such a manner that the
benefits likely to accrue in future from money spent now or the future consequences of the events occurring now
are also taken into consideration. It is because of this concept that fixed assets are valued on the basis of cost
less proper depreciation keeping in mind their expected useful life ignoring fluctuations in the prices of these
assets.
However, if it is certain that a business will continue for a limited period, then the accounting records will be
kept on the basis of expected life of the business and there will be no need for such detailed accounting
information as to revenue and capital expenditure.
When an enterprise liquidates a branch or one segment of its operations, the ability of the enterprise to
continue as a going concern is not impaired. But the enterprise will not be considered as a going concern if it
goes into liquidation or it has become insolvent. If the assumption of the going concern is not valid, the
financial statements should clearly state this fact.
(v) Dual Aspect Concept: This concept is based on double entry book-keeping which means that accounting
system is set up in such a way that a record is made of the two aspects of each transaction that affects the
records. The recognition of the two aspects to every transaction is known as dual aspect concept. Modern
financial accounting is based on dual aspect concept. One entry consists of debit to one or more accounts
and another entry consists of credit to some other one or more accounts. However, the total amount debited
is always equal to the total amount credited. Therefore, at any point of time total assets of a business are
equal to its total liabilities. Liabilities to outsiders are known as liabilities, but a liability to owners is referred to
as capital. Thus, this concept expresses the relationship that exists among assets, liabilities and the capital in
the form of an accounting equation which is as follows:
Assets = Liabilities + Capital, or
Capital = Assets Liabilities
Since accounting system requires recording of the two aspects of each transaction, this concept shows the
effect of each transaction on them. Assets and liabilities are two independent variables and capital is the
dependent variable, for it is the difference between assets and liabilities. Any change in any one of these
three, must lead to a change in any of the other two.
(vi) Realisation Concept: According to this concept revenue is recognised only when a sale is made. Unless
money has been realised i.e., cash has been received or a legal obligation to pay has been assumed by the
customer, no sale can be said to have taken place and no profit can be said to have arisen. It prevents
Lesson 1 Theoretical Framework 11
business firms from inflating their profits by recording incomes that are likely to accrue i.e. expected incomes
or gains are not recorded.
(vii) Accrual Concept: Every transaction and event affects, one or more or all the three aspects viz., assets,
liabilities and capital. Normally all transactions are settled in cash but even if cash settlement has not taken
place, it is proper to record the transaction or the event concerned into the books. This concept implies that
the income should be measured as a difference between revenues and expenses rather than the difference
between cash received and disbursements. Business transactions are recorded when they occur and not
when the related payments are received or made. This concept is called accrual basis of accounting and it is
fundamental to the usefulness of financial accounting information.
It is not necessary that there is an immediate settlement in cash for any transaction or event therefore
accrued revenues and costs are recognized as they are earned and incurred and recorded in the financial
statements of the period. On the basis of this concept, adjustment entries relating to outstanding and prepaid
expenses and income received in advance etc. are made. They have their impact on the profit and loss
account and the balance sheet.
(viii) Accounting Period Concept: It is customary that the life of the business is divided into appropriate
parts or segments for analyzing the results shown by the business. Each part or segment so divided is known
as an accounting period. It is an interval of time at the end of which the income or revenue statement and
balance sheet are prepared in order to show the results of operations and changes in the resources which
have occurred since the previous statements have been prepared. Normally, the accounting period consists
of twelve months.
(ix) Revenue Match Concept: This concept is based on accounting period concept. In order to determine the
profit earned or loss suffered by the business in a particular defined accounting period, it is necessary that
expenses of the period should be matched with the revenues of that period. The term matching means
appropriate association of related revenues and expenses. Therefore, income made by the business during a
period can be ascertained only when the revenue earned during a period is compared with the expenditure
incurred for earning that revenue. According to this concept, adjustments should be made for all outstanding
expenses, accrued incomes, unexpired expenses and unearned incomes etc. while preparing the final
accounts at the end of the accounting period.
Accounting Conventions
The term convention denotes custom or tradition or practice based on general agreement between the
accounting bodies which guide the accountant while preparing the financial statements. It is a guide to the
selection or application of a procedure. In fact financial statements, namely, the profit and loss account and
balance sheet are prepared according to the following accounting conventions:
(i) Consistency: The consistency convention implies that the accounting practices should remain the same
from one year to another. The results of different years will be comparable only when accounting rules are
continuously adhered to from year to year. For example, the principle of valuing stock at cost or market price
whichever is lower should be followed year after year to get comparable results. Similarly, if depreciation is
charged on fixed assets according to diminishing balance method, it should be done year after year. The
rationale behind this principle is that frequent changes in accounting treatment would make the financial
statements unreliable to the persons who use them.
The consistency convention does not mean that a particular method of accounting once adopted can never
be changed. When an accounting change is desirable, it should be fully disclosed in the financial statements
along with its effect in terms of rupee amounts on the reported income and financial position of the year in
which the change is made.
(ii) Disclosure: Apart from statutory requirements good accounting practice also demands all significant
information should be fully and fairly disclosed in the financial statements. All information which is of material
interest to proprietors, creditors and investors should be disclosed in accounting statements. This convention
is gaining more importance because most of big business units are in the form of joint stock companies where
ownership is divorced from management. The Companies Act makes ample provisions for disclosure of
essential information so that there is no chance of any material information being left out.
(iii) Conservatism: Financial statements are usually drawn up on a conservative basis. There are two
principles which stem directly from conservatism.
12 FP-FA&A
(a) The accountant should not anticipate income and should provide for all possible losses, and
(b) Faced with the choice between two methods of valuing an asset the accountant should choose a
method which leads to the lesser value.
Examples:
Making provisions for bad debts in respect of doubtful debts.
Amortizing intangible assets like, goodwill, patents, trade marks, etc. as early as possible.
Valuing the stock in hand at lower of cost or market value.
(iv) Materiality: According to the convention of materiality, accountants should report only what is
material and ignore insignificant details while preparing the final accounts. The decision whether the
transaction is material or not should be made by the accountant on the basis of professional experience and
judgment.
An item may be material for one purpose while immaterial for another. For the items appearing in the profit
and loss account, materiality should be judged in relation to the profits shown by the profit and loss account.
And for the items appearing in the balance sheet, materiality may be judged in relation to the groups to which
the assets or liabilities belong e.g. for any item of current liabilities, it should be judged in relation to the total
current liabilities.
ACCOUNTING STANDARDS
Accounting as a language of business communicates the financial results of an enterprise to
various interested parties by means of financial statements, which have to exhibit a true and fair view of its state
of affairs. Like any other language, accounting, has its own complicated set of rules. However, these rules have to
be used with a reasonable degree of flexibility in response to specific circumstances of an enterprise and also in
line with the changes in the economic environment, social needs, legal requirements and technological
developments. Therefore, these rules cannot be absolutely rigid nor they can be applied arbitrarily.
Accounting standards (ASs) are written policy documents issued by expert accounting body or by government
or any other regulatory body. Accounting Standards cover the aspects of recognition, measurements,
presentation and disclosure of accounting transactions in the financial statements. These are set in the form
of general principles and left to the professional judgment for application.
An accounting standard may be regarded as a sort of law - a guide to action, a settled ground or basis of
conduct or practice. The objective of setting standards is to bring about uniformity in financial reporting and to
ensure consistency and comparability in the data published by enterprises. The Institute of Chartered
Accountants of India (ICAI) constituted the Accounting Standards Board (ASB) on 21st April, 1977, with a
view to harmonising the diverse accounting policies and practices in use in India. The ICAI has issued 32
Accounting Standards and 29 Accounting Standards Interpretations so far.
Lesson 1 Theoretical Framework 13
ACCOUNTING POLICIES
Accounting policies refer to the specific accounting principles and the methods of applying those principles
adopted by the enterprise in the preparation and presentation of financial statements. Policies are based on
various accounting concepts, principles and conventions.
The accounting standards issued by professional accounting bodies limit and reduce alternatives out of which
accounting policies are to be selected by an enterprise for measurement and reporting of business transactions.
Thus, the specific accounting policies are selected by an enterprise in conformity with generally accepted
accounting principles and the accounting standards. For example, as per matching concept, depreciation should
be treated as cost of doing business and matched with revenue of the same period. As per Accounting
Standard-6 depreciation can be calculated by straight line method, written down value method etc. So, the
organization has to make a policy as to which method it wants to follow. Similarly, valuation of inventory,
treatment of goodwill, valuation of investments, valuation of fixed assets etc. are the significant areas which
require standardization of accounting policies to ensure relevance and reliability of accounting information.
Classification of
Accounts
Personal Accounts
Impersonal
Accounts
Intangible Real
Accounts
Classification of Accounts
(I) PERSONAL ACCOUNTS: These accounts show the transactions with customers, suppliers, money
lenders, the banks and the owner. Personal accounts can take the following forms:
(a) Natural Personal Accounts: The term natural persons means persons who are the creation of
God. For example proprietors account or the account of say, Naresh a customer or supplier.
(b) Artificial Personal Accounts: These accounts include accounts of corporate bodies or
institutions which are recognized as persons in business dealings. For example, any limited
companys account, bank account, insurance companys account, any firms account, any clubs
account, etc.
(c) Representative Personal Accounts: These are accounts which represent a certain person or
group of persons. In books, the names of the parties will appear. Since these accounts are many
in number but are of the same nature, they are added and put under a common title. For example,
salary is outstanding towards 15 employees, the amount may be shown against one name Salary
Outstanding representing all the 15 employees. Interest outstanding, rent receivable are other
such examples.
(II) REAL ACCOUNTS: Real accounts may be of the following types:
(a) Tangible Real Accounts: These are accounts of such things as are tangible i.e. can be seen,
touched or felt physically. Examples land, building, furniture, cash etc.
(Note: please note that bank account is a personal account and is not a real account because
bank account is the account of some banking company which is an artificial person).
(b) Intangible Real Accounts: These accounts represent such things as cannot be touched but can
be measured in terms of money. Example are, goodwill, trade marks, patent rights etc.
(III) NOMINAL ACCOUNTS: Nominal accounts are opened in the books to explain the expenses and
incomes. For example, in a business- salary is paid to the employees, rent is paid to the landlord, wages
Lesson 1 Theoretical Framework 15
are paid to the workers, commission is paid to the salesmen, wherein cash goes. Example are salary
account, rent account, commission account etc. Nominal accounts include accounts of all expenses,
losses, income and gains.
Valuation Accounts: In addition to the traditional classification of accounts - personal and impersonal -
valuation accounts are also being recognized e.g. provision for depreciation account, provision for
doubtful debts account, stock reserve account etc.
REVIEW QUESTIONS
1. Classify the following into personal, real and nominal accounts:
Stationery Account, Depreciation Account, Cash Account, Bank Current
Account, Goodwill Account, Interest Account, Patents and Trade Marks
Account, Capital Account, Bank Loan Account, Freight Account, Drawings
Account, Rent Account and Account of Govind, a customer.
2. A firm spends money for the following. Mention whether they are
assets, expenses or losses :
Purchasing computers
Acquiring trade marks
Paying salaries
Acquiring a lease of land for 15 years
Paying interest
Purchasing furniture
Paying compensation to injured workers
Theft by burglars
GOLDEN RULES
Personal Accounts: Debit the receiver and credit the giver
Real Accounts: Debit what comes in and credit what goes out
Nominal Accounts: Debit all expenses and losses and credit all incomes and gains
from extent to include gains
Explanation:
Personal Accounts: Debit the receiver and credit the giver, i.e. debit the account of the person who receives
something and credit the account of the person who gives something. For example, if you purchase goods from
Ram on credit, the two accounts involved are Goods (Purchase) Account and Rams Account. The latter account is
a personal account. Since, Ram is the giver in this transaction, his account will be credited. Similarly, if cash is paid
to Ram, Rams Account will be debited since he is the receiver. Thus, the account of a person is debited with any
benefit such person receives and is credited with any benefit such person imparts.
Real Accounts: Debit what comes in, and credit what goes out, i.e. debit the account of the thing which
comes in and credit the account of the thing which goes out. For example, where furniture is purchased for
cash, furniture account is debited while cash account is credited.
Nominal Accounts: Debit all expenses and losses and credit all incomes and gains i.e. debit the
accounts of expenses and losses and credit all incomes and gains. For example, if firm/business pays salary
to its clerk, the two accounts involved are salary account and cash account. Salary account is a nominal
account. Salary paid is an expense of the business and therefore this account will be debited. Similarly if
interest is received, interest account will be credited, since interest is an income item.
Illustration 1: From the following transactions, identify the nature of accounts involved and state which
account will be debited and which account will be credited?
Mr. Anil started business with ` Cash Account Real Debit Incomings
1.
60,000. Capital Account Personal Credit Giver
Purchased goods from Mr. Bansal Purchases i.e. good Real Debit Incomings
4.
for cash ` 10,000. the A/c Cash Account Real Credit Outgoings
ACCOUNTING EQUATION
All business transactions are recorded as having a dual aspect. At any point of time, a firm will possess things
which may either be sold or converted into cash or which may be later used for a fairly long time. All these things
are called assets. Building, land, machinery, furniture, stock, debtors, bills receivable, cash at bank, cash in hand
etc. are a few examples of assets. The proprietor of the business brings capital into the business out of which the
business (a separate entity) purchases assets for its use. Thus, the amount of the assets of a business is equal to
the amount of capital contributed by the proprietor of the business. Thus, Capital = Assets.
In case the capital contributed by the proprietor is insufficient, the business takes borrowing from other parties
or outsiders. These parties may give loan or allow credit facilities at the time of purchase of goods. The
amounts which are owed to outsiders and which have to be paid, sooner or latter are called liabilities. For
example: Loans, Bank Overdraft, Creditors, Bills Payable, and Outstanding Expenses etc. On the one hand,
the loan given by the outside parties increases the assets of the business, on the other hand, claims of
creditors and lender of money on the assets of the business increase.
Hence, the sum of resources (assets) = obligations (capital + liabilities)
Therefore, Capital + Liabilities = Assets; or
Capital = Assets Liabilities.
This equation is known as accounting equation. This equation is based on
the concept that for every debit, there is an equivalent credit. The entire
system of double entry book-keeping is based on this concept.
Example: Suppose A starts a business with a capital of ` 50,000, immediately the firm will have `
50,000 as cash as asset and at the same time the firm will owe to the owner ` 50,000 which is taken as
the proprietors capital. Thus,
Capital (` 50,000) = Assets ` 50,000 (Cash).
If the firm purchases furniture worth ` 10,000 out of the money provided by A, the situation will be:
Capital (` 50,000) = Cash (` 40,000) + Furniture (` 10,000).
Subsequently, if the business borrows ` 15,000 from a bank, the position will be as follows:
Capital (` 50,000) + Bank loan (` 15,000) = Cash (` 55,000) + Furniture (` 10,000).
LESSON ROUND UP
Accounting is the art of recording, classifying and summarizing transactions and events which are of a
financial character in terms of money, and interpreting the results thereof.
Three main branches of accounting are financial accounting, cost accounting and management
accounting.
Accounting functions are: keeping systematic records; protecting and controlling business properties;
ascertaining the operational profit/loss; ascertaining the financial position of the business; and
facilitating rational decision-making.
Lesson 1 Theoretical Framework 19
Accounting is the language of business and used to communicate financial and other information to
different interested parties like owners, manager, creditors, investors, researchers, government etc.
Accounting information should be relevant, reliable, comparable, understandable, timely, neutral,
verifiable and complete.
Accounting can be based on cash or accrual system. In cash system, accounting entries are passed
only when cash is received or paid while in accrual system, transactions are recorded on the basis of
amounts having become due for payment or receipt.
Book keeping is different from accounting. Book keeping is concerned with the permanent recording or
maintaining of all transactions in a systematic manner to show its financial effect on the business.
Accounting is concerned with its summarizing of the recorded transcations.
Accounting principles are guidelines to establish standards for sound accounting practices and
procedures in reporting the financial status of a business. These principles can be accounting
concepts and accounting conventions.
Accounting concepts are defined as basic assumptions on the basis of which financial statements of a
business entity are prepared. While convention denotes custom or tradition or practice based on
general agreement between the accounting bodies which guide accountant while preparing the
financial statements.
Some of the important accounting concepts are: business entity concept, money measurement
concept, cost concept, going concern concept, dual aspect concept, realization concept, accrual
concept, accounting period concept and revenue match concept.
Accounting conventions are consistency, disclosure, conservatism and materiality.
Accounting standards (ASs) are written policy documents issued by expert accounting body or by
government or any other regulatory body.
Two classes of accounts are personal accounts and impersonal accounts. Impersonal accounts can
be further classified into real and nominal accounts.
Accounting Equation represents that sum of resources (assets) is equal to the obligations (capital and
liabilities) of the business.
GLOSSARY
Book Keeping The permanent recording or maintaining of all transactions in a systematic manner
to show its financial effect on the business.
Accounting Summarizing of the recorded transactions to prepare various reports
Accounting Guidelines to establish standards for sound accounting practices and procedures in
Principles reporting the financial status of a business.
Accounting Basic assumptions on the basis of which financial statements of a business entity
Concepts are prepared.
Accounting Written policy documents issued by expert accounting body or by government or
Standards any other regulatory body.
SELF-TEST QUESTIONS
Theory Questions
1. Define accounting and state its characteristics.
2. Name the users of accounting information.
3. Discuss the system of accounting.
20 FP-FA&A
4. What are the functions of accounting?
5. Distinguish between book-keeping and accounting
6. State the difference between accounting concepts and conventions.
7. Explain important accounting conventions.
8. What are accounting standards?
9. Discuss the merits of double entry system of accounting.
10. Explain the basic rules of debit and credit in accounting.
11. What do you mean by accounting equation?
12. Define the term account and name the types of accounts? Also explain with examples.
Practical Questions
1. Point out the accounts which will be debited and credited for each one of the following transactions:
Cash received from X and discount allowed to him.
Cash paid to Y and discount received from him.
Credit Sales to Z.
Cash Sales to A.
Purchases from B on credit.
Salary paid to clerk by means of cheque.
Payment of cash to landlord for rent.
Depreciation on furniture.
Interest due but not yet paid.
Interest provided on capital.
2. Give Accounting Equation for the following transactions of Jitesh:
Started business with cash ` 36,000
Paid rent in advance `800
Purchased goods for cash `10,000 and on credit `4,000
Sold goods for cash `8,000
Rent paid `2000 and rent outstanding `400
Bought cycle for personal use `16,000
Purchased equipments for cash `10,000
Paid to creditors `1,200
Some business expenses paid `1,800
Depreciation on equipment `2,000
3. Aman had the following transactions. Use accounting equation to show their effect on his assets,
liabilities and capital.
Brought ` 20,00,000 in cash to start business.
Purchased Government Bonds for cash ` 1,06,000.
Purchased an office building for ` 9,00,000 giving ` 6,00,000 in cash and the balance through
a loan.
Sold Government Bonds costing ` 6,000 for ` 6,500.
Lesson 1 Theoretical Framework 21
Purchased an old car for `1,68,000.
Received cash for rent ` 21,600.
Paid cash ` 3,000 for loan and ` 1,800 for interest.
Paid cash for office building expenses ` 1,800.
Received cash for Interest on Government Bondss `1,200.
4. Prepare the Accounting Equation on the basis of the following transactions:
Sohan commenced business with `10,00,000
Withdrew for private use ` 1,700
Purchased goods on credit ` 14,000
Purchased goods for cash ` 10,000
Paid salaries `6,000
Paid to creditors `10,000
Sold goods on credit for `15,000
Sold goods for cash (cost price was `3,000) ` 4,000
Purchased machinery for ` 45,000
22 FP-FA&A
Lesson 2
Accounting ProcessI
(Recording of Transactions)
LESSON OUTLINE
LEARNING OBJECTIVES
Accounting Cycle
Accounting process involves identification and
Journal
Procedure of Journalising analysis of financial transactions. These transactions
Warren Buffet
24 FP-FA&A
ACCOUNTING CYCLE
Accounting cycle or accounting process includes the following:
1. Identifying the transactions from source documents like purchase orders, loan agreements, invoices,
etc.
2. Recording the transactions in the journal proper and other subsidiary books as and when they take
place.
3. Classifying all entries posted in the journal or subsidiary books and posting them to the appropriate
ledger accounts.
4. Summarising all the ledger balances and preparing the trial balance and final accounts with a view to
ascertaining the profit or loss made during a particular period and ascertaining the financial position of
the business on that particular date.
JOURNAL
Journal is the book of primary entry in which every transaction is recorded before being posted into the
ledger. It is that book of account in which transactions are recorded in a chronological (day to day) order. In
modern times, besides the main journal, specialized journals are maintained to record different types of
transactions. The process of recording transactions in a journal is termed as journalising. A journal is
generally kept in a columnar from.
SPECIMEN OF JOURNAL
Name of Item
Journal
(i) Date: The date on which the transaction has taken place is recorded here. The year is written at the top of
the date column of each page of the journal. On the next line of the date column, the month & day of the first
entry are written. Unless the month or year changes or until a new page is begun, neither the month nor the
year is repeated on the page. Year and month are written in the under left hand sub-column and date is
written is right hand smaller sub-column.
(ii) Particulars: The two aspects of a transaction are recorded in this column i.e. However, mostly there are
no sub-column and year, month and date in one column of Date. the accounts which have to be debited and
credited. The name of the account(s) to be debited is entered at the extreme left of the particulars column
next to the date column. The abbreviation Dr. is written at the right end of the particulars column on the same
line of the account debited. The name of the account to be credited is entered in the next line with a prefix
To. A brief explanation of the transaction known as narration is written below the account titles of the
transaction. Finally, a thin line is drawn all through the particulars column to indicate that the entry of the
transaction has been completed.
(iii) L.F. (Ledger Folio): This column records the page number in the ledger in which the accounts in the
particulars column are posted.
(iv) Debit Amount (Debit): The debit amount is recorded in the debit amount column opposite to the title of
the account being debited.
Lesson 2 Accounting Process-I 25
(v) Credit Amount (Credit): The credit amount is recorded in the credit amount column opposite to the title of
the account being credited.
Procedure of Journalising
The following procedure is followed for passing journal entries-
Analyze each transaction in terms of accounts affected. As a rule every transaction has at least two
accounts.
Find out the type of accounts affected in a transaction i.e. personal, real or nominal.
Apply the rules of debit and credit to each type of accounts involved.
The debit and credit accounts must be equal. Sometimes, a journal entry may have more than one
debit or/and more than one credit. This type of journal entry is called compound journal entry.
Regardless of the number of debits or credits in a compound journal entry, the aggregate amount of
debits should be equal to the aggregate amount of credits.
For a business, journal entries generally extend to several pages, hence, totals of debit and credit
amount columns are cast at the end of each page. Against the debit and credit total at the end of a
page, the words, Total c/f (c/f - indicates carried forward) are written in the particulars column. The
debit and credit totals are then written in the beginning of the next page in the amount columns and
against them the words Total b/f (b/f - indicates brought forward) are written in the particulars column.
On the last page Grand Total is written.
Entries in the purchases book are made from the invoices received from the suppliers. Posting is done in the
suppliers/ creditors account daily from the purchases book with their respective amounts. At the end of
week/month, the total of the purchases book is debited to the purchases account in the ledger.
In Particulars Column the names of the suppliers together with details of goods purchased are recorded. In
Details Column detail amounts of different items are recorded whereas in Amount Column the net amount
of various invoices is recorded.
SALES BOOK
In the Sales Book, only credit sale of goods are recorded. Sales Book is prepared on the basis of copies of
invoice sent to customers. To post sales book, the accounts of the customers are individually debited with
respective amounts at the end of every month. Sales Account is credited with the monthly total of the Sales
Book. In Particulars Column, the name of the customers along with details of the goods sold to them are
recorded.
Cash Sales will be entered in the Cash Book; credit sale of various assets or investments will be recorded in
General Journal.
Sales Book
The total of amount Column of the purchases return book is credited to the purchases returns account and the
account of the supplier(s) to whom debit notes have been sent are debited individually in their respective accounts.
The individual accounts of the customers are credited with of the respective amounts while the periodical total
of the sales returns book is posted to the debit of sales returns account.
Illustration 3:
Record the following transactions in the appropriate books of original entry and show how they will be posted.
Assume invoice numbers, folio number, etc.
2013
Mar. 6 Purchased on credit from Kadam
200 Shirts @ ` 1,500 each
100 Neckties @ ` 500 each.
Mar.10 Sold on Credit to Mehta
36 FP-FA&A
20 Bush Shirts @ 1,750 each
40 Hand towels @ ` 100 each.
13 Goods returned to Kadam
4 Shirts @ 1,500 each
17 Sold to Andley on Credit
40 Trousers @ ` 1,000 each
10 Neck-ties @ ` 600 each
18 Goods received back from Manohar, a customer
8 Neck-ties @ ` 550 each
4 Shirts @ ` 2,500 each
22 Sold to Apte on credit
10 Bush Shirts @ ` 2,500 each
200 metres of long cloth @ ` 150 per metre
28 Apte returns 2 Bush Shirts invoiced at ` 2,500
30 Purchased goods on credit from Gyani Cloth Store
300 Bush Shirts @ ` 2,000 each
400 metres of long cloth @ ` 125 per metre
100 metres of shirting @ ` 750 per metre
Gyani Cloth Store allows Trade Discount @ 5%
Andley returns one Neck-tie invoiced at ` 600
Solution:
Purchases Book
Date Particulars Inv. L.F. Details Amount
No. ` `
2011
Mar. 6 Kadam
200 shirts ` 1,500 each 62 8 3,00,000
100 Neck-ties ` 500 each 50,000 3,50,000
Mar. 30 Gyani Cloth Store
300 Bush Shirts `2,000 each 6981 17 6,00,000
400 metre long cloth
@ ` 125 per metre 50,000
100 metres Shirting
@ ` 750 per metre 75,000
7,25,000
Less : Trade Discount 5% 36,250 6,88,750
Total 1,03,8,750
Lesson 2 Accounting Process-I 37
Sales Book
Date Particulars Inv. L.F. Details Amount
No. ` `
2013
Mar. 10 Mehta
20 Bush Shirts
@ ` 1,750 each 408 9 35,000
40 Hand towels
@ ` 100 each 4,000 39,000
17 Andley
40 Trousers
@ ` 1,000 each 409 12 40,000
10 Neck-ties
@ ` 600 each 6,000 4,600
22 Apte
10 Bush Shirts
@ ` 2,500 each 410 15 25,000
200 metre long cloth
@ ` 150 per metre 30,000 55,000
Total 1,40,000
Purchases Returns Book
Date Particulars Debit Note L.F. Amount Amount
No. ` `
2013
Mar. 13 Kadam
4 Shirts 22 8
@ ` 1,500 each 6,000
Total 6,000
Sales Returns Book
Date Particulars Credit Note L.F. Amount Amount
No. ` `
2013
Mar. 18 Manohar
8 Nick-ties @ ` 550 each 34 7 4,400
4 Shirts @ ` 2,500 each 10,000 14,400
28 Apte
2 Bush Shirts @ ` 2,500 35 15 5,000
30 Andley
2 Nick-tie @ ` 600 36 12 1,200
Total 20,600
38 FP-FA&A
Ledger Accounts
Dr. Kadam Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013 2013
Mar. 13 To Purchase Mar. 6 By Purchases
Returns A/c (PRB 3) 6,000 A/c (PB 8) 35,000
Dr. Mehta Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013 2013
Mar. 10 To Sales
Account (SB23) 39,000
Dr. Andley Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013 2013
Mar. 17 To Sales A/c (SB 23) 46,000 Mar. 30 By Sales Returns
Account (SRB 10) 1,200
Dr. Manohar Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013
Mar. 18 By By Sales Returns
A/c (SRB 10) 14,400
Dr. Apte Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013 2013
Mar. 22 To Sales Account (SB 23) 55,000 Mar. 28 By Sales Returns
Account (SRB 10) 5,000
Dr . Gyani Cloth Stores Account Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013
Mar. 30 By Purchases A/c (PB8) 6,88,750
Dr. Sales Account Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013
Mar. 31 By Sundries as per
Sales Book (SB 23) 1,40,000
Lesson 2 Accounting Process-I 39
Dr. Purchase Account Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013
Mar. 31 To Sundries as per
Purchases Book (PB 10) 10,38,750
Dr. Purchases Returns Account Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2013
Mar. 31 By Sundries as per
Purchases Returns
Book (PRB 3) 6,000
Dr. Sales Returns Account Cr.
Date Particulars J.F. ` Date Particulars J.F. `
2011
Mar. 31 To Sundries as per
Sales Returns
Book (SRB 10) 20,600
REVIEW QUESTIONS
Fill in the Blanks:
1. _______ is the book of primary entry in which all transactions are
recorded.
2. _______ means transferring the debit and credit items from the journal
to the ledger accounts.
3. When the goods purchased are returned to the supplier, ____ note is
sent to him.
Bill Date Drawn By Ledger Payee Date Term Due Amount Disposal
No. Acceptance Folio of the Date
`
Bill
CASH BOOK
Cash book is the book in which all transactions concerning cash receipts and cash payments are recorded.
Cash Book is in the form of an account. It serves the purpose of Cash Account also. On the debit side, all cash
receipts are recorded while on the credit side, all cash payments are recorded. In case of cash transactions,
only a single aspect of transactions is recorded in ledger because the other aspect has to be recorded in Cash
Book. Cash Book thus serves the purpose of a book of original entry as well as that of a ledger account.
A cash book has the following features:
(a) Only cash transactions are recorded in chronological order in the cash book.
(b) It performs the functions of both journal and ledger at the same time.
(c) All cash receipts are recorded on the debit side and all cash payments are recorded on the credit side.
(d) It records only one aspect of transaction i.e. cash.
(ii) Two (Double) Column Cash Book: It has two amount columns on both sides; one is for cash
and another is for discount. Cash column is meant for recording cash receipts and payments while
discount column is meant for recording discount received and allowed. The discount column on the debit
side represents the discount allowed while discount column on the credit side represents the discount
received.
Lesson 2 Accounting Process-I 41
Date Particulars L.F. Discount Amount Date Particulars L.F Discount Amount
` ` ` `
Note: Discount columns do not serve the function of a discount account. Discount columns are merely
memorandum columns. Discount allowed account and discount received account are opened in the ledger
and the totals of discount columns are posted to these accounts.
Illustration 4:
Record the following transactions in Cash Book of Mr. Singh:
2012 `
April 1 Mohan Lal commenced business with cash 1,00,000
2 Bought goods for cash 65,700
3 Sold goods for cash 4,320
6 Received cash from Fateh Singh 1,800
6 Allowed him discount 50
9 Paid cash to Shugan Chand 19,500
Discount allowed by Shugan Chand 500
12 Paid for Office Furniture 5,680
18 Sold goods for cash 7,810
23 Received cash from Subramaniam 9,870
Discount allowed to him 120
27 Paid for advertising 500
28 Cash paid to Asia Trading Co. 20,300
Discount received 250
30 Cash sales 1,280
30 Cash received from Fateh Singh 2,850
Discount allowed to him 100
Salary paid in cash 3,150
42 FP-FA&A
Solution:
Mr. Singh
Dr. Cash Book Cr.
Date Particulars L.F Discount Cash Date Particulars L.F Discount Cash
` ` ` `
2012 2012
April April
1. To Capital A/c 1,00,000 2. By
3. To Sales A/c 4,320 Purchases
6. To Fateh Singh 50 7,810 A/c 65,700
18. To Sales A/c 1,800 9. By Shugan
23. To Subramaniam 120 Chand 500 19,500
30. To Sales A/c 9,870 12. By Furniture
30. To Fateh Singh 100 1,280 A/c 5,680
2,850 By
27. Advertising 500
By Asia
28. Trading 250 20,300
Co. 3,150
By Salary 13,100
30. By Balance
30. c/d
___ _______ ___ _______
To Balance B/d 270 1,27,930 750 1,27,930
May1 13,100
REVIEW QUESTIONS
1. ____ Cash book has two account columns on both sides
Double/Triple).
(iii) Three Columnar Cash Book: This type of cash book contains the following three amount columns on
each side:
(a) Discount column for discount received and allowed;
(b) Cash column for cash received and cash paid; and
(c) Bank column for money deposited and money withdrawn from the bank.
Dr. Cash Book (Triple Column) Cr.
Date Particulars L.F. Discount Cash Bank Date Particulars L.F Discount Cash Bank
` ` ` `` ` `
Lesson 2 Accounting Process-I 43
When triple column cash book is prepared, there is no need for a separate bank account in the ledger. The
bank account maintained by the enterprise is a personal account and the cash account is a real account. For
recording transactions in the bank column of the cash book the rule of debit and credit applicable to personal
accounts should be followed i.e. debit the receiver and credit the giver. Thus, when cash is deposited with
bank, the bank would be the receiver and would be debited in the bank column of the cash book. Similarly, for
cash withdrawn from the bank the bank would be the giver and would be credited in the bank column of the
cash book.
Contra Entry: If a transaction involves both cash and bank accounts, it is entered on both sides of the cash
book, one in the cash column and other in the bank column, though on opposite sides. There are is called
contra entries and word C is indicated against that item in L.F. columns e.g. when cash is withdrawn from the
bank, it is recorded on the debit side in cash column and on the credit side in the bank column. Similarly,
when cash is deposited with the bank, the amount is recorded on the debit side in bank column and on the
credit side in the cash column.
Illustration 5:
On 1st May, 2012 the columnar cash book of Mitra showed that he had ` 2,000 in his cash box and that there
was a bank overdraft of ` 8,000. During the day the following transactions took place:
` 1,800 in cash and a cheque of ` 8,000. The cheque was immediately deposited in bank
Bank returns a cheque of ` 9,900 received from Kulu & Sons in settlement of an
account of ` 10,000
Write up the Cash Book for the day and balance it.
44 FP-FA&A
Solution:
Dr. Cash Book (Triple Column) Cr.
Date Particulars L.F. Discount Cash Bank Date Particulars L.F. Discount Cash Bank
` ` ` ` ` `
2012 2012
May To Bal. b/d 2,000 May By Bal. b/d 8,000
1 1
To Bank (C) 10,000 By Cash (C) 10,000
To G.Guha 200 1,800 8,000 By
Salaries
To Sales A/c 3,000
A/c 6,500
By Harish 6,500
To Cash (C) 6,000
By Drawings
To Bal. c/d 15,400 A/c 1,000
By Kulu &
Sons 100 9,900
By Rent A/c
1,500
By Bank 6,000
By Bal c/d ___3,800
(C)
______ _____ _____
______ _____
___200 20,300 29,400
___200 20,300 29,400
Petty cashier is not allowed to keep idle cash with him if the float is found to be more than adequate;
its amount will be immediately reduced. This reduces the chances of misuse of cash by the petty
cashier.
The record of petty cash is checked by the cashier periodically, so that a mistake, if committed, is soon
rectified.
It enables a great saving to be effected in the posting of small items to the ledger accounts.
Petty Cash Book may be treated either as a part of the double entry system or merely as a memoranda book.
If the former course is adopted, each payment to petty cashier is shown on the credit side of the main Cash
Book which is considered to have been balanced by a debit entry in the petty cash book. The two entries are
folioed against each other completing the double entry aspect. Payments recorded in the Petty Cash Book
are directly posted to the different nominal accounts. Of course, entries for expenses are made only with the
periodical totals of expenses under various heads. If the latter course is adopted, for amounts paid to petty
cashier, petty cash account in the ledger is debited besides entering the amounts (paid to petty cashier) on
the credit side of the main cash book. Periodically, different nominal accounts are debited and the petty cash
account is credited in ledger for expenses recorded in Petty Cash Book.
Illustration 6:
Petty cash is maintained on the basis of imprest system. On 21st January, 2013 the petty cashier had with
him ` 328. He received ` 672 to make up the expenses of the previous week. During the week the following
expenses were met by the petty cashier:
2013 `
March 21 Bus fare 6
21 Revenue stamps 85
21 Tea for customers 22
22 Cartage 43
24 Payment to Coolie 10
24 Telegram charges 76
24 Refreshment for customer 52
25 Repairs to furniture 100
25 Taxi charges 87
25 Post cards 90
25 Cloth for dusters 74
25 Tea for customers 20
46 FP-FA&A
Solution:
Analytical Petty Cash Book
Amount Date Particulars Vouc Total Cartage Printing Customers Conveya Sundri
Received her Amou & Cooli & Entertainm nce es
No. nt Stationery ent
Paid
2013
Jan.
328 22. To Balance b/d
672 21. To Cash
21. By Bus Fare 6 6
21. By Rev. Stamps 85 85
21. By Tea for Customers 22 22
22. By Cartage 43 43
24. By Cooli 10 10
By Telegram charges 76 76
24.
24. By Refreshment to
customers 52 52
25. By Repairs to
Furniture 100 100
25. By Taxi Charges 87 87
25. By Post Cards 90 90
By Cloth for Dusters 74 74
25.
By Tea for Customers 20 20
25.
____ By Balance c/d _335
1,000 1,000
335 28. To Balance b/d
665 28. To Cash A/c
The journal entry required for various petty cash expenses are the following:
Journal Entry
` `
Cartage A/c Dr. 53
Postage and Telegrams A/c Dr. 251
Conveyance A/c Dr. 93
Customers Entertainment A/c Dr. 94
Repairs A/c Dr. 100
General Expenses A/c Dr. 74
To Petty Cash Account 665
The Petty Cash Account in the ledger will appear as follows:
Dr. Petty Cash Account Cr.
2013 2013
Jan. 21 To Balance b/d 328 Jan. 25 By Sundries* 665
To Cash A/c 672 By Balance c/d 335
1,000 1,000
Mar. 28 To Balance b/d 335
To Cash 665
GENERAL JOURNAL
This is also known as Journal Proper or General Jounral. It is used for making the original record of such
transactions for which no special journal has been kept in the business. Entries recorded in the a journal
proper may be confined to the following transactions:
Lesson 2 Accounting Process-I 47
(i) Opening Entries: Opening entries are passed at the beginning of the financial year to open the accounts
by recording the assets, liabilities and capital appearing in the balance sheet of the previous year. It is written
as follows:
Assets Account Dr.
To Liabilities Account
To Capital Account
(ii) Closing Entries: Closing entries are passed at the end of the accounting year for closing of accounts
relating to expenses and revenues. These accounts are closed by transferring their balances to the Trading
and Profit & Loss Account.
(iii) Adjustment Entries: At the end of the accounting year, adjustments entries are passed for
outstanding/prepaid expenses, accrued income/income received in advance etc. Entries for all these
adjustments are passed in the journal proper.
(iv) Transfer Entries: Transfer entries are passed in the general journal for transferring an item entered in
one account to another account.
(v) Rectification Entries: Rectification entries are passed for rectifying errors which might have committed in
the books of account.
(vi) Purchase of Fixed Assets: When fixed assets are purchased on credit, the entries are passed in the
general journal.
(vii) Sale of Worn-out or Obsolete Assets: When obsolete assets are sold on credit, these are originally
recorded in the general journal.
Illustration 7:
On 31st March, 2012 following balances are available in ledger for the year 2011-12.
`
Furniture (debit balance) 20,000
Stock of Goods Account (debit balance) 70,000
S. Sircar (debit balance) 14,000
M. Mitra (debit balance) 7,500
Cash (debit balance) 2,400
B. Basu (credit balance) 13,900
Capital Account (credit balance) 1,00,000
Write the opening entry for 1st April, 2012.
Solution :
2012
April 1 Furniture A/c Dr. 20,000
Stock of Goods Dr. 70,000
S.Sircar Dr. 14,000
M. Mitra Dr. 7,500
Cash A/c Dr. 2,400
To B. Basu 13,900
To Capital Account 1,00,000
(For opening balances of various assets, liabilities
and capital as on 1st April, 2012)
48 FP-FA&A
TRIAL BALANCE
A trial balance is a schedule or list of debit and credit balances extracted from various accounts in the ledger
including cash and bank balances from cash book. Since every transaction has a dual effect i.e. every debit
has a corresponding credit and vice versa, the total of the debit balances and credit balances extracted from
the ledger must tally. Thus, at the end of the accounting period or at the end of each month, the balances of
the ledger accounts are extracted and trial balance is prepared to test as to whether the total debits are equal
to total credits or not.
Illustration 8:
Raju started business on 1st January 2013. You are required to pass entries, in journal & subsidiary books,
post them in ledger and prepare trial balance under totals & balances method for January 2013. His
transactions for the month were follows:
Lesson 2 Accounting Process-I 49
2013 `
Jan. 1 Cash brought in by Raju as his capital 2,00,000
Furniture purchased on credit from Nuluk Furniture Home 25,000
2 Goods purchased from Modi & Sons on credit 61,400
3 Goods purchased for cash 35,000
4 Goods purchased from Delhi Traders on credit 73,300
5 Cash sales 4,600
8 Sold goods to Bhatia & Co. on credit 19,860
11 Purchased stationery for cash 1,050
12 Paid Modi & Sons cash to settle account
Received 5% discount from the firm ......
13 Received from Bhatia & Co. in full settlement of account 19,800
17 Cash sales 10,700
18 Sold on credit to Ganesh & Co. 5,000
19 Received cash from Ganesh & Co. 1,000
21 Sold on credit to Hoshiar Singh 4,000
23 Purchased goods for cash 26,000
27 Hoshiar Singh becomes insolvent. A first and final
dividend of ` 3,000 is received from his estate
31 Ganesh & Co. pays cash 3,900
31 Discount allowed to Ganesh & Co. 100
31 Cash paid for rent 2,800
31 Depreciation on furniture 250
31 Payment to Delhi Traders in full settlement 73,000
Solution:
In the books of Raju
Journal Entries
Date Particulars L.F. Dr. Cr.
` `
2013
Jan. 1 Furniture Account Dr. 25,000
To Nuluk Furniture Home 25,000
(For furniture purchased on credit from
Nuluk Furniture Home)
27 Bad Debts Dr. 1,000
To Hoshiar Singh 1,000
(Bad debts written off on the insolvency of
Hoshiar Singh)
31 Depreciation A/c Dr. 250
To Furniture A/c 250
(For depreciation provided on Furniture)
______ ______
Total 26,250 26,250
50 FP-FA&A
Purchases Book
Month : January, 2011
Date Particulars Invoice No. L.F. Details Amount
`
2013
Jan. 2 Modi & Sons Goods 61,400
Jan. 4 Delhi Traders Goods 73,300
Total 1,34,700
Sales Book
Month : January, 2011
LESSON ROUND UP
Accounting cycle includes identifying, recording, classifying and summarizing of the transactions.
Every transaction is recorded in the Journal before being posted into the ledger. It is that book of
account in which transactions are recorded in a chronological order.
Recording in the journal is done following the rules of debit and credit.
Posting is the process of recording transactions in the ledger based on the entries in the journal.
The main function of a ledger is to classify or sort out all the items appearing in the journal or other
subsidiary books under their appropriate accounts so that at the end of the accounting period
summary of each account is easily available.
Balancing of ledger accounts involves equalization of both sides of the account by putting the
difference on the side where the amount is short.
Lesson 2 Accounting Process-I 55
Various subsidiary books are: purchases book; sales book; purchases returns book; sales returns
book; bills receivable book; bills payable book and cash book.
Petty Cash Book may be maintained under Imprest System of petty cash.
General Journal or journal proper is maintained for recording those transactions for which there are
no other appointment subsidiary book.
Trial Balance is prepared after posting the entries in ledger to verify the arithmetical accuracy of
entries made in the ledger.
GLOSSARY
Journal Book of prime entry in which every transaction is recorded before being posted into the
ledger.
Compound Transactions which are inter-connected or of the same nature and have taken place
Journal simultaneously are recorded by means of compound or combined journal entries Posting is
Entry the process of recording transactions in the ledger based on the entries in the subsidiary
books.
Cash Book It is a record of transactions concerning cash receipts and cash payments.
Trial A schedule or list of balances both debit and credit extracted from various accounts in the
Balance ledger.
SELF-TEST QUESTIONS
Theory Questions:
1. Distinguish between journal and ledger.
2. What do you mean by contra-entries in a columnar cash book?
3. What is meant by columnar cash book?
4. What is meant by analytical petty cash book?
5. Describe the imprest system of patty cash.
Practical Questions:
1. Journalise the following transactions:
2013 `
(i) Jan. 1 Bought office furniture from Kanji & Co. 6,000
(ii) 5 Bought goods from F. Roy 5,000
(iii) 10 Bought goods from P. Gupta 10,000
(iv) Feb. 1 Sold goods to K. Peter 4,000
(v) 5 Sold goods to P. Turpin & Co. 7,000
(vi) 12 Bought goods from C. Henry 4,500
(vii) 17 Bought goods from J. Jones 2,000
(viii) 20 Sold goods to S. Sorab & Co. 18,000
(ix) 23 Sold goods to B. Byramji 1,750
(x) 25 Received cash from P. Turpin & Co. 3,000
(xi) 27 Received cash from K. Peter 2,500
(xii) 28 Paid cash to F. Roy 1,000
56 FP-FA&A
(xiii) 28 Paid cash to P. Gupta 5,000
(xiv) Mar. 4 Paid salaries 9,000
(xv) 5 Paid office rent 750
(xvi) . 7 Sold goods for cash 2,750
(xvii) 8 Bought goods for cash 1,250
(xviii) 11 Paid for stationery 250
(xix) 15 Received cash from S. Sorab & Co. 14,750
(xx) 15 Received cash from B. Byramji 1,750
(xxi) 17 Paid cash to C. Henry 3,500
(xxii) 17 Paid cash to J. Jones 2,000
(xxiii) 20 Purchased goods for cash 1,000
(xxiv) 25 Paid Kanji & Co. 6,000
2. Rolly Polly was carrying on business as a cloth dealer. His transactions during April, 2012 were as
follows:
2012 `
Apr., 1 Sold cloth on credit to Gifloo 5,000
2 Purchased cloth from Amboo on credit 20,000
3 Paid rent for April by cheque 3,000
4 Cash purchases of cloth (paid by cheque) 8,000
Cash sales 4,500
6 Paid for stationery and postage 500
8 Drawn cash for private use 2,500
10 Drawn cash from Bank for office 15,000
13 Purchased goods on credit from Minoo 25,000
16 Sold goods on credit to Gopal 18,000
17 Paid telephone charges 4,800
18 Cash sales 3,000
Paid for advertising 3,500
22 Cash purchases 9,000
24 Purchased filing cabinet and paid by cheque 5,000
27 Purchased Government securities 30,000
Paid wages for the month 8,000
Journalise the transactions and prepare ledger accounts.
3. Enter the following transactions in a triple column cash book.
March, `
2012
1 Balance at bank 20,000
Purchased goods by cheque 10,000
Lesson 2 Accounting Process-I 57
Drew cheque for office cash 500
Purchased stationery for cash 100
8 Received from C-cheque 1,250
Allowed discount 30
9 Received from A-cheque 1,400
Allowed discount 40
10 Carriage paid in cash 30
12 Received cheque from D 1,750
Allowed discount 30
13 Paid to coolie hired-cash 80
Drew cheque favoring G for rent 1,800
15 Paid for purchases-cheque 20,000
Received from C-cheque 900
Allowed discount 20
20 Paid for postage-cash 50
Paid K by cheque 1,950
Discount allowed by him 50
22 Received cheque for sales 1,500
25 Paid for cleaning office 50
27 Paid wages-cash 500
30 Drew cheque for electricity 2,000
Drew cheque for office use 3,000
(Ans.: Cash in hand ` 2,690; Bank overdraft ` 12,450; Discount - Dr. ` 120 and Cr. ` 50).
58 FP-FA&A
Lesson 3
Accounting Process II
(Rectification of Errors)
LESSON OUTLINE
LEARNING OBJECTIVES
ERRORS
Accounting errors are the errors committed by persons responsible for recording and maintaining accounts of
a business firm in the course of accounting process. These errors may be in the form of omitting the
transactions to record, recording in wrong books, or wrong account or wrong totalling and so on. While
discussing about the trial balance, we have seen that preparation of trial balance is a method of verifying the
arithmetical accuracy of entries made in the ledger. But it may be noted that an agreement of the trial balance
does not prove that- (i) all transactions have been correctly analyzed and recorded in the proper accounts;
and (ii) all transactions have been recorded in the books of original entry. Hence, we can say that a trial
balance should not be regarded as a conclusive proof of the correctness of the books of account, that is if the
trial balance does not agree, there are errors or mistakes but even if the trial balance agrees, there may be
errors in the accounts.
CLASSIFICATION OF ERRORS
ERRORS
Complete Omission
Partial Omission
A. Clerical Errors
Errors other than errors of principle are called clerical errors. The following are the types of clerical errors.
1. Errors of Omission: These errors arise as a result of some act of omission on the part of the
person responsible for the maintenance of books of account. It refers to the omission of a transaction
at the time of recording in subsidiary books or posting to ledger. Omission may be complete or
partial.
(a) Complete Omission: When any particular transaction has not at all been entered in the journal
or in the book of original entry, it cannot be posted into the ledger at all and complete error of
omission will occur. The trial balance is not affected at all by such errors e.g. failure to record
completely credit sales in sales book. However, the trial balance will agree, if debit side as well
as credit side of a journal entry is not posted to ledger.
(b) Partial Omission: This means that the transaction is entered in the subsidiary book, but is not
posted to the ledger, such errors affect the agreement of trial balance e.g. omitting to post the
discount columns of the cash book.
2. Errors of Commission: These errors arise due to some positive act of commission on the part of the
person responsible for the maintenance of the books of account. These mistakes are committed
because of ignorance, lack of proper accounting knowledge and carelessness of the accounting staff.
They are committed while recording transactions. These errors may or may not affect the agreement
of trial balance.
Lesson 4 Accounting Process-II 61
For example:
Mistake in balancing an account.
Mistake in posting in so far as the amount is wrongly written. A common mistake, for example, is to
transpose figures - to write ` 115 instead of ` 151. This will cause a mistake of ` 36 and a
corresponding difference in the trial balance. The total of all the figures of the difference thus
caused is 9 or multiples of 9. (Students should note that in case of transposition of figures, (i) the
difference in trial balance will always be divisible by 9, (ii) the total of all the figures of the
difference will also be divisible 9. Suppose, you have written 67895 instead of 95678 or in any
other way, provided the figures are the same, the difference 27783 (i.e. 95678 - 67895) is divisible
by 9. Hence, if the difference in trial balance is divisible by 9, it may be assumed that there may be
transposition of figures.
Making an entry on the wrong side. For example, if instead of debiting an account with ` 500 it is
credited with the amount, the debit balance, in the trial balance will be shorter by ` 1,000. A
mistake on the wrong side causes the difference to be double of the amount involved.
A mistake in the casting of subsidiary books. A mistake in the total of the Purchases Book will
affect the Purchases Account, a mistake in the total of the Sales Book will mean a corresponding
mistake in the Sales Account. Similarly, total of the Returns Book, if wrongly done, would mean
that the Returns Inwards Account or Returns Outwards Account will be posted with wrong amount.
These mistakes will be reflected in the trial balance.
It must be noted that a mistake in the totals of the subsidiary books will not affect the correctness of
the various personal accounts of customers and creditors.
3. Compensating Errors: They are group of errors, the total effect of which is not reflected in the
trial balance. These errors are neutralizing in nature, hence one error is compensated by other error
or errors of opposite nature. For example, an extra debit in purchase account may be compensated
by an extra credit in sales account. Thus, compensating errors do not affect the agreement of trial
balance.
B. Errors of Principle
These errors arise because of the failure to differentiate between capital expenditure and revenue
expenditure and capital receipts and revenue receipts. The distinction between capital and revenue is of
relevance because any incorrect adjustment or allocation in this respect would falsify the final results shown
by the profit and loss account and the balance sheet. These errors do not affect the agreement of trial
balance. For example, debiting purchase of furniture to office expenses account, crediting sale of furniture to
sales account, etc.
REVIEW QUESTIONS
1. Classify the following errors:
(i) Credit sale of ` 1,500 to P was correctly recorded in sales book but
not posted to Ps Account.
(ii) Purchases book was undercast by ` 100.
(iii) Cash paid to Brij Behari, ` 500 was debited to Bankey Behari as `
5,000.
(iv) Purchase of furniture ` 3,000 was recorded in Purchases Book.
(v) Whitewashing charges ` 500 were debited to Buildings Account.
[Ans. Errors of Omission = (i), Errors of Commission
= (ii), (iii), Errors of Principle = (iv), (v)]
2. Which of the above mentioned errors will not affect the trial balance?
[Ans. (iv) and (v)]
3. What will be effect of the above mentioned errors on the profits for the
year?
[Ans. Increase in profit by ` 2,400]
Lesson 4 Accounting Process-II 63
STEPS TO LOCATE ERRORS
Whenever there is a difference in the trial balance even by a small amount, the mistakes involved must be
located. A small amount may be the net result of a number of mistakes and it is not safe to ignore a difference
in trial balance howsoever small it may be. The following steps are suggested to find out errors:
(i) Total the debit and credit columns of the trial balance again. If one amount has been shown for a
group of accounts (for example, in place of all customers individually, only one amount against
Sundry Debtors may be shown), recheck the total of the list of such accounts.
(ii) See that the balances of all accounts including the cash, bank balances have been written in the trial
balance.
(iii) See that there is no mistake in the balancing of the various accounts.
(iv) Find out the exact difference in the trial balance. Look for such accounts which show the same amount. It
is possible that the balance of the particular account has been omitted from the trial balance. Accounts
showing a balance equal to half the difference should also be checked; the amount may have been
written on the wrong side of the trial balance
(v) Recheck the totals of the subsidiary books.
(vi) If the difference is a large one, compare the figures with the trial balance of the corresponding date of
the previous year. Any account showing a rather large difference over the figures of the corresponding
trial balance of the previous year should be rechecked.
(vii) Posting of all the amounts corresponding to the difference or half the difference should be checked.
(viii) If the difference is still not traced, posting of the accounts will have to be checked. For this, it is better,
first of all, to check the posting of the totals of subsidiary books such as sales book, purchases book,
returns books etc. The subsidiary books should then be gone through to see if any items have not
been posted. It should also be checked whether the various accounts have been opened with correct
balances. Nominal accounts should be checked first, then real accounts and then personal accounts
should be taken up.
RECTIFICATION OF ERRORS
It is better to rectify errors always through journal entries. However, if an error is located immediately after it
has been entered, the accountant may neatly cross out the wrong amount and initial the rectification. There
should not be any overwriting. If however, some time has elapsed between the commission of the error and
its detection, the error should be rectified by making suitable journal entries only.
Illustration 1:
Solution:
(i) Credit Madhav with ` 180 saying By Excess debit for sales on .....` 180".
(ii) Debit the Discount Account with ` 2,000 saying To Rectification of wrong credit of ` 1,000 for discount
allowed.... ` 2,000.
(iii) Credit Sohan with ` 2,750 and debit Mohan with ` 3,750.
(iv) Debit Purchases Account with ` 10,000 saying To Short total of Purchases Book..... ` 10,000".
(v) Debit Sales Account with ` 1,750 and Loss on Sale of Furniture Account with ` 750 and credit
Furniture Account with ` 2,500.
(b) Errors Affecting Two or More Accounts. (Two Sided Errors): Errors which affect two or more accounts
are as follows:
(i) Errors of complete omission.
(ii) Errors in recording in the subsidiary books.
(iii) Errors in posting to wrong account with or without wrong amount.
(iv) Errors of principle.
For rectification of these types of errors, following steps may be taken:
(i) Write down in the rough sheet, the correct entry necessary for recording the transaction.
(ii) Write down in the rough sheet the entry that has actually been passed.
Lesson 4 Accounting Process-II 65
(iii) Pass in the journal the requisite entry to arrive at the correct entry of step (i) and cancel the entry of
step (ii).
Example: A purchase of ` 5,000 from Rajesh entered in the purchases day book as ` 500.
The rectification of this error shall involve:
` `
(a) Purchases A/c Dr. 5,000 (correct entry)
To Rajesh 5,000
(b) Purchases A/c Dr. 500 (entry passed)
To Rajesh 500
(c) The rectifying entry in the journal will be:
Purchases A/c Dr. 4,500 (rectifying entry)
To Rajesh 4,500
Illustration 2:
Pass journal entries necessary to rectify the following errors:
1. An amount of ` 2,000 withdrawn by the proprietor for his personal use has been debited to Trade
Expenses Account.
2. A purchase of goods from Nathan amounting to ` 3,000 has been wrongly entered in the Sales
Book.
3. A credit sale of ` 1,000 to Santhanam has been wrongly passed through the Purchases Book.
5. ` 3,750 paid on account of salary to the cashier Dhawan stands debited to his personal account.
6. A contractors bill for extension of premises amounting to ` 2,75,000 has been debited to Building
Repairs Account.
7. On 25th March, goods of the value of ` 5,000 were returned by Akash Deep and were taken into stock
but the returns were entered in the books under date 3rd April, i.e.; after the expiration of the financial
st
year on 31 March.
8. A bill of ` 2,000 for old office furniture sold to Sethi was entered in the Sales Day Book.
You received a remittance of ` 2,000, but you may not know who has sent the amount. Therefore, for
the time being you may pass the following entry:
Cash Account Dr. 2,000
To Suspense Account 2,000
(Being remittance received from unknown person)
Later when you get the information that Mr. Ram Singh had sent the amount, then pass the following
entry:
Suspense Account Dr. 2,000
To Ram Singh 2,000
(Being credit given for the sender for remittance
which had been credited previously to suspense
account)
(b) Errors Affecting Two or More Accounts (Two Sided Errors): For rectification of two sided errors, the
following steps may be taken:
(i) Write down on the rough sheet, the correct entry necessary for recording the transaction.
(ii) Write down on the rough sheet, the entry that has actually been passed.
(iii) Pass in the journal, the requisite entry to arrive at the correct entry of step (i) and to cancel entry of
step (ii).
Example: Sale of old furniture for ` 3,000 has been credited to sales account. The rectification
of this error shall call for:
(a) Cash Account Dr. 3,000 (correct entry)
68 FP-FA&A
To Furniture Account 3,000
(b) Cash Account Dr. 3,000 (entry passed)
To Sales Account 3,000
(c) The rectifying journal entry will be:
Sales Account Dr. 3,000 (rectifying entry)
To Furniture Account 3,000
Illustration 3:
Pass journal entries to rectify the following errors assuming the existence of Suspense Account:
(i) Goods bought from Mukesh amounting to ` 5,500 was posted to the credit of his account as ` 5,000.
(ii) Sales book was overcast by ` 10,000.
(iii) While carrying forward the total of one page of the Purchases Book to the next, the amount of
` 2,12,350 was written as ` 2,13,250.
(iv) Cartage ` 780 paid on machinery newly acquired was debited to carriage inward account.
(v) Purchases returns to Shivalker Bros. ` 3,100 were not recorded in purchases returns book but the
account of Shivalker Bros. was duly debited with the amount.
(vi) Drawings of goods costing 300 were not recorded in the books of account.
(vii) Whitewashing expenses, ` 670 were posted from cash book to the nominal account as ` 760.
Also prepare Suspense Account starting it with debit balance of ` 320. Have you any comments to offer on
Suspense Account?
Solution:
Journal
Date Particulars LF Dr. Cr.
Amount (`) Amount (`)
(i) Suspense Account Dr. 500
To Mukesh 500
(For rectification of short credit to Mukesh)
(ii) Sales Account Dr. 10,000
To Suspense Account 10,000
(For rectification of wrong total of Sales Book)
(iii) Suspense Account Dr. 900
To Purchases Account 900
(For rectification of wrong carry forward of
total from one page to another in the
Purchases Book)
(iv) Machinery Account Dr. 780
To Carriage Inwards Account 780
(For rectification of wrong debit to carriage
inwards for cartage paid on newly acquired
machinery)
Lesson 4 Accounting Process-II 69
(v) Suspense Account Dr. 3,100
To Purchases Returns Account 3,100
(For rectification of omission of credit to
Purchases Returns Account for goods
returned to Shivalkar Bros.)
(vi) Drawings Account Dr. 300
To Purchases Account 300
(For rectification of omission of drawings of
goods costing ` 300 by the proprietor)
(vii) Suspense Account Dr. 90
To Whitewashing Account 90
(For rectification of excess debit to
whitewashing account)
LEDGER
Dr. Suspense Account Cr.
Particulars ` Particulars `
To Differnce in trial balance 320 (ii) By Sales Account 10,000
(i) To Mukesh 500
(iii) To Purchases Account 900
(v) To Purchases Returns 3,100
(vii) To Whitewashing Account 90
To Balance c/d 5,090 _____
10,000 10,000
By Balance b/d 5,000
Comment: As suspense account still shows a balance, it means all errors have not yet been rectified.
Illustration 4:
Rectify the following errors by passing necessary journal entries:
(i) Goods purchased for proprietors use for ` 2,500 was debited to purchases account;
(ii) ` 2,750 received from Hari Chand was debited to his account;
(iii) Returns inward book was short totalled by ` 650.
(iv) Interest received on deposit ` 500 had been debited in the cash book, but had not been credited to
interest account.
(v) ` 2,000 being purchases returned were posted to the debit of purchases account.
(vi) Interest on overdraft ` 1,200 was not posted to the ledger from the cash book.
(vii) An invoice for the purchase of machinery costing ` 1,00,000 was erroneously passed again and
entered into the books.
70 FP-FA&A
Solution:
Rectifying Journal Entries
Date Particulars L.F. Dr. Cr.
Amount (`) Amount (`)
(i) Drawings A/c Dr. 2,500
To Purchases A/c 2,500
(Goods purchased for personal use
wrongly debited to purchases account, error
now rectified)
(ii) Suspense A/c Dr. 5,500
To Hari Chand 5,500
(Cash received from Hari Chand of
` 2,750 wrongly debited to his account,
now rectified)
(iii) Returns Inward A/c Dr. 650
To Suspense A/c 650
(Returns inward book under-cast
by ` 650, now rectified)
(iv) Suspense A/c Dr. 500
To Interest Received A/c 500
(Interest received not having been credited,
error now rectified)
(v) Suspense A/c Dr. 4,000
To Purchases A/c 2,000
To Purchases Returns A/c 2,000
(Purchases returns wrongly debited to
purchases account, now rectified)
(vi) Interest A/c Dr. 1,200
To Suspense A/c 1,200
(Being interest on overdraft not posted to the
ledger from cash book, error now rectified)
(vii) Suppliers A/c Dr. 10,000
To Machinery A/c 10,000
(Being invoice for purchase of machinery
recorded in books twice, error now reversed)
Examples:
(a) Wages of ` 2,500 paid for the installation of machinery charged to wages account. In
the same accounting period, the rectifying entry would be:
` `
Machinery Account Dr. 2,500
To Wages Account 2,500
But if the final accounts have been prepared, the wages account has been closed by
transfer to trading account, so the rectifying entry will be:
Machinery Account Dr. 2,500
To Profit and Loss Adjustment Account 2,500
(b) Salaries paid ` 3,500 posted to wages account in the ledger. In the same accounting
period, the rectifying entry would be:
Salaries Account Dr. 3,500
To Wages Account 3,500
But if the final accounts have been prepared, no entry is required to be passed
because both the accounts are nominal accounts and the profit has not been affected
by the error.
Illustration 5:
The trial balance of M. Mukherjee did not tally on 31.3.2012. The following errors were detected afterwards.
Pass the necessary journal entries to rectify the errors and find out the difference in trial balance assuming
that all errors have been rectified.
(i) A sum of ` 600 received from Mathur on 31.3.2012 was entered in the cash book on 2.4.2012.
(ii) Returns inwards book was undercast by ` 300.
(iii) The purchase of typewriter for ` 25,000 was entered in the purchases day book.
(iv) Wages of workmen engaged in the construction of building amounting ` 35,000 were debited to wages
account.
(v) A purchase of ` 2,671 had been posted to the debit of suppliers account as ` 2,617.
(vi) Goods amounting to ` 1,000 had been returned by Raju and were taken into stock, but no entry was
passed in the books for the transaction.
72 FP-FA&A
(vii) ` 24,000 paid for purchase of T.V. for proprietors own use had been charged to miscellaneous expense
account.
(viii) A sale of ` 600 to Sethi was credited to his account with ` 60.
(ix) A sale of ` 2,000 has been passed through the purchases journal.
(x) ` 75 paid for repairs to furniture had been entered in the total column of petty cash book, but not entered
in the appropriate analysis column, the total of which has been posted.
Solution:
Rectifying Journal Entries
Date Particulars L.F. Dr. Cr.
(`) (`)
(i) No further entry required as receipt has already
been recorded and no nominal account is
(ii) Returns Inwards A/c Dr. 300
To Suspense A/c 300
(Returns inward book was undercast by
` 300, error now rectified)
(iii) Typewriter A/c Dr. 25,000
To Purchases A/c 25,000
(Typewriter purchased was wrongly passed
through purchases day book, error now rectified)
(iv) Building A/c Dr. 35,000
To Wages A/c 35,000
(Wages paid for construction of building
was wrongly debited to wages account, error now
rectified)
(v) Suspense A/c Dr. 5,288
To Suppliers A/c (` 2,671 + ` 2,617) 5,288
(Purchase of ` 2,671 from supplier wrongly
debited to his account by ` 2,617, error now
rectified)
(vi) Returns Inwards A/c Dr. 1,000
To Raju 1,000
(Goods returned by Raju not entered in
the books of account, now entered)
(vii) Drawings A/c Dr. 14,000
To Miscellaneous Expenses A/c 14,000
(Purchase of T.V. for owner earlier
charged to miscellaneous expenses account,
error now rectified)
Lesson 4 Accounting Process-II 73
Date Particulars L.F. Dr. Cr.
(`) (`)
(viii) Sethi (600 + 60) Dr. 660
To Suspense A/c 660
(Being goods of ` 600 sold to Sethi wrongly
credited to his account for ` 60, error now
rectified)
(ix) Suspense A/c Dr. 4,000
To Purchases A/c 2,000
To Sales A/c 2,000
(Being a sale of ` 2,000 wrongly passed through
purchases journal, error now rectified)
(x) Repairs to Furniture A/c Dr. 75
To Suspense A/c 75
(Being repairs for furniture earlier not posted
from petty cash book, error now rectified)
Illustration 6:
While closing his books of account, Om Prakash finds that the Trial Balance on that date, i.e. 31st March,
2012 is out by ` 907 excess debit. He places the difference in a newly opened Suspense Account and
prepares his final accounts which reveal a profit of ` 14,780 for the year ended 31st March, 2012. In April
2012, the following errors were detected in the accounts for the year 2011-12;
(i) Purchases book was undercast by ` 1,000.
(ii) Cash received from Jamna Das ` 687 was posted to the debit of Janki Das as ` 678.
(iii) Discount received ` 7,630 and discount allowed ` 6,873, the totals of the appropriate columns in cash
book were not posted to the ledger.
(iv) Schedule of debtors was totalled ` 1,16,280 instead of ` 1,16,380. Om Prakash maintains a provision
for bad debts @ 5%.
(v) Bank charges and interest, ` 115 remained unposted to the debit side of the nominal account.
(vi) Depreciation on furniture ` 2,970 was wrongly recorded as ` 2,790.
74 FP-FA&A
Pass journal entries to rectify the above-mentioned errors, prepare Suspense Account and Profit and Loss
Adjustment Account and ascertain the correct amount of profit for the year ended 31st March, 2012.
Solution:
Journal
Date Particulars LF Dr. Cr.
Amount (`) Amount (`)
(i) Profit and Loss Adjustment Account Dr. 1,000
To Suspense Account 1,000
(Being rectification of error caused by undercasting of
Purchases Book for the year 2011-12 by ` 1,000)
(ii) Suspense Account Dr. 1,365
To Jamna Dass 687
To Janki Dass 678
(Being rectification of wrong debit of
` 678 to Janki Das and omission of credit of ` 687
to Jamna Das, in 2011-12 books)
(iii) Suspense Account Dr. 757
To Profit and Loss Adjustment Account 757
(Being rectification of omission of posting of
discount received `7,630 and discount allowed
` 6,873 in 2011-12)
(iv) Schedule of Debtors Account Dr. 100
Profit and Loss Adjustment Account Dr. 5
To Suspense Account 100
To Provision for Bad Debts Account 5
(Being rectification of schedule of debtors and
also rectification of Provision for bad debts
account due to wrong basis on which the amount
of bad debts was calculated in 2011-12)
(v) Profit and Loss Adjustment Account Dr. 115
To Suspense Account 115
(Rectification of omission of posting to bank
charges and interest account)
(vi) Profit and Loss Adjustment Account Dr. 180
To Furniture Account 180
(Being rectification of wrong entry for depreciation
on furniture)
Lesson 4 Accounting Process-II 75
Ledger Accounts
Dr. Suspense Account Cr.
Date Particulars Amount Date Particulars Amount
` `
2012 2012
March March 31 By Difference in Trial
31 To Balance c/fd ___907 2011 Balance ___907
2011 April 1
April 1 To Jamna Das 687 By Balance b/fd 907
By P & L Adj. A/c 1,000
To Janaki Das 678 By Schedule of
Debtors 100
To P & L Adjustment 757 By P & L Adj. A/c 115
_______ ______
___2,122 _2,122
Illustration 7:
The books of account of Bipin Lal for the year ended 31st March, 2013, were closed with a difference in the
trial balance carried forward. Subsequently the following errors were detected:
(i) ` 1,500 being the total of discount column on the credit side of the cash book was not posted to
discount account.
(ii) Closing stock was overstated by ` 9,000 being casting error in the schedule of inventory.
(iii) Returns outwards book was undercast by ` 150.
(iv) A credit sale of ` 870 was wrongly posted as 780 to the customers account.
(v) ` 6,000 being the cost of purchase of office furniture was entered in the purchases book.
Pass rectification entries, prepare suspense account, and find the effect of correction on profit for the year
ended 31st March, 2013.
76 FP-FA&A
Solution:
Rectification Entries
L.F. Dr. Cr.
Date Particulars Amount Amount
(i) Suspense A/c Dr. 1,500
To Profit and Loss Adjustment A/c 1,500
(Discount received not posted from cash
book to ledger, error now rectified)
(ii) Profit and Loss Adjustment A/c Dr. 9,000
To Stock in Trade 9,000
(Closing stock was overstated by ` 9,000, error now rectified)
(iii) Suspense A/c Dr. 150
To Profit and Loss Adjustment A/c 150
(Returns outwards book undercast, error now rectified)
(iv) Customers Dr. 90
To Suspense A/c 90
(Credit sale of ` 870 wrongly posted as 780,
to the customers account, error now rectified)
(v) Office Furniture A/c Dr. 6,000
To Profit and Loss Adjustment A/c 6,000
(Purchase of office furniture wrongly entered
in purchases account, error now rectified)
LESSON ROUND UP
Accounting errors can be classified into errors of principle and clerical errors.
Clerical errors are further classified into errors of omission, errors of commission and compensating
errors.
Some errors affect the agreement of trial balance and are disclosed by the trial balance e.g. errors
in casting, carry forward, totaling, balancing of accounts etc.
Some errors do not affect the agreement of the trial balance and hence are not disclosed such as
errors of complete omission, errors of commission, compensating errors and errors of principle.
Most of the errors are rectified by passing journal entries.
The difference in trial balance is transferred to Suspense Account if the errors are not identified.
Profit & Loss Adjustment Account is opened to rectify the which involve nominal accounts in the
next according period.
GLOSSARY
Accounting Mistakes committed by persons recording and keeping accounts.
Errors
Errors of These errors arise because of the failure to differentiate between capital expenditure
Principle and revenue expenditure and capital receipts and revenue receipts.
Errors of These errors arise due to some positive act of commission on the part of the person
Commission responsible for the maintenance of the books of account.
Errors of These errors arise as a result of some act of omission on the part of the person
Omission responsible for the maintenance of books of account.
Compensating The total effect of these errors is not reflected in the trial balance.
Errors
SELF-TEST QUESTIONS
Practical Questions:
1. On 31st March, 2013 the accountant of a firm, while preparing the final accounts for the year, finds
that the trial balance is out by ` 1,000 excess credit. He places the amount in Suspense Account. In
April 2013, the under mentioned errors are discovered:
(i) The opening balance of furniture and fittings account for 2012-13 was written as ` 2,6,700
instead of ` 27,600. The firm depreciates furniture and fittings @ 10% p.a. on written down
value basis.
(ii) Sales Book for February 2013 was found overcast by `100.
(iii) A sum of ` 575 was received from I.N. Chakarvaty but the amount was wrongly credited to I.N.
Chaturvedy.
Lesson 4 Accounting Process-II 79
(iv) Cartage amounting to ` 125 paid in respect of new machinery purchased on 29th March was
debited to carriage inwards account.
(v) Goods invoiced at ` 130 were returned by Neelam Stores but by mistake an entry was passed
in Returns Outwards Book.
Pass journal entries necessary to rectify the errors without affecting the profit for 2012-13. Also
show Suspense Account.
2. How would you rectify the following errors?
(i) A sale of goods of the value of ` 2,500 to R. Roberts has been wrongly debited to Robertson
& Co.
(ii) A purchase of ` 1,500 from S. Narayan instead of being credited to him from the Invoice Book,
has been wrongly debited to him.
(iii) Cash ` 750 received from P. Basu and entered on the receipt side of the cash book has not
been posted.
(iv) A payment of ` 250 made to J. Jones for cash purchase of goods from him stands debited to
his account.
(v) A payment of ` 9,000 in respect of salary has been posted twice to salaries account.
(vi) An amount of ` 4,500 drawn by the proprietor for his personal use stands debited to general
expenses account.
(vii) The total of the discount column on the debit side of the cash book for the month has been
added short by ` 200.
(viii) ` 400 relating to purchase of office stationery has been wrongly debited to the personal
account of the proprietor.
(ix) A credit purchase of ` 750 from Ramdas & Co. stands wrongly credited to Ramji & Co.
3. After getting an agreed trial balance, the account of M/s Senco Stores drafted the trading and profit
loss a/c and the balance sheet. The following errors were then detected by the auditors:
(a) ` 2,500 received from the insurance company in full payment of claim for loss of stock in
transist was deposited by the proprietor into his private bank account and was not recorded in
the business books.
(b) Goods purchased for ` 2,000 were included in stock, but the invoice was not entered in the
books for the period under review.
(c) There were compensating errors in the books i.e. (i) a payment of ` 300 as commission to
a sales agent had not been posted from the cash book; (ii) dividends received were
undercast by ` 100; (iii) purchases amounting to ` 190 were not posted to the account of
the supplier from purchases journal and (iv) debit side of a customers account was
overcast by ` 10.
(d) Goods sold for ` 500 were returned by a customer, but no record of this was made in the
books although the returned goods were included in the stock at their cost price, ` 380.
Show the journal entries and effect of these errors and summarise the alterations necessary in the
originally drafted statement of accounts.
4. A merchant, while balancing his books of account, finds that the trial balance shows ` 3,765 excess
credit. Being required to prepare the final accounts, he places the difference to a newly opened
suspense account, which he carries forward. In the next accounting year, he locates the following
errors:
(i) A sale for ` 4,000 has been passed through the purchases book. The customers account has,
however, been correctly debited.
(ii) A sum of ` 896 paid to Dwarka Prasad has been credited to Durga Prasad as ` 869.
(iii) Salary ` 5,500 paid to a peon has been debited to the peons personal account.
80 FP-FA&A
(iv) Schedule of debtors has been totalled ` 3,66,560 instead of ` 3,76,560. A provision for bad
debts @ 5% of the debtors has been created.
Draft journal entries necessary for rectifying the above-mentioned errors.
Prepare the suspense account and show the ultimate effect of the errors on the last years profit by
preparing profit and loss adjustment account.
Lesson 4
Accounting Process II
(Capital and Revenue Items)
LESSON OUTLINE
LEARNING OBJECTIVES
Difference between Capital and Revenue items are included only in income statement and
Receipts capital items form part of balance sheet figures.
Capital and Revenue Profits The distinction between the capital and revenue
transactions is done by analysing the basic nature
Capital and Revenue Losses
of transactions. The classification depends upon
Review Questions the recurringness of the transaction and the
There is no business like show business, but there are several businesses like accounting.
David Letterman
82 FP-FA&A
CAPITAL EXPENDITURE
Capital expenditure is that expenditure which results in acquisition of an asset or which results in an increase
in the earning capacity of a business. The benefit of such expenditure lasts for a long period of time.
Examples: Purchases of land, buildings, machinery, furniture, patents, etc. All these assets stay in business
and are used again and again. Other examples are money paid for goodwill (like the right to use the
established name of an outgoing firm) since it will attract the old firms customers and thus will result in higher
sales and profits; money spent to reduce working expenses like conversion of hand-driven machinery to
power-driven machinery and expenditure enabling a firm to produce a large quantity of goods. Expenditure
which does not result in an increase in capacity or in reduction of day-to-day expenses is not capital
expenditure, unless there is a tangible asset to show for it.
All sums spent up to the point an asset is ready for use should also be treated as capital expenditure.
Examples are: fees paid to lawyer for drawing a purchase deed of land, overhauling expenses of second
hand machinery, cartage paid for bringing machinery to the factory from suppliers premises and money spent
to install a machinery; and even interest on loans taken to acquire fixed assets only for the period before the
asset becomes operational.
REVENUE EXPENDITURE
Expenses whose benefit expires within the year of expenditure and which are incurred to maintain the earning
capacity of existing assets are termed as revenue expenditure. Amounts paid for wages, salary, carriage of
goods, repairs, rent and interest, etc., are examples of revenue expenditure. Depreciation on fixed assets is
also a revenue expenditure. To the extent the materials are used up, they will be revenue expenditure.
Similarly, cost of goods sold is revenue expenditure. Costs incurred to acquire an asset are capital but costs
incurred to keep them in working condition or to defend their ownership are revenue. Fee paid to a lawyer for
checking whether all the papers are in order before land is purchased is capital expenditure. But if later a suit
is filed against the purchaser, the legal costs will be of revenue type.
(i) Amount realised by the sale of fixed assets or by (i) Amount realised by sale of goods or rendering
issue of shares or debentures is a capital receipt. services is always a revenue receipt.
(iii) Amount received for surrender of certain rights (iii) Amount received as compensation under an
under an agreement is a capital receipt, because agreement for the loss of future profits is a
a capital asset is being given up in the form of revenue receipt.
these rights.
(iv) Instead of lump sum payment if the payment is (iv) If an income is received in a lump sum it is a
received in installments, it is a capital receipt. revenue receipt.
(v) Amount realised from the sale of a capital asset (v) Amount realised from the sale of an asset kept
or investment is capital receipt. for sale is revenue receipt.
REVIEW QUESTIONS
1. Expenses whose benefit expires within the year are _________.
2. _________ profits are earned in the ordinary course of business.
3. Payment into the business by proprietor is_________ receipt.
4. White-washing charges of office building is an example of _______
expenditure.
Illustration 1:
State which of the following expenditures are capital, revenue, deferred revenue expenditures and capital loss:
(i) Cost of overhauling and painting a second-hand truck newly purchased.
(ii) Cost of making more exits in a cinema hall under order of the Government.
(iii) ` 25,000 were spent on air conditioning the office of the General Manager.
(iv) An old machine which stood in the books at ` 15,000 was sold for ` 13,000.
Lesson 3 Accounting Process-III 85
(v) ` 2,000 were paid as municipal tax in connection with a building which was purchased last year for `
2,00,000.
(vi) ` 30,000 were spent on heavy advertising in connection with the introduction of a new product.
(vii) ` 500 was paid out in connection with carriage on goods purchased.
(viii) A temporary room constructed for ` 25,000 for storing raw material for the construction of a big
building.
(ix) ` 5,00,000 was spent on putting up a gallery in a theatre hall.
(x) Freight and cartage amounting to ` 4,000 were paid on purchase of a new plant and a sum of ` 2,000
was spent as erection charges of that plant.
Solution:
(i) When a second hand machine is purchased, the entire expenditure incurred in the beginning to make
it fit for working is treated as capital expenditure. The value of the machine is increased by the amount
spent. Therefore, the cost of overhauling and painting the truck will be treated as capital expenditure.
(ii) Making more exits in a cinema hall does not increase the capacity of the hall and therefore, it should
be treated as revenue expenditure.
(iii) The sum of ` 25,000 spent on air conditioning the office of General Manager is capital expenditure
because it represents a fixed asset. Moreover, the effect of air conditioning will be available for several
years to come, and it can possibly be disposed of, if desired, at a future date, when it will fetch some
amount.
(iv) The old machine costing ` 15,000 was sold for ` 13,000 only, and the loss of ` 2,000 is clearly a
capital loss.
(v) ` 2,000 paid by way of municipal tax on a building purchased is an item of revenue nature. It is an
expenditure of routine nature, which was necessary for using the building.
(vi) Since the benefit of ` 30,000 spent on advertising will occur for several years, it is of capital nature. It
may be treated as a deferred revenue expenditure and be written off against the profit and loss
account of a number of years.
(vii) The expenditure of ` 500 incurred on carriage on goods purchased is of revenue nature because the
goods are meant for resale.
(viii) ` 25,000 spent on construction of temporary room should be treated as capital expenditure because it
was necessary for the construction of the main building. The cost of the room will be added to the cost
of the building.
(ix) When a new gallery is put up, it will increase the number of seats (capacity) of the hall. Therefore, this
cost of ` 5,00,000 should be treated as a capital expenditure.
(x) The expenditure incurred by way of freight and cartage amounting to ` 4,000 and the erection charges
of ` 2,000 are both of capital nature. The former has been incurred in connection with the receipt of a
capital asset while the latter has been incurred for erecting it so that it may be used for business
purposes.
Illustration 2:
State whether the following expenses are capital, revenue or deferred revenue expenditure:
(i) A Ltd. spent ` 2,00,000 for overhauling the machinery which improved the capacity utilization and
saved running expenditure by ` 15,000 p.a.
(ii) M/s Capital Properties, property dealers, purchased ten flats @ ` 7,00,000 each.
(iii) A firm incurred ` 10,000 to retain the title of a land purchased for business in litigation with third party.
(iv) Compensation paid to undesirable employees.
86 FP-FA&A
(v) M/s Durga & Co. spent ` 2,50,000 for organizing an Inter-school Cricket Tournament in Delhi. This
was held for advertising their new school bag and certain books and stationery which they wanted to
market.
(vi) ` 12,000 paid to Mahanagar Telephone Nigam Ltd. for installing a telephone in the office.
(vii) Damages paid on account of breach of contract to supply certain goods.
(viii) ` 25,000 has accrued during the year on term loan obtained and utilized for the construction of factory
building and purchase of machinery, however, the production did not commence till the last date of the
year.
(ix) Imported goods worth ` 1,75,000 confiscated by customs authorities for non-disclosure of material facts.
(x) ` 20,000 spent for the trial run of newly installed machinery.
Solution:
(i) Expenses for overhauling the machinery increased capacity utilization which contributes to increase
the revenue generating capacity. Also, saving in revenue expenditure for more than one accounting
period will accrue from this overhauling which will increase future profits. Hence, this expense is
capital in nature.
(ii) Purchase of flats in the ordinary course of business by property dealers is revenue expenditure as flats
are stock in trade for it.
(iii) Legal expenses incurred to retain the title of land are expenses for maintaining the asset. The
expenses will not generate any revenue in future directly. Hence, it is revenue in nature.
(iv) Compensation paid to retrench undesirable employees is expected to increase revenue earning
capacity of the business because such undesirable employees would either waste resources or time
with adverse effect on profit. The expenditure is capital in nature.
(v) The purpose of expenses incurred for organizing the Inter-School Cricket Tournament is to advertise
for some new products. This advertisement has some enduring effect so far as the marketability of the
new products is concerned. The expense may be treated as deferred revenue expenditure.
(vi) The money deposited with Mahanagar Telephone Nigam Ltd. for acquiring a telephone connection is
treated as an asset; hence it is a capital expenditure.
(vii) Damages paid on account of the breach of contract to supply certain goods are treated as revenue
expenditure incurred in the ordinary course of the business.
(viii) Interest accrued on term loan obtained and utilized for the construction of factory building and
purchase of machinery should be treated as capital expenditure since commercial production did not
start till the last date of the accounting year.
(ix) The confiscation of imported goods by the customs authorities is a loss arisen on account of
negligence and is of abnormal nature. It is appropriate to write it off to profit and loss account over a
period of 2 to 5 years treating it as a deferred revenue expenditure.
(x) Expenses incurred for trial-run of newly installed machinery is capital expenditure in nature.
LESSON ROUND UP
All items of capital expenditure are taken in the balance sheet while all items of revenue nature are
taken in the income statement.
Deferred revenue expenditure is revenue in character but the benefit of it is not exhausted in the
same year, or is applicable either wholly or in part of the future years, or is accidental with heavy
amount and it is not prudent to charge against the profit of one year.
Revenue receipts must be set off against the revenue expenses in order to calculate the profit or
loss of the business in an accounting period.
Capital receipts and expenditure have no bearing on the profit or loss for the accounting period.
Revenue profits appear in the income statement and are available for distribution as profit, or for
creating reserves and funds, or for being used in the business.
Capital profits are either capitalized i.e. transferred to capital account or transferred to capital
reserve account which may be utilized for meeting capital losses.
Contingent assets are not recognized in financial statements since this may result in the recognition
of income that may never be realised.
Contingent liabilities are recorded in a company's accounts and shown in the balance sheet only
when both probable and reasonably estimable.
88 FP-FA&A
GLOSSARY
Capital Expenditure Expenditure incurred in acquiring or improving an asset which is not meant for sale.
Revenue Expenditure of a routine nature and incurred to maintain an asset.
Expenditure
Deferred Revenue Heavy expenditure of revenue nature
Expenditure
Capital Receipts Payments or contributions into the business by the sole proprietor, partners or other
shareholders towards the capital of the firm.
Revenue Receipts Outcome of a firms activity as rewards for offering goods or services to the public.
Revenue Profits Earned in the ordinary course of business.
Capital Profits Earned as a result of selling some fixed assets or raising capital for the firm.
Revenue Losses They arise during the normal course of business
Capital Losses They occur on selling the fixed assets or in raising of share capital.
Contingent Assets They are rights to a future potential claim based on past events.
Contingent These are defined obligations by a company that must be met, but the probability of
Liabilities such payment is minimal.
SELF-TEST QUESTIONS
1. State the considerations which would guide you in deciding whether any particular expense should
be regarded as capital expenditure or revenue expenditure.
2. Explain deferred revenue expenditure with examples.
3. What are contingent assets and contingent liabilities? Give examples.
4. Distinguish between capital receipts and revenue receipts.
5. Differentiate between capital expenditure and deferred revenue expenditure.
6. State in each of the following cases whether the expenditure is (a) capital expenditure, (b) revenue
expenditure, or (c) deferred revenue expenditure.
Repairs to furniture.
Legal expenses incurred to defend a suit for breach of contract to supply goods.
Custom duty paid on imported machinery.
Heavy expenditure incurred on advertising a new product.
Carriage paid on goods purchased.
Amount spent to overhaul a motor truck purchased second-hand.
Wages paid to workers for setting up new machinery.
Preliminary expenses incurred in setting up a joint stock company.
Wages paid to workers for converting raw material into finished goods.
Office rent paid in advance for three years.
Lesson 3 Accounting Process-III 89
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Lesson 5
Bank Reconciliation Statement
LESSON OUTLINE
LEARNING OBJECTIVES
Introduction In the modern times, business operates in a
Bank
financial system of the country wherein it uses
Types of Personal Accounts in Bank
the facilities and services provided by the banks.
Deposits
Most of the business houses conduct majority
Withdrawals
of transactions through bank account. Business
Bank Pass Book
enterprises record transactions with the bank
Bank Reconciliation Statement
in the bank columns of the cash book. Bank also
Review Questions
maintains accounts of customers in its ledger
Causes of difference between bank
which are supplied to customers by the bank in
balance as per cash book and pass book
INTRODUCTION
Bank
A bank is an institution which deals in money. Its main business is to accept deposits and to lend money. It
also collects money and makes payments on behalf of its clients. Bank account is a personal account and the
account-holders record their transaction with the bank in a similar manner as they do with any other person.
Deposits
In savings accounts and current accounts, a deposit is made by filling up a form called pay-in-slip. There is a
counterfoil which is stamped by the banks cashier and signed by him and returned to the client. This counter-
foil is evidence that money has been duly received by the bank. Separate pay-in-slips have to be filled in for
depositing cash and cheques. Also, there are different pay in slips for local and out-station cheques.
Withdrawals
Withdrawals are made by means of cheques. A cheque is an unconditional order on the bank made by the
client instructing the bank to pay a certain sum of money to the person named in the cheque or his order or
the bearer. In the case of a savings bank account withdrawals may be allowed by filling in withdrawal form
supplied by the bank rather than cheques.
The money deposited with bank is debited to bank account while money withdrawn from the bank is credited
to bank account. The record of money deposited and withdrawn from the bank is maintained by the business
in its cash book with bank columns which can be balanced on any date and the balance so arrived at is
known as bank balance as per cash book.
Lesson 5 Bank Reconciliation Statement 93
Bank Pass Book
The bank on its part maintains in its ledger the account of its customers. Pass book is a copy of the clients
account in the banks ledger. Bank issues pass book to its client. It is the duty of the client to send it to bank at
intervals so that transactions can be recorded up-to-date. Pass book shows the transactions already entered
into by the bank and the client (like cheques and cash deposited, amounts withdrawn, cheques paid by the
bank, collections and payments made by the bank on behalf of the client) and the balance or overdraft shown
by the clients account at the bank. The money deposited by the customer is credited to his account and the
money withdrawn from the bank is debited to his account. The balance as per bank ledger indicated in the
bank pass book is called the bank balance as per pass book.
REVIEW QUESTIONS
Fill in the blanks:
(a) A bank is an institution which deals in ___________.
(b) In a ________________ with the bank, money can be deposited as often as
desired and also, it can be withdrawn without notice as often as necessary.
(c) In a savings bank account, restrictions are made on the __________ as well
as _________of withdrawals.
(d) A deposit is made by filling up a form called _____________.
(e) In Recurring Deposit Account, deposits are made mostly every _____.
CAUSES OF DIFFERENCE BETWEEN BANK BALANCE SHOWN BY CASH BOOK AND THAT
SHOWN BY PASS BOOK
The following are the reasons for the difference between the balances shown by the cash book and the pass
book.
(i) Cheques issued but not presented for payment:
When a cheque is drawn or issued in favour of a third party, it is immediately recorded in the cash book by
debiting the party and crediting the bank and this has the effect of reducing the bank balance in the cash
book. But the bank will not debit clients account until that cheque is presented for payment, and honoured.
So long as it is not presented, the balance shown in the pass book is more than the balance shown by the
cash book.
(ii) Cheques deposited for collection but not yet collected:
The client debits bank column of cash book as soon as he deposits cheques with the bank for collection, but
the bank credits clients account only when it has collected cash on the cheque so deposited. It results in
bank balance as per cash book being higher than the balance as per pass book.
(iii) Bank charges not entered in the cash book:
The bank charges some amount from each customer by way of incidental charges, collection charges, etc.
94 FP-FA&A
and debits his account for this reason from time to time. As soon as these charges are made, the bank debits
the customers account in its own books and this reduces the bank balance. But the customer will know such
charges only when he receives a statement of account from the bank, until then, bank balance as per pass
book will be less than bank balance as per cash book.
(iv) Interest credited or debited by bank, not entered in the cash book:
When bank allows interest to a customer for deposits, it will credit customers account and his bank balance
as per pass book will increase. But the customer will not pass the entry in cash book simultaneously till he
knows the fact, thus the balances will differ. Likewise, interest on overdraft is debited to the customers
account and till the same is not entered in the cash book, it will result in a difference in the balances.
(v) Direct collections on behalf of customers:
A banker may receive amounts due to the customer by way of dividends, rent, interests etc. directly from the
persons concerned on account of standing instructions of the customer to such persons. Similarly, debtors
may also deposit the amounts directly to the bank. The bank credits the account of the customer for such
collections as soon as it gets such payments. But same will be entered in the cash book only when customer
receives the statement from the bank. Thus the balances differ.
(vi) Direct payment by bank:
Usually, the bank is given standing instructions for certain payments to be made, such as payment of
insurance premium, interest on loan, electricity bill etc. Bank, while making payments, debits pass book but
the customer has no information of the same till he is informed. It results in a difference in balances.
(vii) Dishonour of cheques/bills:
When cheque or bill of exchange discounted with the bank is dishonoured, the same is debited in the pass
book but not given effect in the cash book until the intimation is received. It will cause a difference in the two
balances.
(viii) Cheques received and entered in the cash book but omitted to be deposited into the bank.
When cheque is received, the same is entered in the cash book but it may not be deposited into the bank
immediately. This will cause a difference in the two balances.
(ix) Errors:
There may be errors in the accounts maintained by the customer or/ and by the bank. A wrong debit or credit
given by the customer or the bank leads to a difference in the balances.
SIGNIFICANCE OF BANK RECONCILIATION STATEMENT
(i) It highlights the causes of difference between the bank balance as per cash book and the balance as
per pass book. Necessary adjustments can, therefore, be carried out at an early date.
(ii) It reduces the chance of fraud by the staff dealing with cash and cash bring.
(iii) It acts as a moral check on the staff of the organization to keep the cash records always up to date.
(iv) Bank balance as per cash book cannot be accepted as final unless it is supported by statement of
passbook. When these two balances do not tally, reconciliation becomes essential to determine the
correct bank balance that can be used while finalizing the accounts.
(v) It helps in finding out actual position of the bank balance.
SUMMARY
Transactions Starting with the Bank Balance Starting with the Bank
as per Pass Book Balance as per Cash Book
Cheques issued but not Deduct : The amount of Add : The amount of
presented unpresented cheques. unpresented cheques.
Cheques deposited but not yet Add : The amount of cheques Deduct : The amount of
collected deposited cheques deposited
Cheques received and Add : The amount of cheques. Deduct : The amount of
entered in the bank column of cheques.
the cash book but not
deposited
Collection of interest and Deduct : The amount of these Add : The amount of these
dividends and interest allowed items items.
by the banker not yet recorded
in the cash book.
Bank charges Add : The amount of bank Deduct : The amount of bank
charges charges.
Balance Bank Balance as per Cash Book Bank Balance as per Pass
Book
Particulars ` `
Overdraft as per Cash Book XXX
Add :
Cheques deposited into bank but not yet collected XXX
Bank charges XXX
Insurance premium paid by the bank XXX
Interest on overdraft charged by the bank XXX
Dishonoured cheques / bills XXX
Drawings made but not entered in cash book XXX
Cheques received and entered in the cash book but not deposited XXX
Any wrong debit in the pass book XXX XXX
Less :
Cheques issued but not yet presented for payment XXX
Interest allowed by the bank XXX
Direct payment by customers into bank XXX
Interest on investment received by the bank XXX
Dividend on shares collected by the bank XXX
Rebate on bills retired under rebate through the bank but full amount entered XXX
in the cash book
Any wrong credit in the pass book XXX (XXX)
Overdraft as per Pass Book XXX
Note: If the reconciliation statement has been started with overdraft as per the pass book to arrive at overdraft
as per the cash book the entries made above should be reversed i.e. all added items should be deducted and
all deducted items should be added.
SUMMARY
PREPARATION OF BANK RECONCILIATION STATEMENT
Transactions Starting with the Overdraft as Starting with the Overdraft
per Cash Book as per Pass Book
Cheques issued but not Deduct: The amount of Add: The amount of
presented unpresented cheques. unpresented cheques.
Cheques deposited but not yet Add: The amount of cheques Deduct: The amount of
collected deposited cheques deposited
Cheques received entered in Add: The amount of cheques. Deduct: The amount of
the bank column of the cash cheques.
book but not deposited
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Balance/ Overdraft Bank Overdraft as per Cash Bank Overdraft as per Pass
Book Book
Alternative Method is to keep two columns Plus and Minus. All additions are to be shown in plus column
while all deductions in the minus column. Balance is to be shown in plus column while overdraft is shown in
minus column.
ILLUSTRATIONS
Illustration 1:
On 31st March, 2013 the pass book of Mitra showed a credit balance of ` 2,16,000. A comparison of pass
book and cash book revealed the following:
`
(i) Cheques deposited but not cleared by 31st March 1,08,150
(ii) Cheques issued by Mitra but not presented for payment before 1st April, 2013 26,000
(iii) Insurance premium paid by bank on behalf of Mitra but not yet recorded in cash book 52,075
(iv) Commission charged by bank not yet recorded in cash book 750
(v) Interest on bonds collected by bank on behalf of Mitra not yet recorded in cash book 25,000
Lesson 5 Bank Reconciliation Statement 99
Bank balance as per cash book as on 31st March, 2013 is ` 3,25,975. Prepare a Bank Reconciliation
Statement as on 31st March, 2013.
Solution:
Bank Reconciliation Statement of Mitra
as on 31st March, 2013
Particulars ` `
Balance as per Pass Book 2,16,000
Add :
Cheques deposited with bank but not yet collected 1,08,150
Commission charged 52,075
Insurance premium paid by the bank 750 1,60,975
3,76,975
Less:
Cheques issued but not yet presented for payment 26,000
Interest on bonds received by the bank 25,000 _51,000
Balance as per Cash Book 3,25,975
Alternatively:
Bank Reconciliation Statement of Mitra
as on 31st March, 2013
Particulars ` `
Balance as per Cash Book 3,25,975
Add :
Cheques issued but not yet presented for payment 26,000
Interest on bonds received by the bank 25,000 51,000
3,76,975
Less:
Cheques deposited into bank but not yet collected 1,08,150
Commission charged 52,075
Insurance premium paid by the bank ____750 1,60,975
Balance as per Pass Book 2,16,000
Illustration 2:
The cash book of Shri Gupta showed an overdraft of ` 30,000 on 31.3.2013. The scrutiny of the entries in the
cash book and the pass book revealed that:
(a) On 22nd March, cheques totaling ` 6,000 were sent to bankers for collection, out of these, a cheque
for ` 1,000 was wrongly recorded on the credit side of the cash book and cheques amounting to ` 300
could not be collected by bank within the accounting year.
(b) A cheque for ` 4,000 was issued to a supplier on 28th March, 2013. The cheque was presented to
bank on 4th April, 2013.
(c) There were debits in the pass book for interest ` 2,000 on overdraft and bank charges ` 600 not
recorded in the cash book.
100 FP-FA&A
(d) The credit side of the bank column of the cash book was undercast by ` 100.
(e) A cheque for ` 1,000 was issued to a creditor on 27th March, but the same was not recorded in the
cash book. The cheque was, however, duly en-cashed before 31st March.
(f) As per standing instructions, the banker collected dividend of ` 500 on behalf of Gupta and credited
the same to his account within 31st March, 2013. The fact was, however, intimated to Gupta on 3rd
April, 2013.
You are required to prepare a bank reconciliation statement as on 31st March, 2013.
Solution:
Shri Gupta
Bank Reconciliation Statement as on 31.3.2013
Particulars ` `
Bank Overdraft as per Cash Book 30,000
Add :
Cheques deposited into bank but not yet collected 300
Bank charges not yet recorded in cash book 600
Interest on overdraft charged by the bank 2,000
Credit side of the bank column of the cash book undercast 100
Cheques issued to creditor not recorded in the cash book but duly
encashed by 31st March 1,000 4,000
34,000
Less:
Cheque wrongly recorded on the credit side of the cash book (` 1,000 x 2) 2,000
Cheques issued but not yet presented for payment 4,000
Dividend collected by the bank but not recorded in the cash book __500 _6,500
Overdraft as per Pass Book 27,500
Illustration 3:
From the following information, prepare Bank Reconciliation Statement as on 31st March, 2013:
Cash Book of Mr. S. Ray
Dr. (Bank Columns only) Cr.
Date Particulars Amount Date Particulars Amount
` `
2013 2013
Mar. 1 ToBalance b/fd 7,000 Mar. 5 By Drawings 5,000
5 Manohar Lal 4,000 8 Interest 150
10 Deepak Kumar 10,000 10 Cheque Book 100
17 Sher Singh 13,000 15 Salaries 3,500
25 Mohan Lal 4,000 17 Ajit Singh 4,000
31 Harish Kumar 1,900 21 Abdul & Co. 5,000
25 Karim & Sons 7,000
30 Harish & Co. 1,000
______ 31 Balance c/fd 14,150
39,900 39,900
Lesson 5 Bank Reconciliation Statement 101
Bank Pass Book
(Bank in Account with Mr. S. Ray)
Dr. Cr.
Date Particulars Amount Date Particulars Amount
` `
2013 2013
Mar. 1 To Balance b/fd 7,000 Mar. 5 By Drawings 5,000
8 Manohar Lal 4,000 8 Interest 150
15 Deepak Kumar 10,000 10 Cheque Book 100
24 Sher Singh 13,000 15 Salaries 3,500
28 Interest on 22 Ajit Singh 4,000
Investment 1,200 29 Abdul & Co. 5,000
30 Rent 300 31 Bank charges 32
31 Bhura Mal 800 31 Electricity charges 78
______ 31 Balance c/fd 18,440
36,300 36,300
Solution:
Illustration 4:
On 30th April, 2013 the cash book of Sircar showed a bank overdraft of ` 1,970. A comparison of entries in
the pass book with those in the cash book revealed the following:
Cheques deposited with the bank but not yet credited in the pass book ` 8,505.
Cheques issued by Sircar but not yet presented by payees to bank for payment ` 12,500.
Interest on fixed deposit credited by bank under standing instructions but not yet recorded in cash
book ` 650.
102 FP-FA&A
Prepare bank reconciliation statement as on 30th April, 2013 to ascertain the balance as per pass book.
Solution:
Mr. Sircar
Bank Reconciliation Statement as at 30th April, 2013
Particulars ` `
Overdraft as per cash book 1,970
Add :
Cheques deposited with the bank but not yet credited in pass book 8,505
10,475
Less :
Cheques issued but not yet presented to bank for payment 12,500
Interest on fixed deposit credited by bank under standing instructions ___650 13,150
Balance as per pass book 2,675
Illustration 5:
On 30th April, 2013 pass book of Ghosh showed a debit balance of ` 32,675. You are required to prepare
bank reconciliation statement taking into consideration the following information:
`
Cheques issued but not yet presented for payment 18,513
Total cheques deposited with bank for collection 1,38,000
But so far credited in the pass book 1,12,000
Interest collected by the bank but not recorded in cash book by Ghosh 1,200
Bank charges not yet entered in cash book 150
Solution:
Mr. Ghosh
Bank Reconciliation Statement as at April 30, 2013
Particulars ` `
Overdraft as per pass book 32,675
Add :
Cheques issued but not yet presented for payment 18,513
Interest collected by bank but not yet recorded in cash book by Ghosh 1,200 19,713
52,388
Less :
Cheques deposited with bank not yet credited in pass book 26,000
(`1,38,000 `1,12,000)
Bank charges not yet entered in cash book 150 26,150
Overdraft as per cash book 26,238
Lesson 5 Bank Reconciliation Statement 103
The bank reconciliation statement can also be prepared by having two amount columns, one for the amounts
that increase the positive balance (or reduce the overdraft) and one for those amounts that reduce positive
balance (or increase the overdraft). The first may be headed + and the second -, the opening balance is
first entered in the appropriate column and finally the two columns are balanced. The illustration given above
is solved below in the manner just stated:
Mr. Ghosh
Bank Reconciliation Statement as at April 30, 2013
Particulars (+) (-)
` `
Overdraft as per pass book 32,675
Cheques issued but not yet presented for payment 18,513
Interest collected by bank but not yet recorded in cash book 1,200
Cheques deposited with bank not yet credited in pass book 26,000
Bank charges not yet entered in cash book 150
Overdraft as per cash book 26,238
52,338 52,338
Illustration 6:
From the following information supplied by Shri Mehta, prepare his bank reconciliation statement as on 31st
March, 2013 after amending the cash book on that date:
`
1. Bank overdraft as per bank statement 1,65,000
3. Cheques deposited with the bank but not yet collected 1,05,000
4. Cheque recorded in the bank column of the cash book but not sent to the
bank for collection 20,000
7. A bill for ` 30,000 (discounted with the bank in February at ` 29,780) dishonored
on 31st March and noting charges paid by the bank 100
8. Premium on life policy of Mehta paid by the bank on standing advice 1,800
Cash Book
Dr. (Bank Column only) Cr.
Particular ` Particular `
31.3.2013 31.3.2013 `
To Balance b/fd 29,600 By Bank charges 200
(balancing figure) Customer 30,100
Customer 35,000 (discounted bill
(amount directly dishonoured and noting
collected by Bank) charges paid by bank)
Balance c/d 1,27,500 Drawings 1,800
(life insurance premium
paid by bank)
Error 1,60,000
(overdraft balance carried
_______ over as debit balance) _______
1,92,100 1,92,100
1.4.2013
By Balance b/d 1,27,500
Notes:
(a) Discounted value of the bill is immaterial here, because on dishonor, the bank has debited the pass
book with ` 30,100.
(b) Overdraft credit balance means overdraft as per Cash Book.
Bank Reconciliation Statement of Shri Mehta
as on 31st March, 2013
Particulars ` `
Overdraft as per bank statement 1,65,000
Add:
Cheques issued but not presented for payment 87,500
2,52,500
Less:
Cheques deposited with the bank but not collected 1,05,000
Cheques recorded in cash book but not sent to bank for collection 20,000 1,25,000
Overdraft as per cash book 1,27,500
Lesson 5 Bank Reconciliation Statement 105
Illustration 7:
On 31st March, 2013, the cash book of Ajay Ghosh showed a bank overdraft of ` 3,458. On examination of the
cash book and bank statement, the following discrepancies were noted:
(i) Cheques issued for `1,200 were entered in the cash book but were not presented at the bank till first
week of April, 2013.
(ii) Cheques amounting to ` 1,000 were entered in the cash book on 30th March, 2013 but were banked
on 2nd April, 2013.
(iii) Cheques amounting to ` 500 were deposited in the bank but were not collected till March 31st, 2011.
(iv) A cheque for ` 300 received from Mr. Dass Gupta and deposited in the bank was dishonored but
advice of non-payment was not received from the bank upto 31st March.
(v) ` 3,000 being the proceeds of a bill collected on 20th March did not appear in the cash book.
(vi) ` 300 being the proceeds of a bill collected on 20th March were omitted to be credited in the pass
book.
(vii) The pass book showed an amount of ` 340, being rent which his tenant Madan Gopal had directly
th
deposited on the bank on 30 March, 2013. The item did not appear in cash book.
(viii) A bill payable of ` 600 was duly paid off on 30th March according to the instructions of Ajay Ghosh but
st
this was not entered in cash book before 1 April, 2013.
(ix) Bank charges of ` 30 and interest an overdraft ` 170 appeared in the pass book but not in the cash
book.
Prepare a bank reconciliation statement and find out the balance as per pass book.
Solution:
Ajay Ghosh
Bank Reconciliation Statement as on 31st March, 2013
Particulars ` `
Overdraft as per cash book 3,458
Add : Items increasing overdraft in pass book:
Cheques entered in cash book but not banked 1,000
Cheques deposited but not collected 500
Cheques deposited but dishonoured 300
Bill collected but omitted to be entered in pass book 300
Pay off of bills payable not entered in cash book 600
Bank charges 30
Interest on overdraft 170 2,900
6,358
Less : Items reducing overdraft in pass book:
Cheques issued, not presented for payment 1,200
Bill collected, not entered in cash book 3,000
Direct deposit of rent into bank 340 4,540
Overdraft as per pass book 1,818
106 FP-FA&A
Illustration 8;
On 31st March 2013, the cash book of a trader showed a bank overdraft of ` 15,280. On a comparison of the
cash book with the bank pass book, the trader ascertained the following differences.
(` )
Cheques deposited with bank, but not credited by the bank 20,000
Interest on securities collected by the bank, but not yet
recorded in the cash book 2,560
Dividend collected by the bank, but not yet recorded in the cash book 2,000
Cheques issued, but not yet presented to the bank for payment 74,800
Bank charges not yet recorded in the cash book 680
Solution:
Bank Reconciliation Statement as on 31st March 2013
Particulars ` Particulars `
Illustration 9:
The following is a summary of the Cash Book of Shri Mohan Das, for the month of June 2012.
` `
Receipts 14,690 Balance b/d 7,610
Balance c/d 5,540 Payments 12,620
20,230 20,230
All receipts are banked and payments are made by cheque.
On investigation it is found that:
Bank charges of ` 1,360 entered in the bank statement had not been entered in the cash book.
Cheques drawn amounting to ` 2,670 had not been presented to the bank for payment.
Cheques received totaling ` 17,620 had been entered in the cash book and paid into the bank, but had
not been credited by the bank until July, 2012.
A cheques for ` 1,220 had been entered as a receipt in the cash book instead of as a payment.
A cheque for ` 1,250 had been debited by the bank in error.
A cheque received for ` 800 had been dishonored. No adjustments had been made in the cash book.
All dividends receivable are credited directly to the bank account. During June, amount totaling `
2,620 were credited by the bank and no entries were made in the cash book.
A cheque drawn for ` 600 in favour of a creditor had been incorrectly entered in the cash book as `
6,000.
The balance brought forward should have been ` 7,110
The bank statement as on 30th June, 2011, showed an overdraft ` 17,820.
You are required to:
Show the adjustments required in the cash book; and
Prepare a bank reconciliation statement as on 30th June, 2012.
Solution:
Shri Mohan Das
Cash Book
Dr. (Bank column only) Cr.
Particulars ` Particulars `
30.6.2012 30.6.2012
To Dividend 2,620 By Balance b/d 5,540
To Creditor - cheque drawn By Bank charges 1,360
for ` 600 wrongly By Error - cheque issued
entered as ` 6,000 5,400 wrongly entered as
To Error - wrong carry received ` 1,220 2,440
forward of balance on By Customer - cheque
1st June, 2011 500 returned 800
To Balance c/d 1,620 _____
10,140 10,140
108 FP-FA&A
Particulars ` `
Bank balance as per cash book (overdraft) 1,620
Add: Cheques deposited but not credited by the
bank until after 30th June, 2011 17,620
Cheque debited by the bank in error 1,250 18,870
20,490
Less: Cheque issued but not presented for payment 2,670
Bank overdraft as per bank statement 17,820
LESSON ROUND UP
GLOSSARY
Current Account Account in which money can be deposited as often as desired and can be
withdrawn without notice as often as necessary.
Savings Bank Account in which deposits can be made as often as required but there are
Account restrictions on the number as well as amount of withdrawals that can be made.
Fixed Deposit Account in which money is deposited only and cannot be withdrawn before the
expiry of that period for which fixed deposit is made.
Recurring Deposits Account in which money is deposited monthly & withdrawn only after the expiry of
Account fixed tenure.
Lesson 5 Bank Reconciliation Statement 109
SELF-TEST QUESTIONS
Theory Questions
1. What is a bank reconciliation statement?
2. What is the significance of preparing a bank reconciliation statement?
3. What are the types of personal accounts in bank?
4. Describe the reasons why bank balance as per cash book may not agree with the bank balance as per
pass book.
5. Briefly mention the steps of preparing bank reconciliation statement.
Practical Questions
1. On 31st March, 2012 the cash book of Gupta showed a debit bank balance of ` 4,800. Prepare a bank
reconciliation statement as at that date taking into account the following additional information:
Cheques deposited but not yet credited by bank ` 3,610.
Cheques issued but not yet presented by payees for payment in the bank ` 2,050.
Bank charges appearing in pass book but not yet recorded in cash book ` 40.
Collections made by the bank and appearing in pass book but not yet recorded in cash book ` 1,000.
[Balance as per Pass Book ` 4,200].
2. On 31st March, 2012 the cash book of a trader shows a bank overdraft of ` 1,800. A comparison of the
cash book with the pass book reveals the following facts:
Cheques issued but not presented for payment upto 31st March, 2012 ` 8,500.
Cheques deposited with the bank on 31st March, 2012 but credited by bank on 1st April, 2012
` 9,200.
Bank charges debited by bank, ` 230 and dividends collected by bank on behalf of the trader `
5,000 have not been recorded in the cash book.
A cheque of ` 1,400 received from X and deposited with the bank on 26th March, 2012 was
recorded as that of ` 400 in the cash book.
You are required to prepare a bank reconciliation statement after passing the necessary entries in the
cash book to bring its balance up-to-date. The firm closes the books on 31st March. How much will be
shown in the balance sheet as bank balance/overdraft?
(Balance as per Pass Book ` 3,270; Amended cash book balance ` 3,970.)
3. Following are the transactions recorded in the bank column of the Cash Book of Madhur for the month
ending 31 December, 2011 :
LESSON OUTLINE
LEARNING OBJECTIVES
INTRODUCTION
Meaning of Depreciation
A business enterprise acquires different types of fixed assets depending upon its requirements and financial
conditions. Fixed assets have a long life and are held for use in the business for production of goods and
services. Whenever an asset is used in business its value gets reduced and sooner or later the asset
becomes useless. Depreciation is a permanent, continuous and gradual shrinkage in the book value of a fixed
asset. It is the fall in the quality or value of a fixed asset through physical wear and tear due to use or passage
of time or from any other cause. Depreciation takes place irrespective of regular repairs and maintenance. As
the asset is used for business purpose, the annual loss in the value of the asset is like any other expenditure.
Hence, the cost of fixed assets has to be written off over its useful economic life as a loss.
Thus, depreciation is a process of allocating the cost of a fixed asset over its estimated useful life in a rational
and systematic manner.
Definition of Depreciation
The Institute of Charted Accountants of India has defined depreciation as a measure of the wearing out,
consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence
through technology and market changes. Depreciation is allocated so as to charge a fair proportion of
depreciable amount in each accounting period during the expected useful life of the asset. Depreciation
includes amortisation of assets whose useful life is predetermined.
Depreciation Accounting has been defined by the American Institute of Certified Public Accountants as a
system of accounting which aims to distribute the cost or other basic value of tangible capital assets less
salvage (if any) over the estimated useful life of the unit (which may be a group of assets) in a systematic and
rational manner. It is a process of allocation and not of valuation.
Characteristics of Depreciation
The following are the important characteristics of depreciation:
(i) Depreciation refers to a permanent, continuous and gradual decrease in the utility value of a fixed
asset and it continues till the end of the useful life of the asset.
(ii) Depreciation is a charge against profit (i.e. revenue earned) for a particular accounting period.
(iii) Depreciation is always computed in a systematic and rational manner since it is not a sudden loss.
(iv) Depreciation is a process of allocation of expired cost and not of valuation of fixed assets.
(v) Whatever method for calculating depreciation is followed, the exact amount of depreciation can never
be calculated, and it can only be estimated.
(vi) Depreciation is caused due to physical factors and functional factors.
(vii) The fundamental objectives of depreciation are - (a) to maintain the nominal capital invested in fixed
assets, and (b) to allocate the expired portion of the cost of fixed assets over a number of accounting
periods.
(viii) Depreciation is must, i.e. it always takes place whether the asset is carefully handled or neglected.
(ix) If the market value of a fixed asset is fluctuating, the same does not affect the amount of depreciation
so made on the respective assets.
(x) Depreciation is calculated in respect of fixed assets only, i.e. plant, machinery, furniture etc.
(xi) Total depreciation cannot exceed its depreciable value or original cost where the scrap value is nil.
Causes of Depreciation
(i) Physical Wear and Tear Resulting from Use: Tangible fixed assets like, machinery, buildings, furniture
Lesson 6 Depreciation Accounting 115
etc. get worn out or torn out on account of friction, strain, weathering, intensity of use, chemical
reaction, handling etc. This is the most important cause of charging depreciation in respect of such
assets which are in constant use.
(ii) Physical Deterioration Resulting from Atmospheric Exposure: Number of assets deteriorates for being
continually exposed nature.
(iii) Passage of Time: A machine also becomes potentially useless by the passage of time. It is so even if
the machine is kept continuously idle.
(iv) Depletion: Wasting assets such as mines and quarries lose their value because they get exhausted on
account of continuous extractions.
(v) Obsolescence: Sometimes an asset becomes useless because of technical changes within the
industry, technical progress in other industries, changes in tastes and habits of consumers, changes in
supply and locations of natural resources etc.
are held by the organization for use in the production or supply of goods and services.
When a fixed asset is purchased, it is recorded in the books of accounts at its original cost. But, the fixed
asset is used to earn revenues for a number of accounting periods in future with the same acquisition cost
until the concerned fixed asset is sold or discarded. It is therefore, necessary that a part of the acquisition cost
of the fixed asset is treated or allocated as an expense in each of the accounting periods in which the asset is
used. This allocation of cost in the form of an expense is known as depreciation in accounting.
Suppose, a business purchases a machinery for ` 10,00,000 and after using it for five years, it is sold for `
2,00,000. The cost of the machinery used in the business is ` 8,00,000 (`10,00,000 `2,00,000). This cost
must be allocated as an expense of the business at the rate of `1,60,000 (8,00,000 5 ) for each of five
accounting periods in which the machinery has been used to earn revenues. This ` 1,60,000 charge as
expense is called accounting concept of depreciation.
It is the cost for the services obtained from the use of the asset in the same manner as the cost of wages,
rent, etc. Depreciation is the expense charged to profit and loss account before arriving at the net profit for the
year. In other words, the cost of fixed asset in the form of depreciation has to be matched against the
revenues of the years over which the asset is used.
Thus, in accounting, depreciation means apportionment or allocation of the cost of the fixed asset over its
useful life. Its aim is to spread over and allocate or distribute the cost of the fixed asset to the years of its use
and charge the depreciable cost to profit and loss account before arriving at the profits of each of the
accounting periods in which the fixed asset utilized.
Purpose of Depreciation Accounting: The primary purpose of depreciation accounting is cost allocation.
Provision for depreciation in the profit and loss account does not involve the outflow of cash and hence funds
to the extent of depreciation charged over the years will remain in the business and these funds can be easily
used for replacement of asset.
SUMMARY
Depreciation accounting is the process of allocating the cost of the tangible fixed asset less its salvage
value over its serviceable life.
Depreciation is an expense that is to be charged against the revenue whether the business makes
profit or incurs loss;
Depreciation provides funds for replacing the asset when its useful life ends. Depreciation is not a
process of valuation but it is an allocation. Even if the market value of an asset increases, depreciation
has to be recorded because of allocation process.
JOURNAL ENTRIES
REVIEW QUESTIONS
ANNUITY METHOD
Illustration 1:
A firm acquired a machinery on 1st July 2010 at a cost of ` 45,000 and spent ` 5,000 for its installation. The
firm writes off depreciation at 10% per annum on the original cost every year. The books are closed on 31st
March every year. Show Machinery Account and Depreciation Account for three years.
Solution:
Dr. Machinery Account Cr.
Date Particulars ` Date Particulars `
2010 2011
Jul 1 To Bank 45,000 Mar.31 By Depreciation
Jul 1 To Bank (Installation (10% on `50,000 for 9
Expenses) 5,000 months) 3,750
_______ Mar.31 By Balance c/d 46,250
50,000 50,000
2011 2012
April 1 To Balance b/d 46,250 Mar. 31 By Depreciation
(10% on `50,000) 5,000
_______ Mar. 31 By Balance c/d 41,250
46,250 46,250
2012 2013
April 1 To Balance b/d 41,250 Mar. 31 By Depreciation
(10% on `50,000) 5,000
_______ Mar. 31 By Balance c/d 36,250
41,250 41,250
2013
April 1 To Balance b/d 36,250
Dr. Depreciation Account Cr.
ADVANTAGES DISADVANTAGES
A separate sum is provided for replacing the There is a fixed charge for depreciation. The
asset. charge for repairs increases every year. Hence,
the profit and loss account is unduly burdened in
later years.
Illustration 2:
A company purchased 3 years, lease on 1st April, 2010 for ` 50,000. It is decided to provide for the
replacement of the lease at the end of 3 years by setting-up a depreciation fund. It is expected that
investment will fetch at 12% p.a. Sinking fund tables shows that ` 0.296349 invested each year will produce
`1 at the end of 3 years at 12% per annum. The investments are sold for ` 28,500.
Give Lease Account, Depreciation Fund Account and Depreciation Fund Investments Account.
Solution:
Annual Depreciation = ` 50,000 x 0.296349 = ` 14,817.45
Dr. Lease Account Cr.
Illustration 3:
On 1st April 2009, Glory Ltd., purchased a machine for ` 1,10,000 and spent ` 6,000 on its installation. The
expected life of the machine is 4 years at the end of which the estimated scrap value will be ` 16,000.
Desiring to replace the machine on the expiry of its life, the company establishes a sinking fund. Investments
are expected to realize at 12% interest.
On 31st March, 2013, the machine was sold off as scrap for ` 18,000 and the investments were realised at
5% less than the book value. On 1st April, 2013, a new machine was installed at a cost of ` 1,25,000, Sinking
fund tables show that Re. 0.2092 invested each year will produce Re. 1 at the end of 4 years at 12%. Show
the necessary ledger accounts in the books of Glory Ltd. for all the years.
Lesson 6 Depreciation Accounting 123
Solution:
Working Notes:
(i) Interest is an integral part of sinking fund (i) Interest is not considered under insurance
method policy method
(ii) Investment in securities is the basic feature (ii) The money is not invested in any outside
of sinking fund method securities under insurance policy method.
Only an insurance policy is taken for the
required amount to replace the asset at the
end of the useful life of the asset.
(iii) Under sinking fund method, investments are (iii) Premium is paid in advance at the beginning
made at the end of the accounting period. of the year under insurance policy method.
(iv) Under sinking fund method, the amount (iv) But, under insurance policy method, the
realised is affected by fluctuations in interest amount realised at the end of the life of the
rate and value of securities. asset is fixed.
REVIEW QUESTIONS
Illustration 4:
A firm purchases a lease for 3 for years for ` 60,000 on 1.4.2010. It decides to provide for its replacement by
means of an insurance policy for ` 60,000. The annual premium is ` 19,000. On 1.4.2013, the lease is
renewed for a further period of 3 years for ` 60,000. You are required to show necessary ledger accounts.
Books are closed on 31st March every year.
126 FP-FA&A
Solution:
Dr. Lease Account Cr.
Date Particulars ` Date Particulars `
2010 2011
Apr. 1 To Bank 60,000 Mar.31 By Balance c/d 60,000
2011 2012
Apr. 1 To Balance b/d 60,000 Mar.31 By Balance c/d 60,000
2012 2013
Apr. 1 To Balance b/d 60,000 Mar.31 By Depreciation Reserve A/c 60,000
Dr. Depreciation Insurance Policy Account Cr.
Date Particulars ` Date Particulars `
2010 2011
Apr. 1 To Bank (premium) 19,000 Mar.31 By Balance c/d 19,000
2011 2012
Apr. 1 To Balance b/d 19,000 Mar.31 By Balance c/d 38,000
To Bank 19,000
38,000 38,000
2012 2013
Apr. 1 To Balance b/d 38,000 Mar.31 By Bank 60,000
To Bank 19,000
To Depreciation 3,000
Reserve A/c (profit
transferred) ______ ______
60,000 60,000
Dr. Depreciation Reserve Account Cr.
Date Particulars ` Date Particulars `
2011 2011
Mar.31 To Balance c/d 19,000 Mar.31 By Profit & Loss A/c 19,000
2012 2011
Mar.31 To Balance c/d 38,000 Apr. 1 By Balance b/d 19,000
2012
______ Mar.31 By Profit & Loss A/c 19,000
38,000 38,000
2013 2012
Mar.31 To Lease A/c 60,000 Apr. 1 By Balance b/d 38,000
2013
Mar.31 By Profit & Loss A/c 19,000
By Depreciation Insurance
______ Policy A/c` 3,000
60,000 60,000
4. Annuity Method
The annuity method considers that the business besides losing the original cost of the asset also loses
interest on the amount used for buying the asset, which would have been earned in case the same amount
would have been invested in some other form of investment. Thus, this method takes into account the interest
factor. The amount of interest is calculated on the book value of the asset in the beginning of each year. The
amount of depreciation is uniform and is determined on the basis of annuity table.
Lesson 6 Depreciation Accounting 127
Journal Entries
(i) On purchase of the asset:
Asset Account Dr.
To Bank
(ii) For charging interest on asset:
Asset Account Dr.
To Interest Account
(iii) For charging depreciation:
Depreciation Account Dr.
To Asset Account
(iv) For transfer of Interest Account to Profit and Loss Account:
Interest Account Dr.
To Profit and Loss Account
(v) For transfer of Depreciation Account to Profit and Loss Account:
Profit and Loss Account Dr.
To Depreciation Account
Illustration 5:
A firm purchased a lease-hold property on 1st April 2008 for 5 years at a cost of ` 5,00,000. It decided to write
off the lease by annuity method presuming the rate of interest at 14%. The annuity table shows that annual
amount necessary to write off ` 1 in 5 years at 14% is ` 0.291284. Show the lease account for 5 years.
Calculations to be made to the nearest rupee.
Solution:
Dr. Lease Account Cr.
Date Particulars ` Date Particulars `
2008 2009
April 1 To Bank 5,00,000 Mar.31 By Depreciation
2009 (`5,00,000 x 0.291284) 1,45,642
Mar.31 To Interest
(14% of 5,00,000) __70,000 Mar.31 By Balance c/d 4,24,358
5,70,000 5,70,000
2009 2010
April 1 To Balance b/d 4,24,358 Mar. 31 By Depreciation
2010 (`5,00,000 x 0.291284) 1,45,642
Mar.31 To Interest Mar. 31 By Balance c/d 3,38,126
(14% of 4,24,358) __59,410 ________
4,83,768 4,83,768
2010 2011
April 1 To Balance b/d 3,38,126 Mar. 31 By Depreciation
2011 (`5,00,000 x 0.291284) 1,45,642
Mar.31 To Interest Mar. 31 By Balance c/d 2,39,822
(14% of 3,38,126) 47,338 ________
3,85,464 3,85,464
128 FP-FA&A
Date Particulars ` Date Particulars `
2011 2012
April 1 To Balance b/d 2,39,822 Mar. 31 By Depreciation
2012 (`5,00,000 x 0.291284) 1,45,642
Mar.31 To Interest Mar. 31 By Balance c/d 1,27,755
(14% of 2,39,822) _33,575 ________
2,73,397 2,73,397
2012 2013
April 1 To Balance b/d 1,27,755 Mar. 31 By Depreciation
2013 (`5,00,000 x 0.291284) 1,45,642
Mar.31 To Interest _17,887 _______
1,45,642 1,45,642
Working Notes:
Amount of depreciation ` 5,00,000 x ` 0.291284 = ` 1,45,642
The amount of depreciation is fixed for all the years.
The amount of interest is reduced every year because it is calculated on the written down balance.
DISTINCTION BETWEEN SINKING FUND AND ANNUITY METHODS OF DEPRECIATION
(i) Under sinking fund method, the annual amount is set aside to a separate fund account. However, the
annual amount is not set aside to a separate fund account in annuity method.
(ii) Since annual amount set aside are invested in outside securities, sufficient funds will be available for
replacement of asset under sinking fund method. However, there is no provision of funds at the time of
replacement of assets in annuity method.
(iii) In sinking fund method, as the investment is made at the end of the first year, the first interest is
earned only during the second year. In annuity method, interest is assumed to accrue in the first year
of purchase of asset, therefore, it is charged from the end of the first year.
(iv) Under sinking fund method, the total depreciation is less than the assets depreciable cost due to
deduction of interest. However, in annuity method, as the interest is added to the cost of the asset, the
total depreciation is more than the depreciable cost of the asset.
(v) Under sinking fund method, interest is actually realised since it is to be received from investments
outside the business. In annuity method, interest is only assumed as against actual receipt.
(vi) Under sinking fund method, annual net effect on profit and loss account is same because of uniform
fixed amount of depreciation. However, in annuity method, annual net effect on profit and loss account
increases due to fixed depreciation charge and declining interest.
(vii) Under sinking fund method, interest realised is credited to sinking fund account, while interest is
credited to profit and loss account and debited to asset account in annuity method.
B. DECLINING CHARGE METHODS
The amount of depreciation charged decreases for each subsequent year of the assets life. This method can
be applied:
(a) When the asset becomes old and receipts decline or
(b) When it is necessary to charge depreciation according to the assets expected earnings.
The following three methods fall in this category.
1. Diminishing Balance Method (Reducing Balance Method)
Under this method, depreciation is calculated at a certain percentage each year on the balance of the asset
which is brought forward from the previous year. The amount of depreciation charged for each period is not
fixed but it goes on decreasing gradually as the opening balance of the asset in each year will reduce. Thus,
amount of depreciation becomes higher at in the earlier periods and becomes gradually lower in subsequent
periods, while repairs and maintenance charges increase gradually.
Lesson 6 Depreciation Accounting 129
Rate of Depreciation = 1 n
Where, n = life of the asset in years.
ADVANTAGES DISADVANTAGES
It is a simple and easy method. It is difficult to determine an appropriate rate of
depreciation.
Every year, there is an equal burden for using the The value of the asset cannot be brought down to
asset. This is because depreciation goes on zero.
decreasing every year whereas cost of repairs
increases.
The obsolescence problem is given due care Depreciation is neither based on the use of the
since major part of the depreciation is charged in asset nor distributed evenly throughout the useful
earlier years and the management may find it life of the asset.
easy to replace the asset.
Income tax authorities recognize this method.
(i) Depreciation is charged at a fixed rate on the (i) Depreciation is charged at a fixed rate on
original cost of the asset. the original cost in the first year and on the
written down value (cost-minus total
depreciation) in the subsequent years.
(ii) The amount of depreciation remains the same (ii) The amount of depreciation goes on
in all the years of useful life of the asset. decreasing year after year.
(iii) The total burden on the profit and loss (iii) The total burden on the profit and loss
account is more in the later years because the account is almost same in the early years as
repair charges increase while the amount of well as is the later years because of more
depreciation remains the same. depreciation plus repairs cost in the
beginning and less depreciation plus more
repairs cost in the later years.
(iv) The book value of the asset becomes zero or (iv) The book value never becomes zero.
equal to scrap value.
(v) It is easy to calculate the rate of depreciation. (v) It requires the use of mathematical tables.
(vi) It is suitable where repair charges are less (vi) It is suited where repair charges are more in
and obsolescence is not frequent. later years and also where there is
obsolescence.
130 FP-FA&A
Illustration 6:
A firm acquired machinery on 1st July 2010 at a cost of ` 45,000 and spent ` 5,000 for its installation. The
firm writes off depreciation at 10% per annum on diminishing balance method. The books are closed on 31st
March every year. Show Machinery Account and Depreciation Account for three years.
Solution:
Dr. Machinery Account Cr.
Date Particulars ` Date Particulars `
2010 2011
Jul 1 To Bank 45,000 Mar.31 By Depreciation
Jul 1 To Bank (Installation (10% on `50,000 for 9
Expenses) 5,000 months) 3,750
______ Mar.31 By Balance c/d 46,250
50,000 50,000
2011 2012
April 1 To Balance b/d 46,250 Mar. 31 By Depreciation
(10% on ` 46,250) 4,625
______ Mar. 31 By Balance c/d 41,625
46,250 46,250
2012 2013
April 1 To Balance b/d 41,625 Mar. 31 By Depreciation
(10% on ` 41,625) 4,163
______ Mar. 31 By Balance c/d 37,462
41,625 41,625
2013
April 1 To Balance b/d 37,462
Dr. Depreciation Account Cr.
Date Particulars ` Date Particulars `
2011 2011
Mar.31 To Machinery A/c 3,750 Mar.31 By Profit & Loss A/c 3,750
2012 2012
Mar.31 To Machinery A/c 4,625 Mar.31 By Profit & Loss A/c 4,625
2013 2013
Mar.31 To Machinery A/c 4,163 Mar.31 By Profit & Loss A/c 4,163
C. OTHER METHODS
1. Depletion Method
This method is applicable in case of wasting assets, e.g. mines, quarries, oil well etc. from which a certain
quantity of output is expected to be obtained.
Under this, depreciation is charged on the basis of output extracted in comparison with the estimated total
contents of mine.
Rate of Depreciation = Total cost of mine
Total units
Depreciation = Quantity extracted during the year X Rate of Depreciation
ADVANTAGES DISADVANTAGES
It relates depreciation with the use of the It is difficult to estimate the output correctly.
asset.
ADVANTAGES DISADVANTAGES
Depreciation is related to actual working time of This method can be used only when the life of the
the asset. asset can be measured in terms of hours.
Illustration 7:
M Ltd. which depreciates its machinery @ 10% per annum according to diminishing balance method, had on
1st April, 2012 ` 4,86,000 balance in its machinery account. During the year ended 31st March, 2013, the
machinery purchased on 1st April, 2010 for ` 60,000 was sold for ` 40,000 on 1st October, 2012 and a new
machinery costing ` 70,000 was purchased and installed on the same date; installation charges being `
5,000.
The company wants to change its method of depreciation from diminishing balance method to straight line
method w.e.f. 1st April, 2010 and adjust the difference before 31st March, 2013, the rate of depreciation
remaining the same as before.
Show the machinery account for the year ended 31st March, 2013.
Solution:
Dr. Machinery Account Cr.
100 100
Cost of machinery on 1st April, 2010 4,86, 000 6,00,000
90 90
Book value on 1st April, 2010 for machinery sold in 2012 60,000
Book value on 1st April, 2010 on original group 5,40,000
Depreciation for 2 years (2010-11 and 2011-12) @ 10% on ` 5,40,000 1,08,000
Less: Depreciation provided for 2 years under diminishing balance method 1,02,600
(` 54,000 + `48,600) ______
Additional depreciation due to change in the system charged to profit and loss account 5,400
______
(3) Depreciation for 2012-13
On machinery sold 2,430
On machinery purchased and installed 3,750
On machinery brought from previous year (i.e. on ` 5,40,000 on straight line method) 54,000
______
60,180
______
Profit or loss on sale of assets = Sale price of asset - Book value of the asset on the date of
sale
Book value of the asset on the date of sale = Original cost of the asset Total depreciation
on the asset till date of sale
134 FP-FA&A
The following journal entries are passed to record the above transactions when the depreciation is
directly credited to the asset account:
(i) On sale of assets:
Bank Dr.
To Assets Account (with the sale price)
(ii) For profit on sale of asset:
Asset Account Dr.
To Profit and Loss Account
(In case of loss the above entry is reversed.)
When Provision for Depreciation Account is maintained then the asset account appears at its cost
price and the following accounting procedure is followed:
(i) Transfer of accumulated depreciation including the depreciation created at the time of sale:
Provision for Depreciation Account Dr.
To Asset Account
(ii) On sale of the asset:
Bank Dr.
To Asset Account
(iii) If the amount of accumulated depreciation and sale price put together is less than the original cost of
the asset, the difference is loss on sale and transferred to profit and loss account:
Profit and Loss Account Dr.
To Asset Account
(iv) In case the accumulated depreciation and sale price put together is more than the original cost of the
asset, the difference is treated as profit on sale and is credited to profit and loss account:
Asset Account Dr.
To Profit and Loss Account
When Provision for Depreciation Account is maintained on sale of asset, alternatively, it is suggested
to open an `Asset Disposal Account in such case the following accounting entries may be passed:
(i) On transfer of original cost of asset to Asset Disposal Account:
Asset Disposal Account Dr.
To Asset Account
(ii) On sale of the asset:
Bank Dr.
To Asset Disposal Account
(iii) On transfer of Provision for Depreciation Account to Asset Disposal Account:
Provision for Depreciation Account Dr.
To Asset Disposal Account
(iv) For profit on disposal of asset:
Asset Disposal Account Dr.
To Profit and Loss Account
(In case of loss the above entry is reversed.)
Lesson 6 Depreciation Accounting 135
Illustration 8:
On 1st April, 2010, a firm purchased a machinery for ` 2,00,000. On 1st October in the same accounting year,
additional machinery costing ` 1,00,000 was purchased. On 1st October, 2011, the machinery purchased on
1st April, 2010, having become obsolete, was sold off for ` 90,000. On 1st October, 2010, new machinery
was purchased for ` 2, 50,000 while the machinery purchased on 1st October, 2010 was sold for ` 85,000 on
the same day.
The firm provides depreciation on its machinery @ 10% per annum on original cost on 31st March every year.
Show machinery account, provision for depreciation account and depreciation account for the period of three
accounting years ending 31st March, 2013.
Solution:
Dr. Machinery Account Cr.
LESSON ROUND UP
Depreciation is the process of allocation of cost of the asset to the period of its useful life. It is not the
process of valuation of asset.
Depreciation is used for recording the expired utility of a physical asset.
Causes of depreciation are: physical wear and tear; deterioration in value of asset; disuse; depletion;
obsolescence; accidents, etc.
Depreciation is provided to: ascertain the correct profit; present correct financial position; make
provision for replacement of asset; ascertain proper cost of the product; maintain uniform rate of
return; attain maximum tax benefit; to meet the legal requirements, etc.
The main factors in measurement of depreciation are: total cost of the asset; estimated useful life;
estimated residual value, etc.
The various methods of depreciation are: fixed installment method or straight line method; diminishing
balance method or written down value method and other methods.
In order to adjust depreciation for past periods due to change of method, depreciation is to be
calculated for the past period of asset used both by existing as well as by the changed method and the
difference is adjusted in the current years asset account by giving debit or credit to profit and loss
account.
GLOSSARY
Depreciation Depreciation is a process of allocating the cost of a fixed asset over its
estimated useful life in a rational and systematic manner.
Useful Economic Life Useful economic life of an asset is either the period over which a depreciable
asset is expected to be used by the organization or the number of production
or similar units expected to be obtained from the use of the asset by the
organization.
Depreciable Value It is the cost price of the asset less scrap value or salvage value of the
asset.
Salvage Value The estimated value of an asset at the end of its useful life.
SELF-TEST QUESTIONS
Theory Questions
1. Why is correct calculation of depreciation necessary?
2. What are the methods of providing depreciation?
3. Discuss the various factors which are considered for calculating depreciation.
4. What are the various causes of depreciation on fixed assets?
5. Distinguish between straight line and diminishing balance methods of depreciation.
6. What do you mean by replacement cost? What are the difficulties faced while providing for
depreciation on the basis of replacement cost? What steps may be taken to obviate these difficulties?
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7. Distinguish between sinking fund and annuity methods of depreciation.
8. Depreciation is a process of allocation and not of valuation. Comment.
Practical Questions
1. Deva Ltd. charges depreciation on its plant and machinery @10% per annum on the diminishing
balance method. On 31st March, 2013, the company decides to adopt straight line method of charging
depreciation with retrospective effect from 1st April, 2009, the rate of depreciation being 15%. On 1st
April, 2012, the plant and machinery account stood in the books at ` 2,91,600. On 1st July, 2012, a
sum of ` 65,000 was realised by selling a machine cost of which on 1st April, 2009 was ` 90,000. On
1st January, 2013, a new machine was acquired at a cost of ` 1,50,000. Show the plant and
machinery account in the books of the company for the year ended 31st March, 2013.
2. A firm acquired a machine for ` 5,00,000 on 1.4.2010. Depreciation was to be charged at 20% p.a. on
straight line method. During 2012-13, a modification was made to improve machines technical
reliability at a cost of ` 50,000 which it was considered would extend the useful to life of machine for 2
years. At the same time one important component of the machine was replaced at a cost of ` 10,000
because of excess wear and tear. Routine maintenance during the said accounting period cost `
7,500. Show the machine account, provision for depreciation on machine account and charge to profit
and loss account for the year ending 31st March, 2013.
3. Suman Enterprises purchased machinery on 1st April 2010 for `71,800 and paid `3,200 on its
installation. New machinery was acquired for `45,000 on October 1, 2010. On 1st April 2011, first
machinery was sold at `50,000 and on the same date fresh machinery was purchased for `45,000.
Depreciation is provided annually on 31st March at 10% p.a. on written down value method. On April
1, 2012 the firm changed the method of providing depreciation and decided to provide depreciation at
10% p.a on the original cost with retrospective effect. Prepare machinery account to ascertain the
value of machinery as on 31st March 2013.
4. Simmon Ltd., charges deprecation on its plant and machinery @ 10% per annum on the diminishing
balance method. On 31st March, 2013, the company decided to adopt straight line method of charging
depreciation with retrospective effect from 1st April, 2010, the rate of depreciation being 15% p.a.
5. On 1st April, 2012, the plant and machinery account stood in the books of account at `5,00,000. On
1st August, 2012 a sum of `1,00,000 was realised by selling a machine the cost of which on 1st April,
2010 was `1,50,000. On 1st January, 2013 a new machine was acquired at a cost of `3,00,000. Show
the plant and machinery account in the books of the company for the year ended 31st March, 2013.
Lesson 6 Depreciation Accounting 139
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Lesson 7
Preparation of Final Accounts for Sole
Proprietors
LESSON OUTLINE
LEARNING OBJECTIVES
Introduction A sole trader is the sole owner and manager of
Trading Account the business. At the end of a accounting year the
Profit & Loss Account sole trader would like to know the financial results
Main Principles for preparation of Trading and the financial position of his business. He
and Profit & Loss Account
would be interested to know the profits or losses
Difference between Trading and Profit &
made by the business. For this purpose, he would
Loss Account
prepare income statements i.e. trading and profit
Review Questions
Balance Sheet and loss accounts. He would also be interested
Differences between Trading and Profit & balance sheet. Trading accounts profit loss
Loss Account account and balance sheet together are called
Review Questions final accounts.
Differences between Trial Balance and
Balance Sheet After recording transactions of a business for an
Differences between Profit & Loss A/c & accounting period in subsidiary books, posting
Balance Sheet to the ledger and testing their accuracy with the
Adjustment Entries help of a trial balance, the last stage in the
Closing Entries accounting process is the preparation of final
Manufacturing Account accounts. In this lesson, we will learn in detail
Limitations of Financial Statements about the preparation of final accounts for a sole
Lesson Round Up proprietor.
Glossary
Self-Test Questions
You have to know accounting. Its the language of practical business life. It was a very useful thing to
deliver to civilization. Ive heard it came to civilization through Venice which of course was once the
great commercial power in the mediterrarean. However, double entry book keeping was a hell of an
invention.
Charlie Munger
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INTRODUCTION
Final Accounts or Financial Statements are the end products of the financial accounting process which
involves the preparation of a summary of the accounts with a view to determine:
(i) net profit from the trading activities in terms of profit made or loss incurred for a given period, and
(ii) its financial position in terms of assets and liabilities as on the last date of the given period.
For the purpose of determining the profit or loss, a statement known as Trading and Profit and Loss Account
(Income Statement) is prepared which incorporates all items of expenses and losses and all incomes and
gains occurring during the accounting period.
In order to show the financial position on the last date of the accounting period, another statement known as
Balance Sheet (Position Statement) is prepared which consists of all assets, liabilities and capital of the
business. These two statements are collectively known as Final Accounts.
Final Accounts are prepared from the balances appearing in the trial balance. Debit balances of assets are
transferred on the right hand side of the balance sheet while expenses and losses are debited to the Trading
Account or to the Profit and Loss Account, depending upon the nature of expenditure or loss. Credit account
balances like capital, liabilities, provisions and reserves are entered on the left hand side of the balance sheet
while incomes and gains are credited to Trading Account or Profit and Loss Account.
TRADING ACCOUNT
Trading Account is the first part of income statement which
is prepared to ascertain the gross profit or gross loss for a Gross Profit = Net Sales Cost of the
given accounting period. Goods Sold.
Trading Account is prepared before the preparation of Gross Loss = Cost of the Goods Sold
profit & loss account. It shows the result of trading Sales
activities relating to purchases & sales of goods &
Net Sales = Total Sales Sales Returns
services. Trading account is prepared to calculate
(Return Inwards)
separately the profit from sale & purchase transactions
only. The profit or loss is termed as gross profit or gross Cost of goods sold = Opening stock of
loss as various other expenses of an organsiation like goods + net purchases - closing stock of
administrative, selling & distribution and maintenance goods at the end + all direct expenses
expenses etc. are not deducted. Only the direct expenses
which are incurred to bring goods into saleable condition Net Purchases = Total Purchases
like freight, insurance, carriage inwards, fuel, power, Purchases Returns (Returns Inwards)
royalties on production, consumption of stores etc. are
taken into account to calculate gross profit/loss.
In case debit side exceeds the credit side, the balance will be gross loss and that will be shown on the
credit side of Trading Account as By Gross Loss.
In trading account, closing stock is shown at cost price or net realisable market value whichever is
lower.
Lesson 7 Preparation of Final Accounts for Sole Proprietors 143
While taking stock for the purpose of preparation of trading account, stock in hand on the last day of
the accounting year should be adjusted for purchases recorded but goods not yet received, goods sold
but not yet delivered and goods that may be out of business premises because of consignment, goods
delivered on sale or return basis, etc.
Gross profit or gross loss revealed by Trading Account is transferred to Profit and Loss Account.
PROFIT AND LOSS ACCOUNT
Profit and Loss Account is prepared to calculate the net profit or loss of
the business for a given accounting period. The balance of Trading Net profit = Total Revenues
Account i.e. gross profit/gross loss is transferred to the Profit and Loss Total Expenses
Account which is the starting point of the preparation of this account. Net Loss = Total Expenses
Thereafter, all those expenses and losses which have not been debited Total Revenues
already to the Trading Account are debited to the Profit and Loss
Account. Other incomes and gains, if any, are credited to this account, e.g. interest earned or commission
received etc. The net profit, thus arrived at is transferred to Capital Account of the proprietor/partners.
Specimen of Profit & Loss Account is given on next page. Net profit increases the capital whereas net loss
decreases the capital.
MAIN PRINCIPLES FOR PREPARATION OF TRADING AND PROFIT & LOSS ACCOUNT
The following principles must be kept in mind while preparing Trading and Profit & Loss Account:
Only revenue receipts i.e. sale proceeds and other incomes should be entered.
Only revenue expenses together with losses should be taken into account.
Profit or loss is determined by matching revenues and expenses according to the matching principle.
Application of Concept of Matching Principle
A fundamental principle which must be observed while preparing final accounts is that of `matching cost
and revenue. It means that in final accounts, expenses and incomes for the full trading period whether
they have been paid or received or not, must be included and no expenditure or income which does not
pertain to the period for which final accounts are being prepared be included. The distinction between
capital and revenue items is also made on the basis of this principle.
DIFFERENCE BETWEEN TRADING AND ACCOUNT PROFIT & LOSS ACCOUNT
REVIEW QUESTIONS
Fill in the blanks:
(i) Trading account reveals __________ profit or _________ loss.
(ii) Profit and loss account reveals _________ profit or _________ loss.
(iii) Expenses appear on _________ side of trading and profit and loss
account.
(iv) Provision for bad debts account shows _________ balance.
(v) Reserve for discount on creditors account shows ________ balance.
(vi) Carriage inwards appears in ____________ account, whereas
carriage outwards appears in ___________ account.
Decide whether the following statements are true or false:
(i) Trade expenses account is transferred to trading account.
Lesson 7 Preparation of Final Accounts for Sole Proprietors 145
(ii) Capital account appears on assets side of balance sheet.
(iii) Drawings account is revenue expenditure to be shown on debit side of profit and loss account.
(iv) If trading account reveals gross loss, profit and loss account results in net profit in any case.
(v) Interest on capital and salary to proprietor are incomes and hence are shown on credit side of profit
and loss account.
Tick the correct answers:
(i) What type of account is goodwill? Fictitious/Intangible
(ii) What type of account is furniture? Fixed/Current
(iii) On which side of balance sheet is unexpired insurance shown? Assets/Liabilities
(iv) Which type of items appear in profit and loss account? Revenue/Capital/Both
(v) Is balance sheet an account or a statement? An Account/A Statement
(vi) Where will amount spent on stationery appear? In Profit and Loss Account/
In Balance Sheet.
BALANCE SHEET
Balance sheet is a statement which shows the financial position i.e. the balances of assets, liabilities and
capital, of a business entity at a given date. It is prepared from the real accounts and personal accounts of
trial balance. A debit balance in a real account or personal account represents an asset of the concern/firm.
Likewise a credit balance in a personal account represents a liability. There can be some newly opened
accounts as well on account of adjustment entries. The assets and liabilities are arranged in a proper way and
the resultant statement is the balance sheet. On the right hand side, assets are arranged while on the left
hand side, liabilities are recorded. The totals of the two sides of the balance sheet must agree because of the
equation, viz. Assets = Liabilities + Capital.
If there is a difference, it means that there is some mistake. The difference, if it does occur, should be placed
on the deficit side as Suspense Account to make the two sides agree apparently.
Features of Balance Sheet
The primary objective of the preparation of balance sheet is to ascertain the financial position of a
concern.
It shows (a) the nature and value of assets, (b) the nature and value of liabilities and (c) the position of
capital.
Balance sheet is always prepared on a certain date, never for a particular period.
Balance sheet, unlike a trading and profit and loss account, is not an account. It is a statement
containing information regarding assets, liabilities and capital.
Marshalling of Balance Sheet
The arrangement of assets and liabilities in accordance with a particular order is known as marshalling of
balance sheet. The items in the balance sheet are generally marshalled in two ways-
(i) Liquidity order or according to time: In liquidity order, the assets are stated in the order in which they
can be easily converted into cash and the liabilities in the order in which they have to be paid off.
(ii) Permanence order or according to purpose: In permanence order, assets which are to be used
permanently in the business and are not meant for sale are shown first and the assets that are liquid are
shown last in order. Similarly, liabilities may also be shown according to the permanence arrangement.
Specimen of Balance Sheet in permanence order is given below. The order will be reversed in liquidity
order.
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SPECIMEN OF BALANCE SHEET
CLASSIFICATION OF ASSETS
(i) Fixed Assets are those which are acquired for long use in the business itself and not for resale. For
example, plant and machinery, land and buildings, furniture and fixtures, patents and trade marks are
examples of fixed assets.
(ii) Current or Floating Assets are those that are meant to be converted into cash as soon as possible.
Stock of goods, amount due from customers to whom goods have been sold on credit and balance at
bank are examples of current (or floating) assets.
(iii) Liquid Assets are those current assets which are already in the form of cash or which can be readily
converted into cash, such as Government Securities.
(iv) Wasting Assets are those fixed assets which have a fixed content, like coal in a coal mine; the value of
the asset goes down as the contents are taken out. When the minerals have been taken out totally, the
mine will become useless.
(v) Intangible Assets are those fixed assets which cannot be seen or touched or felt. Goodwill (the value
of ones name) is an intangible asset because there is no physical form to show it. Intangible assets
are not necessarily useless.
(vi) Fictitious Assets are valueless assets but shown as assets in the financial statements (such as
useless trade marks) or expenses treated as assets (such as expenses incurred to establish a
company i.e. preliminary expenses).
CLASSIFICATION OF LIABILITIES
(i) Fixed and Long-term Liabilities: Fixed liabilities are those liabilities which are payable on the
termination of the business such as capital of the proprietor, whereas long-term liabilities are those
which will be redeemed after a long period of time e.g. long-term loans.
Lesson 7 Preparation of Final Accounts for Sole Proprietors 147
(ii) Current liabilities: These are liabilities which have to be redeemed in the near future, usually within a
year. Trade creditors, bank overdraft, bills payable etc. are examples of current liabilities.
(iii) Contingent liabilities: These are not actual liabilities but their becoming actual liability depends on the
happening of certain events. If such events do not occur, no liability is incurred. Liability in respect of
pending suit is a contingent liability because it is only if and when suit is lost that the liability will be
incurred. Bills discounted with a bank are also a contingent liability because if the acceptor fails to
meet the bill on due date, the firm will become liable to the bank. Such liabilities are not shown in
balance sheet; usually a foot note is appended at the balance sheet for such liabilities.
REVIEW QUESTIONS
1. The following are the names of assets. Classify them: Leasehold
premises, Accounting machines, Coal mine, Goodwill, Stock of raw
materials, Motor vehicles, Cash in hand, Government securities, Copyright
of book (no longer in demand),Amount due from customers, Loose tools
and Cost of floating a company.
2. Classify the following assets into fixed, current and fictitious assets,
mentioning sub-types, also in the case of fixed assets: Land and buildings,
Furniture, Bills receivable, Cash in hand, Cash at bank, Plant and
machinery, Coal mine, Loose tools, Preliminary expenses, Stock in trade,
Amount due from customers, Copyright of a book no longer in demand,
Stone quarries, Livestock, Motor vehicles, Government bonds and
Goodwill of a firm incurring heavy losses.
2. It is prepared to test the arithmetical accuracy of 2. It is prepared to ascertain the financial position of
books of account. the organization on a particular date.
3. Balances of all types of accounts i.e. personal, 3. Balances of real and personal accounts only are
real, and nominal accounts are shown. shown.
4. It is usually prepared at the end of each month, 4. It is usually prepared at the end of the year after
three months, six months or at the end of the preparation of trading and profit and loss
accounting year before the preparation of trading account.
and profit and loss account.
5. Closing stock does not appear in the trial 5. Closing stock is shown on the assets side of the
balance. balance sheet.
6. It is prepared for internal use. 6. It is prepared for external use, i.e. for outside
parties such as, creditors, shareholders (in case
of companies), government authorities, etc.
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DIFFERENCE BETWEEN PROFIT & LOSS ACCOUNT AND BALANCE SHEET
3. Profit and loss account is prepared for the 3. Balance sheet is prepared as at the last day of
accounting period the accounting period.
4. The accounts that are transferred to the profit 4. The accounts which are shown in the balance
and loss account are closed and cease to exist. sheet do not lose their identity and become
the opening balances in the next accounting
period
ADJUSTMENT ENTRIES
Usually, final accounts are prepared from the balances given in the trial balance. However, at times some
account balances in the trial balance do not reflect the correct amount when considered in relation to
accounting period. For example, payment on account of expense, say, rent, may be less or more than the
actual payment that ought to have been made during the accounting period. Similar situation may arise in
respect of some revenue items also, say interest on investments.
In order to ensure that the final accounts disclose the true trading results and correct balances, it is necessary
that all expenses incurred whether paid or not and the whole amount of loss sustained whether ascertained or
estimated should be taken into consideration. Similarly, incomes and gains whether actually received or not
during the accounting period should be accounted for. All this requires adjustment entries which are used to
establish correct values of account balances at the end of an accounting period. Thus, adjustment entries are
those entries which are passed at the end of each accounting period for the purpose of adjusting various
nominal and other accounts so that true net profit or loss is indicated in profit and loss account and the
balance sheet represents a true and fair view of the financial condition of an enterprise.
The following are the usual adjustment entries which are made while preparing the final accounts.
(I) CLOSING STOCK
The unsold stock at the end of the accounting period is termed as closing stock. There can be two entries for
closing stock.
When this entry is passed the closing stock at the end appears in
(a) Closing Stock Account Dr.
trading account and on the assets side of balance sheet. It becomes
To Trading Account the opening stock for the next year.
(b) Stock Account Dr. In this case, closing stock will appear in the trial balance, it means that
To Purchases Account double entry has been completed in the accounting period itself by
reducing the purchases. Therefore it will appear as an asset in the
balance sheet only.
(II) ACCRUED OR OUTSTANDING EXPENSES
Expenses which have been incurred during the year and whose benefit has been derived during the year but
payment in respect of which has not been made are called outstanding or accrued expenses. At the end of
the year, all such expenses must be brought into books, otherwise, the profit will be overstated and liability
will be understated. The following journal entry is passed:
The amount of prepaid expenses is shown in the profit and loss account by way of deduction from the
concerned expenses.
These are also shown as assets in the balance sheet.
In the beginning of the next year, a reverse entry will be passed to cancel the effect of adjusting entry.
EXAMPLE 2:
Fire insurance premium of ` 2,000, paid for the year ending 30th June 2013. On 31st March, 2013
insurance policy has run only for 9 months and hence only 3/4th of the premium can be said to
pertain to 2012-13: 1/4th of the premium amount, i.e. ` 500 will be treated as an asset. Entry will be:
` `
Unexpired Insurance Premium Dr. 500
To Insurance Premium Account 500
Unexpired insurance premium will appear as an asset in the balance sheet and insurance premium
account will be reduced by ` 500.
(IV) ACCRUED OR OUTSTANDING INCOME
Accrued income means income which has been earned by the business during the accounting year but which
has not become due and hence has not been received. But outstanding income means any income which has
become due during the accounting year but has not been so far received by the firm. Though there is a
distinction between the two, for adjustment entry no such distinction is necessary, both the accrued income
and outstanding income are added to the given income figure in the trial balance. The following entry is
passed:
This item is shown on the credit side of the profit and loss account by way of deduction from the
income.
It is also shown in the balance sheet on the liabilities side as Income received in advance.
EXAMPLE 4: Rent for April, 2013 ` 8,000 received in advance
` `
Rent Received Account Dr. 8,000
To Rent Received in Advance Account 8,000
The balance of rent received account appearing on the credit side of profit and loss account will
diminish by ` 8,000 and rent received in advance account will appear on liabilities side of balance
sheet because service for this rent is to be rendered in the year to come.
(VI) DEPRECIATION
Depreciation is the reduction in the value of fixed assets due to a use, wear and tear or obsolescence. When
an asset is used for earning purpose, it is necessary that reduction due to its use must be charged to the
profit for the year in order to show correct value in the balance sheet. The following journal entry is passed for
charging depreciation:
The provision for bad debts is charged to profit and loss account.
It is also deducted from debtors in the balance sheet.
Provision for bad debts created out of profit of the current year should be carried forward to the next
period. Bad debts occurring during that period would be debited to bad debts account as usual, but
total debits given to this account should be transferred to provision for bad debts account. At the end
of the next year suitable adjustment entry is passed for keeping the provision for bad debts at an
appropriate amount to be carried forward.
Sometimes the balance brought down from the previous year is so large that even after debiting the
current years bad debts and leaving the desired balance at the end of the year, a surplus is left. This
surplus is transferred to the credit side of profit and loss account.
EXAMPLE 6: If debts of 2011-12, prove to be bad in 2012-13 the loss is to be treated as one
for 2011-12. But on 31st March, 2012 when final accounts are be prepared, it will not be
possible to know accurately, which debts will prove bad in 2012-13. Hence, only an estimate
is made on the basis of past experience. If it is estimated that 6% of the debts may prove bad
and on 31st March, 2012 debtors amount to ` 40,000, then `2,400 will be provided for future
bad debts. The entry is:
` `
Profit and Loss Account Dr. 2,400
To Provision for Bad Debts Account 2,400
It will reduce the profit for 2011-12 by `2,400. Provision for bad debts will appear in the
balance sheet as a deduction from sundry debtors on assets side although it is a separate
account showing credit balance.
In the next year, the actual amount of bad debts will be debited to provision for bad debts
account which will then stand reduced. On 31st March, 2013 the amount of the provision will
be brought up by an appropriate debit to profit and loss account depending on the amount of
sundry debtors as at that date.
(IX) PROVISION FOR DISCOUNT ON DEBTORS
This is a charge made against profits in order to provide for an expected loss in the form of discounts which
are likely to be allowed to the debtors, for encouraging them to make prompt payments. In order to
incorporate such provision for discount on debtors, the following journal entry is passed:
This provision is shown on the debit side of the profit and loss account.
It is also shown in the balance sheet by way of deduction from sundry debtors.
Note: Provision for discount is always calculated on the amount of debtors left after deducting the provision
for bad debts i.e. provision should be calculated on good debts. It is because no discount will be allowed on
amounts which are not recovered and hence no provision for discount on such amounts is required.
Lesson 7 Preparation of Final Accounts for Sole Proprietors 153
For example, if 2% discount is allowed, debtors are of ` 10,000 and 5% provision for bad debts is required
then provision for discount will be made @2% on ` 9,500, i.e., on ` 10,000 less 5% for provision for bad debts
amounting to ` 500.
(X) RESERVE FOR DISCOUNT ON CREDITORS
A firm may like to create reserve for discount on its creditors to record discounts expected to be received from
them. The adjustment entry for this purpose is as follows:
The reserve for discount on creditors account is credited to the profit and loss account.
It should also be deducted from the sundry creditors in the balance sheet. Keeping with the principle of
conservatism, the provision for discount on creditors is often not made in actual practice.
(XI) INTEREST ON CAPITAL
It is a normal practice to charge business with interest on the capital employed in the business. The purpose
is to know whether the profits of the business are more than what could be earned from simple investments
outside business. Interest charged is an expense to the business but it is a gain to proprietor. The following
adjustment entries are passed:
(i) Interest on Capital Account Dr.
To Capital Account
(ii) Profit and Loss Account Dr.
To Interest on Capital Account
Interest on capital is debited to the profit and loss account and
It is shown on the liabilities side of the balance sheet by way of addition to the capital.
(XII) INTEREST ON DRAWINGS
As business allows interest on capital, it also charges interest on drawings made by the proprietor. This is a
gain to the business and an expense for the proprietor. The following adjustment entries are made:
(i) Capital Account Dr.
To Interest on Drawings Account
(ii) Interest on Drawings Account Dr.
To Profit and Loss Account
It is credited to the profit and loss account and
Shown on the liabilities side of the balance sheet by way of deduction from capital.
(XIII) ACCIDENTAL LOSS OF AN ASSET
When asset is not insured:
Sometimes asset of the organization may be destroyed due to earthquake, fire or accidents. The firm has
to bear the entire loss if the asset is not insured. The following entries are passed to make adjustments for
loss:
(a) When loss is incurred due to accident
Accidental Loss Account Dr.
To Asset Account
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(b) When loss is transferred to profit and loss account
Profit and Loss Account Dr.
To Accidental Loss Account
When asset is insured:
When the asset destroyed by accident is insured, then the firm will not have to bear the entire loss. The
insurance company will pay certain amount on loss of the asset. The amount of loss will be reduced to the
extent of amount recovered from the insurance company. The difference in the book value of asset on the
date of accident and the amount of claim admitted by the insurance company is the loss suffered by the
company. This loss will be transferred to the profit and loss account.
On admission of claim:
Insurance Company Dr.
To Asset Account
On receipt of money claimed:
Bank Dr.
To Insurance Company
On transfer of loss:
Profit and Loss Account Dr.
To Asset Account
(vi) It may vary with the time period within (vi) It may vary with the quantity of goods
which payment is received purchased or amount of purchases
made.
The list of adjustment entries given above is not exhaustive. The student may analyse each transaction
and pass necessary journal entries for adjustments considering following principles:
(i) The items given in the trial balance will appear in only one of the statements i.e. the Trading
Account, the Profit and Loss Account or the Balance Sheet.
(ii) The amount in respect of adjustments will appear in two of the above-mentioned
statements, normally in the Balance Sheet and in the Trading Account or in the Profit and Loss
Account.
The reason being that for items appearing in the trial balance, the double entry has already been
completed but in respect of adjustments, the double entry has yet to be completed, hence two accounts
will be affected.
CLOSING ENTRIES
In order to prepare final accounts, all nominal accounts have to be transferred to Trading and Profit and Loss
Account. It is done by passing journal entries which are called closing entries as they close the nominal
accounts. The entry to transfer the balance of profit and loss account itself is also one of the closing entries.
Some of the closing entries are given below:
To Sundry Expenses
To Depreciation
(Transfer of various nominal accounts to profit and loss
account)
(v) Interest Received Dr.
To Profit and Loss A/c
(Transfer of credit balance of interest received account
to profit and loss account)
(v) Profit and Loss Account Dr.
To Capital Account
(Transfer of net profit to capital account)
In case of no loss, the above mentioned entry will be the reversed one.
MANUFACTURING ACCOUNT
A manufacturing concern may like to ascertain the cost of goods during the accounting period and may prepare
Manufacturing Account for this purpose. Trading Account is not capable of showing the cost of goods
manufactured because it deals with stock of finished goods also and because some of the expenses connected
with manufacture of goods (such as depreciation and repairs of machinery and factory) are debited to the Profit
and Loss Account. Manufacturing Account is debited with all expenses incurred in the factory on production of
goods. This means that depreciation and repairs to plant and machinery and factory building, salary to works
manager, etc. are also debited to this account. The total of such expenses plus cost of raw material used gives
cost of goods manufactured during the period. This is transferred to Trading Account which deals with stock of
finished goods and sales also. The remaining nominal accounts appear in Profit and Loss Account.
In fact, there is no prescribed format for the presentation of Manufacturing Account. However, a format
covering various elements is given below. The Trading Account and Profit and Loss Account should be
prepared in the same way as discussed earlier.
Lesson 7 Preparation of Final Accounts for Sole Proprietors 159
Financial statements are the result of the accounting process which begins with recording of transactions.
Accounting process involves recording, classifying and summarizing business transactions. Financial
statements are the result of the third process viz. summarizing. The financial statements are based on certain
accounting concepts and conventions which cannot be said to be foolproof.
The following are the limitations of the financial statements:
(i) Financial statements are essentially interim reports and therefore, cannot be final because the final
gain or loss can be computed only at the termination of the business. Financial statements only reflect
the progress and position of the business at frequent intervals during its life.
(ii) Financial statements though expressed in exact monetary terms, are not absolutely final and accurate.
As the balance sheet is prepared on the basis of the going concern concept, asset valuation
represents neither the realizable value nor replacement costs. Further, they depend on the judgment
of the management in respect of various accounting policies.
(iii) The values ascribed to the assets presented in the statements depend upon the standards of the persons
dealing with them. For instance, the method of depreciation, mode of amortization of fixed assets, treatment
of deferred revenue expenditure, all depend on the personal judgment of the accountant.
(iv) Financial statements take into consideration only the financial factors. They fail to bring out the
significance of non-financial factors which may have considerable bearing on the operating results and
financial conditions of an enterprise. For example, public image of the enterprise, the caliber of its
management, efficiency and loyalty of its workers etc.
(v) It is not always possible to discover false figures in financial statements. Unscrupulous managements
generally resort to window dressing in the preparation of such statements.
(vi) Financial statements are prepared primarily for shareholders. Other interested parties have to
generally make many adjustments before they use them profitably.
160 FP-FA&A
(vii) Quite often, financial statements do not disclose current worth of the business. Only historical facts are
presented and the true current worth is not reflected.
(viii) Owing to the fact that financial statements are compiled on the basis of historical costs, while there is a
marked decline in the value of the monetary unit and resultant rise in prices, the balance sheet loses
its function as an index on current economic realities. Again, the financial statements contain both
historical and current costs items, hence figures are distorted.
ILLUSTRATIONS
Illustration 1:
A business house maintains provision of 5% against bad debts and 3% for discount on debtors and a reserve
for discount on creditors at 2%. On 1st April, 2011 it had the following balances:
Provision for Bad and Doubtful Debts ... ` 5,000
Provision for Discount on Debtors ... ` 2,850
Provision for Discount on Creditors ... ` 4,800
During the year 2011-12, bad debts, discount allowed to debtors and discount received from creditors
amounted to ` 3,950, ` 8,800 and ` 9,840 respectively while for 2012-13 they amounted to ` 1,800, ` 7,000
and ` 6,800 respectively. Sundry Debtors were ` 1,20,000 on March 31, 2012 and ` 80,000 on March 31,
2013. Sundry Creditors on these two dates were ` 2,10,000 and ` 1,95,000 respectively.
Show provision for bad debts account, provision for discount on debtors account and reserve for discount on
creditors account along with relevant portions of profit and loss account.
Solution:
Provision for Bad Debts Account
Dr. Cr.
Date Particulars ` Date Particulars `
2012 2011
March 31 To Bad Debts 3,950 April 1 By Balance b/fd 5,000
March 31 To Balance c/d 6,000
2012
March 31 By Profit & Loss A/c
(Balancing Figure) 4,950
9,950 9,950
2013 2012
March 31 To Bad Debts 1,800 April 1 By Balance b/d 6,000
March 31 By Profit & Loss A/c
(Balancing Figure) 200
March 31 To Balance c/d 4,000
6,000 6,000
2013
April 1 By Balance b/d 4,000
Lesson 7 Preparation of Final Accounts for Sole Proprietors 161
Provision for Discount on Debtors A/c
Dr. Cr.
Date Particulars ` Date Particulars `
2012 2011
March 31 To Discount Allowed 8,800 April 1 By Balance b/fd 2,850
March 31 To Balance c/d 3,420 2012
March 31 By Profit & Loss A/c
(Balancing Figure) 9,370
12,220 12,220
2013 2012
March 31 To Discount Allowed 7,000 April 1 By Balance b/d 3,420
March 31 To Balance c/d 2,280 2013
March 31 By Profit & Loss A/c
(Balancing Figure) 5,860
9,280 9,280
2013
April 1 By Balance b/d 2,280
Profit and Loss Account for the year ended 31st March, 2013
Dr. Cr.
Particulars ` ` Particulars ` `
To Discount Allowed 7,000 By Old Provision for
Add: New Provision 2,280 bad and doubtful
for Discount 9,280 debts 6,000
Less: Old Provision 3,420 5,860 Less: Bad Debts 1,800
Less: New Provision 4,200 200
By Discount Received 4,000
Add: New Reserve for 6,800
Discount on Creditors 3,900
10,700
Less: Old Reserve 4,200 6,500
Illustration 2:
Following is the trial balance of Amar as on 31st March, 2013:
` `
Capital Account 8,00,000
Drawing Account 60,000
Stock (1.4.2012) 4,50,000
Purchases 26,00,000
Sales 31,00,000
Furniture 1,00,000
Sundry Debtors 4,00,000
Freight and Octroi 4,6,000
Trade Expenses 5,000
Salaries 55,000
Lesson 7 Preparation of Final Accounts for Sole Proprietors 163
Rent 24,000
Advertising Expenses 50,000
Insurance Premium 4,000
Commission 13,000
Discount 2,000
Bad Debts 16,000
Provision for Bad Debts 9,000
Creditors 2,00,000
Cash in hand 52,000
Bank 58,000
Goodwill (at cost) 2,00,000 _______
41,22,000 41,22,000,
Adjustments:
(a) Stock on 31st March, 2013 was valued at ` 5,30,000.
(b) Salaries have been paid only for 11 months.
(c) Unexpired insurance included in the figure of ` 4,000 appearing in trial balance is ` 1,000.
(d) Commission earned but not yet received amounting to ` 1,220 is to be recorded in books of account.
(e) Provision for bad debts is to be brought upto 3% of sundry debtors.
(f) Manager is to be allowed a commission of 10% of net profits after charging such commission.
(g) Furniture is depreciated @10% per annum.
(h) Only 1/4th of advertising expenses is to be written off.
Prepare trading and profit and loss account for the year ended 31st March, 2013 and balance sheet as on
that date. Also show adjustments entries and closing entries.
Solution:
Mr. Amar
Trading and Profit and Loss Account
for the year ended 31st March, 2013
Dr. Cr.
Particulars ` ` Particulars ` `
To Stock (1.4.2012) 4,50,000 By Sales 31,00,000
To Purchases 26,00,000 By Closing Stock 5,30,000
To Freight & Octroi 46,000
To Gross Profit
transferred to P&L a/c 5,34,000
36,30,000 36,30,000
To Trade Expenses 5,000 By Gross Profit
To Depreciation 10,000 transferred from
trading A/c 534,000
To Salaries 55,000 Commission 1,300
Add: Outstanding 5,000 60,000 Add: Commission
To Rent 24,000 earned but not
To Advertising received 1220 14,220
Expenses 50,000
Less: Amount C/f 37,500 12,500
164 FP-FA&A
Particulars ` ` Particulars ` `
To Insurance Premium 4,000
Less: Unexpired
Insurance 1,000 3,000
To Discount 2,000
To Provision for Bad
`
12,000
Add: Bad Debts 16,000
Less: Old provision 9,000 19,000
To Commission
payable to Manager 37,520
To Net Profit
transferred to Capital
Account 3,75,200
5,48,220 5,48,220
st
Balance Sheet as on 31 March, 2013
Liabilities ` ` Assets ` `
Capital Fixed Assets:
Opening Balance 800,000 Goodwill 2,00,000
Add: Net profit 3,75,200 Furniture 100,000
Less: Drawings 60,000 11,15,200 Less: Depreciation 10,000 90,000
Creditors 2,00,000 Current Assets:
Outstanding Salary 5,000 Unexpired Insurance 1,000
Commission Payable to Unexpired advertising
Managers 37,520 expenses 37,500
Commission earned
but not received 1,220
Stock 5,30,000
Sundry Debtors 4,00,000
Less: Provision for bad
debts 12,000 3,88,000
Cash at bank 58,000
Cash in hand 52,000
13,57,220 1,35,7220
Lesson 7 Preparation of Final Accounts for Sole Proprietors 165
Journal Book
Adjustment Entries
Particulars ` `
Stock Account Dr. 530,000
To Trading Account 5,30,000
(Being closing stock credited to trading account)
Salaries Account Dr. 5,000
To Salaries Outstanding Account 5,000
(Being the amount of salaries outstanding on 31st March,
2013)
Unexpired Insurance Dr. 1,000
To Insurance Premium Account 1,000
(Being the amount of unexpired insurance premium as on 31st
March, 2013)
Commission Earned But not Received Dr. 1,220
To Commission Account 1,220
(Being the amount of commission earned but not received till
31st March, 2013)
Bad Debts Account Dr. 16,000
To Provision for Bad Debts Account 16,000
(Transfer of bad debts to provision for bad debts)
Profit and Loss Account Dr. 19,000
To Provision for Bad Debts Account 19,000
(Being credit given to provision for bad debts to make its
balance 3% of ` 40,000)
Profit and Loss Account Dr. 37,520
To Commission Payable to Manager 37,520
(Being commission payable to manager @10% of net profits
remaining after charging such commission)
Depreciation Account Dr. 10,000
To Furniture Account 10,000
(Being the amount of depreciation provided on furniture
@10% per annum)
Unexpired Advertising Expenses Account Dr. 37,500
To Advertising Expenses Account 37,500
(For advertising expenses carried forward to next year)
166 FP-FA&A
Closing Entries:
Particulars ` `
Trading Account Dr. 30,96,000
To Stock Account (1.4.2012) 4,50,000
To Purchases Account 26,00,000
To Freight & Octroi Account 46,000
(Transfer of various nominal accounts showing debit balances
to trading account)
Sales Account Dr. 31,00,000
To Trading Account 31,00,000
(Transfer of sales account to trading account)
Note: Entry for closing stock has already been passed by way
of adjustment
Trading Account Dr. 5,34,000
To Profit and Loss Account 5,34,000
(Transfer of gross profit from trading account to profit and loss
Account)
Profit and Loss Account Dr. 1,16,500
To Trade Expenses Account 5,000
To Salaries Account 60,000
To Rent Account 24,000
To Advertising Expenses Account 12,500
To Insurance Premium Account 3,000
To Discount Account 2,000
To Depreciation Account 10,000
(Transfer of various nominal accounts showing debit balances
to profit and loss account)
Commission Account Dr. 14,220
To Profit and Loss Account 14,220
(Transfer of credit balance in commission account to profit and
loss Account)
Profit and Loss Account Dr. 3,75,200
To Capital Account 3,75,200
(Transfer of net profit to capital account)
Note: Profit and Loss Account has already been debited in respect of provision for bad debts and commission
payable to manager. Refer to adjustments entries.
Illustration 3:
Following are the balances in the ledger of Mr. Patel for the year ended 31st March, 2013:
`
Stock (1.4.2012):
Raw materials 1,00,000
Semi-finished goods 50,000
Finished goods 2,60,000
Purchases:
Raw materials 8,00,000
Finished goods 1,70,000
Lesson 7 Preparation of Final Accounts for Sole Proprietors 167
Carriage inwards on raw materials 30,000
Manufacturing wages 1,00,000
Salary of the supervisor 36,000
Rent of the factory 70,000
Gas and water 30,000
Return of raw materials 13,000
Fuel and coal 33,000
Factory power 1,25,000
Fire insurance 13,000
Sales returns 1,20,000
Depreciation on factory building 12,000
Stock on 31.3.2013:
Raw materials 80,000
Semi-finished goods 1,30,000
Finished goods 2,20,000
Sales 22,00,000
Carriage outwards 35,000
Office salaries 1,50,000
Prepare manufacturing account and trading and profit and loss accounts for the year ended March, 2013.
Manufacturing Account
for the year ended 31st March, 2013
Dr. Cr.
Particulars ` ` Particulars ` `
To Opening stock: By Closing stock:
Raw materials 1,00,000 Raw materials 80,000
Semi-finished Goods __50,000 1,50,000 Semi-finished goods 1,30,000 2,10,000
To Purchases 8,00,000 By Cost of production
Less : Returns __13,000 7,87,000 transferred to
Trading Account 11,76,000
To Carriage on raw
materials 30,000
To Manufacturing
wages 1,00,000
To Factory expenses:
Salary of supervisor 36,000
Rent of factory 70,000
Gas and water 30,000
Fuel and coal 33,000
Factory power 1,25,000
Fire insurance 13,000
Depreciation 12,000 3,19,000
13,86,000 13,86,000
168 FP-FA&A
Trading and Profit and Loss Account
for the year ended 31st March, 2013
Dr. Cr.
Particulars ` Particulars `
To Opening stock of finished By Sales 22,00,000
goods 2,60,000 Less: Returns 1,20,000 20,80,000
To Cost of production transferred By Closing Stock of finished
from Manufacturing Account 11,76,000 goods 2,20,000
To Purchases 1,70,000
To Gross Profit c/d 6,94,000
23,00,000 23,00,000
To Carriage outwards 35,000 By Gross Profit b/d 6,94,000
To Office salaries 1,50,000
To Net Profit transferred to
Capital A/c 5,09,000
6,94,000 6,94,000
Illustration 4:
From the following particulars of Mr. Murthy, prepare Manufacturing, Trading and Profit and Loss Accounts for
the year ended 31.3.2013 and the Balance Sheet as on the date after making necessary adjustments:
`000
Capital (1.4.2012) 2,500
Drawings account 700
Sundry creditors 800
Discount received 702
Bank overdraft 4,000
Provision for bad and doubtful debts 60
Purchases returns 53
Sales 6,750
Sales returns 8.6
Stock of finished goods (1.4.2012) 900
Plant and machinery (including machinery for ` 50,000 purchased on 1.1.2013) 1,700
Furniture 1,500
Building 1,500
Purchases 302,3
Sundry debtors 1,100
Manufacturing wages 6,000
Manufacturing expenses 5,000
Carriage inwards 400
Carriage outwards 420
Bad debts 150
Salaries 280
Lesson 7 Preparation of Final Accounts for Sole Proprietors 169
Interest and bank charges (Dr.) 12.6
Discount allowed 15
Insurance (Dr.) 30
Cash at bank 14
Cash in hand 3
Stock of finished goods (31.3.2013) 755
The following adjustments are to be made:
(i) Interest on capital at 10% p.a. (no interest is to be provided on drawings)
(ii) Outstanding expenses:
`
(a) Salaries 100
(b) Manufacturing wages 5
(c) Interest on bank loan 100
( a ) M a c h in e r y a t 1 0 %
( b ) F u r n it u r e a t 1 0 %
( c ) B u ild in g a t 2 . 5 %
Manufacturing account shows cost of production; trading account shows the gross profit or gross loss
while profit and loss account shows the net profit earned or net loss suffered by the organization
during a particular period.
Balance sheet discloses the financial position i.e. the balances of assets, liabilities, and capital of the
business as on a particular date.
Balance sheet is prepared with assets on the right hand side and liabilities on the left hand side.
Assets and liabilities are classified into fixed and current and are shown in the balance sheet either in
the order of liquidity or permanence
Adjustment entries are passed at the end of the accounting period in order to adjust various nominal
accounts to find out the correct profit or loss.
Closing entries are journal entries required for transferring all accounts relating to expenses and gain
to trading and profit loss account.
GLOSSARY
SELF-TEST QUESTIONS
1. The following are the balances taken from the books of Mr. Atma Ram:
Balances on 31st March, 2013
`
Atma Rams capital 300
Atma Rams drawings 50
Furniture and fittings 26
Bank overdraft 42
Creditors 133
Lesson 7 Preparation of Final Accounts for Sole Proprietors 173
Business premises 200
Stock on 1st April, 2012 220
Debtors 186
Rent from tenants 10
Purchases 1,100
Sales 1,500
Sales returns 20
Discount-debit 16
Discount-credit 20
Taxes and insurance 20
General expenses 40
Salaries 90
Commission-debit 22
Carriage on purchases 18
Provision for bad and doubtful debts 6
Bad debts written off 8
Stock on hand on 31st March, 2013 was estimated at ` 200 thousand. Rent
` 3 thousand, is still due from the tenant. Salaries, ` 7.5 thousand are as yet unpaid. Write off bad debts ` 6
thousand and depreciate business premises by ` 300 and furniture and fittings by ` 266. Make a provision
of 5% on debtors for bad and doubtful debts and provision of 2% for discounts. Allow interest on capital at 5
per cent and carry forward ` 7 for unexpired insurance. The manager is entitled to a commission of 10% on
profits remaining after charging his commission.
Prepare Trading Account, Profit and Loss Account and Balance Sheet on 31st March, 2013.
Hints: Suspense Account (difference in trial balance) = 500.
[Ans : G.P = 342 thousand, N.P. = 132.2 thousand, B/s Total = 597.92 thousand].
Rates have been prepaid to the extent of `17.5 thousand. Bad debts totaling ` 50 thousand have to be
written off. A provision for doubtful debts @5% on debtors is necessary. Buildings have to be depreciated
174 FP-FA&A
at 2% and furniture @10%. The manager is entitled to a commission of 5% of net profits before charging
such commission.
You are required to prepare the profit and loss account for the year ended 31st March, 2013 and the
balance sheet as on that date.
[Hints: (a) The trial balance gives Adjusted Purchases. It means that the opening stock has already been
transferred to the Purchases Account and has thus been closed. Further, entry for closing stock has
already been passed by debiting the Closing Account and crediting Purchases Account. That is why closing
stock appears in the trial balance. It will now be shown in the Balance Sheet and not in the Trading Account
since Purchases already stand reduced.
(b) There is a loan of Mohan @ 9% taken in October, 2012. The trial balance makes no mention of any
interest being paid to him. Hence, interest @9% must be provided for six months i.e. from October 2012 to
March 2013.]
[Ans.: G.P. = 2,040 thousand, N.P. =1212.2 thousand, Total B/S =10,216 thousand].
3.The following figures were taken from the books of Amar on 31st March, 2011.
` 000 `000
Cash at bank 2640 Royalties received 40
Cash in hand 3 Trade and general expenses 502
Sales 26,123 Reserve on patents 500
Stock (1st April, 2010) 2,741 Interest on loan 124
Sales returns 330 Repairs 84
Discount (Dr.) 638 Sundry creditors 2,078
Bills receivable 182 Buildings 95,82
Sundry debtors 5,272 Patent rights 5,000
Depreciation 478 Loan (raised on
Purchases 18,403 mortgage of buildings) 4,500
Discount on purchases 3,90 Agents commission 650
Wages 1,404 Bad debts 190
Provision for bad debts 540 Plant and machinery 3,000
Provision for discounts Capital 20,000
on debtors 197 Drawings 3,000
Advertising 100
Carriage 45
LESSON OUTLINE
LEARNING OBJECTIVES
Basic Concepts of Partnership As we know, sole proprietorship form of business
Goodwill
organisation has limited financial and managerial
Methods of Valuation of Goodwill
resources. It is also not possible to expand the
Average Profit Method
business activities beyond a certain limit. So, in
Super Profit Method
order to overcome these drawbacks, another
Capitalization Method
form, i.e., partnership form of business has come
Preparation of Final Accounts of
Partnership into existence. When two or more persons come
Profit & Loss Appropriation Account together to share profits of the business carried
Interest on Capital on by them, it is called partnership form of
Interest on Drawings organIsation. Accounting for partnership firm is
Salary or Commission payable to different from sole proprietorship in certain
Partners
aspects as there are more than one contributor
Past Adjustments of Profit
to capital who share profits and losses.
Guarantee of Profit to a Partner
Reconstitution of Partnership Here in this lesson, we will study about
Change in Profit Sharing Ratio partnership form of business and preparation of
Admission of a Partner accounts under various situations like admission
Retirement of a Partner of new partner, retirement and death of partner
Death of a Partner
and dissolution of partnership firm. We would also
Dissolution of Partnership Firm
cover the concept of goodwill and valuation of
Lesson Round-Up
goodwill for partnership firms under various
Glossary
situations.
Self Test Questions
The main reason businesses should care now is because they need to account for the liability
and in order to account for a liability in a years time you need to start accounting for it now.
Steve Nathan
180 FP-FA&A
(iii) It is carried on under firms name. (iii) There is no common firms name in joint
venture.
(iv) Persons carrying on partnership business are (iv) Parties are called co-venturers.
called partners.
(v) Profit or loss is ascertained on an annual basis. (v) Profit or loss is ascertained only after the end of
the specific venture.
(vi) Partnership firms are governed by Indian (vi) There is no specific act for joint ventures.
Partnership Act, 1932.
(vii) The doctrine of implied authority is applicable (vii) The doctrine of implied authority is not
to partners. applicable to co-venturers.
Loan Account: If a partner advances to the firm a sum over and above the amount of capital required to be
contributed by him under the partnership contract, the amount is credited to a loan account opened in his
name. In the event of dissolution of partnership, a partner is entitled to receive the amount of loan advanced
by him in priority to repayment of capital to the partners. However, if capital is insufficient to meet losses on
dissolution, the amount of the loan can be used to meet losses.
Capital Accounts: There are only a few points of difference between the accounts of a partnership firm
and those of a sole proprietorship concern. One difference is that in a sole proprietorship concern
there is only one capital account, whereas, in the firms ledger there are as many capital accounts as
there are partners in the firm (unless some partner is not required to contribute capital at all). Amount
contributed by a partner whether in cash or in the form of some other asset or assets is credited to his capital
account.
Types of Capital Account: The capital account of a partner may be either a Fixed Capital Account or a
Fluctuating Capital Account.
182 FP-FA&A
(i) Fixed Capital Account : Under Fixed Capital Account method, there will be two accounts for each partner,
i.e. (i) Partners Capital Account recording only capital of the partner and (ii) Partners Current Account
recording the transactions relating to drawings, interest on capital, commission, salary, share of profit or loss,
etc of the partner. Under this method, capital accounts are not touched at all and debits and credits for
interest on capital, interest on drawings, profits, losses, drawings, etc., are made in separate accounts called
current accounts or drawing accounts. Capital account is credited only when fresh (or further) capital is
introduced or debited when capital is withdrawn.
If there is no addition or withdrawal of capital during the year, the capital account does not change and it
remains fixed through-out the year. Sometimes, there may be current accounts as well as drawings accounts.
Drawing accounts are used to record only the withdrawals made by partner; and transferred to the respective
current accounts at the end of the year. Such drawings accounts are maintained when drawings are irregular
and extensive to facilitate calculation of interest on drawings.
(ii) Fluctuating Capital Account : Just as in a sole proprietorship concern, in partnership also, profits or losses,
drawings, interest on capital, interest on drawings, salary (to partners), commission, additional capital
introduced, etc., may all be recorded in the capital accounts. Such capital accounts are called Fluctuating
Capital Accounts because the balances of these accounts continue to fluctuate due to various debits and
credits. Under this method, there is no need to maintain respective current accounts because all transactions
passing through current accounts are passed through capital accounts.
DIFFERENCE BETWEEN FIXED & FLUCTUATING CAPITAL METHODS
Fixed Capital Method Fluctuating Capital Method
(i) Two accounts of each partner are maintained, (i) Only one account of each partner i.e. capital
i.e. capital account and current account account is maintained.
(ii) Balance in capital account remains the same (ii) The balance in capital account changes every
except when capital is introduced or capital is year because of profits/losses, drawings, interest
withdrawn. on capital, interest on drawings, etc.
(iii) All adjustments in respect of profit, loss, (iii) All adjustments in respect of profit, loss,
drawings, interest on capital, interest on drawings, interest on capital, interest on
drawings, salary, commission, etc. are made in drawings, salary, commission, etc. are made in
the current account. the capital account.
(iv) The capital account will always have a plus or (iv) Fluctuating capital account may sometimes show
credit balance while the current account may a debit (negative) balance.
have a debit (negative) balance.
GOODWILL
Goodwill is the value of reputation of a business house in respect of the profits expected in future over and
above the normal level of profits earned by undertakings belonging to the same class of business. In other
words, goodwill is the present value of a firms anticipated super normal earnings. The term super normal
earnings means the earnings over and above the normal rate of return earned by representative firms in the
same industry. Goodwill refers to the reputation of a business enterprise acquired by it over the period of time
through its successful operations and customers satisfaction. It is an attribute of business which enables it to
earn more than other firms in the industry. Goodwill is an intangible asset but not a fictitious one. The
following are some of the factors that generally contribute to the value of goodwill of a firm:
Quality of goods sold by the firm
Location of the business unit
Reputation of the owners of the firm
Monopolistic nature of the business
Risk involved in the business
Efficiency of management
Lesson 8 Partnership Accounts 183
Possibility of competition
Government attitude
Possession of special contracts for availability of materials
Trends of profits, etc.
Example: Suppose on 1st April, 2013 on the admission of a new partner, it is agreed that goodwill of the
firm is valued at three years purchase of average profits for the last five years. Further, suppose the
profits for last five years have been as follows:
`
For the year ended 31st March 2013 10,740
For the year ended 31st March 2012 7,900
For the year ended 31st March 2011 5,430
For the year ended 31st March 2010 400 (loss)
For the year ended 31st March 2009 8,500
Value of goodwill will be calculated as follows:
Total profits for the last 5 years = ` (10,740 + 7,900 + 5,430 400 + 8,500)
= ` 32,170
32170
,
Average profits = ` = ` 6,434
5
Three years purchase of the above mentioned average profit= ` 6,434 x 3 = ` 19,302
Hence, value of goodwill = ` 19,302
184 FP-FA&A
(ii) Super Profit Method
In this case the future maintainable profits of the firm are
Note: Normal rate of earning is that rate of
compared with the normal profits for the firm. Normal earnings earning which investors in general expect on their
of a business can be judged only in the light of normal rate of investments in the particular type of industry.
earning and the capital employed in the business. Hence, this Normal rate of earning depends upon the risk
method of valuing goodwill would require the following attached to the investment, bank rate, market
need and the period of investment.
information:
Capital employed is the aggregate of capital and
(i) A normal rate of return for representative firms in the reserves less the amount of non-trading assets
industry. such as investments. The capital employed may
also be ascertained by adding up the present
(ii) The fair value of capital employed. values of trading assets and deducting all
liabilities therefore. Super profit is the simple
(iii) Estimated future maintainable profits. difference between future maintainable operating
profit and normal profit.
There are three methods of calculating goodwill based on
super profit:
(a) Purchase of super profit
As per this method, value of goodwill is obtained by multiplying super profit by a certain number of years.
(b) Annuity method
Goodwill according to the annuity method is the present value of a terminal annuity of super profit for a
reasonable period during which the super profit is likely to occur. It is calculated as:
Super profit x Annuity rate.
(c) Capitalization of super profit
In this method, the value of goodwill is arrived at by capitalizing the super profit at the normal rate of return. It
is calculated as:
Super profit x 100
Normal rate of return
Example: A firm of X,Y and Z has a total capital investment of ` 2,25,000. The firm earned net profit
during the last four years as ` 35,000, ` 40,000, ` 60,000 and ` 50,000. The fair return on the net capital
employed is 15%. Find out the value of goodwill if it is based on 3 years purchase of the average super
profits of past four years.
Solution:
`
Total Profits earned during four years 1,85,000
Average annual profit ` 1,85,000 / 4 46,250
Fair return on capital employed: 15% of ` 2,25,000 33,750
Super Profit: ` 46,250 ` 33,750 12,500
Value of goodwill being 3 years purchases of the average
Super profit = ` 12,500 x 3 37,500
(iii) Capitalization Method
The capitalization of profit method values goodwill at the excess of capital that should have been employed
for earning the average profit over the capital which has been actually employed. In this method, the value of
whole business is found by using the formula:
From this figure, the net assets (excluding goodwill) of the firm are deducted and the resultant figure will be
the goodwill.
Lesson 8 Partnership Accounts 185
Example: Average profit of a firm is ` 48,000. The rate of capitalization is 12%. Assets and liabilities of the
firm are ` 4,00,000 and 1,70,000 respectively.
Value of goodwill be:
= `48,000 x 100 - (400,000-1,70,000)
12
= ` 4, 00,000 ` 2, 30,000
= ` 1, 70,000
REVIEW QUESTION
On the admission of a new partner, it is decided that goodwill of the firm
be calculated at 2 years purchase of average profits for the past three
years which amounted to ` 8,620, ` 9,430 and ` 11,800 respectively.
What is the value of goodwill?
1. Interest on Capital
Where the profit sharing ratio is different from the ratio of capitals contributed by the partners, interest on
capitals may be allowed to partners and charged against the profits of the firm to make the distribution of
profits equitable. Interest on capital being an appropriation of profits, should be charged only out of the profits
available. In case of loss, no interest on capital is provided. Interest is mostly calculated on the capitals at the
commencement of the year. Where fresh capital has been introduced during the course of the year, interest is
also allowed on this additional amount for the period for which the amount has been in business. Journal
entry for interest on capital will be:
2. Interest on Drawings
Interest may be charged on drawings made by partners to make distribution of profit more equitable. Interest
on drawings should be charged on different amounts withdrawn for different periods. Journal entry for interest
on drawing will be:
Note: If a partner withdraws a fixed sum at the end of each month, the interest on his drawings for the
year will be equal to the interest on his total drawings for a period of 5 months.
If a partner withdraws the fixed amount in the middle of each month, interest will be calculated on his
total drawings for a period of 6 months.
If he withdraws the amount at the beginning of each month, interest will be calculated on his total
drawings for the period of 6 months.
REVIEW QUESTION
st
P, a partner withdraws the following sums during the year ended 31
March 2011:
On 1st May 2012 ` 3,000
On 1st August 2012 ` 9,000
On 1st January 2013 ` 6,000
On 1st March 2013 ` 4,000
Calculate interest on his drawing @ 10% p.a.
A pro-forma of profit and Loss account is as follows: (It is assumed that there are two partners X & Y)
Lesson 8 Partnership Accounts 187
Note: - Interest on loan is charged against profit in Profit & Loss Account only. It is not the appropriation of
profits.
Illustration 1:
On 1st April, 2012 P and Q started business in partnership agreeing to share profits and losses equally. P
contributed ` 3,00,000 while Q contributed ` 2,00,000 by way of capital. It was agreed that interest be allowed
on capital @6% per annum and charged on drawing @ 8% per annum. P withdrew ` 200 at the end of every
month whereas Q withdrew ` 4,500 in the middle of every month.
Profits before the above noted adjustments for the year ended 31st March, 2013 amounted to ` 89,700. Show
the necessary ledger accounts assuming:
(a) capital accounts are fluctuating
(b) capital accounts are fixed.
Solution:
Working Notes:
3, 00, 00 6
Interest on Ps Capital = `
100
= ` 18,000
2, 00, 000 6
Interest on Qs Capital = `
100
= ` 12,000
= ` 24,000
6 8
Interest on Qs drawings = ` 54, 000
12 100
= ` 2,160
Lesson 8 Partnership Accounts 189
(a) When capital accounts are fluctuating:
Profit and Loss Appropriation Account
Dr. Cr.
Particulars ` Particulars `
To Interest on Capital: By Profit and Loss Account 89,700
Ps Capital A/c 18,000 By Interest on drawings:
Qs Capital A/c 12,000 Ps Capital A/c 880
To Profit transferred to: Qs Capital A/c 2,160
Ps Capital A/c (1/2 of Profit) 31,370
Qs Capital A/c (1/2 of Profit) 31,370
92,740 92,740
Ps Capital Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2012
Mar. 31 To Ps Drawings A/c 24,000 Apr.1 By Cash A/c 3,00,000
Mar. 31 To Profits and Loss 2013 By Profits and Loss
Appropriation A/c Mar. 31 Appropriation A/c
(Interest on Drawings) 880 (Interest on Capital) 18,000
Mar. 31 To Balance c/d 3,24,490 Mar. 31 By Profits and Loss
Appropriation A/c 31,370
3,49,370 3,49,370
2013
Apr. 1 By Balance b/d 3,24,490
Qs Capital Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2012
Mar. 31 To Qs Drawings A/c 54,000 Apr.1 By Cash A/c 2,00,000
Mar. 31 To Profits and Loss 2013 By Profits and Loss
Appropriation A/c Mar. 31 Appropriation A/c
(Interest on Drawings) 2,160 (Interest on Capital) 12,000
Mar. 31 To Balance c/d 1,87,210 Mar. 31 By Profits and Loss
Appropriation A/c 31,370
2,43,370 2,43,370
2013
Apr. 1 By Balance b/d 1,87,210
(b) When capital accounts are fixed:
Profit and Loss Appropriation Account
Dr. Cr.
Particulars ` Particulars `
To Interest on Capital : By Profit and Loss Account 89,700
Ps Current A/c 18,000 By Interest on drawings:
Qs Current A/c 12,000 Ps Current A/c 880
To Profit transferred to: Qs Current A/c 2,160
Ps Current A/c (1/2 of Profit) 31,370
Qs Current A/c (1/2 of Profit) 31,370
92,740 92,740
190 FP-FA&A
Ps Capital Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2012
Mar. 31 To Balance c/d 3,00,000 Apr.1 By Cash A/c 3,00,000
2013
Apr.1 By Balance b/d 3,00,000
Qs Capital Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2012
Mar. 31 To Balance c/d 2,00,000 Apr.1 By Cash A/c 2,00,000
2013
Apr.1 By Balance b/d 2,00,000
Ps Current Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2013
Mar. 31 To Ps Drawings A/c 2,400 Mar. 31 By Profits and Loss
Mar. 31 To Profits and Loss Appropriation A/c
Appropriation A/c (Interest on Capital) 18,000
(Interest on Drawings) 880 Mar. 31 By Profits and Loss
Appropriation A/c 31,370
Mar. 31 To Balance c/d 24,490
49,370 49,370
2013 By Balance b/d 24,490
Apr. 1
Qs Current Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2013
Mar. 31 To Qs Drawings A/c 54,000 Mar. 31 By Profits and Loss
Mar. 31 To Profits and Loss Appropriation A/c
Appropriation A/c (Interest on Capital) 12,000
(Interest on Drawings) 2,160 Mar. 31 By Profits and Loss
Appropriation A/c 31,370
Mar. 31 By Balance c/d 12,790
56,160 56,160
2013
Apr.1 To Balance b/d 12,790
Illustration 2:
On 1st April, 2013 the capital accounts of A, B and C stood at ` 30,000, ` 20,000 and ` 10,000
respectively. They shared profits and losses equally. Profit and Loss account for the year ended 31 March,
2013 revealed a net profit of `12, 000 which was transferred to capital accounts of the partners equally.
It was decided in April 2013 that profits should be distributed equally after allowing interests on capital @ 6%
Lesson 8 Partnership Accounts 191
per annum with effect from 1st April, 2012. While going through the books of account for 2012-13 it was
discovered that repair charges for As personal scooter amounting to ` 90 had been charged to Repairs
Account.
Show the journal entries necessary to adjust the current account of the partners.
Solution:
` `
Profits as already distributed 12,000
Add: Repair charges to be charged to As Current Account 90
12,090
Less : Interest on:
As Capital 1,800
Bs Capital 1,200
Cs Capital 600 3,600
Net profit after adjustment 8,490
Each partner will get ` 8,490 = ` 2,830
3
Revised Distribution
A B C
` ` `
Net Profit 2,830 2,830 2,830
Interest of Capital 1,800 1,200 600
4,630 4,030 4,430
Less : Repair charges 90
4,540 4,030 3,430
Distribution as already made of ` 12,000 4000 4000 4000
Net Adjustment to be made +540 +30 570
Journal Entry
Particulars Dr. (`) Cr. (`)
Cs Current Account Dr. 570
To As Current Account 540
To Bs Current Account 30
(Adjustment effected for change on the basis of
distribution of profit for 2010-11 and error located in
the accounts for 2010-11)
Illustration 3:
C and D were sharing profits in the ratio of 3:1. Profits as per books for 2012-13 amounted to ` 40,000. In
April 2013, they agreed to change the profit sharing ratio to 5:3 with retrospective effect from 1st April, 2012. It
was found that outstanding expenses of ` 4,000 as on 31st March, 2012 and outstanding expenses of
` 3,000 as on 31st March, 2013 had not been taken into account while drawing up the final accounts for
2011-12 and 2012-13. Also by mistake interest on drawings had been ignored while preparing the accounts
for 2012-13 such interest being ` 600 on Cs drawings and ` 300 on Ds drawings. Pass the necessary journal
entries to adjust the capitals of partners.
192 FP-FA&A
Solution:
Working Notes:
C D
Old ratio 3:1 or 6 : 2
New Ratio 5 : 3
D gets 1/8 more
C D
` `
Old distribution of ` 40,000 (A) 30,000 Cr. 10,000 Cr.
New distribution of ` 40,000 +
` 600 + ` 300 or ` 40,900
in the ratio of 5 : 3 25,562.50 Cr. 15,337.50 Cr.
Interest on Drawings 600 Dr. 300 Dr.
(B) 24,962.50 (Net) Cr. 15,037.50 (Net) Cr.
Difference (A) (B) 5,037.50 Dr. 5,037.50 Cr.
Outstanding expenses of ` 4,000 as on 31st March, 2012 will be debited to partners capital accounts in the
old ratio (to raise Outstanding Expenses Account) and then will be credited to partners capital accounts in
the new ratio (to write off Outstanding Expenses Account). Outstanding Expenses of ` 3,000 will be debited
to capital accounts in the new ratio and credited to Outstanding Expenses Account. In the entry shown
below, only the net effect has been recorded:
Journal Entries
Particular Dr. (`) Cr. (`)
Cs Capital Account Dr. 2,375*
Ds Capital Account Dr. 625*
To Outstanding Expenses Account 3,000
(Adjustment entry for outstanding expenses of
` 4,000 as on 31st March, 2012 and of ` 3,000 as on
31st March, 2013)
Illustration 5:
P and S were in partnership sharing profits and losses in the ratio of 7:3 respectively. As a mark of
appreciation of the services of their manager Z, they admitted him into partnership on 1st April, 2012 giving
him 1/10th share of the future profits; the mutual ratio between P and S remaining unchanged. Before
becoming a partner, Z was getting a salary of ` 4,000 per month and a commission of 5% on the net profits
remaining after charging his salary and commission. It was agreed that any excess over his former
remuneration to which Z as a partner becomes entitled will be provided out of Ps share of profit.
The net profit for the year ended 31st March, 2013 amounted to ` 19,80,000. Prepare the profit and loss
appropriation account for the year ended 31st March, 2012 showing the distribution of the profits of the net
profits amongst the partners. Show your working notes clearly.
Solution:
Working Notes:
` `
(1) Zs share: 1/10 of ` 19, 80,000 1, 98,000
Less: Zs share as manager:
Salary: ` 4,000 x 12 48,000
Commission: 5 of ` 1,98,000-48,000 92,000 1, 40,000
105
_______
Excess amount chargeable to P 58,000
(2) When Z acted as manager, divisible profit of the old
partner would have been (` 19,80,000 ` 1,40,000) 18,40,000
Ps share of profit would have been
( 7 of ` 18,40,000) 12,88,000
10
Ss share of profits would have been
( 3 of ` 18,40,000) 5,52,000
10
(3) When Z becomes a partner, share of profit of each:
Particulars ` Particulars `
To Zs Capital A/c (1/10) 1, 98,000 By Net Profit b/d 19, 80,000
To Balance c/d 17, 82,000 _________
19, 80,000 19, 80,000
Final Distribution
`
P=` 12,88,000 - `58,000 = 12,30,000
S = 5,52,000
Z = 1,98,000
19,80,000
Lesson 8 Partnership Accounts 195
RECONSTITUTION OF PARTNERSHIP
When there is any change in the existing agreement of partnership, it is reconstitution of partnership. As a
result of reconstitution, the existing agreement of partnership comes to an end and a new agreement is formed.
The firm continues its business in usual manner. Some special adjustments are to be made in the accounts of
partnership firm in cases of change in the constitution of the firm.
There may be changes in the constitution of the firm due to following reasons:
Retirement of a Partner
Death of a Partner
Journal Entries
Particulars Dr. (`) Cr. (`)
Land and Buildings Account Dr. 1,40,000
To Revaluation Account 1,40,000
(Appreciation in the value of land and buildings)________
Revaluation Account Dr. 1,40,000
To As Capital Account 70,000
To Bs Capital Account 42,000
To Cs Capital Account 28,000
(Transfer of profit on revaluation to partners capital
accounts in old profit sharing ratio)
Bs Capital Account Dr. 15,000
Capital Account Dr. 60,000
To As Capital Account 75,000
(Adjustment for goodwill on change in profit sharing ratio)
Working Notes:
Old profit sharing ratio = 5 : 3 : 2
10 10 10
1 1 1
: :
New profit sharing ratio = 3 3 3
5 1 15 10 5
A loses =
10 3 30 30
B gains = 1 3 10 9 1
3 10 30 30
1 2 10 6 4
C gains =
3 10 30 30
REVIEW QUESTION
On 1st April, 2013 A and B who are sharing profits and losses in the ratio
of 3:2 decided to become equal partners with effect from 1st April, 2012
with the additional provision that interest on capitals will be allowed @ 7%
per annum. A and B started the firm on 1st April, 2012 with a capital of
` 90,000 and ` 60,000 respectively. The profit for the year ended 31st
March, 2013 amounted to ` 54,000. Pass the necessary adjustment entry.
Lesson 8 Partnership Accounts 197
ADMISSION OF A NEW PARTNER
A new partner can be admitted with the consent of all existing partners. The various reasons for admission of
a new partner may be requirement of more capital, influence or managerial skill of the new partner etc.
A new partner may either purchase his share of profits from one or more of the existing partners or he may
contribute to a share in the assets of the firm. In the former case, the total capital of the firm does not change;
the amount brought in by the new partner is paid to the partners from whom share is purchased. In the latter
case, however, the total capital of the firm is increased by the amount brought in by the new partner.
Suppose, A and B share profits and losses in the ratio of 2:1 respectively and their capitals stand at
1
` 10,000 and ` 5,000 respectively. If C is admitted and he buys 1/5th share from A, C will bring ` 15,000
5
or ` 3,000 in cash which will be withdrawn by A. The new balances of the capital accounts of A, B and C will
be ` 7,000, ` 5,000 and 3,000 respectively. If C contributes to the capital for 1/5th share of profits, he will
5 1
bring ` 15, 000x x ` 3,750. Total capital of the new firm will be ` 18,750.
4 5
Admission of new partner results in the reconstitution of partnership firm, as a new agreement to carry on the
business as a partnership firm comes into existence. When there is a change in the constitution of
partnership, the profit sharing ratio of the existing partners may be revised. When a new partner is admitted,
he is entitled to a share in the assets of the firm and in the future profits of the firm.
When a new partner is admitted, the amount may be contributed to the capital of the firm in the form of assets
other than cash also. Journal entry will be :
Bank Dr.
Any other Asset Dr.
To New Partners Capital A/c
Example: X and Y are carrying on business in partnership. Z is admitted as a new partner who brings in
` 8,000 in cash and trademarks and patents valued at ` 2,000. The journal entry will be:
Bank Dr. 8,000
Patents and Trade Marks Dr. 2,000
To Zs Capital Account 10,000
(Capital brought in by Z in the form of cash, patents &
and trade marks)
When a new partner is admitted, a number of things have to be done. Some of the major adjustments to be
made are as follows:
Calculation of new profit sharing ratio
Calculation of sacrificing ratio
Transfer of accumulated profits and reserves to existing partners
Revaluation of assets and liabilities
Treatment of goodwill
198 FP-FA&A
Calculation of New Profit Sharing Ratio
Case 1:When the new profit sharing ratio is not specially mentioned but only the share given to the new
partner is mentioned, the assumption is that the old partners among themselves continue to share profits in
the same relative ratio in the which they were sharing profits prior to admission of the new partner. In such a
case, the share given to the new partner should be deducted from 1 and then the remainder should be
divided among the old partners in the old ratio. Suppose, A and B are partners sharing profits and losses in
the ratio of 3:2 and they admit C as a new partner giving him 1/5 share in future profits. Then the new ratio will
be calculated as follows:
1
Cs share =
5
1 4
Remaining share = 1 - =
5 5
4 3 12
A' s share = =
5 5 25
4 2 8
B' s share = =
5 5 25
1 5
C's share = =
5 25
New ratio for A, B, and C is 12: 8: 5
Case II: Sometimes the new partner purchases his share from the other partner in different proportions.
ths th
Suppose, in the above example C purchases 4/25 share from A and 1/25 share from B. Then the new ratio
will be calculated as follows:
3 4 15 - 4 11
A' s share = - = =
5 25 25 25
2 1 10 - 1 9
B' s share = - = =
5 25 25 25
4 1 5
Cs share =
25 25 25
Hence, the new ratio = 11: 9: 5.
REVIEW QUESTION
1. P and Q are equal partners. R is admitted as a new partner and he is
given 1/5th share in the profit of the firm. What will be the new profit
sharing ratio?
2. A & B are partners sharing profits in the ratio of 3:2. They admit C, a
th th
new partner who acquires 1/5 share from A and 4/25 share from B.
Calculate new profit sharing ratio.
Example: A and B are partners in a business sharing profits and losses in the ratio of 3:2 respectively.
The Profit and Loss Account shows an undistributed profit of ` 5,000 and the General Reserve is ` 10,000.
th
They admit a new partner N with 1/4 share in the profits. The journal entry will be:
Profit and Loss A/c Dr. 5,000
General Reserve A/c Dr. 10,000
To As Capital A/c 9,000
To Bs Capital A/c 6,000
(Being the amount of Profit and Loss A/c
and the General Reserve distributed among
the old partners in the old profit sharing ratio.)
Sometimes, all the partners including the new partner may agree not to alter the book value of assets and
liabilities even when they agree to revalue them. In order to record this, Memorandum Revaluation Account
is opened. It has two parts. In the first part, the entries for revaluation of assets and liabilities are made in the
usual manner. But no record of revaluation of assets and liabilities is made through the respective ledger
accounts. The resultant profit or loss on revaluation in the first part is transferred to the capital accounts of old
partners in the old profit sharing ratio. In order to complete the double entry, entries regarding assets and
liabilities made in the first part are reversed in the second part so that the values of assets and liabilities
remain unchanged. The balance in the second part is transferred to the capital accounts of all the partners
including the new partner in their new profit sharing ratio. If there is a profit, the following entries are passed.
(i) Revaluation account is prepared to find out the (i) Memorandum revaluation account is also
profit or loss on revaluation of assets and prepared to record the effect of revaluation of
liabilities which appear in the new balance sheet assets and liabilities but they are recorded at
at the revalued figures. their old figures in the new balance sheet.
(ii) Revaluation account is not divided in parts. The (ii) Memorandum revaluation account has two parts.
profit or loss of goes to old partners only. The profit or loss of first part goes to old partners
while the profit or loss of the second part goes to
all the partners including the new partner.
Treatment of Goodwill on Admission
Whenever a new partner is admitted, he is generally expected to pay cash to old partners for his share of
goodwill for the right he acquires to share in profits of the firm in future. Strictly, such a payment should be
made only when there are super profits but in actual practice, some premium or goodwill may have to be paid
by the new partner on his admission even when the business of the firm is not unusually profitable and
consequently there are no super profits. The payment is made to the old partners for the sacrifice they make
on their shares of profits for future. It is not necessary that the new partner must bring cash for his share of
goodwill, only adjustment may be made for goodwill. The various alternative courses for the accounting
treatment of goodwill on admission of a partner are as follows:
1) Goodwill should be recorded in the books of account only when some consideration in money or
moneys worth has been paid for it. Whenever a business is acquired for a price (payable in cash or in
shares or otherwise) which is in excess of the value of the net assets of the business taken over, the
excess should be treated as goodwill. For example, when a partnership firm of X and Y purchases the net
assets of Z amounting to ` 6,00,000 for ` 6,50,000 in cash, the additional payment of ` 50,000 is a
payment for goodwill in cash. It is a case of purchased goodwill (an asset) and can be recorded in the
books of account of X and Y. Thus, only purchased goodwill is recorded in the books of account when the
payment is made directly in cash or moneys worth.
2) When no payment is made for the purchase of goodwill, it is a case of internally, generated goodwill or
inherent goodwill. For instance, in the event of reconstitution of the firm as a result of admission, retirement,
death or change in profit sharing ratio, goodwill of the firm is evaluated. In such cases, the value of goodwill
should not be brought into books of account as it is an inherent or self generated goodwill and no money or
moneys worth has been paid for it. The goodwill is calculated as per any of the methods of valuation of
goodwill and adjusted through the capital accounts of the partners. No goodwill account is raised in the
books of accounts on reconstitution of the firm or change in the profit sharing ratio among the partners.
Therefore, the internally generated or inherent goodwill is not raised in the books of account. It is treated
through the capital accounts of the concerned partners. Always remember that in this case the goodwill
raised will not be shown in the balance sheet.
(i) When the incoming partner brings in the required amount of goodwill in cash and this amount is
retained in the business:
The amount of goodwill brought in by the incoming partner along with his share of capital is credited to
his capital account and
Then this amount of goodwill is debited to the new partners capital account and credited to the old
partners capital account in the sacrificing ratio.
202 FP-FA&A
JOURNAL ENTRIES:
(a) Bank Dr.
To New Partners Capital A/c
(Being amount of goodwill and capital brought by the new partner)
(b) New Partners Capital A/c Dr.
To Old Partners Capital Accounts
(Being the amount of goodwill brought in by the new partner shared
by the old partners in the sacrificing ratio)
(ii) When the required amount of goodwill brought in by the new partner in cash is immediately
withdrawn by the old partners
In this case the amount of goodwill is withdrawn by the partners in the sacrificing ratio and the entry for
withdrawal will be:
JOURNAL ENTRIES:
(a) Bank Dr.
To New Partners Capital A/c
(Being amount of goodwill and capital brought by the new partner)
(b) New Partners Capital A/c Dr.
To Old Partners Capital Accounts
(Being the amount of goodwill brought in by the new partner is
shared by the old partners in the sacrificing ratio)
(c) Old Partners Capital Accounts Dr.
To Bank
(Being the amount of goodwill brought in by the new partner is withdrawn
by the old partners in the sacrificing ratio)
(iii) Where the new partner pays amount of goodwill privately to the old partners
In this case, no entry is passed in the books of the firm. The amount to be paid to each partner should be
calculated as per the profit-sacrificing ratio.
(iv) Where the partner is unable to bring anything for goodwill
In this case, the value of goodwill should not be raised in the books. Since it is inherent goodwill, it is
preferable that such value of goodwill should be adjusted through partners capital accounts. The new
partners capital is debited with his share of goodwill and the amount is credited to old partners capital
accounts in the ratio in which they make sacrifice of profits. The journal entry will be:
(v) When the new partner brings a portion of the required amount of goodwill
In this case, the amount brought in by the new partner will be shared by the old partners in the sacrificing ratio
and the portion of amount of goodwill not brought in by the new partner is adjusted through the capital
accounts of partners by debiting, new partners capital account with the amount and crediting the old partners
capital accounts in their sacrificing ratio.
Lesson 8 Partnership Accounts 203
JOURNAL ENTRIES
(a) Old Partners Capital Accounts Dr.
To Goodwill A/c
(Being goodwill written off from the books)
REVIEW QUESTIONS
X and Y are sharing profits and losses in the ratio of 7:4. They admit Z as
5
new partner and the new profit sharing ratio is agreed upon to be X ,Y
11
3 3
and Z . Z brings in ` 20,000 by way of his share of goodwill. How will
11 11
this amount be distributed between X and Y?
It is often agreed that after the admission of a new partner, capitals of all the partners should be in proportion to
their respective shares in profit. The basis may be the amount of capital brought in by the new partner or the
new partner himself may be required to bring in capital equal to his share in the firm. If the new partners capital
is given, the total capital of the firm should be ascertained on that basis. Then, the capital required for each one
of the old partners should be ascertained and it should be compared with the actual balances in the accounts of
204 FP-FA&A
the partners concerned, adjustments may then be made in cash or through current accounts to bring the
balances of capital accounts of all the old partners to the desired figures. Suppose, C brings in ` 10,000 for 1/5th
share of profits. Total capital of the firm should be ` 10,000 x 5 or ` 50,000. If A and B are to share profits as to
1 3 1
A and B , then As capital account should show a balance of ` 50,000 or ` 25,000 and Bs capital
2 10 2
3
should show a balance of ` 50,000 or ` 15,000. If As capital account shows a balance of ` 24,000 and the
10
capital account of B shows a balance of ` 16,500, A will bring in ` 1,000 and B will withdraw ` 1,500.
Alternatively, the new partner may be required to bring capital on the basis of capital of old partners.
Suppose, the capital accounts A and B after all adjustments are ` 32,000 and ` 18,000 respectively and C is
admitted as a new partner to whom 1/5th share of profits is given. Then
1
Cs Share =
5
1 4
Remaining share = 1
5 5
Combined capital of A and B = ` 32,000 + ` 18,000 = ` 50,000
5
Total Capital = 50000
, = ` 62,500
4
1
Cs Capital = ` 62,500 = ` 12,500
5
If A and B are to share profits as to A 1/2 and B 3/10, then
1
As Capital = ` 62,500 = ` 31,250
2
3
Bs Capital = ` 63,500 = ` 18,750
10
A will withdraw ` 750 and B will bring in ` 750.
Illustration 7:
On 31st March, 2013 the following was the Balance Sheet of A and B who were equal partners:
Liabilities ` Assets `
Sundry Creditors 8,940 Cash in hand 950
General Reserve 10,000 Stock 32,710
As Capital Account 35,000 Debtors 11,000
Bs Capital Account 20,000 Less: Provision
for Bad Debts 220 10,780
Furniture and Fittings 9,500
Land and Buildings 20,000
_____ _____
73,940 73,940
On 1st April 2013, C was admitted as a new partner on the following conditions:
(i) A, B and C share profits and losses in the ratio 4:3:2 respectively.
(ii) Prior to Cs admission appreciation of ` 15,000 in the value of land and buildings would be recorded
and provision for bad debts would be brought upto ` 820.
(iii) C would bring ` 20,000 in cash as his capital.
Pass journal entries to record the abovementioned transactions and show the balance sheet of firm
immediately after Cs admission.
Lesson 8 Partnership Accounts 205
Solution :
Journal Entries
Particulars Dr. (`) Cr.( `)
Revaluation Account
Dr. Cr.
Particulars ` Particulars `
To Provision for Bad Debts 600 By Land and Buildings 15,000
To As Capital Account 7,200
To Bs Capital Account 7,200
15,000 15,000
206 FP-FA&A
Particulars A B C Particulars A B C
` ` ` ` ` `
To Balance c/d 47,200 32,200 20,000 By Balance b/fd 35,000 20,000
By General 5,000 5,000
Reserve
By Revaluation 7,200 7,200
By Cash 20,000
47,200 32,200 20,000 47,200 32,200 20,000
If the values of assets and liabilities were not to be changed, the following would have been the solution:
Journal Entries
Particulars Dr. (`) Cr. (`)
General Reserve Dr. 10,000
To As Capital Account 5,000
To Bs Capital Account 5,000
(Transfer of general reserve to old partners in old
profit sharing ratio)
Memorandum Revaluation Account Dr. 14,400
To As Capital Account 7,200
To As Capital Account 7,200
(Record of profit on revaluation)
Bank Dr. 20,000
To Cs Account 20,000
(Amount brought in by C as his capital)
As Capital Account Dr. 6,400
Bs Capital Account Dr. 4,800
Cs Capital Account Dr. 3,200
To Memorandum Revaluation Account 14,400
(Transfer of Memorandum Revaluation Account after
Cs admission to all the partners capital accounts in the
new profit sharing ratio)
Lesson 8 Partnership Accounts 207
Working Notes:
Particulars ` Particulars `
To As Capital Account 7,200 By As Capital account 6,400
To Bs Capital Account 7,200 By Bs Capital Account 4,800
By Cs Capital Account 3,200
_____ _____
14,400 14,400
Journal Entries
Particulars Dr. (`) Cr. (`)
Bank Dr. 24,000
To Rs Capital A/c 24,000
(Amount brought in by R as his capital)
Bank Dr. 5,000
To Ps Capital Account 3,750
To Qs Capital Account 1,250
(Goodwill brought in by R credited to old partners in
their ratio of sacrifice i.e., 3:1)
Ps Capital Account Dr. 1,875
Qs Capital Account Dr. 625
To Bank 2,500
(Half of the amount of goodwill credited to old
partners withdrawn by them in cash)
Journal Entries
Particulars ` `
Case (c):
Journal Entries
Particulars Dr. (`) Cr. (`)
Bank Dr. 24,000
To Rs Capital Account 24,000
(Capital brought in by R)
Bank Dr. 3,000
To Ps Capital Account 2,250
To Qs Capital Account 750
(Being the amount of goodwill brought in by R
credited to old partners in sacrificing ratio)
210 FP-FA&A
Particulars ` `
Rs Capital Account Dr. 2,000
To Ps Capital Account 1,500
To Qs Capital Account 500
(Being portion of Rs share of goodwill adjusted
through the capital accounts by debiting new
partners capital account and credited to old partners
capital accounts in the sacrificing ratio.)
Balance Sheet of P, Q and R
as on 1st April, 2013
Liabilities ` Assets `
Sundry Creditors 10,900 Furniture and Fittings 15,000
Capital Accounts Stock 48,000
P 48,750 Sundry Debtors 16,500
Q 28,250 Bank 30,400
R 22,000 _______
1,09,900 1,09,900
Illustration 9:
A and B sharing profits in proportion of three-fourth and one-fourth showed the following as their Balance
Sheet as on 31st March, 2013:
Liabilities ` Assets `
Creditors 375,000 Cash at Bank 2,25,000
General Reserve 40,000 Bills Receivable 30,000
Capital Account: Debtors 1,60,000
A `3,00,000 Stock 2,00,000
B `1,60,000 4,60,000 Office Furniture 10,000
_____ Land and Buildings 2,50,000
8,75,000 8,75,000
They admit C into partnership on 1st April, 2013 on the following terms:
(1) That C pays ` 10,000 as his capital for a fifth share in the future profits.
(2) That goodwill of the new firm is valued at ` 20,000 and C brings his share of goodwill in cash.
(3) That a stock and furniture be reduced by 10% and a 5% provision for doubtful debts is created on
debtors.
(4) That the value of land and buildings be appreciated by 20%.
(5) That the capital accounts of all the partners be re-adjusted on the basis of their profits-sharing
arrangement and any additional amount be immediately withdrawn by them.
Pass the journal entries; prepare the Profit and Loss Adjustment Account (Revaluation Account), Partners
capital accounts and the opening Balance Sheet of the new firm.
Lesson 8 Partnership Accounts 211
Solution:
Journal Entries
Particulars Dr. (`) Cr. (`)
Profit and Loss Adjustment Account Dr. 29,000
To Stock 20,000
To Office Furniture 1,000
To Provision for doubtful debts 8,000
(Adjustment for writing down the values
of assets)_________________________________________
Land and Buildings Account Dr. 50,000
To Profit and Loss Adjustment Account 50,000
(Adjustment for appreciation in the value
of Land and Buildings)______________________________
General Reserve Account Dr. 40,000
To As capital Account 30,000
To Bs Capital Account 10,000
(Transfer of General Reserve to partners
capital accounts in the profit sharing ratio) _____________
Profit and Loss Adjustment Account Dr. 21,000
To As Capital Account 15,750
To Bs Capital Account 5,250
(Transfer of profit arising from adjustments
to partners capital accounts in their profit-sharing
proportions)________________________________ _
Bank Dr. 1,40,000
To Cs Capital Account 1,40,000
(Amount brought in by C as his share
capital and th share of goodwill)__________ ______
Cs Capital Account Dr. 40,000
To As Capital Account 30,000
To Bs Capital Account 10,000
(Share of goodwill brought in by the incoming
partner credited to old partners in their sacrificing ratio) _ _
As Capital Account Dr. 75,750
To Bank 75,750
(Withdrawal of excess of capital over profit-
sharing proportion)____________________________ _
Bs Capital Account Dr. 85,250
To Bank 85,250
(Withdrawal of excess of capital over his profit sharing
proportion)
212 FP-FA&A
Cs Capital Account
Particulars ` Particulars `
To As Capital A/c 30,000 By Bank 1,40,000
To Bs Capital A/c 10,000
To Balance c/d 1,00,000 ______
1,40,000 1,40,000
By Balance b/d 1,00,000
Lesson 8 Partnership Accounts 213
Note: from the above balance sheet, it is clear that the capitals of the partners now bear the same proportions
as their profit sharing arrangement.
Illustration 10:
st
Ajay and Binoy are partners in a firm sharing profits and losses in the ratio of 2:1 respectively. On 31 March,
2013 their balance sheet stood as follows:
Liabilities (`) Assets (`)
Bills payable 6,000 Cash at bank 90,000
Sundry creditors 90,000 Bills receivable 20,000
General reserve 42,000 Sundry debtors 1,00,000
Ajays capital 2,82,000 Stock 1,60,000
Binoys capital 2,40,000 Furniture 40,000
Machinery 2,50,000
6,60,000 6,60,000
st
On 1 April 2013, a new partner Harry is admitted into partnership on the following terms:
(i) That Harry brings in cash ` 60,000 as goodwill for his one-third share in future profits.
(ii) That Harry brings such an amount that his capital will be one-third of total capital of the new firm.
(iii) That the value of stock be raised to ` 1,68,000.
(iv) That furniture and machinery be depreciated by 5% and 10% respectively.
(v) That a provision for doubtful debts be created at 5% on sundry debtors.
(vi) That the capital accounts of the partners be re-adjusted on the basis of their profit sharing ratio
through their current accounts.
Prepare the necessary ledger accounts and the opening balance sheet of the new firm.
214 FP-FA&A
Solution:
Revaluation Account
Dr. Cr.
Particulars ` Particulars `
To Furniture A/c 2,000 By Stock A/c 8,000
To Machinery A/c 25,000 By Ajays Capital A/c(2/3 loss) 16,000
To Provision for doubtful debts By Binoys Capital A/c (1/3 loss) 8,000
A/c 5,000
32,000 32,000
Capital Accounts
Dr. Cr.
Particulars Ajay Binoy Harry Particulars Ajay Binoy Harry
` ` ` ` ` `
To Revaluation By Balance b/fd 2,82,000 2,40,000
A/c (Loss) 16,000 8,000 -- By General
To Ajays Reserve 28,000 14,000
Capital A/c By Bank
(Goodwill) 40,000 (Goodwill) 60,000
To Binoys By Harrys
Capital A/c Capital A/c
(Goodwill) 20,000 (Goodwill) 40,000 20,000
To Binoys By Bank 3,00,000
Current A/c 66,000 By Ajays
To Balance c/d 4,00,000 2,00,000 3,00,000 Current A/c 66,000 _______ _______
4,16,000 2,74,000 3,60,000 4,16,000 2,74,000 3,60,000
Balance Sheet of Ajay, Binoy and Harry
st
as on 1 April, 2013
Liabilities ` Assets `
Bills Payable 6,000 Cash at Bank 4,50,000
Sundry Creditors 90,000 Bills Receivables ` 20,000
Binoys Current A/c 66,000 Sundry Debtors 1,00,000
Ajays Capital A/c 4,00,000 Less : Provision for
Binoys Capital A/c 2,00,000 Doubtful Debts 5,000 95,000
Harrys Capital A/c 3,00,000 Stock 1,68,000
Furniture 38,000
Machinery 2,25,000
________ Ajays Current Account __66,000
10,62,000 10,62,000
Working Notes:
(i) Calculation of Harrys Capital
Total capital:
Ajays capital: ` (2,82,000 + 28,000 + 40,000 16,000) = ` 3,34,000
Binoys capital: ` (2,40,000 + 14,000 + 20,000 8,000) = ` 2,66,000
Total capital of Ajay and Binoy before Harrys Admission = ` 6,00,000
Lesson 8 Partnership Accounts 215
This capital is for 1-(1/3) = 2/3 share
So total capital of new firm (`6,00,000 x 3/2) = ` 9,00,000
Harrys Capital = 1/3 x `9, 00,000 = ` 3,00,000
(ii) Calculation of new profit sharing ratio and capital of Ajay and Binoy:
Harrys share = 1/3
Balance = 1-(1/3) = 2/3 to be shared by Ajay and Binoy
Ajays new share = 2/3 x 2/3 = 4/9
Binoys new share = 2/3 x 1/3 = 2/9
New profit share ratio = 4:2:3
Ajays capital in new firm = 4/9 x `9,00,000 = `4,00,000
Binoys capital in new firm = 2/9 x `9,00,000 = `2,00,000
Adjustment of capitals is made through partners current accounts
Sacrifice by Ajay = (2/3) (4/9) = 2/9
Sacrifice by Binoy = (1/3) (2/9) = 1/9
Sacrificing ratio = 2:1
So goodwill is distributed between Ajay and Binoy in the ratio of 2 : 1 respectively.
Illustration 11:
st
Bansal and Chandar were partners in a firm sharing profits and losses equally. Their balance sheet as on 31
March, 2013 was as follows:
Liabilities ` ` Assets `
Sundry Creditors 1,26,000 Cash at Bank 14,000
General Reserve 70,000 Debtors 1,40,000
Capital Accounts: Stock 1,68,000
Bansal 2,10,000 Furniture 28,000
Chander 1,68,000 3,78,000 Buildings 2,24,000
5,74,000 5,74,000
Sagar was admitted as a partner and was given one-fourth share of profits on the following terms:
He would bring ` 2,10,000 in cash as his capital.
His share of goodwill was valued at `70,000 but he was unable to bring it in cash.
Stock and furniture be depreciation by 10%.
A provision of 5% on debtors be created for doubtful debts.
An amount of `14,000 included in creditors not to be treated as a liability.
A provision of `7,000 be created against bills discounted.
The buildings be treated as worth `2,80,000.
It was agreed that except cash, the other assets and liabilities were to be shown at old figures in the balance
sheet. Give journal entries to record the transactions and prepare Memorandum Revaluation Account and
capital accounts of the partners. Also prepare the balance sheet after admission of Sagar.
216 FP-FA&A
Solution:
Journal Entries
Particulars Dr. Cr.
(`) (`)
General Reserve Account Dr. 70,000
To Bansals Capital Account 35,000
To Chanders Capital Account 35,000
(The transfer of general reserve to capital accounts of old
partners in the old ratio)
Particulars ` Particulars `
To Provision for Doubtful By Buildings 56,000
Debts 7,000 By Sundry Creditors 14,000
To Stock 16,800
To Furniture 2,800
To Provision for Bills
Discounted 7,000
To Profit transferred to : `
Bansal 18,200
Chander 18,200 36,400 ______
70,000 70,000
To Buildings 56,000 By Provision for Doubtful Debts 7,000
To Sundry Creditors 14,000 By Stock 16,800
By Furniture 2,800
Lesson 8 Partnership Accounts 217
Particulars ` Particulars `
By Provision for Bills Discounted 7,000
By Loss transferred to: `
Bansal (3/8) 13,650
_______ Chander (3/8) 13,650
_70,000 Sagar(1/4) 9,100 ___36,400
___70,000
Dr. Capital Accounts Cr.
RETIREMENT OF A PARTNER
According to Section 32(1) of the Indian Partnership Act, a partner may retire:
(a) with the consent of all the partners;
(b) in accordance with an express agreement by the partners;
(c) where the partnership is at will, by giving notice in writing to all the other partners of his intention to
retire.
Generally, the business of the partnership firm may not come to an end when one of the partners retires.
Other partners continue to run the business of the firm. Just as a number of adjustments have to be made on
the admission of a partner, a number of similar adjustments have to be made before a partner retires. These
adjustments may be as regard to reserves and undistributed profits, revaluation of assets and liabilities,
profits sharing ratio, goodwill etc.
218 FP-FA&A
Calculation of New Profit Sharing Ratio on Retirement
Unless an intention to the contrary is expressed, the assumption should be made that on the retirement of a
partner, the remaining partners continue to share profits and losses in the same relative ratio in which they were
sharing profits and losses prior to retirement of the partner.
The absolute share of the remaining partners may increase but the ratio between the increased shares does not
change because the increase itself is in that very ratio.
Example 1: A, B and C share profits and losses in the ratio of 7:4:3 respectively and B retires.
Now in the absence of an agreement to the contrary, A and C will continue to share profits and losses in the
ratio of 7:3 respectively.
However, their absolute shares will go up. New shares will be: 7/10 and 3/10.
ths ths
Previously, A and C got 7/14 and 3/14 of the profit respectively.
Example 2: If the remaining partners decide to distribute among themselves the share left by the retiring
partner in a different ratio, the relative profit sharing ratio between the remaining partners will also change.
Suppose, A and C agree that one half of Bs share be added to As share and the other half of Bs share be
added to Cs share.
7 1 4 9
Then As share will be or
14 2 14 14
3 1 4 5
and Cs share will be or .
14 2 14 14
Example: If A, B and C share profits and losses in the ratio of 7:5:3 respectively and after Bs retirement A
and C decide to share profits and losses in the ratio of 3:2 respectively, then the ratio of gain will be
calculated as follows:
7
As old share =
15
3
As new share =
5
3 7 97 2
As gain =
5 15 15 15
3
Cs old share =
15
2
Cs new share =
5
2 3 63 3
Cs gain =
5 15 15 15
Hence, ratio of gain between A and C is 2:3 respectively.
Lesson 8 Partnership Accounts 219
Treatment of Reserves and Undistributed Profits on Retirement
Before a partner retires, reserves created out of profits or balances in profit and loss account must be
transferred to the capital accounts of all the partners in the ratio in which they share profits and losses at the
time of retirement (old ratio). It is done so that the retiring partner may get his share of accumulated profits
and may contribute his share of the loss that has not been transferred to capital accounts so far.
The journal will be:
Alternative Method: Only the share of the retiring partner is credited to his capital account for his share of
profit.
Journal Entries
Particulars Dr. (`) Cr. (`)
Revaluation Account Dr. 2,000
To Stock 2,000
(Fall in value of stock debited to revaluation
account)
Plant and machinery A/c Dr. 8,000
Sundry creditors Dr. 1,000
To Revaluation A/c 9,000
(Gain on revaluation of plant and machinery
and sundry creditors credited to revaluation
account)
Revaluation Account Dr. 7,000
To As Capital A/c 3,500
To Bs Capital A/c 2,333
To Cs Capital A/c 1,167
(Revaluation profit transferred to all partners
in the old profit sharing ratio.)
REVIEW QUESTIONS
1. Mahesh, Ramesh and Dinesh were sharing profits and losses in the ratio
of 3:2:1 respectively. On 31st March, 2013 Ramesh decides to retire.
Mahesh agrees to purchase 1/3rd Rameshs share while Dinesh purchases
the balance of Rameshs share. Find out the new profit sharing ratio
between Mahesh and Dinesh.
2. P, Q and R, partners sharing profits and losses in the ratio of 7:4:3
respectively. On 31st March, 2013 Q retires and P and R decide to become
equal partners. Goodwill of the firm is valued at ` 28,000. What adjustment
will you make if no Goodwill Account is to be opened and none already
exist. What will be the entry if Goodwill Account already appears at `
21,000 and it is desired that Goodwill Account be allowed to show the
same balance?
Lesson 8 Partnership Accounts 221
Capitals in Profit Sharing Ratio
After the retirement of a partner, the remaining partners may decide that their capitals be in their new profit
sharing ratio. For this purpose, the total capital of the new firm may be fixed which will then be divided among
the remaining partners in their new profit sharing ratio. Alternatively, the total of the balance of capital accounts
of the remaining partners after all the adjustments in respect of retirement have been made may be considered
to be the total capital of the firm which may then be reallocated to the different partners in their new profit
sharing ratio. The adjustments in the capital accounts for this purpose may be made either by bringing in or
payment of cash or through current accounts.
Liabilities ` Assets `
Sundry Creditors 89,400 Cash in hand 1,800
General Reserves 1,50,000 Cash at Bank 39,700
As Capital Account 2,40,000 Investments 50,000
Bs Capital Account 1,90,000 Debtors 2,10,000
Cs Capital Account 1,75,000 Less:
Provision for Bad debts 2,200 2,07,800
Stock 3,70,100
_______ Furniture and Fittings 1,75,000
8,44,400 8,44,400
On that date, A decided to retire due to ill health and the following adjustments were agreed upon by the
partners:
Investments be appreciated by ` 15,000
Lesson 8 Partnership Accounts 223
Provision for bad debts be brought upto 5% of debtors.
Furniture be depreciated by 10%
Stock be depreciated by ` 7,200
A was paid the amount due to him by means of cheque, the bank agreed to allow the necessary overdraft.
Pass journal entries to record the above mentioned transactions and show the balance sheet of the firm
immediately after As retirement.
Solution:
JOURNAL ENTRIES
Particulars Dr.(`) Cr.(`)
General Reserve Dr. 1,50,000
To As Capital Account 50,000
To Bs Capital Account 50,000
To Cs Capital Account 50,000
(Transfer to general reserve to capital accounts)______
Investments Dr. 15,000
To Revaluation Account 15,000
(Increase in the value of investments)
Revaluation Account Dr. 33,000
To Provision for Bad Debts 8,300
To Furniture 17,500
To Stock 7,200
(Various adjustments as agreed upon by partners)
As Capital Account Dr. 6,000
Bs Capital Account Dr. 6,000
Cs Capital Account Dr. 6,000
To Revaluation Account 18,000
(Transfer of loss on revaluation to partners capital
account)
As Capital Account Dr. 2,84,000
To Bank 2,84,000
(Payment of the amount due to A on his retirement)
Journal Entries
Particulars Dr. (`) Cr. (`)
Goodwill Account Dr. 4,500
To Cs Capital Account 4,500
(Credit given to C for his share of goodwill)
Cs Capital Account Dr. 14,500
To Bank 14,500
(Payment to C)__________________________________
As Capital Account Dr. 1,500
Bs Capital Account Dr. 3,000
To Goodwill Account 4,500
(Transfer of Goodwill Account to the remaining
partners in the ratio of gain which turns out to be 1:2)*
*The ratio of gain in this case has been calculated as under:
As old share = 7
15
As new shares = 8
15
226 FP-FA&A
As gain = 8 7 1
15 15 15
Bs old share = 5
15
Bs new share = 7
15
Bs gain = 7 5 2
15 15 15
Hence ratio of gain between A and B is 1:2
Balance Sheet of A and B as on 1st April, 2013
Liabilities ` Assets `
Sundry Creditors 15,400 Furniture and Fittings 12,000
As Capital Account 38,500 Sundry Debtors 16,000
Bs Capital Account 22,000 Stock 44,000
______ Cash at Bank 3,900
75,900 75,900
Case (ii)
Journal Entries
Journal Entries
Cs Capital Account Dr. 10,000
To Bank 10,000
(Payment to C)
Balance Sheet of A and B as on 1st April, 2013
Liabilities ` Assets `
Sundry Creditors 15,400 Furniture and Fittings 12,000
As Capital Account 40,000 Sundry Debtors 16,000
Bs Capital Account 25,000 Stock 44,000
______ Cash at Bank 8,400
80,400 80,400
Lesson 8 Partnership Accounts 227
Illustration 15:
The balance sheet of Anil, Bashin and Chaman who were sharing profits in proportion to their capitals stood
as follows on 31st March, 2013.
Liabilities ` Assets ` `
Sundry Creditors 69,000 Cash in Bank 55,000
General Reserve 1,80,000 Sundry Debtors 50,000
Capital Accounts: Less : Provision for Bad Debts 1,000 49,000
Anil 2,00,000 Stock 2,60,000
Bashin 1,50,000 Plant and Machinery 1,35,000
Chaman 1,00,000 Land and Buildings 2,00,000
______ ______
6,99,000 6,99,000
Bashin retired on the above date and the following was agreed upon:
That the provision for bad debts be brought upto 5% on debtors.
That land and buildings be appreciated by 25%.
That a provision of ` 350 be made in respect of outstanding legal charges.
That the goodwill of the entire firm be fixed at ` 1,08,000 and Bashins share of it be adjusted into the
accounts of Anil and Chaman who are going to share future profits in the ratio of 5:3 respectively.
That the entire capital of the new firm be fixed at ` 4,80,000 and the capital accounts of the partners
be made in their new profit sharing ratio; actual cash to be brought in or paid off as the need be.
Pass journal entries, show profit and loss adjustment account and capital accounts and prepare balance
sheet of Anil and Chaman.
Solution:
Journal Entries
Particulars ` `
General Reserve Dr. 1,80,000
To Anils Capital Account 80,000
To Bashins Capital Account 60,000
To Chamans Capital Account 40,000
(Transfer of general reserve to capital accounts)
Profit and Loss Adjustment Account Dr. 5,000
To Provision for Bad Debts 1,500
To Outstanding Legal Expenses 3,500
(Increase in provision for bad debts and record of
outstanding legal expenses)
Land and Building Dr. 50,000
To Profit and Loss Adjustment Account 50,000
(Appreciation in the value of land and buildings)
228 FP-FA&A
Particulars ` `
Profit and Loss Adjustment Account Dr. 45,000
To Anils Capital Account 20,000
To Bashins Capital Account 15,000
To Chamans Capital Account 10,000
(Transfer of profit on revaluation)
Particulars ` Particulars `
To Provision for Bad Debts A/c 1,500 By Land and Buildings 50,000
To Outstanding Legal Expenses A/c 3,500
To Anils Capital A/c (4/9 profit) 20,000
To Bashins Capital A/c (3/9 profit) 15,000
To Chamans Capital A/c (2/9 profit) 10,000 _____
50,000 50,000
Dr. Capital Accounts Cr.
Particulars Anil Bashin Particulars Anil Bashin Chaman
(`) (`) Chaman (`) (`) (`)
(`)
To Bashins By Balance
Capital A/c 19,500 16,500 b/fd 2,00,000 1,50,000 1,00,000
To Bashins By General
Loan A/c 2,61,000 Reserve 80,000 60,000 40,000
To Balance By P & L
c/d 3,00,000 1,80,000 Adjustment
A/c 20,000 15,000 10,000
By Anils
Capital 19,500
By Chamans
Capital 16,500
_______ _______ ______ By Bank __19,500 _____ __46,500
3,19,500 2,61,000 1,96,500 3,19,500 2,61,000 1,96,500
By
Balance b/d 31,950 26,100 1,96,500
Lesson 8 Partnership Accounts 229
Balances Sheet of Anil and Chaman
as on 1st April, 2013
Liabilities ` Assets ` `
Sundry Creditors 69,000 Cash in Bank 1,21,000
Outstanding Legal Expenses 3,500 Sundry Debtors 50,000
Bashins Loan Account 2,61,000 Less: Provision
for Bad Debts 2,500 47,500
Capital Accounts: `
Anil 3,00,000 Stock 2,60,000
Chaman 1,80,000 4,80,000 Plant and Machinery 1,35,000
______ Land and Buildings 2,50,000
8,13,500 8,13,500
Working Notes:
5 4 45 32 13
Anils gain in profit =
8 9 72 72
3 2 27 16 11
Chamans gain in profit =
8 9 72 72
Ratio of Gain = 13:11
3
Bashins share of goodwill = ` 1, 08, 000x or `36,000
9
13
Anils will be debited with ` 36, 000 or ` 19,500 and
24
11
Chaman will be debited with ` 36, 000 or ` 16,500 for goodwill.
24
Illustration 16:
On 31st March, 2013 the balance sheet of M/s. Ashok, Basu, and Chauhan, who were sharing profits and
losses in proportion to their capitals, stood as follows:
Liabilities ` Assets `
Capital Accounts: Land and Buildings 2,00,000
Ashok 3,00,000 Machinery 2,00,000
Basu 2,00,000 Closing Stock 1,00,000
Chauhan 1,00,000 6,00,000 Sundry Debtors 2,00,000
Sundry Creditors 2,00,000 Cash and Bank Balances 1,00,000
8,00,000 8,00,000
On 31st March, 2013, Ashok desired to retire from the firm and the remaining partners decided to carry
on. They agreed on the following terms and conditions:
230 FP-FA&A
(i) Land and buildings be appreciated by 30%
(ii) Machinery be depreciated by 20%
(iii) Closing stock to be valued at ` 80,000.
(iv) Provision for bad debts be made at 5%.
(v) Old credit balances of sundry creditors amounting to ` 10,000 be written back.
(vi) Joint Life Policy of the partners be surrendered. Cash received was ` 60,000.
(vii) Goodwill of the entire firm be valued at ` 1,80,000 and Ashoks share of the goodwill be adjusted in the
accounts Basu and Chauhan who would share the future profits equally.
(viii) The total capital of the firm was to be the same as before retirement. Individual capitals of
partners were to be in their profit sharing ratio.
(ix) Amount due to Ashok was to be settled on the following basis:
50% on retirement and balance 50% within one year.
Prepare Revaluation Account, Capital Accounts of the Partners, Loan Account of Ashok, Cash Book and
st
Balance Sheet as on 1 April 2013 of M/s. Basu and Chauhan.
Solution:
Particulars ` Particulars `
To Bank 2,10,000 By Balance b/d 3,00,000
To Ashok Loan A/c 2,10,000 By Revaluation A/c 30,000
By Basus Capital A/c
(Goodwill) 30,000
By Chauhans Capital A/c
_______ (Goodwill) 60,000
4,20,000 4,20,000
Particulars ` Particulars `
To Balance c/d 2,10,000 By Ashoks Capital A/c 2,10,000
By Balance b/d 2,10,000
M/s. B and C
Balance Sheet as on 1.4.2013
Liabilities ` ` Assets `
DEATH OF A PARTNER
All the problems which arise on the retirement of a partner also arise in case of the death of a partner.
However, there are a few additional points which have to be noted.
If the balance of deceased partners capital account is not immediately paid in cash, the amount should be
transferred to the deceased partners Executors Account and not to any Loan Account.
A partner usually retires at the close of an accounting year when his capital account is credited with his share
of profits for the year. But a partners death may take place any day. Partnership deed may provide that in
case of death of a partner during the accounting year, the deceased partners capital account will be credited
with his share of profits for the period for which he remained alive during the year on the basis of profits of the
year preceding the year in which death takes place. Suppose, a partner C getting 1/3 share in profits died on
30 June 2013 and the profits for the year ended 31st March, 2013 have been ` 18,000. Then Cs Capital
3 1
Account will be credited with ` 1500 (` 18,000 = ` 1,500) for his share of profits for 3 months. Of
12 3
course, some other basis may also be provided for, or the partnership deed may provide that final accounts
will be prepared to ascertain profits for the part of the year.
Under this method, the annual premium is treated as an expense and debited to the Profit and Loss Account.
On the death of a partner, the amount of the policy received by the firm is credited to all the partners capital
accounts in the profit sharing ratio.
JOURNAL ENTRIES
(i) For payment of premium of the joint life policy
(a) Joint Life Insurance Premium A/c Dr.
To Bank
(Amount of premium paid on joint life policy)
Lesson 8 Partnership Accounts 233
2. When premium paid is treated as an asset and surrender value is taken into account
Under this method, Joint Life Policy Account is debited with the amount of premium as and when paid. At the
end of the year, the amount in excess of surrender value is treated as loss and transferred to Profit and Loss
Account. The balance in Joint Life Policy Account is shown as an asset in the balance sheet. The amount
received on maturity of policy in excess of surrender value will be net gain and divided among all the partners
in their profit sharing ratio.
JOURNAL ENTRIES
(i) Joint Life Policy A/c Dr.
To Bank
(The premium paid on policy) ________
(ii) Profit and Loss A/c Dr.
To Joint Life Policy A/c
(The adjustment of book value with the
surrender value i.e. excess of joint life policy
over the surrender value)_____________ __
(iii) Bank Dr.
To Joint Life Policy A/c
(Amount received on maturity of policy)_
(iv) Joint Life Policy A/c Dr.
To All Partners Capital Accounts
(The amount received minus the surrender
value on that date distributed among the
partners.)___ _______________
_
3. When premium paid is treated as an asset and life policy reserve account is maintained.
Under this method, whenever premium is paid, the amount of the premium is debited to Joint Life Policy
Account. At the end of the year, Profit and Loss account is debited and Joint Life Policy Reserve Account is
credited with the amount of the premium paid for the year. Then, in order to reduce the balances of Joint Life
Policy Account and Joint Life Policy Reserve Account to the figure of surrender value of the policy, Joint Life
Policy Reserve Account is debited and Joint Life Policy Account is credited with the difference between
balance of Joint Life Policy Account and surrender value of the policy. The entries are repeated every year.
On maturity of the policy, the amount received from the insurance company is credited to Joint Life Policy
Account, Joint Life Policy Reserve Account is transferred to Joint Life Policy Account and the balance in Join
Life Policy Account is transferred to all the partners capital accounts in their profit sharing ratio. The amount
standing to the credit of Joint Life Policy Reserve Account may alternatively be transferred directly to partners
capital accounts in their profit sharing ratio.
234 FP-FA&A
JOURNAL ENTRIES
(i) For payment of premium of the Joint Life Policy
Joint Life Policy A/c Dr.
To Bank
(The amount of premium paid on Joint Life
Policy)
(ii) For appropriation of amount equal to annual premium
Profit and Loss A/c Dr.
To Joint Life Policy Reserve A/c
(The amount transferred to Joint Life Policy
Reserve Account)
(iii) For adjusting the difference between the premium paid and the
increase in the surrender value
Joint Life Policy Reserve A/c Dr.
To Joint Life Policy A/c
(Excess of premium over surrender value adjusted)
(iv) For receipt of the policy money
(a) Bank Dr.
To Joint Life Policy A/c
(The amount received of joint life policy on maturity)
(b) Joint Life Policy Reserve A/c Dr.
To Joint Life Policy A/c
(The credit balance of joint life policy
reserve account transferred
to Joint Life Policy A/c)
(c) Joint Life Policy A/c Dr.
To All Partners Capital Accounts
(Balance joint life policy transferred to capital accounts
in the old profit sharing ratio of all the partners)
If instead of one joint life policy, a number of individual policies are taken, on the death of a partner, the
amount of the policy of the life of the deceased partner will be received in cash. The other policies will be
shown at their respective surrender values while ascertaining the amount due to the executors of the
deceased partner.
Average profit for four years = 60, 000 75, 000 90, 000 95, 000 = ` 80,000
4
1 1
Goodwill at 1 times=80,0001 `1,20,000
2 2
Less: Existing goodwill ` 30,000
Increase in the value of goodwill ` 90,000
Calculation of gain in joint life policy
Sum received from insurance company 1,50,000
Less: Joint life policy amount 20,000
Net gain to be distributed amongst the partners 1,30,000
236 FP-FA&A
` `
Amount payable to As legal representatives 2.10,000
Add: Desired cash in hand 30,000
Amount required 2,40,000
Less: Amount received from Insurance company 1,50,000
Existing balance of cash in hand 10,000 1,60,000
Shortage of cash to be brought in By B and C 80,000
Bs capital after adjustment of Goodwill and Life Policy 70,000
Cs capital after adjustment of Goodwill and Life Policy 50,000
Shortage of cash to be brought in 80,000
Total capital of B and C after As death 2,00,000
Share of B being 1/2th of ` 20,000 1,00,000
Less: Already in the business 70,000
Cash to be introduced by B 30,000
Share of C being 1/2 of ` 20,000 1,00,000
Less: Already in the business 50,000
Cash to be introduced by C 50,000
Balance Sheet of B and C
Liabilities ` ` Assets `
Journal Entries
Particulars ` Particulars `
To Cs Executors 89,250 By Balance b/fd 50,000
By Reserve fund 8,000
By Interest on Capital 1,875
By As Capital A/c 16,667
By Bs Capital A/c 8,333
_______ By Profit and Loss A/c 4,375
89,250 89,250
Working Notes
(i) Calculation of Goodwill
Total profit of three years = ` 2,10,000
Lesson 8 Partnership Accounts 239
Average Profit = ` 2,10,000 3 = ` 70,000
Goodwill = ` 70,000 2 = ` 1,40,000
Existing Goodwill = ` 40,000
Goodwill to be increased by ` 1,00,000
Cs Share = ` 1,00,000 4 = ` 25,000
(ii) Calculation of Cs Share of Profit
Average Profit = ` 70,000
1 3
Cs Share for 3 months = ` 70,000 = ` 4,375
4 12
DISSOLUTION OF PARTNERSHIP
Dissolution of a firm means that the business of the firm is put to an end, assets are disposed of, liabilities are
paid off, and the accounts of all the partners are also settled. Dissolution of a firm differs from dissolution of a
partnership. A partnership is dissolved on the expiry of the term or on the completion of the specified venture,
death, retirement or insolvency of a partner. However if the remaining partners decide to continue to run the
business, the partnership firm is not dissolved. If they do not continue, then the firm is also dissolved
automatically. Thus, there is difference between dissolution of partnership and dissolution of firm which may
be summarized as under:
In case of dissolution of firm, the firm ceases to continue its business i.e. the business comes to an
end. But in the case of dissolution of partnership, the business of the firm is continued.
In dissolution of firm, the partnership among all the partners no longer exists while in case of
dissolution of partnership, the partnership among all the partners does not come to an end.
Dissolution of partnership does not necessarily mean dissolution of firm whereas dissolution of firm
necessarily implies dissolution of partnership.
A firm is dissolved when:
the partners of the firm decide to dissolve it,
all the partners or all the partners except one become insolvent,
the business of the firm is declared illegal,
in case partnership at will, a partner gives notice of dissolution,
The Court may order dissolution of the firm which may happen in the following circumstances:
(a) where a partner has become of unsound mind,
(b) where a partner suffers from permanent incapacity,
(c) where a partner is guilty of misconduct affecting the business,
(d) where there is persistent disregard of partnership agreement by a partner,
(e) where a partner transfers his interest or share to a third person,
(f) where a business cannot be carried on except at a loss, and
(g) where a dissolution appears to the Court to be just and equitable on any other ground.
Important principles
The private property of a partner should be used to pay his private debts first and if there is
any surplus it can be used to pay firms liabilities.
Similarly, firms assets should be first used to pay firms liabilities. A partner can use his
share of the surplus only to pay his private liabilities.
The liability of partners is joint and several. It means that if a partner is unable to bring in
his share of loss, the other partners have to make up his share of loss also.
Realisation Account
Revaluation Account
(i) The effect of the revaluation of assets and (i) It records the sale of various assets and
liabilities is recorded in revaluation account. payment of liabilities.
(ii) Revaluation account is prepared at the time (ii) It is prepared only at the time of dissolution of
of reconstitution of the firm. the firm.
(iii) Revaluation account is prepared to find out (iii) Realisation account is prepared to find out the
the profit (loss) on the revaluation of assets profit (loss) on the realization of assets and
and liabilities. settlement of liabilities.
(iv) It contains only those assets and liabilities (iv) It contains generally all assets and liabilities.
which are revalued.
(v) The balance of this account is transferred to (v) The balance of this account is transferred to the
the old partners capital accounts. capital accounts of all partners.
(vi) Accounting entries are made on the basis of (vi) Accounting entries are made at the book values
the difference between book value and of assets and liabilities.
revalued figures.
(vii) On revaluation, the accounts of assets and (vii) The accounts of assets and liabilities are closed
liabilities are not closed. on preparation of realization account.
REVIEW QUESTIONS
C, on his admission paid ` 20,000 for goodwill on the condition that
partnership will be for 10 years. But after only 3 years, the firm has to be
dissolved due to misconduct of B, an old partner. Will C be entitled to get
refund of the amount paid by him by way of goodwill?
(Ans. : Yes, but only ` 14,000)
Will it make any difference if the firm is dissolved due to misconduct of C
himself?
(Ans.: Yes, C wont get anything)
What will be the position if the partnership firm has to be dissolved due to
Bs death?
(Ans.: wont get anything)
242 FP-FA&A
Insolvency of a Partner
In dissolution, if the capital account of a partner shows a debit balance, he will have to pay the amount to the
firm. But if he is insolvent, he will not be able to do so; he will not be able to pay the full amount of such a
debit balance. The sum which becomes irrecoverable from a partner due to his insolvency is a loss to be
borne by other partners. Before the decision in Garner v. Murray case was made, such loss used to be
treated as an ordinary loss and transferred to the capital accounts of the solvent partners in their relative profit
sharing ratio. But decision in Garner v. Murray changed the position.
Decision in Garner Vs. Murray
According to the decision in Garner v. Murray, in case of insolvency of a partner:
(a) first, the solvent partners should bring in cash equal to their respective shares of the loss on
realisation, and
(b) then, the loss due to the insolvency of a partner should be divided among the other partners in the
ratio of capitals then standing.
The effect of this decision practically is that the deficiency in the capital Important Note:
account of the insolvent partner has to be borne by the solvent partners in
the ratio of capitals standing just prior to dissolution. If on the date of dissolution, a
partner had no credit balance in
If the capitals are fixed, then the loss due to the insolvency of a partner will his capital account, he will not
be borne by the solvent partners in the ratio of their capitals. bear any loss on account of
insolvency of another partner.
If the capitals are fluctuating, all necessary adjustments in respect of This is irrespective of his private
reserves or profit and loss account are first made (but the loss on wealth.
realisation is not adjusted) in the capital accounts of all the partners, and
then the ratio of their capitals is calculated to transfer the deficiency of the insolvent partner.
Particulars ` Particulars `
To Sundry Assets: By
Provision for Bad Debts 1,020
Goodwill 10,000 By
Mrs. As Loan 5,000
Plant and Machinery 20,000 By
Bills Payable 10,000
Furniture 8,000 By
Sundry Creditors 6,530
Investments 10,000 By
Bank 1,00,600
Stock 51,060 By
As Current Account
Debtors 23,600 (Investments) 13,000
Bills Receivable 5,000 By Bs Current Account
Unexpired Insurance 125 (B/R) 4,800
To Bank (Liabilities) 21,420 By As Current Account
To Bank (Expenses) 1,441 (1/3rd loss) 3,232
By Bs Current Account
(1/3rd loss) 3,232
By Cs Current Account
_______ (1/3rd loss) 3,232
1,50,646 1,50,646
Particulars ` Particular `
To Balance b/fd 2,760 By Realisation (liabilities) 21,420
To Realisation A/c By Realisation (expenses) 1,441
(Sale proceeds of assets) 1,00,600 By Bs Loan Account 5,000
By As Capital Account 19,628
By Bs Capital Account 24,863
_______ By Cs Capital Account 31,008
1,03,360 1,03,360
246 FP-FA&A
Dr. Partners Current Accounts Cr.
Particulars A B C Particulars A B C
(`) (`) (`) (`) (`) (`)
To Balance 105 By Balance
b/fd b/fd 12,860 1,240
To Realisation 13,000 4,800 By General
To Realisation Reserve 3,000 3,000 3,000
(loss) 3,232 3,232 3,232 By As Capital 10,372
To Cs Capital 1,008 By Bs Capital 5,137
_______ _______ _______ _______ ______ ________
16,232 8,137 4,240 16,232 8,137 4,240
Dr. Partners Capital Accounts Cr.
Particulars A B C Particulars A B C
(`) (`) (`) (`) (`) (`)
To As Current By Balance
A/c 10,372 b/fd 30,000 30,000 30,000
To Bs Current By Cs Current
A/c 5,137 A/c 1,008
To bank 19,628 24,863 31,008 _______ ______ ________
30,000 30,000 31,008 30,000 30,000 31,008
Illustration 22:
A, B and C commenced business on 1st April, 2012. They agreed to share the profits and losses in the ratio
of 2: 2: 1. Their capitals were ` 30,000, ` 22,500 and ` 15,000 respectively. The partnership deed provided for
interest on capital at 6% per annum. During 2012-13 the firm earned a profit of ` 20,050 (before providing for
interest on capital). During the year the partners drawings were A `7,000; B ` 6,250; and C 4,000.
The relations between partners were not good. They decided to dissolve the firm on 31st March, 2013. The
assets were sold which realised ` 75,000. There were creditors to the extent of ` 12,000 which were paid off
at a discount of 5%. Expenses of realisation amounted to ` 1,200.
Prepare the necessary accounts to close the books of the firm.
Solution:
Profit and Loss Account
Dr. Cr.
Date Particulars ` Date Particulars `
2013 2013
Mar. 31 To Capital Accounts Mar. 31 By Net Profit 20,050
(interest)
`
A 1,800
B 1,350
C 900 4,050
To Profit trans-
ferred to:
`
A 6,400
B 6,400
C 3,200 16,000 _____
20,050 20,050
Lesson 8 Partnership Accounts 247
Dr. As Capital Account Cr.
Date Particulars ` Date Particulars `
2013 2012
Mar.31 To Drawings 7,000 Apr.1 By Bank 30,000
To Balance c/d 31,200 2013
Mar.31 By Profit & Loss A/c
(interest) 1,800
By Profit & Loss A/c
_____ (share of profit) 6,400
38,200 38,200
2013 2013
Mar. 31 To Realisation (loss) 3,160 Mar. 31 By Balance b/d 31,200
To Bank 28,040 ______
31,200 31,200
Dr. Bs Capital Account Cr.
2013 2012
Mar. 31 To Drawings 6,250 Apr. 1 By Bank 22,500
To Balance c/d 24,000 2013
Mar. 31 By Profit & Loss A/c
(interest) 1,350
By Profit & Loss A/c
_____ (share of profit) 6,400
30,250 30,250
2013 2013
Mar. 31 To Realisation (loss) 3,160 Mar. 31 By Balance b/d 24,000
To Bank 20,840 ______
24,000 24,000
Dr. Cs Capital Account Cr.
Date Particulars ` Date Particulars `
2013 2012
Mar. 31 To Drawings 4,000 Apr. 1 By Cash 15,000
To Balance c/d 15,100 2013
Mar. 31 By Profit & Loss A/c
(interest) 900
By Profit & Loss A/c
_____ (share of profit) 3,200
19,100 19,100
2013 2013
Mar. 31 To Realisation (loss) 1,580 Mar. 31 By Balance b/d 15,100
To Bank 13,520 ______
15,100 15,100
248 FP-FA&A
Liabilities ` Assets `
Sundry Creditors 12,000 Sundry Assets 82,300
Capital Accounts:
A 31,200
B 24,000
C 15,100 70,300 ______
82,300 82,300
Cash Account
Note: Since, current accounts have not been specified in the question the adjustments have been made in
capital accounts.
Case (ii) Loss due to deficiency is divided in the ratio of fluctuating capital accounts
Realisation Account will be the same as in the case (i)
Capital Accounts
Particulars A B C Particulars A B C
(` ) (` ) (` ) (` ) (` ) (` )
To Realisation 20,000 10,000 10,000 By Balance
b/d 30,000 20,000 14,000
To Cs Capital 2,343 1,532 By Gen. Res. 2,500 1,250 1,250
To Cash A/c 30,157 19,718 By Cash A/c 20,000 10,000 3,875
By As Capital
(26/43ths share) 2,343
By Bs Capital A/c
_____ _____ _____ (17/43ths share) _____ 1,532
52,500 31,250 10,000 52,500 31,250 10,000
Balances in As Capital Account and Bs Capital Account after adjustment for General Reserve
are ` 32,500 and ` 21,250 respectively. Hence, A and B will bear the loss of ` 3,875 due to Cs
insolvency in the ratio of 32,500 : 21,250 or 26 : 17 respectively.
As share = ` 3,875 26 = ` 2,343
43
Bs share = ` 3,875 17 = ` 1,532
43
Dr. Cash Account Cr.
Particulars ` Particulars `
To Balance b/fd 200 By Realisation A/c (Creditors) 16,000
To Realisation A/c (Assets) 32,000 By Realisation A/c (Expenses) 200
To As Capital Account 20,000 By As Capital Account 30,157
To Bs Capital Account 10,000 By Bs Capital Account 19,718
To Cs Capital Account 3,875
_____ _____
66,075 66,075
Lesson 8 Partnership Accounts 251
Illustration 24:
A, B, C and D are partners in a firm sharing profits and losses in the ratio of 4 : 1 : 2 : 3. The following is
the balance sheet as at March 31st, 2013.
Liabilities ` ` Assets ` `
Sundry creditors 30,000 Cash in hand 14,000
Capital accounts: Sundry debtors 35,000
A 70,000 Less: Provision for bad debt 5,000 30,000
D 30,000 1,00,000 Other assets 51,000
Capital accounts:
B 20,000
C 15,000 35,000
_______ _______
1,30,000 1,30,000
On March 31st, 2013, the firm is dissolved. The partnership agreement provides that the deficiency of an insolvent
partner will be borne by the solvent partners in the ratio of capitals as they stand just before dissolution.
The following arrangements are agreed upon:
(i) A is to take over 60% of book debts at 70% and D is to take over the balance at 75%. Further, they
are to be allowed ` 2,100 and 1,100 respectively to cover future losses.
(ii) D is to realise other assets and to pay off the creditors. He is to receive 5% gross commission on the
amounts finally payable to other partners but to bear expenses of realisation. He reports the results of
realisation as follows:
Other assets realize at a loss of 2% on net collection and pays of the creditors at a discount of 30%. Realisation
expenses amount to ` 3,000 but the same is paid by the firm. B is declared insolvent and a dividend of 20% in a
rupee is realised from his estate.Prepare Cash Account, Realisation Account and Capital Accounts.
Solution:
Dr. Cash Account Cr.
Particulars ` Particulars `
To Balance b/fd 14,000 By Realisation A/c
To Realisation A/c 50,000 (payment to creditors) 21,000
To Bs Capital A/c By Ds Capital A/c (expenses) 3,000
(20% dividend) 4,000 By As Capital A/c 44,000
To Cs Capital A/c 15,000 By Ds Capital A/c 15,000
______ ______
83,000 83,000
Dr. Realisation Account Cr.
Particulars ` Particulars `
To Debtors 35,000 By Provision for bad debts 5,000
To Other assets 51,000 By Sundry creditors 30,000
To Cash A/c By Cash A/c (realisation
(30,000 9,000) of other assets) 50,000
(payment to creditors) 21,000 By As Capital A/c
(debtors taken over) 12,600
By Ds Capital A/c
(debtors taken over) 9,400
_______ _______
1,07,000 1,07,000
252 FP-FA&A
Particulars ` Particulars `
To Realisation A/c By Balance b/fd 70,000
(debtors taken over) 12,600
To Bs Capital A/c
(deficiency) 11,200
To Ds Capital A/c
(commission) 2,200
To Cash A/c
(final payment) 44,000
_____ _____
70,000 70,000
Particulars ` Particulars `
To Balance b/fd 20,000 By Cash A/c 4,000
By As Capital A/c
(7/10ths deficiency) 11,200
By Ds Capital A/c
(3/10ths deficiency) 4,800
_____ ______
20,000 20,000
Particulars ` Particulars `
To Balance b/fd 15,000 By Cash A/c 15,000
_____ _____
15,000 15,000
Particulars ` Particulars `
To Realisation A/c By Balance b/fd 30,000
(debtors taken over) 9,400 By As Capital A/c
To Cash A/c (expenses) 3,000 (commission) 2,200
To Bs Capital A/c (deficiency) 4,800
To Cash A/c (final payment) 15,000
_____ _____
32,200 32,200
Working Notes:
Sundry Debtors taken over by A:
` 35,000 x 60% x 70% = ` 14,700
Less: Allowance for further loss = ` 2,100
Lesson 8 Partnership Accounts 253
` 12,600
Sundry Debtors taken over by D:
` 35,000 x 40% x 75% = ` 10,500
Less : Allowance for further loss = ` 1,100
` 9,400
Ds Commission
Gross amount payable ` 46,200
5
Commission 46,200 ` 2,200
105
Illustration 25:
Below is the Balance Sheet of C, D and E as on 31st March, 2013
Liabilities ` Assets `
Sundry Creditors 2,00,000 Cash 31,200
Loan 1,00,000 3,00,000 Stock 1,56,300
Capital Accounts: Debtors 47,200
C 80,000 Furniture 95,300
D 60,000 Profit & Loss Account 1,20,000
E 10,000 1,50,000 _______
4,50,000 4,50,000
The firm was dissolved due to insolvency of all the partners. Stock was sold for ` 1,09,000 while furniture
fetched ` 40,000. ` 41,000 were received from Debtors. Expenses were ` 2,200. Nothing could be recovered
from D and E but Cs private estate showed a surplus of ` 6,000. Close the books of the firm.
Solution:
Dr. Realisation Account Cr.
Particulars ` Particulars `
To Stock 1,56,300 By Cash A/c (assets) 1,90,000
To Debtors 47,200 By Cs Capital A/c 37,000
To Furniture 95,300 By Ds Capital A/c 37,000
To Cash A/c (expenses) 2,200 By Es Capital A/c 37,000
_______ _______
3,01,000 3,01,000
Dr. Capital Account Cr.
Particulars C D E Particulars C D E
(`) (`) (`) (`) (`) (`)
To Profit and By Balance b/fd 80,000 60,000 10,000
Loss A/c - By Cash A/c 6,000
Transfer 40,000 40,000 40,000 By Deficiency 17,000 67,000
To Realisation
(Loss) 37,000 37,000 37,000
To Deficiency A/c 9,000
_____ _____ _____ ______ ______ _____
86,000 77,000 77,000 86,000 77,000 77,000
254 FP-FA&A
Dr. Cash Account Cr.
Particulars ` Particulars `
To Balance b/d 31,200 By Realisation A/c (expenses) 2,200
To Realisation A/c (assets) 1,90,000 By Loan A/c 75,000
To Cs Capital Account 6,000 By Sundry Creditors 1,50,000
_______ _______
2,27,200 2,27,200
Dr. Loan Account Cr.
Particulars ` Particulars `
To Cash A/c 75,000 By Balance b/fd 1,00,000
To Deficiency A/c 25,000
_______ _______
1,00,000 1,00,000
Particulars ` Particulars `
To Cash A/c 1,50,000 By Balance b/fd 2,00,000
To Deficiency A/c 50,000 _______
2,00,000 2,00,000
Particulars ` Particulars `
To Ds Capital Account 17,000 By Loan Account 25,000
To Es Capital Account 67,000 By Sundry Creditors 50,000
_____ By Cs Capital 9,000
84,000 84,000
LESSON ROUND UP
Partnership is the relationship between persons who have agreed to share the profits of a business
carried on by all or any of them acting for all.
Following are the features of partnership:
There must be an agreement entered into by all the persons concerned.
There must be a business and for this purpose business would include any trade, profession or
occupation.
The business must be carried on for the purpose of earning profits which would be divided among
the partners.
The business must be carried on by some or all of the partners for the benefit of all of them.
In partnership accounts, capital accounts of the partners may be fixed or fluctuating depending upon
the method of recording.
Lesson 8 Partnership Accounts 255
Profit and loss appropriation account is prepared to make adjustments regarding salary to partners,
interest on capital and drawing, commission, etc. and then the profit is distributed among the partners
in the agreed ratio.
When there is a change in profit sharing ratio, it results in gain to one partner and loss to the others.
On admission of a new partner, one is required to: calculate new profit sharing ratio, find out sacrificing
ratio, adjust the re-value of assets and liabilities, treat the goodwill, and make adjustments for reserves,
past profit or loss and capital according to new profit sharing ratio.
The difference between the old ratio and the new ratio is known as sacrificing ratio.
Revaluation account is prepared to find out the effects of revaluation of assets and liabilities on
admission and retirement/death of a partner and the effect of net increase or decrease in assets and
liabilities is transferred to old partners in old profit sharing ratio.
On the admission of a new partner, capitals of all the partners may be required to be in proportion to
their respective shares in profit and the capital brought in by the new partner may be taken as the
basis.
On retirement of a partner, adjustments may be made for reserves and undistributed profits,
revaluation of assets and liabilities, profit sharing ratio, goodwill, share of the partner in the profit or loss
up to the date of retirement, share of joint life policy, etc.
The net amount payable to the retiring partner after making all adjustments will be settled by paying
cash or by transferring it to a separate loan account.
Whenever a partner dies, the deceased partners share is calculated and the payment is made to the
legal representatives of the deceased partner.
Dissolution of partnership is different from dissolution of firm. In case of dissolution of firm, the firm
ceases to continue its business but in the case of dissolution of partnership, the business of the firm is
continued.
On dissolution, the books of accounts of the firm are closed. For this, a realisation account is prepared.
Capital accounts of the partners are also prepared, the partners with debit balances in their capital
accounts are required to bring in the required cash while partners with credit balances in their capital
accounts are paid off.
When a partner cannot bring cash because of insolvency, the other partners have to share such a
deficiency according to the rule laid down in Garner vs. Murray.
GLOSSARY
Partners Persons who have entered into partnership with one another.
Partnership deed The written contract of partnership.
Goodwill Present value of a firms anticipated super normal earnings.
Sacrificing ratio The difference between old profit sharing ratio and the new profit sharing ratio of the
old partners.
Surrender The sum of money an insurance company will pay to the policy holder in the event of
Value voluntary termination of the policy before its maturity if the insured event occurs.
256 FP-FA&A
SELF-TEST QUESTIONS
Theory Questions:
1. What is meant by partnership?
2. What is a partnership deed?
3. Distinguish between fluctuating and fixed capital accounts.
4. Why is interest allowed on capital?
5. Why is interest charged on drawings? How is it calculated?
6. What is goodwill? In what ways can it be treated on admission of a partner?
7. Why are adjustments in the values of assets and liabilities made on the admission of a partner?
8. What are the accounting adjustments necessary at the time of retirement of a partner?
9. What is the significance of purchase of shares of a retiring partner by the remaining partners?
10. What is dissolution of a firm? How does if differ from dissolution of a partnership?
11. When is a firm dissolved?
12. When may the Court order dissolution of a firm?
13. On dissolution of a firm, in what order are payments made to creditors and partners?
14. What is Garner v. Murray rule? What is its effect in case of insolvency of a partner? Will it make any
difference if capital accounts of the partners are fixed or fluctuating?
15. How does insolvency of all the partners of a firm affect the creditors of the firm?
Practical Questions:
1. 1st March, 2013 the following was the balance sheet of A and B who were carrying on business in
partnership sharing profits and losses in the ratio of 3:2 respectively:
Liabilities ` ` Assets ` `
2. Following is the balance sheet of A and B (sharing profit and losses in the ratio of 3:2 respectively
on 31st March, 2013:
Liabilities ` Assets `
A retires on that date. Goodwill is valued at ` 2,50,000. It is also agreed that plant and machinery be
depreciated by 10% and provision for bad debts amounting to ` 1,500 be made. A new partner named C is
admitted who buys one half of As share, B buying the remaining half share. Find out the amount brought in
by C and prepare the initial balance sheet of B and C.
st
3. Balance Sheet C, D and E as on 31 March, 2012
Liabilities ` Assets `
C died on 31st December, 2012 by which date he had withdrawn ` 8,500. Partnership deed provided that in
case of death of a partner, in addition to the amount standing to the credit of capital and current accounts of
such a partner, the executors will also been titled to a share of the profits from the closing of the last accounting
year to the date of death on the basis of the last years profits. It also provided that goodwill of the firm in case of
death of a partner should be revalued at 2 years purchase of the average profits of the last three years. Profits
for 2009-10, 2010-11, and 2011-12 were ` 37,500, ` 45,800 and ` 37,700 respectively.
Investments were sold for ` 24,000 net at the stock exchange to pay immediately to Cs executors for one-
third of the total amount due to them.
Find out the balance left in Cs Executors Account? Calculations may be made to the nearest rupee.
(Hints: Profit on sale of investment will be shared by the executors also since it is due to appreciation in the
value of assets within the life time of C.)
258 FP-FA&A
4. A, B and C were carrying on business in partnership sharing profit and loses in the ratio 3:2:1
respectively. On 31st March, 2013 balance sheet of the firm stood as follows:
Liabilities ` Assets `
5. A, B and C were equal partners. On 31st March, 2013 their balance sheet stood as follows:
Liabilities ` Assets `
On this date, the firm was dissolved due to Cs insolvency. Only ` 1,17,000 could be realised from debtors
while stock and furniture fetched ` 1,16,800 and ` 80,000 respectively. Expenses came to ` 1,800. Cs
estate could pay only 50% of what was due from C. Show Realisation Account and the accounts of the
partners. Assume the capitals are fluctuating. Apply Garner v. Murray rule.
Lesson 8 Partnership Accounts 259
260 FP-FA&A
Lesson 9
Introduction to Company Accounts
LESSON OUTLINE
LEARNING OBJECTIVES
Basic Concepts of Company Accounts The company form of business organization is
Issue of Shares formed to overcome the limitations of partnership
For Cash form of business organization. A company is an
Under Subscription of Shares association or collection of individual real persons
Over Subscription of Shares and/or other companies, who provide some form
Calls in Advance and Interest on Calls in of capital with a common purpose or focus and
Advance
an aim of gaining profits. Thus, a company can
Calls in Arrears and Interest on Calls in
Arrears be defined as an artificial person created by law,
Issue of shares for consideration other with a discrete legal entity, perpetual succession
than cash and a common seal. It is not affected by the death,
Review Questions insanity or insolvency of an individual member.
Forfeiture of Shares
Company accounting is different from sole
Re-issue of Forfeited Shares
proprietorship and partnership accounting.
Forfeiture and Re-issue of Shares allotted
on Pro-Rata basis in case of over Company being a legal entity, has to maintain
subscription proper books of accounts to give a true and fair
Issue of Debentures view of the state of affairs of the company. The
For cash books are kept on accrual basis and according
For consideration other than Cash to double entry system of accounting. The
As Collateral Security company has to prepare its balance sheet and
Redemption of Preference Shares profit & loss account from the books of account
Out of the profits of the company
maintained by it.
Out of the proceeds of the fresh issue
Out of the profits of the company and In this lesson, we will study some basic concepts
proceeds of the fresh issue of company accounts like shares, share capital,
Lesson Round Up entries for issue of share, debentures, forfeiture
Glossary and re- issue of shares and redemption of
Self-Test Questions preference shares.
We are not going to see a signficant upside until we get a clearer sense of how companies make their money
and how it is accounted for.
Charles Pradilla
262 FP-FA&A
Meaning of Shares
Share as defined in Section 2(84) of the Companies Act, 2013 means a share in the share capital of a
company and it also includes stock. A share is one unit into which the total share capital is divided. It is a
fractional part of the share capital and forms the basis of ownership in the company. For example, when a
company has a share capital of ` 5,00,000 divided into 50,000 shares of ` 10 each and a person who has
taken 50 shares of that company is said to have a share in the share capital of the company to the tune of `
500. In other words, shares are divisions of the share capital of a company.
(a) Equity share capital: Equity share capital with reference to any company limited by shares means all
share capital which is not preference share capital. Equity share capital can be
(b) Preference share capital: Preference share capital with reference to any company limited by shares
means that part of the issued share capital of the company which carries or would carry a preferential
right with respect to
payment of dividend, either as a fixed amount or an amount calculated at a fixed rate, which may
either be free of or subject to income-tax; and
repayment, in the case of a winding up or repayment of capital, of the amount of the share capital
paid-up or deemed to have been paid-up, whether or not, there is a preferential right to the
payment of any fixed premium or premium on any fixed scale, specified in the memorandum or
articles of the company.
Deemed preference share capital: The capital shall be deemed to be preference capital,
notwithstanding that it is entitled to either or both of the following rights, namely:
that in respect of dividends, in addition to the preferential rights to the payment of dividend, it has a
right to participate, whether fully or to a limited extent, with capital not entitled to the preferential
right aforesaid;
that in respect of capital, in addition to the preferential right to the repayment, on a winding up,
Lesson 9 Introduction to Company Accounts 263
it has a right to participate, whether fully or to a limited extent, with capital not entitled to
that preferential right in any surplus which may remain after the entire capital has been
repaid.
(b) Issued Capital: It refers to that part of the authorized capital of the company which has actually been
offered to the public for subscription in cash and the shares allotted to vendors/promoters for consideration
other than cash. It sets the limit of the capital available for subscription. The prescribed form of the Balance
Sheet requires that under the head Issued Capital, should be stated (i) the different classes of share capital
as also the sub-classes of the preference shares, (ii) the date and terms of redemption or conversion (if any)
of any redeemable preference capital, and (iii) any option on un-issued share capital.
(c) Subscribed Capital: It refers to that part of the issued capital which has actually been subscribed by the
public and subsequently allotted to them by the directors of the company which are fully paid or partially paid.
(d) Called up Capital: It is that portion of the subscribed capital which the shareholders are called upon to
pay on the shares allotted to them. A company does not necessarily require the full amount at once on the
shares subscribed and hence calls up only such portion as it needs. The balance then remaining is known as
uncalled capital.
(e) Paid-up Capital: It refers to that part of the called up capital which has actually been paid by the
shareholders. This is the actual capital of the company which is included in the total of the Balance Sheet.
Paid-up capital is equal to the called up capital if all the shareholders have paid the amount called up by the
company.
ISSUE OF SHARES
When a public company desires to raise capital by issuing its shares to the public, it has to invite the public to
subscribe for its shares. The invitation is made through a document called the prospectus. The person who
intends to subscribe to those shares should make an application for the desired number of shares to the
company. Then, the company will allot shares to the applicant.
Allotment means the appropriation of a certain number of shares to an applicant in response to his
application. The company cannot allot more than the number of shares offered to the public for subscription
through the prospectus. Moreover, the company cannot make allotment unless the amount stated in the
prospectus as the minimum subscription has been subscribed and the sum payable on application for the
stated amount has been received by the company.
If the number of shares applied for is less than the number of shares offered, the allotment can be only for the
shares applied for provided minimum subscription is raised. The minimum subscription is 90% of the issued
amount.
264 FP-FA&A
ISSUE OF SHARES
FOR CASH
FOR CONSIDERATION
OTHER THAN CASH
Note:
(i) When the capital of the company consists of shares of different classes, a separate share application
account will be opened for each class of shares, i.e. equity share application account/preference share
application account etc.
(ii) Unless shares are allotted by the company, the receipt of application is simply an offer and cannot be
credited to Share Capital Account.
(iii) If the company fails to raise the minimum subscription, then no shares can be allotted and the application
money has to be returned to the applicants. For this, the entry will be as follows:
Share Application and Allotment A/c Dr. (With the application money
To Bank received now refunded)
(iv) In actual practice, the cash transactions are not journalised but the same have to be entered in the cash
book. The entry in the Cash Book will be as follows:
Lesson 9 Introduction to Company Accounts 265
Cash Book (Bank Columns)
Dr. Cr.
Particulars ` Particulars `
Example: A Ltd. issued 10 lakh equity shares of ` 10 each payable in full on application. The company
received application for 10 lakh shares. Applications were accepted in full.
Journal Entries
Particulars Dr. Cr.
Bank Dr. 1,00,00,000
To Equity Share Application and Allotment A/c 1,00,00,000
(Application money on 10 lakh equity shares @ `10
per share)
Equity Share Application and Allotment A/c Dr. 1,00,00,000
To Equity Share Capital A/c 1,00,00,000
(Allotment of 10 lakh equity shares of ` 10 each)
(b) When shares are issued at par and the amount is payable in installments:
When shares are not payable in a lump sum, the amount can be called in a number of installments. After
allotment, whenever the need arises, the directors may demand further money from the shareholders towards
payment of the value of shares taken up by them. Such demands are termed as calls. The different calls are
distinguished from each other by their serial numbers, i.e. first call, second call, third call and so on. The last
installment is also termed the final call along with the number of the last call.
First installment is called application money
Second installment is called allotment money
Third installment is called first call money and
The last installment is called final call money.
JOURNAL ENTRIES
(i) On receipt of application money
Bank Dr. (with the amount received
To Share Application Account on application)
(Being the application money received in respect
of...... shares @ `.........per share)
(v) On receipt of allotment money is received the following journal entry is made
Bank Dr. (with the actual amount
To Share Allotment Account received as allotment money)
(Being the amount received on.......shares @
`........ each)
The shares of many successful companies which offer attractive rates of dividend on their existing capitals
fetch a higher price than their face value in the market. When shares are issued at a price higher than the
face value, they are said to be issued at a premium. Thus, the excess of issue price over the face value is the
amount of premium. For example, if a share of Rs. 10 is issued at Rs. 12, Rs. (12 10) = Rs. 2 is the
premium.
The premium on issue of shares must not be treated as revenue profits. On the contrary, it must be regarded
as capital receipt. The Companies Act requires that when a company issues shares at a premium whether for
cash or otherwise, a sum equal to the aggregate amount of the premium collected on shares must be credited
to a separate account called Securities Premium Account. There are no restrictions in the Companies Act on
the issue of shares at a premium, but there are restrictions on its disposal. Under Section 52(2) of the
Companies Act 2013, the Securities Premium Account may be applied by the company
(a) towards the issue of unissued shares of the company to the members of the company as fully paid
bonus shares;
(b) in writing off the preliminary expenses of the company;
(c) in writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or
debentures of the company;
(d) in providing for the premium payable on the redemption of any redeemable preference shares or of
any debentures of the company; or
(e) for the purchase of its own shares or other securities under section 68.
It is to be noted here that utilization of the amount of Securities Premium Account except in any of the modes
specified above, will attract the provisions relating to the reduction of share capital of a company under the
section 66 of the Companies Act 2013.
The Securities Premium Account must be shown as Securities premium reserves separately in the liabilities
side of the balance sheet under the head Reserves & Surplus.
The premium is usually payable with the installment due on allotment. However, some companies may
charge premium with share application money or partly with share application money and partly at the time of
allotment of shares. It may be included in call money also.
JOURNAL ENTRY
When allotment money becomes due:
Share Allotment A/c Dr. (with the money due on allotment
including premium)
To Securities Premium A/c (with the premium amount)
To Share Capital A/c (with the share allotment amount)
(Being allotment money due on shares
issued at premium)
As per companies Act 2013, a company shall not issue shares at a discount except as provided in section 54
for issue of sweat equity shares. Any share issued by a company at a discounted price shall be void.
Where a company contravenes the provisions of this section, the company shall be punishable with fine
which shall not be less than one lakh rupees but which may extend to five lakh rupees and every officer
who is in default shall be punishable with imprisonment for a term which may extend to six months or
with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees, or with
both.
REVIEW QUESTIONS
1. When shares are issued at a price higher than the face value, they are
said to be issued at _____.
2. ____ means the appropriation of a certain number of shares to an
applicant in response to his application.
3. When shares are issued at a price lower than the face value, they are
said to be issued at ________.
Illustration 1:
P Ltd. was registered with an authorised capital of ` 10,00,000 divided into 1,00,000 equity shares of ` 10
each out of which 50,000 equity shares were offered to the public for subscription. The shares were payable
as under:
` 3 per share on application
` 2 per share on allotment
` 2 per share on 1st call
` 3 per share on 2nd and final call
The shares were fully subscribed for and the money was duly received.
Show the journal and cash book entries.
Solution:
In the books of P Ltd.
Journal Entries
Date Particulars ` `
12% Preference Share First Call A/c Dr. 2,50,000
270 FP-FA&A
To 12% Preference Share Capital A/c 2,50,000
(First call money due @ ` 25 per share on 10,000, 12%
Preference Shares as per Boards resolution dated.......)
Calls-in-Arrear A/c Dr. 25,000
To 12% Preference Share First Call A/c 25,000
(First call money due on 1,000, 12% Pref. Shares @ ` 25 per
share transferred to Call-in-Arrear A/c)
12% Preference Share Final Call A/c Dr. 2,50,000
To 12% Preference Share Capital A/c 2,50,000
2,50,000
(Final call money due @ ` 25 per share on 10,000, 12% Pref.
shares as per Boards resolution dated...)
Calls-in-Arrear A/c Dr. 50,000
To 12% Preference Share Final Call A/c 50,000
(Final call money due on 2,000, 12% Pref. Shares @ ` 25 per
share transferred to Calls-in-Arrear A/c)
OVER-SUBSCRIPTION OF SHARES
When the number of shares applied for exceeds the number of shares issued, the shares are said to be over-
subscribed. In such a situation, the directors allot shares on some reasonable basis because the company can
allot only that number of shares which has been actually offered for subscription. Moreover, as per the
guidelines issued by SEBI, the company cannot reject out-rightly any application for shares unless it has
incomplete information or absence of signature(s) or insufficient application money and so on. In short, the
following procedure is adopted:
(i) Total rejection of some applications;
(ii) Acceptance of some applications in full; and
(iii) Allotment to the remaining applicants on pro-rata basis.
The shares should be issued in tradable lot. In case of pro-rata allotment, no applicant for shares is refused
and no applicant is allotted the shares in full. Each applicant receives the shares in some proportion. In such
cases, the excess amount of application money (i.e. overpaid amount) is not refunded but retained and treated
as a payment towards allotment money. The following journal entry is made to transfer excess application
money to allotment account.
Surplus money exceeding that due on allotment should be refunded to the allottees. However, the company
may transfer this to Calls-in-Advance Account if:
(i) Acceptance of calls in advance is permitted by the companys Articles.
(ii) The consent of the applicant has been taken either by a separate letter or by inserting a clause in the
companys prospectus.
The company can retain the calls in advance at the most so much amount as is sufficient to make the allotted
shares fully paid up ultimately.
The journal entry will be as follows:
Accounting Treatment
(i) On receipt of call money in advance:
Bank Dr. (with the amount of call
To Call-in-Advance A/c money received in advance)
(Being the calls received in advance)
(ii) As and when calls are made:
Calls-in-Advance A/c Dr. (with the amount adjusted on
To Relevant Call A/c relevant call becoming due)
The amount received as calls-in-advance is a debt of the company, the company is liable to pay interest on the
amount of Calls-in-Advance from the date of receipt of the amount till the date when the call is due for
payment. Generally the Articles of the company specify the rate at which interest is payable. If the articles do
not contain such rate, Table A will be applicable which leaves the matter to the Board of directors subject to a
maximum rate of 12% p.a.
It is to be noted that the interest payable on Calls-in- Advance is a charge against the profits of the company.
As such, Interest on Calls-in-Advance must be paid even when no profit is earned by the company.
Accounting Treatment
(i) If Interest on Calls-in-Advance is paid in cash -
Interest on Calls-in-Advance A/c Dr. (with the amount of
To Bank interest paid)
(Interest on Calls-in-Advance paid @ .....% p.a. on
`........... for............ months)
(ii) If interest on Calls-in-Advance is not paid in cash -
Interest on Calls-in-Advance A/c Dr. (with the amount of
To Sundry Shareholders A/c interest payable)
When payment is made, Sundry shareholders
. Debited and Bank articles.
(iii) At the end of the year, when interest on Calls-in-Advance is transferred to Profit and Loss A/c -
Profit and Loss A/c Dr. (with the amount of interest)
To Interest on Calls-in-Advance A/c
Note: The liability to sundry shareholders is to be treated as outstanding liability and should be shown under
the head Current Liabilities in the balance sheet.
Lesson 9 Introduction to Company Accounts 273
Illustration 3:
Newlook Ltd. issued, 1,00,000 Equity Shares of ` 10 each payable as follows:
On Application (On 1st March, 2012) `4
On Allotment (On 1st April, 2012) `1
On First Call (On 1st August, 2012) `3
On Final Call (On 1st October, 2012) `2
Application were received for 2,60,000 shares. Of these 10,000 shares were in disorder; 40,000 shares in lots of
100 shares; 1,20,000 shares in lots of exceeding 100 but less than 500 shares; 60,000 shares in lots of exceeding
500 but less than 1,000 shares and the balance in lots of exceeding 1,000 shares.
Allotment was made as follows:
Application for the 10,000 shares in disorder were rejected.
9 10 11 12 13 14 15 16
` ` ` ` ` ` ` `
Journal Entries
(i) When call money is in arrear:
Calls-in-Arrear A/c Dr. (with the amount-failed by
To Relevant Call A/c the shareholders)
Illustration 4:
On 1st January, 2012, New Ventures Ltd. issued 1,00,000 equity shares of `10 each payable as follows:
On application `3
On allotment `2
On 1st Call ` 2 (Payable after 2 months, from the
date of allotment)
On Final Call ` 3 (Payable after 2 months from the
date of 1st call)
Applications were received on 15th January, 2012 for 1,20,000 shares and allotment was made on 1st
February, 2012. Applicants for 50,000 shares were allotted in full, those for 60,000 shares were allotted 50,000
shares and applications for 10,000 shares were rejected.
Balance of amount due on allotment was received on 15th February. The calls were duly made on 1st March,
2012 and 1st April, 2012 respectively. One shareholder did not pay the 1st call money on 3,000 shares which
he paid with the final call together with interest at 5% p.a. Another shareholder holding 2,000 share did not pay
st
the final call money till end of the accounting year which ended on 31 March, 2013. Show the Cash Book and
Journal Entries.
Lesson 9 Introduction to Company Accounts 277
Solution:
Journal Entries
Journal Entries
(i) When assets are acquired from the vendors -
Illustration 5:
Rocket Ltd. purchased the business of Comet Ltd. for ` 2,70,000 payable in fully paid shares. Rocket Ltd.
allotted equity shares of ` 10 each fully paid in satisfaction of the claim by Comet Ltd. Show the necessary
journal entries in the books of Rocket Ltd. assuming that:
Solution:
Journal Entries
Particulars Dr. (`) Cr.( `)
Sundry Assets Dr. 2,70,000
To Comet Ltd. 2,70,000
(Purchase of assets from Comet Ltd. as per agreement
dated.....)
(a) If shares are issued at par
Comet Ltd. Dr. 2,70,000
To Equity Share Capital A/c 2,70,000
(Allotment of 27,000 equity shares of ` 10 each to vendors
as fully paid-up for consideration other than cash as per
Boards resolution dated...)
(b) If shares are issued at a premium of 20%
Comet Ltd. Dr. 2,70,000
To Equity Share Capital A/c 2,25,000
To Securities Premium A/c 45,000
(Allotment of 22,500 equity shares of ` 10 each at a
premium of `2 per share to vendors as fully paid-up for
consideration other than cash as per Boards resolution
dated.....)
280 FP-FA&A
Working Notes:
20
Issue price per share = ` 10 = ` 12
100
Illustration 6:
Bright Ltd. was registered with a share capital of ` 10,00,000 in equity shares of ` 10 each. The company
acquired factory building worth ` 1,00,000 and plant and machinery worth ` 80,000 from Delite Ltd. and issued
18,000 equity shares of ` 10 each to the vendors as fully paid-up. The directors also decided to allot 2,000
equity shares credited as full paid to the promoters for their services. Further capital was issued to the public
for cash to the extent of ` 3,00,000 payable in full with the application. All the shares were taken up by the
public and fully paid for. Show the necessary journal entries and the balance sheet.
Solution:
Journal Entries
Particulars Dr. (`) Cr.( `)
Factory Building A/c Dr. 1,00,000
Plant and Machinery A/c Dr. 80,000
To Delite Ltd. 1,80,000
(Purchase of assets from Delite Ltd. as per agreement dated.....)
Delite Ltd. Dr. 1,80,000
To Equity Share Capital A/c 1,80,000
(Allotment of 18,000 equity shares of ` 10 each to vendors as fully paid-
up for consideration other than cash as per Boards resolutions dated.....)
Goodwill A/c Dr. 20,000
To Equity Share Capital A/c 20,000
(Allotment of 2,000 equity shares of ` 10 each to promoters as fully paid-
up for consideration other than cash as per Boards Resolution dated.....)
Bank Dr. 3,00,000
To Equity Share Application and Allotment A/c 3,00,000
Lesson 9 Introduction to Company Accounts 281
(Application money on 30,000 equity shares ` 10 each per share)
Equity Share Application and Allotment A/c Dr. 3,00,000
To Equity Share Capital A/c 3,00,000
(Allotment of 30,000 equity shares of ` 10 each as fully paid as per
Boards resolution dated.....)
II Assets
Non-current Assets
Fixed Assets
Tangible Assets 2 1,80,000
Intangible Assets 3 20,000
Current Assets
Cash and Cash Equivalents 4 3,00,000
Total 5,00,000
Notes:
1. Share Capital
Authorised
1,00,000 Equity Shares of ` 10 each 10,00,000
Issued, Subscribed and Paid-up :
50,000 Equity Shares of ` 10 each, fully paid-up 5,00,000
(Of the above shares, 20,000 equity shares have
been issued to vendors and promoters for
consideration other than cash)
2. Tangible Assets
Factory Building 1,00,000
Plant and Machinery 80,000
1,80,000
3. Intangible Assets
Goodwill 20,000
4. Cash and Cash Equivalent
Balance with Bank 3,00,000
282 FP-FA&A
FORFEITURE OF SHARES
If a shareholder fails to pay the allotment money and/or calls made on him, his shares are liable to be
forfeited. Forfeiture of shares may be said to be the compulsory termination of membership by way of penalty
for non-payment of allotment and/or any call money.
The Companies Act does not contain any specific provisions regarding forfeiture. The directors must follow
certain procedure for forfeiting the shares. They have to give notice to the defaulting shareholder calling upon
him to pay the amount due from him together with interest before a specified date (not being earlier than the
expiry of fourteen days from the date of service of the notice). This notice must also state that if the
shareholder fails to pay the amount along with interest due within the specified date, the shares will be
forfeited. If the payment is not received within the specified time, the directors meet to consider the forfeiture
and they can proceed to forfeit the shares. The directors must pass a resolution for forfeiting the shares at a
duly constituted meeting of the Board of Directors and the defaulting shareholder should be informed about
the forfeiture of his shares.
The effect of forfeiture of shares is that the defaulting shareholder loses all his rights in the shares and ceases
to be a member. The name of the shareholder is removed from the Register of Members and the amount
already paid by him is forfeited. He is not entitled in future to dividends and the rights of membership.
However, the directors have the right to cancel such forfeiture before the forfeiture shares are re-issued.
Forfeited shares account is to be shown in the balance sheet by way of addition to the paid-up share capital
on the liabilities side, until the concerned shares are reissued.
Issued at Par
Issued at A Premium
JOURNAL ENTRIES
The forfeiture of shares can be recorded in two ways:
1. Where the unpaid calls have already been transferred to Calls-in-Arrear A/c and the respective
call accounts have been closed:
Share Capital A/c Dr. (with the amount of called up value of shares forfeited i.e.
no. of shares forfeited x the called up value per share.
To Shares Forfeited A/c with the amount already paid-up by the shareholders on
the shares forfeited.)
To Calls-in-Arrear A/c (with the amount of unpaid calls.)
OR
2. Where the unpaid calls have not been transferred to Calls-in-Arrear A/c and the respective call
accounts are showing balances representing unpaid amounts:
Share Capital A/c Dr. (with the amount of called up value of shares forfeited i.e.,
no. of shares forfeited x the called up value per share.)
To Shares Forfeited A/c (with the amount already paid up by the shareholders on
the shares forfeited.)
To Share Allotment A/c (with the amount failed on allotment, if any.)
To Share First Call A/c (with the amount failed on first call, if any.)
To Share Final Call A/c (with the amount failed on final call, if any.)
Lesson 9 Introduction to Company Accounts 283
Forfeiture of Shares Issued at a Premium
Case 1: Where shares to be forfeited were issued at a premium and the premium money remained unpaid:
In this case the credit already given to the Securities Premium A/c will be cancelled at the time of forfeiture of
the shares by debiting Securities Premium A/c.
JOURNAL ENTRIES
Share Capital A/c Dr. (with the amount of called up value of shares
forfeited, i.e., no. of shares forfeited x called up
value per share excluding premium).
Securities Premium A/c Dr. (with the amount of premium money remaining
unpaid on shares forfeited.)
To Shares Forfeited A/c (with the amount already paid by the
shareholders on the shares forfeited.)
To Calls-in-Arrear A/c (with the amount unpaid on calls.)
OR
Share Capital A/c Dr. (with the amount of called up value of shares
forfeited, i.e., no. of shares forfeited x called up
value per share excluding premium.)
Securities Premium A/c Dr. (with the amount of premium money remaining
unpaid on shares forfeited.)
To Shares Forfeited A/c (with the amount already paid by the
shareholders on the shares forfeited.)
To Share Allotment A/c (with the amount failed on allotment, if any.)
To Share First Call A/c (with the amount failed on first call, if any.)
To Share Final Call A/c (with the amount failed on final call, if any.)
Case 2: Where shares to be forfeited were issued at a premium and the premium money was duly received
on the shares to be forfeited:
In this case Securities Premium Account is already credited at the time of making call will not be cancelled at
the time of forfeiture of the shares. In such a case, the accounting entry on forfeiture will be the same as the
one passed in case of shares issued at par.
JOURNAL ENTRIES
1. On re-issue of shares:
Bank Dr. (with the amount received on reissue
To Share Capital A/c i.e. no. of shares re-issued x amount
received per share.)
284 FP-FA&A
JOURNAL ENTRIES
1. On re-issue of shares:
Bank Dr. (with the total amount received on re-
issue.)
To Share Capital A/c (with nominal value or paid-up value of
shares.)
To Securities Premium A/c (with the premium amount received.)
JOURNAL ENTRIES
1. On re-issue of shares:
Bank Dr. (with the amount received on re-issue.)
Shares Forfeited A/c Dr. (with the discount allowed on re-issue.)
To Share Capital A/c (with the total.)
Important Note: In case only a part of the forfeited shares are re-issued, only the
proportionate amount representing the net gain on the shares re-issued should be
transferred to Capital Reserve Account and the balance representing the amount received
on forfeited shares not yet re-issued should be left in the Shares Forfeited Account itself.
This amount should be shown as addition to the paid up capital on the liabilities side of the
balance sheet.
Lesson 9 Introduction to Company Accounts 285
Illustration 7:
X Ltd. forfeited 1,000 equity shares of ` 10 each issued at par for non-payment of the first call of ` 2 per share
and the final call of ` 3 per share. Give journal entry for the forfeiture.
Solution:
In the books of X Ltd.
Journal Entries
Date Particulars Debit (`) Credit (`)
Equity Share Capital A/c (1,000 x `10)* Dr. 10,000
To Shares Forfeited A/c (1,000 x ` 5)* 10,000
To Calls-in-Arrear A/c (1,000 x ` 5)
(Forfeiture of 1,000 equity shares for non-payment of the first
call @ ` 2 per share and the final call @ ` 3 per share as per
Boards resolution dated...)
Alternatively:
Equity Share Capital A/c (1,000 x `10)* Dr. 10,000
To Shares Forfeited A/c (1,000 x ` 5)* 5,000
To Equity Share First Call A/c 2,000
To Equity Share Final Call A/c 3,000
(Forfeiture of 1000 equity shares for non-payment of the first
call @ ` 2 per share and the final call @ ` 3 per share as per
Boards resolution dated...)
Illustration 8:
X Ltd. forfeited 1,500 equity shares of ` 10 each, issued at a premium of ` 5 per share for non-payment of
allotment money of ` 8 per share (including share premium ` 5 per share) the first call @ ` 2 per share and the
final call @ ` 3 per share. Give the journal entry for the forfeiture.
Solution
In the books of X Ltd.
Journal Entries
Date Particulars Debit Credit
(`) (`)
Equity Share Capital A/c (1,500 x `10)* Dr. 15,000
Securities Premium A/c (1,500 x `5)* Dr. 7,500
To Shares Forfeited A/c (1,500 x ` 2)* 3,000
To Equity Share Allotment A/c 12,000
To Equity Share First Call A/c 3,000
To Equity Share Final Call A/c 4,500
Note: As the premium has already been received on these shares, Securities Premium Account will not be
debited.
Illustration 10:
Give journal entries for the forfeiture and re-issue of shares in the following cases:
(a) P Ltd. forfeited 300 shares of ` 10 each, fully called up for non-payment of final call @ ` 4 per share.
These shares were subsequently re-issued by the company @ ` 10 per share as fully paid-up.
(b) Q Ltd. forfeited 300 shares of ` 10 each, fully called up for non-payment of final call @ ` 4 per share.
These shares were subsequently re-issued by the company @ ` 12 per share as fully paid-up.
(c) R Ltd. forfeited 200 shares of ` 10 each, ` 8 per share being called up on which a shareholder paid
application and allotment money @ ` 5 per share but did not pay the first call money @ ` 3 per share.
Of these forfeited shares, 150 shares were subsequently re-issued by the company as fully paid-up @
` 8 per share.
(d) S Ltd. forfeited 100 shares of ` 10 each, ` 8 per share having been called up, which were issued at a
discount of 10% for non-payment of first call money @ ` 3 per share. Of these forfeited shares, 80
shares were subsequently re-issued by the company @ ` 5 as ` 8 paid-up.
Lesson 9 Introduction to Company Accounts 287
Solution:
Journal Entries
Date Particulars ` `
Bank Dr. 3,000
To Share Capital A/c (300 x `10) 3,000
(Re-issue of 300 forfeited shares of ` 10 each fully paid-up as
per Boards resolution dated...)
Shares Forfeited A/c Dr. 1,800
To Capital Reserve A/c 1,800
(Transfer of profit on re-issue of forfeited shares to Capital
Reserve A/c)
(b) In the books of Q Ltd.
Journal Entries
Date Particulars Debit Credit
(`) (`)
Share Capital A/c (300 x `10) Dr. 3,000
To Shares Forfeited A/c (300 x ` 6) 1,800
To Share Final Call A/c (300 x ` 4) 1,200
1. A company forfeited 1,000 shares of ` 10 each held by Mr. X for non payment
of allotment money of ` 4 per share. Called up value is ` 9 what will be total
amount debited to share capital?
2. A company forfeited 2000 shares of ` 10 each for non payment of final call of
` 2 per share. What will be the amount of share forfeiture account?
On Application -- `2
On Allotment -- ` 5 (including premium)
On First Call -- `3
On Second and Final Call -- `2
Applications were received for 3,000 shares and allotment was made pro-rata to the applicants of 2,400
shares. Money overpaid on applications was employed on account of sum due on allotment.
Ramesh, to whom 40 shares were allotted, failed to pay the allotment money and on his subsequent failure to
pay the first call, his shares were forfeited. Mohan, the holder of 60 shares failed to pay the two calls and his
shares were forfeited after the second and final call.
Of the shares forfeited, 80 shares were sold to Krishna credited as fully paid for ` 9 per share, the whole of
Rameshs share being included. Show journal and cash book entries and the Balance Sheet.
Solution:
Working Notes:
1. Ratio between allotment of shares and application for shares = 2,000: 2,400 = 5: 6,
2. Ramesh was allotted 40 shares.
Therefore, Ramesh must have applied for 40 x 6/5 = 48 shares.
3. Ramesh must have paid excess application money on (48 - 40) = 8
290 FP-FA&A
Excess applications @ ` 2 per share, i.e., 8 x ` 2 = ` 16 retained by the company for adjustment
against allotment money.
4. Allotment money due from Ramesh on 40 shares @ ` 5 per share = 40 x ` 5 = ` 200.
5. As the allotment money was failed by Ramesh against which excess money paid on application was
adjusted, the net amount failed by Ramesh on Allotment = ` (200 - 16) = ` 184.
6. As Mohan paid the allotment money and the excess amount paid by him along with the application had
already been adjusted, pro rata allotment in this case has no significance.
7. Amount to be transferred to Capital Reserve A/c from Shares Forfeited A/c has to be determined as
follows:
`
Amount forfeited on 40 shares held by Ramesh (48 x ` 2) 96
Amount forfeited on 60 shares held by Mohan (60 x ` 5) 300
Total amount credited to Shares Forfeited A/c 396
Less: Amount on 20 forfeited shares held by Mohan which are not yet re-issued
(20 x ` 5) 100
296
Less: Discount allowed @ ` 1 on 80 shares (80 x ` 1) 80
Net gain on 80 forfeited shares which are reissued to ___
be transferred to Capital Reserve 216
ISSUE OF DEBENTURES
Meaning of Debentures
Besides raising capital by the issue of shares, a company may supplement its capital by borrowings. Such
borrowings may take the form of both short-term and long-term borrowings. Short-term borrowings by way of
promissory notes, bills of exchange, bank overdrafts, cash credits, public deposits, etc., are needed by a
company to provide for its working capital while long-term borrowings by way of loan on mortgage of property,
term loans from financial institutions, public deposits for a long period, issue of debentures, etc., are needed
by a company for financing expenditure of a capital nature. Loan capital of a company refers to the long-term
borrowings of which issue of debentures is the most important and common method adopted by companies.
Debentures are part of loan capital and the company is liable to pay interest thereon whether it earns profit or
not.
Issue of Debentures
The procedure for issuing debentures by a company is very much similar to that of an issue of shares.
Lesson 9 Introduction to Company Accounts 293
Applications for debentures are invited from the public through the prospectus and the applicants are asked to
pay the application money along with the applications. The company may ask for payment of the whole of the
amount along with the application itself or in installments.
ISSUE OF DEBENTURES
FOR CASH
AT PAR AT A PREMIUM
AT A DISCOUNT
AS COLLATERAL SECURITY
Note:
All cash transactions are generally passed through the Cash Book.
It is customary to prefix the rate of interest payable on debentures with the debenture account.
The company cannot allot more debentures than issued. The excess application money may be
retained by the company against the allotment money due. But the excess application money received
on debentures rejected has to be refunded to the applicants.
If the debentures are issued at a price higher than the nominal value of the debentures, the debentures are
said to be issued at a premium. The excess of issue price over the nominal value is regarded as the premium
amount. In such a case, the Debentures Account should be credited only with the nominal value of the
debentures and the premium should be credited to Securities Premium Reserves.
Lesson 9 Introduction to Company Accounts 295
Illustration 12:
X Ltd. made an issue of 10,000 12% Debentures of ` 100 each, payable as follows:
` 25 on Application
` 25 on Allotment
Applications were received for 12,000 debentures and the directors allotted 10,000 debentures rejecting
applications for 2,000 debentures. The money received on applications for 2,000 debentures rejected was duly
refunded. The call was made and the moneys were duly received.
Show the necessary cash book and journal entries to record the above transactions and above the relevant
items in the balance sheet of the company.
296 FP-FA&A
Solution:
Cash Book (Bank Columns)
Dr. Cr.
Particulars ` Particulars `
To 12% Debenture Application 3,00,000 By 12%A/c
Debenture
Application A/c 50,000
(Application money on (Refund of Application
12,000 12% Debenture @ ` money on 2,000, 12%
25 per debenture) Debenture @ ` 25 per
debenture)
To 12% Debenture Allotment 2,50,000 By Balance
A/c c/d 10,00,000
(Allotment money on 10,000
12% Debenture @ ` 25 per
debenture)
To 12% Debenture First and 5,00,000
Final Call A/c
(First and final call money on
10,000 debentures @ ` 80
per debenture)
10,50,000 10,50,000
Illustration 13:
B Ltd. issued 2,000, 13% Debentures of ` 100 each at ` 110 payable as follows:
On Application ` 25
On Allotment ` 35 (including premium)
On First and Final Call ` 50
The debentures were fully subscribed and the moneys were duly received. Prepare cash book, pass the
necessary journal entries and about the relevant portions of the balance sheet of the company.
Solution:
Cash Book (Bank Columns)
Dr. Cr.
Particulars ` Particulars `
To 13% Debenture Application 50,000 By Balance
A/c c/d 2,20,000
(Application money on 2,000
debentures @ ` 25 per each)
To 13% Debenture Allotment A/c 70,000
(Allotment money on 2,000
debentures @ ` 35 per
debenture including premium
of `10 each)
To 13% Debenture First and Final
Call A/c 1,00,000
(First and final call money on
2,000 debentures @ ` 50 per
debenture)
2,20,000 2,20,000
II Assets
Current Assets
Cash and Cash Equivalents 3 2,20,000
Total 2,20,000
Notes:
1. Reserves and Surplus
Securities Premium 20,000
2. Long-term Borrowings
13% Secured Debentures 2,00,000
3. Cash and Cash Equivalents
Balance with Bank 2,20,000
Illustration 14:
W Ltd. issued 2,000, 14% Debentures of ` 100 each at discount of 5%, the discount being adjustable on
allotment. The debentures were payable as follows:
On Application - ` 25
On Allotment - ` 20
On First and Final Call - ` 50
The debentures were fully subscribed and the moneys were duly received. Show the cash book and journal
entries and prepare the balance sheet of the company.
Lesson 9 Introduction to Company Accounts 299
Cash Book (Book Columns Only)
In the books of W Ltd.
Solution:
Dr. Cr.
Particulars ` Particulars `
To 14% Debenture Application By Balance c/d 1,90,000
A/c 50,000
(Application money on 2,000
debentures @ ` 25 per each)
Journal Entries
Date Particulars Debit Credit
(`) (`)
14% Debenture Application A/c Dr. 50,000
14% Debenture Allotment A/c Dr. 40,000
Discount on issue of debentures A/c Dr. 10,000
To 12% Debentures A/c 1,00,000
(Being capitalization of application money @ ` 25 per
debenture and allotment money due on 2,000 debentures @
` 20 after adjusting discount of ` 5 each as per Boards
resolution dated.....)
14% Debenture First and Final Call A/c Dr. 1,00,000
To 13% Debentures A/c 1,00,000
(First and final call money due on 2,000, debentures @ ` 50
per debenture as per boards resolution dated...)
300 FP-FA&A
Balance Sheet (Relevant Items Only)
Journal Entries
(1) For acquisition of assets:
Sundry Assets (Individually) A/c Dr. (with the value of assets)
To Vendors (with the purchase price)
(2) (a) On allotment of debentures (at par)
Vendors Dr. (with the value of debentures)
To Debentures A/c
(b) On allotment of debentures (at premium)
Vendors A/c Dr. (with the purchase price)
To Debentures A/c (with the nominal value)
To Securities Premium A/c (with the amount of premium)
(c) On allotment of debentures (at discount)
Vendors A/c Dr. (with the amount of purchase)
Discount on Issue of Debentures A/c Dr. (with the amount of discount)
To Debentures A/c (with the nominal value)
To Debentures A/c (with the nominal value)
To Debentures A/c (with the nominal value)
Lesson 9 Introduction to Company Accounts 301
Notes:
(i) If the value of debentures allotted is more than the agreed purchase price, the difference is debited to
Goodwill Account.
(ii) Similarly, if the value of debentures allotted is less than the agreed purchase price, credited to Capital
Reserve Account.
Illustration 15:
Optimist Ltd. purchased building worth Rs.1,20,000 and plant and machinery worth Rs. 1,00,000 from
Depressed Ltd. for an agreed purchase consideration of Rs. 2,00,000 to be satisfied by the issue of 2,000,
12% Debentures of Rs. 100 each. Show the necessary journal entries in the books of Optimist Ltd.
Solution:
Journal
Particulars Dr.(`) Cr.( `)
Building A/c Dr. 1,20,000
Plant and Machinery A/c Dr. 1,00,000
To Depressed Ltd. 2,00,000
To Capital Reserve A/c 20,000
(Purchase of sundry assets and transfer of capital profits as per
agreement with the vendor dated...)
Depressed Ltd. Dr. 2,00,000
To 12% Debentures A/c 2,00,000
(Being 2,000, 12% Debentures of Rs. 100 each allotted to vendors for
consideration other than cash as per Boards resolution dated...)
Note: The net effect of the above two entries is nil. Both the Debentures Suspense Account and the
Debentures Account are cancelled on repayment of the loan. As such, this method is rarely followed in
practice.
Illustration 16:
Z Ltd. secured an a long-term loan of Rs. 50,000 from the bank by issuing 600, 12% Debentures of Rs. 100
each as collateral security. Show relevant items in the Balance Sheet of the Company under both the methods.
Solution:
(First Method):
Balance Sheet (relevant items only)
Particulars Note No. Amount (`)
I Equity and Liabilities
Non-current Liabilities
Long-term Borrowings 1 50,000
Note:
1. Long-term Borrowings
Long term Secured Loan 50,000
(Secured by the issue of .
12% Debentures of ` 100 each as collateral securities)
JOURNAL ENTRIES
1. Transfer profits available for dividend to Capital Redemption Reserve Account:
General Reserve Account Dr. (as the case may be)
Profit and Loss Appropriation A/c Dr.
Dividend Equalization Account Dr.
To Capital Redemption Reserve A/c (with the nominal value of the shares to be
redeemed)
2. If current assets are realized to provide cash for redemption of preference shares:
Bank Dr.
To Respective Assets Account (with the realized value of assets)
Case 2: If the redeemable preference shares are redeemed out of the proceeds of a fresh issue of
shares made for the purpose of redemption:
If the redeemable preference shares are redeemed out of the proceeds of fresh issue of shares, the new
Share Capital Account raised by fresh issue will take the place of the Redeemable Preference Share Capital
Lesson 9 Introduction to Company Accounts 305
Account after the redemption. Thus, in such a case, new Share Capital Account (Equity or Preference) must
be equal to the redeemable preference shares redeemed.
First of all, entries for fresh issue of shares will be passed. Then, entries for redemption passed as given in
previous case.
Case 3: If the redeemable preference shares are redeemed partly out of the profits of the company
which would otherwise be available for dividend and partly out of the proceeds of a fresh issue of
shares made for the purpose of redemption:
If the redeemable preference shares are redeemed partly out of the profits of the company which would
otherwise be available for dividend and partly out of the proceeds of a fresh issue of shares equity or
preference, the Capital Redemption Reserve Account and the new Share Capital Account taken together will
replace the Redeemable Preference Share Capital redeemed. Thus in such a case, Redeemable Preference
Share Capital redeemed = Capital Redemption Reserve Account + New Share Capital Account (Equity or
Preference).
Here, all the entries shown under (1) and (2) have to be passed. But there are certain common entries which
can be combined together.
Illustration 17:
Vanities Ltd. had an issue 1,000, 12% redeemable preference shares of ` 100 each, repayable at a premium
of 10%. These shares are to be redeemed now out of the accumulated reserves, which are more than the
necessary sum required for redemption. Show the necessary entries in the books of the company, assuming
that the premium on redemption of shares has to be written off against the companys Securities Premium
Account.
Solution:
In the books of Vanities Ltd.
Journal Entries
Note: Equity Share Capital Account replaces the 12% Redeemable Preference Share Capital Account and
the capital structure of the company remains unchanged.
Lesson 9 Introduction to Company Accounts 307
Illustration 19:
The following is the balance sheet of Oscar India Ltd. as on 31st March 2011:
Particulars Note No. Amount (`)
I Equity and Liabilities
Shareholders Funds
Share Capital 1 5,48000
Reserves and Surplus 2 1,65,000
Current Liabilities
Trade Payable 3 1,27,000
Total 8,40,000
II Assets
Non-Current Assets
Fixed Assets 6,00,000
Current Assets
Investment 50,000
Inventories 1,10,000
Cash and Cash Equivalents 4 80,000
Total 8 4,000
Notes:
1. Share Capital ` `
Authorised
Issued, subscribed and paid-up: .
30,000 Equity Shares of ` 10 each fully paid-up 3,00,000
2,500 Preference share of ` 100 each fully called-up 2,50,000
Less: Final Call on 100 preference shares @ ` 20 per share unpaid 2,000 2,48,000
5,48,000
2. Reserves and Surplus
Securities Premium 15,000
Surplus 1,50,000
1,65,000
3. Trade Payable
Trade Creditors 1,10,000
Outstanding Expenses 17,000
1,27,000
4. Cash and Cash Equivalent
Balance with Bank 80,000
On 30th June, 2012, the Board of Directors decided to redeem the preference shares at a premium of 10%
and to sell the investments at its market price of ` 40,000. They also decided to issue sufficient number of
equity shares of ` 10 each at a premium of Re. 1 per share, required after utilizing the profit and loss account
leaving a balance of ` 50,000. Premium on redemption is required to be set off against securities premium
account.
308 FP-FA&A
Repayments on redemption were made in full except to one shareholder holding 50 shares only due to his
leaving India for good.
You are required to show the journal entries and the balance sheet of the company after redemption.
Assumption made should be shown in the working.
Solution:
In the books of Oscar Ltd.
Journal Entries
Working Notes:
In order to redeem its preference shares, the company issued 5,000 equity shares of ` 10 each at a premium
of 10% and sold all of its investment for ` 70,800. Preference shares were redeemed at a premium of 10%.
Show the necessary journal entries in the books of the company and prepare the balance sheet of the
company immediately after redemption of preference shares.
Solution:
In the books of Producers Ltd.
Journal Entries
Particulars Dr. (`) Cr.(`)
Bank Dr. 55,000
To Equity Share Application and Allotment Account 55,000
(Application money received on 5,000 equity shares of ` 10
issued at a premium of 10%)
Equity Share Application and Allotment A/c Dr. 55,000
To Equity Share Capital A/c 50,000
To Securities Premium A/c 5,000
(Allotment of 5000 equity shares of ` 10 each issued at a
premium of 10% as per Boards resolution dated....)
312 FP-FA&A
Profit and Loss A/c Dr.
To Capital Redemption Reserve A/c 50,000
50,000
(Transfer of the balance of the nominal value of preference
shares to be redeemed not covered by fresh issue, i.e., `
1,00,000 - ` 50,000 on redemption to Capital Redemption
Reserve A/c)
Bank Dr.
To Investments A/c 60,000
70,800
To Profit and Loss A/c 10,800
(Sale of Investments at a profit and transfer of profit on sale to
Profit and Loss A/c)
10% Redeemable Preference Share Capital A/c Dr.
Premium on Redemption of Preference Shares A/c Dr. 1,00,000
To 10% Preference Shareholders A/c 1,10,000
10,000
(Amount due to 10% preference shareholders on redemption)
Securities Premium A/c Dr.
To Premium on Redemption of Preference Shares A/c 10,000 10,000
(Application of securities premium to write off premium on
redemption of preference shares)
10% Preference Shareholders A/c Dr.
To Bank 1,10,000 1,10,000
(Amount due to 10% Preference Shareholders on redemption
of their shares paid)
Working Notes:
(i) Dr. Bank Account Cr.
Particulars ` Particulars `
To Balance b/fd 4,900 By 8% Preference
To Equity Share Application Shareholders A/c 1,10,000
and Allotment A/c 55,000 By Balance c/d 20,700
To Investment A/c 60,000
To Profit and Loss A/c 10,800 _______
1,30,700 1,30,700
314 FP-FA&A
(ii) Dr. Securities Premium A/c Cr.
Particulars ` Particulars `
To Premium on Redemption of By Balance b/fd 10,000
Preference Shares Account 10,000 By Equity Share Application
To Balance c/d 5,000 and Allotment A/c 5,000
15,000 15,000
(iii) Dr. Profit and Loss A/c Cr.
Particulars ` Particulars `
To Capital Redemption By Balance b/fd 54,000
Reserve A/c 50,000 By Bank (Profit on sale
To Balance c/d 14,800 of investments) 10,800
64,800 64,800
Note: Equity Share Capital issued of ` 50,000 and Capital Redemption Reserve Account ` 50,000 jointly
replace 8% Redeemable Preference Share Capital of ` 1,00,000. Hence, the capital structure of the company
remains unchanged.
LESSON ROUND UP
There are two basic types of share capital which can be issued by a company under the Companies
Act, 2013 i.e. (a) preference shares and (b) equity shares.
Preference shares are those which carry preferential rights as to the payment of dividend at a fixed
rate; and the return of capital on winding up of the company.
An equity share is one which is not a preference share. Equity shares are risk bearing shares.
Share capital of a company can be categorized as: Nominal or Authorised Capital; Issued Capital;
Subscribed Capital; Called up Capital and Paid-up Capital.
When shares are issued at a price higher than the face value, they are said to be issued at a
premium.
When shares are issued at a price lower than the face value, they are said to be issued at a
discount.
Forfeiture of shares may be said to be the compulsory termination of membership by way of penalty
for non-payment of allotment and/or any call money.
The forfeited shares may be re-issued at par, at a premium or even at a discount. If forfeited shares
are re-issued at a discount, the amount of discount can, in no case, exceed the amount credited to
Shares Forfeited Account.
A company limited by shares may, if authorised by its articles, issue preference shares, which are,
or at the option of the company liable to be redeemed. They have to be redeemed within 20 years of
the date of issue.
The issue of debentures to vendors is known as issue of debentures for consideration other than
cash.
A company may issue debentures on any specific condition as to its redemption such as: issued at
par and redeemable at par, issued at a discount redeemable at par, issued at a premium and
redeemable at par, issued at par and redeemable at a premium, issued at a discount, but
redeemable at a premium.
When a company issues debentures it undertakes to pay interest thereon at a fixed percentage. The
payment of interest on the debt is obligatory on the part of the company issuing them irrespective of
the fact whether the company earns profit or not and the interest payable on debentures is a charge
against the profits of the company.
Discount on issue of debentures is a capital loss of the company and it is required to be shown on the
liabilities side of the Balance Sheet under the heading Redemption and Surplus until it is written off.
When a company issues debenture at par or at a discount which are redeemable at a premium, the
premium payable on redemption of the debentures is treated as a capital loss.
The preference shares can be redeemed out of profits or out of the proceeds of fresh issue of equity
or preference shares or a combination of both. The preference shares can be redeemed at a
premium also.
If the redeemable preference shares are redeemed out of the profits of the company which would
otherwise be available for dividend, the Capital Redemption Reserve Account has to be credited
which will represent the redeemable preference shares in the balance sheet after the redemption.
If the redeemable preference shares are redeemed out of the proceeds of a fresh issue of shares,
the new Share Capital Account raised by fresh issue takes the place of the Redeemable Preference
Share Capital Account after the redemption.
GLOSSARY
Shares The total share capital is divided into a number of units known as shares.
Authorized The Company is registered with this amount of capital.
Capital
Issued That part of the authorized capital of the company which has actually been offered to
Capital the public for subscription in cash.
Subscribed It refers to that part of the issued capital which has actually been subscribed by the
Capital public and subsequently allotted to them.
Called Up It is that portion of the subscribed capital which the shareholders are called upon to pay
Capital on the shares allotted to them.
Paid Up It refers to that part of the called up capital which has actually been paid by the
Capital shareholders.
Forfeiture The compulsory termination of membership by way of penalty for non-payment of
allotment and/or any call money.
316 FP-FA&A
SELF TEST QUESTIONS
Theory Questions
1. What do you mean by shares? What are the types of shares?
2. Explain types of share capital in a company.
3. Briefly describe issue of shares at a premium.
4. What do you mean by forfeited shares? Can forfeited shares be re-issued? Explain.
5. What are debentures? What are the type of debentures?
6. Explain various methods of redemption of preference shares.
Practical Questions
1. The authorised capital of a company is 1,00,000 shares of ` 10 each. On April 10, 2012, 50,000
shares are issued for subscription at a premium of ` 2 per share. The share money is payable as
follows: ` 5 (including the premium of ` 2) with application, ` 3 on allotment; ` 2 on first call and ` 2
on second call. The subscription list closes on May 11, 2012 and directors proceed to allotment on
May 18, 2012. The shares are fully subscribed and the application money (including the premium) is
received in full. The allotment money is received by June 30, 2012, except as regards 500 shares. It
is expected that the allotment money on these 500 shares will not be received and hence shares
are forfeited. The first call and second call money is received by September 30, 2012 and December
31, 2012 respectively, barring the second call money on 200 shares which is not received hence the
shares are forfeited. Show the cash book and the structure of the share capital in the balance sheet.
2. X Ltd. forfeited 100 shares of ` 10 each for non-payment of the final call of ` 2; the shares were re-
issued @ ` 9 per share. How much was credited to shares forfeited account and what amount was
transferred to capital reserve?
[Ans.: ` 800; ` 700]
3. Z Ltd. forfeited 150 shares of ` 10, issued at a premium of ` 2, for non-payment of the final call of `
3. Of these 100 shares were re-issued @ ` 11 per share. How much would be transferred to capital
reserve?
[Ans.: ` 700]
4. Redemption of 100,000 preference shares of ` 10 each was carried out by utilisation of reserves
and by issue of 40,000 equity shares of `10 each at `12.5. How much should be credited to capital
redemption reserve account?
[Ans.: ` 6,00,000]
In the above case, the redemption was carried out of reserves and out of the issue of 4,000 shares
of `10 each @ ` 9.5. What is the amount of capital redemption reserve account that is required?
[Ans.: ` 6,20,000]
5. A company having free reserves of ` 30,000 want to redeem rupees one lakh preference shares.
Calculate the face value of fresh issue of shares of ` 10 each to be made at a premium of 10%.
[Ans.: ` 70,000]
6. Bhalla and Co. Ltd. has an authorised equity capital of ` 20 lakhs divided into shares of ` 10 each.
The paid-up capital was ` 12,50,000. Besides this, the company had 9% preference shares of ` 10
Lesson 9 Introduction to Company Accounts 317
each for ` 2,50,000. Balance on other accounts were - Securities Premium ` 18,000; Profit and Loss
Account ` 72,000 and General Reserve ` 3,40,000. Included in Sundry Assets were investments of
the face value of ` 30,000 carried in the books at a cost of ` 34,000. The company decided to
redeem the preference shares at 10% premium, partly by the issue of equity shares of the face
value of ` 1,20,000 at a premium of 10%. Investments were sold at 105% of their face value. All
preference shareholders were paid off except 3 holding 2500 shares. Give the necessary journal
entries bearing in mind that the Directors wanted a minimum reduction in free reserves, while
effecting the above transactions. Working should form part of your answer.
[Ans.: Amount paid to preference shareholders: ` 2,72,250]
7. Krishna Ltd issued 10,000 12% Debentures of `10 each at a discount of 6%. Applications were
received for 7,500 debentures. Journalise the transactions assuming all money has been received.
318 FP-FA&A
Lesson 10 Concept of Auditing 319
PART B
FUNDAMENTALS OF AUDITING
LESSONS
LEARNING OBJECTIVES
From the time of ancient Egyptians, Greeks and
10. Concepts of Auditing
Romans, the practice of auditing the accounts of
public institutions existed. Checking clerks were
11. Types of Auditing
appointed in those days to check the public
accounts. To locate frauds as well as to find out
12. Tools of Auditing whether the receipts and payments are properly
recorded by the person responsible was the main
13. Auditor and Related Provisions objective of Auditing of those days.
321
320 FPFA&A
Lesson 10
Concept of Auditing
LESSON OUTLINE
LEARNING OBJECTIVES
Im not suggesting there are any errors at all. Im saying that without a proper audit, theres no way to be
sure.
Pete Williams
Lesson 10 Concept of Auditing 321
INTRODUCTION
Evolution of Auditing
The term audit is derived from the Latin term audire, which means to hear. In early days a person used to listen
to the accounts read over by an accountant in order to check them. He was known as auditor. Auditing is as old
as accounting and there are signs of its existence in all ancient cultures such as Mesopotamia, Greece, Egypt.
Rome, U.K. and India. Arthasashthra by Kautilya detailed rules for accounting and auditing of public finances.
Audit is performed to ascertain the validity and reliability of information. Examination of books of accounts with
supporting vouchers and documents in order to detect and prevent error and fraud is the main function of
auditing. The goal of an audit is to express an opinion on the financial or non-financial areas. Audit safeguards
the financial interest of persons not associated with the management like partners or shareholders, acts as a
moral check on the employees and prevents from committing fraud. However, due to constraints, an audit seeks
to provide only reasonable assurance that the statements are free from material error. In case of financial audit,
a set of financial statements are said to be true and fair when they are free of material misstatements. But
recently, argument that auditing should go beyond just true and fair is gaining momentum in view of recent
frauds by high profile organizations in connivance with the reputed audit firms.
Traditionally, audits were mainly associated with gaining information about financial systems and the financial
records of a company or a business. However, recently auditing has begun to include non-financial subject
areas, such as safety, security, information systems performance, and environmental concerns. With non-profit
organizations and government agencies, there has been an increasing need for performance audit, examining
their success in satisfying mission objectives of business
In India the Companies Act, 2013 made audit of company accounts compulsory. With the increase in the size of
the companies and the volume of transactions the main objective of audit shifted to ascertaining whether the
accounts were true and fair rather than true and correct. Hence the emphasis was not on arithmetical accuracy
but on a fair representation of the financial efforts. The Companies Act, 2013 also prescribed for the first time the
qualification of auditors. After the independence in year 1956, Company Act, 1956 was implemented and detailed
provisions were made in Act regarding Audit and auditors. Recently Companies Act, 2013 has been implemented
w .
st
e April, 2014 and this contains detailed provisions about statutory audit, Cost Audit, Internal Audit and
. f 1
Secretarial Audit.
to exhibit a true and correct view of the state of affairs of the particular concern according to the information and
explanations given to him and as shown by the books.
Prof. Montgomery Auditing is a systematic examination of the books and records of business or other
organization, in order to ascertain or verify and to report upon the facts regarding its financial operations and the
result thereof.
Spicer & Pegler Audit such an examination of the books of accounts and vouchers of a business, as will
enable the auditor to satisfy himself that the Balance Sheet is properly drawn up, so as to give a true and fair
view of the state affairs of the business, and whether the profit and loss account gives a true and fair view of the
profit or loss for the financial period according to the best of his information and explanations given to him and as
shown by the books, and if not, in what respect he is not satisfied.
Institute of Chartered Accountants of India (ICAI) defines Auditing as Auditing is defined as a systematic
and independent examination of data, statements, records, operations and performance of an enterprise for a
stated purpose. In any auditing situation, the auditor perceives and recognizes the propositions before him for
examination, collect evidences, evaluates the same and on this basis formulates his judgement which is
communicated through his audit report.
In the close scrutiny of the different definitions we found that there are different ways of expressing the concept
of auditing but having lot of similarity therein.
The meaning of an Audit contains
(i) An intelligent and critical examination of the books of accounts of business.
(ii) It is done by an independent qualified person.
(iii) It is done with the help of vouchers, documents, information and explanations received from the clients.
(iv) The auditor satisfies himself with the authenticity of the financial accounts prepared for a particular
period.
FEATURES OF AUDITING
1. Audit is a systematic and scientific examination of the books of accounts of a business;
2. Audit is undertaken by an independent person or body of persons who are duly qualified for the job.
3. Audit is a verification of the results shown by the profit and loss account and the state of affairs as shown
by the balance sheet.
4. Audit is a critical review of the system of accounting and internal control.
5. Audit is done with the help of vouchers, documents, information and explanations received from the
authorities.
6. The auditor has to satisfy himself with the authenticity of the financial statements and report that they
exhibit a true and fair view of the state of affairs of the concern.
7. The auditor has to inspect, compare, check, review, scrutinize the vouchers supporting the transactions
and examine correspondence, minute books of share holders, directors, Memorandum of Association
and Articles of association etc., in order to establish correctness of the books of accounts.
Objectives of Auditing
The objectives of auditing may be classified into two parts:
1. The primary objective
Lesson 10 Concept of Auditing 323
(viii) Accounting System and Internal Control: The management is responsible for maintaining an adequate
accounting system incorporating various internal controls appropriate to the size and nature of business.
The auditor should assure himself that the accounting system is adequate and all the information which
should be recorded has been recorded. Internal control system contributes to such assurance.
(ix) Audit conclusions and reporting: On the basis of the audit evidence, he should review and assess
the audit conclusions. He should ascertain:
1. As whether accounting policies have been consistently applied;
2. Whether financial information complies with regulations and statutory requirements; and
3. There is adequate disclosure of material matters relevant to the presentation of financial information
subject to statutory requirements.
The auditors report should contain a clear written opinion on the financial information. A clean audit report
indicates the auditors satisfaction in all respects and when a qualified, adverse or a disclaimer of opinion is to
be given or reservation of opinion on any matter is to be made, the audit report should state the reasons thereof.
(ix) Statutory Compliance: Auditor has to ensure that all the statutory requirements has been complied by
the entity like provisions of Income Tax Act, Companies Act and other acts if any applicable has been
complied by the organization.
(x) Reporting: The auditor has to report to the authority appointing him for conducting audit whether the
financial statements of accounts examined actually reveals true and fair view of the state of affairs and
of the profit or loss earned during the period by the organization.
BENEFITS OF AUDIT
(i) Satisfaction of Owner: It is because of audit that the owner will be satisfied about the business operations
and working of its various departments.
(ii) Detection and Prevention of Errors and Frauds: The errors whether committed innocently or deliberately
are discovered by the process of audit and its presence prevents their occurrence in the future. No one will try to
commit an error or fraud as the accounts are subject to audit and hence they will have a fear of being detected.
Just like errors, frauds are discovered by audit and its presence minimizes future possibility if not eliminated
totally.
(iii) Verification of Books: Another advantage of audit is the verification of the books of accounts, this helps in
maintaining the records up to date at all times.
(iv) Independent Opinion: Auditing is very useful in obtaining the independent opinion of the auditor about
business condition. If the accounts are audited by an independent auditor, the report of the auditor will be true
and fair in all respects and it will be of extreme importance for the management of the company.
(v) Moral Check: The process of audit will establish a check on the minds of the staff working in the business
and they will not be able to commit any irregularity, as they will have a fear and will also be aware that the
accounts will be examined in the near future and that action would be taken against them if any irregularity is
discovered. Thus the audit prevents the happening of any irregularity before it starts and the staff hence becomes
more active and responsible. The fear of their getting caught act as a moral check on the staff of the company.
(vi) Protection of the Rights and Interests of Shareholders: Audit helps in protecting the interests of
shareholders in case of joint stock company. Audit gives assurance to the shareholders that the accounts of the
company are being maintained properly and their interest will not suffer under any circumstances.
(vii) Reliance by Outsiders: Outsiders like creditors, debenture holders and banks etc. will rely on the books of
accounts and financial statements of the business if they are audited by an independent authority (external
auditor).
(viii) Ensures Compliance with Legal Requirements: Audited statements are necessary to fulfill certain legal
requirements e.g. listing requirements of stock exchange etc.
(ix) Reinforce and Strengthen Internal Control: Since auditing exercise involves the review of internal control
system, an auditor will identify the gaps in internal control system and can suggest the necessary changes in the
internal control system.
(x) Loan Facility: Money can be borrowed easily on the basis of audited balance sheet from financial institutions.
If accounts are audited the true picture will be visible to banks and it will be easy for them to issue loans as early
as possible.
LIMITATIONS OF AUDIT
Besides having various benefits, there are some inherent limitations of auditing. These are as follows :
(i) Higher Cost Burden: Due to Higher Cost Burden, the auditor limits his scope of work to selective
testing or sampling thus in depth checking of books of accounts is not possible.
326 FPFA&A
(ii) Based on test checks. Generally an auditing exercise is based on test checking. Inferring a result on
the basis of test check always need not to be true.
(iii) Insufficient Time: Generally an auditor needs to release the report up to a specified timeline. Sometime
this timeline become a constraint for an auditor in carrying out the auditing exercise effectively. This time
constraint may affect the amount of evidence that can be obtained concerning events and transactions
after the balance sheet date that may have an effect on the financial statements. Moreover, there is a
relatively short time period available for resolving uncertainties existing at the financial statement date
(iv) Inconclusiveness of Evidences: The evidences obtained by an auditor are persuasive rather than
conclusive. For example, an architects certificate of valuation for a newly constructed building of a
client may not be conclusive evidence of the correct value of building.
(v) Based on Estimates: Estimates are an inherent part of the accounting process, and no one, including
auditors, can foresee the outcome of uncertainties. Estimate range from the allowance for doubtful
accounts and an inventory obsolescence reserve to impairment tests of fixed assets and goodwill. An
audit cannot add exactness and certainty to financial statements when these factors do not exist.
(vi) Based on the Information provided by the Management: The audit opinion is based on the information
provided by the management. Hence, outsiders cannot fully rely on the auditors report.
REVIEW QUESTION
1. The evidence obtained by an auditor is __________rather than conclusive.
2. The term Audit originated from the Latin word audire means _________.
3. Auditing can be defined as an _______________ examination of records (financial
or non-financial).
4. If internal control system is effective, ___________ checking is required and vice-
versa.
INVESTIGATION
The investigation is related to critical checking of particular records. Investigation is done when a lapse already
exists to pin point the reason and person involved in it so that responsibility for such lapse could be fixed
whereas audit is a process to check whether the accounts are properly maintained as per required norms
following all the procedures etc. and to point out any lapses in this line. The purpose of auditing and investigation
is different.
LESSON ROUND UP
An Audit is an independent examination of financial or non-financial information of any entity; when
such an examination is conducted with a view to express an opinion thereon.
Principal Aspects to be Covered in Audit: internal control system, review of system and procedures,
accounting principles, books and statements, verification of assets, verification of liabilities, true and
fair view, statutory compliance and report.
Benefits of Audit: satisfaction of owner, detection and prevention of errors and frauds, verification of
books of accounts, independent opinion, moral check, protection of the rights and interests of
shareholders, ensures compliances with legal requirements, reinforce and strengthen internal control
system and reliance by outsiders
Limitations of an Audit: Audit involves higher cost, audit involves reasonable length of time, based on
test checks, evidence obtained by an auditor are persuasive rather than conclusive, auditors cannot
determine the appropriateness of accounting estimates because of uncertainties involved in it and
audit is based on information provided by management.
Difference between Investigation and Auditing: Investigation implies systematic, critical and special
examination of the records of a business for a specific purpose whereas audit is an independent
examination of financial information of any entity, when such an examination is conducted with a view
to expressing an opinion thereon.
GLOSSARY
Connivance Agreement on a secret plot, collusion
Persuasive Intended or having the power to induce action or belief, convincing.
328 FPFA&A
SELF-TEST QUESTIONS
1. What is the meaning of Auditing?
2. What are the principal aspects to be covered in auditing?
3. Why the need of auditing arises and what are benefits of auditing?
4. The evidences obtained by the auditor are persuasive rather than conclusive. Explain.
5. What do you mean by investigation and how it is different from auditing?
SUGGESTED READINGS
1. Fundamentals of Auditing By Kamal Gupta
2. Auditing: Principles and Practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
Lesson 11 Types of Auditing 329
Lesson 11
Types of Audit
LESSON OUTLINE
LEARNING OBJECTIVES
Internal Audit In the last lesson the meaning, benefits and
Advantages of Internal Auditing
limitations of audit is discussed. Here, we will see
Benefits of Internal Auditing
the different types of audit. The requirement of
Limitations of Internal Auditing
getting the books of accounts audited became
Review Questions
mandatory due to legislation. The nature and
Financial Audit
scope of audit vary due to various factors such
Secretarial Audit
as the size of organisation, the strength of internal
Cost Audit
control system, legal requirement etc. In internal
Tax Audit
Audit, the books of accounts may be audited by
Review Questions
internal department of the organisation while in
Bank Audit
Co-operative Society Audit other types of audit; such as statutory audit,
Trust Audit secretarial audit, cost audit, tax audit, bank audit,
Sole Proprietorship Audit, etc. done by independent person. In internal audit the
Government Audit area of work is determined by the management
Management Audit whereas in other types of audit the area of work
Functional Audit is determined by the legislation.
Propriety Audit
In this lesson, you will learn the different types of
Efficiency Audit
audit such as internal audit, financial audit, tax
Lesson Round Up
audit, secretarial audit, cost audit, bank audit, trust
Glossary
audit, insurance audit, etc.
Self-Test Questions
Companies will not receive a rubber stamp certification; this is an in-depth program that requires an exhaustive
and thorough audit of ones processes.
John Kania
330 FPFA&A
INTRODUCTION
Up to early decades of Twentieth Century, Auditing exercise was considered limited to auditing of books of
accounts i.e. finance audit, internal audit. After the advancement of trade/technology various types of audit have
come into existence i.e. operation audit, management audit, efficiency audit, propriety audit, information system
audit etc. Types of audit depend upon various factors such as the nature of work undertaken, approach used for
conducting audit, organization structure, legal requirements etc. The different types of audit have different
objectives. Here, now we will study the different types of audit along with their characteristics, merits and limitation.
TYPES OF AUDIT
Statutory Audit
Statutory Audit is often called financial Audit. Independent financial audit is generally conducted to ascertain
whether the Balance Sheet and Profit & Loss Account presents a true and fair view of the financial position
and working result of the organization under audit. The need for financial audit arises as the control of the
company is vested in the hands of the management of the company and the financial statements are also
prepared by the management. The owners (shareholders), therefore, need assurance that the financial
statements prepared by the management are reliable. The opinion of the auditor an independent expert
assures the owners about the reliability of the financial statements. Similarly, investors wish to invest their
moneys in the shares of companies on the basis of their profitability and financial position. They will also place
greater reliance on financial statements if they have been audited. Other users of financial statements, e.g.,
trade creditors, banks, financial institutions, tax authorities, other government authorities, labour unions, etc.,
also place greater reliance on audited accounts.
Sections 139 to 147 under chapter X of the Companies Act, 2013 contain provisions regarding statutory audit
and auditors. Section 139 contains that at the first annual general meeting every company shall appoint an
individual or firm as it auditor who will hold office from the conclusion of that meeting till the conclusion of the
sixth annual general meeting. Section 141 contains that a person shall be eligible for appointment as an auditor
of a company only if he is a chartered accountant and in case of a firm whereof majority of partners practising in
India are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company.
Section 143 which contains provisions regarding powers and duties of auditors contains that the statutory auditor
shall make a report to the members of the company on the accounts and financial statements examined by him.
The main provisions regarding statutory audit are:
Auditor will have access to books of accounts and vouchers etc. at all times and he can seek information
from officers of the company as he may deem necessary.
In his report he must state, besides other things, whether the financial statements represent a true and
fair view of the state of companys affairs as at the end of the financial year.
In case of any qualifications in the audit report, the reason for same must be stated in the report.
Auditor is required to comply with Auditing Standards.
In case auditor suspects any fraud, he must immediately report the same to the Central Government.
Lesson 11 Types of Auditing 331
Internal Audit
Section 138 of the Companies Act, 2013 contains provisions regarding internal audit. As per Companies Act,
2013, certain class or classes of company as may be prescribed shall appoint an internal auditor who will
conduct an audit of the functions and activities of the company and make a report thereon to the Board of
Directors. Any chartered Accountant (except statutory auditor of the company) or Cost Account or other
professional as may be decided by the Board, can be appointed to conduct the internal audit.
According to Rule 13 of The Companies (Accounts) Rules, 2014 following class or classes of companies shall
be required to appoint an internal auditor or firm of internal auditors, namely:
(a) Every listed company;
(b) Every unlisted public company having-
(i) Paid up share capital of 50 crore rupees or more during the preceding financial year; or
(ii) Turnover of 200 crore rupees or more during the preceding financial year; or
(iii) Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore
rupees or more at any point of time during the preceding financial year; or
(iv) Outstanding deposits of 25 crore rupees or more at any point of time during the preceding financial
year; and
(c) Every private company having-
(i) Turnover of 200 crore rupees or more during the preceding financial year; or
(ii) Outstanding loans or borrowings from banks or public financial institutions exceeding 100 crore
rupees or more at any point of time during the preceding financial year:
The rules also provide that every existing company covered under above criteria in Financial Year 2013-14 shall
comply with requirements of Section 138 and Rule 13 of Companies (Accounts) Rules, 2014 before 30th
September, 2014 (within 6 months of the commencement of Section 138, i.e. 01st April, 2014).
Secretarial Audit
Secretarial Audit is a compliance audit and it is a part of total compliance management in an organisation. The
Secretarial Audit is an effective tool for corporate compliance management. It helps to detect non-compliance
and to take corrective measures.
Secretarial Audit is a process to check compliance with the provisions of various laws and rules/regulations/
procedures, maintenance of books, records etc., by an independent professional to ensure that the company
has complied with the legal and procedural requirements and also followed the due processes. It is essentially
a mechanism to monitor compliance with the requirements of stated laws.
A Company Secretary in Practice has been assigned the role of Secretarial Auditor under section 2(2)(c)(v) of
the Company Secretaries Act, 1980.
Ever-increasing complexities of laws and responsibilities of directors (especially non-executive directors) make
it imperative that a Practicing Company Secretary (PCS) reports whether or not there exists proper compliance
mechanism and systems in the corporate structure. PCS has also to verify whether diverse requirements under
applicable laws have been duly complied with or not and if there is a need for any corrective measures or
improvement in the system.
Secretarial Audit on a continuous basis would help the company in initiating corrective measures and strengthening
its compliance mechanism and processes. It is recommended that the Secretarial Audit be carried out periodically
(quarterly / half yearly) and adverse findings if any, be communicated to the Board for corrective action.
332 FPFA&A
The multiplicity of laws, rules, regulations, etc. has necessitated introduction of a compliance management
system to ensure compliances of laws applicable to a company. This has a two-fold objective:
(a) Firstly, to protect the interests of all the stakeholders;
(b) Secondly, to avoid any legal action against the company and its management.
As of now Secretarial Audit is not mandatory on the Companies. However, it is optionally undertaken by the
companies for maintaining good Corporate Governance practices.
Secretarial Audit is a new requirement which has been prescribed under Section 204 of the Companies Act,
2013. The provisions regarding secretarial audit are as follows :
Every listed company and other class of companies as may be prescribed is required to annex to the
Boards Report, a Secretarial Audit Report.
Secretarial Audit has to be conducted by a Practising Company Secretary in respect of the secretarial
and other records of the company.
Company is required to give all necessary information and assistance to the Practising Company Secretary
to conduct the audit.
The Board is required to provide explanation in the Boards Report to every qualification, observation or
other adverse remark made by the company secretary in his report. The secretarial Auditor will submit
his report in Form MR- 3
As per Section 143(14), all provisions regarding rights, duties and obligations of statutory auditors shall also
apply to Company Secretary in Practice conducting secretarial audit.
Cost Audit
The Institute of Cost and Works Accountants of India defines cost audit as a system of audit introduced by the
Government of India for the review, examination, and appraisal of the cost accounting records and attendant
information, required to be maintained by specified industries. According to CIMA, London, cost audit is the
verification of the correctness of cost accounts and of adherence to the Cost Accounting plan. Thus cost audit
comprises of:
(i) The verification of the cost accounting records such as the accuracy of the cost accounts, cost reports,
cost statements, cost data, costing techniques and
(ii) Examining these records to ensure that they adhere to the cost accounting, plans, procedures and
objectives.
Ministry of Corporate Affairs has issued mandatory cost audit orders on Companies engaged in Bulk drugs,
fertilization, sugar, telecommunications, industrial alcohol, and electricity & petroleum and if in immediate previous
year aggregate value of Net Worth exceeds the specified limits.
The cost auditor has to judge :
(i) Whether the planned expenditure is designed to give optimum results.
(ii) Whether the size and channels of expenditure were designed to produce the best results, and
(iii) Whether the return from expenditure on capital as well as current operations could be improved by
some other alternative plan of action.
Cost Audit is useful for the purpose of Cost Control; Cost reduction and proper utilization of scarce resources.
Moreover, cost audit also ensures that proper records are kept as to purchases and utilisation of material and
expenses incurred on wages, overheads, etc. It also ensures that the unit has been run economically and efficiently.
Lesson 11 Types of Auditing 333
Section 148 of the Act contains provisions regarding cost audit and contains that a cost audit wherever conducted
is in addition to statutory audit conducted under section 143.
The main provisions regarding cost audit as contained in the Act are :
Certain class of companies engaged in the production of such goods or providing such services as may
be prescribed and which have a net worth or turnover of such amount as may be prescribed may be
directed to get their cost audit records audited.
Cost audit has to be conducted by a Cost Accountant in Practice who is required to comply with cost
auditing standards
It shall be the duty of the company to give all assistance and facilities to the cost auditor.
As per Section 143(14), the qualifications, disqualifications, rights, duties and obligations applicable to
statutory auditors will also apply to a cost auditor.
Cost auditor has to submit his report to the Board of Directors who in turn shall file it with the Central
Government within 30 days of the receipt of the report.
Tax Audit
In India, the Income Tax Act, 1961, Section 44AB provides for the compulsory audit of the accounts of certain
income tax assessee whose turnover or receipts exceed the specified limits. The objective of such audit is to
assist the tax authorities in making the correct income tax assessment of the assessee concerned. The tax
auditor has to specifically report on certain transactions which have an effect on the income tax liability of the
assessee concerned and are, thus important to the tax authorities. The income tax act 1961 also contains
various other provisions whereby audit report is required to be submitted to get certain deductions, exemptions
etc.
As per the income tax Act, every person carrying on business whose turnover or gross receipts exceeds Rs.
1,00,00,000 (Rs. 25,00,000 if carrying on profession) in the previous year shall get his accounts audited.
Bank Audit
The huge amount of public monies handled by the banks, make it imperative that the activities of the industry are
closely monitored and regulated without strangulating the spirit of entrepreneurship. Audit forms an integral and
important part of such monitoring and regulation. The Auditors have to certify that statement of accounts of the
bank as at the closure of the financial year reveal true and fair view of the Bank financial position, adequate
provision for Non-Performing Asset(NPA)/bad debts has been made in the books. All expenses/income have
been duly accounted for and profit is correctly worked out. The Banking Regulation Act, 1949 contains the
provisions relating to the maintenance of accounts and their audit.
Insurance Audit
The insurance audit is an examination of the operations, records and books of account of the insurance company.
Auditor performs an audit to ensure that the customer has paid the appropriate premium for risk cover provided
to him. The auditor should be conversant with the provisions of the Insurance Regulatory and Development, Act
1999 which contains the provision of the maintenance of accounts and audit of the insurance companies.
Government Audit
Government audit aims at ensuring that the financial transactions of the government are executed properly
under sanctions and authorities and are correctly recorded in the books of accounts. It is the duty of Comptroller
and Auditor General of India (C&AG) to audit the receipts and expenditure of the Union Government and State
Government.
Further, government audit also includes the audit of government companies conducted by C&AG in accordance
with the provisions of Companies Act, 2013 and other relevant legislations.
Management Audit
Management audit is an emerging concept of auditing. It has been originated from America. Management audit
is an act of evaluation of all the activities of all the departments with a view to provide appropriate suggestions
to the management to help their work. In other words, management auditing is a future oriented task which
evaluates timely in all the levels of management like production management, sales management etc. The main
objective of management audit is to improve the profit earning capacity, work of management, objectives of
program, social objectives and human resource development so that organizational goal can be easily attained.
It refers to the existence of control system, compliance of rules and regulations, process of managerial decisions
etc. Generally management audit/operational audit are not mandatory but it recommendatory certainly.
4. Management audit examines all the scope of work and liability centers.
5. Management audit provides valuable suggestions to the management after the evaluation of all above
facts.
Propriety Audit
Kohler has defined propriety as that which meets the test of public interest, commonly accepted customs and
standard of conduct and particularly as applied to professional performance, requirements of Govt. regulations
and professional codes . Propriety Audit would mean whether the transactions have been done in conformity
with established rules, principles and some established standard.
The Propriety Audit would mean the verification of following main aspects to find out whether:
(i) Proper recording has been done in appropriate books of accounts.
(ii) The assets have not been misused and have been properly safeguarded.
(iii) The business funds have been utilized properly.
(iv) The concern is yielding the expected results.
The system of Propriety Audit is applied in respect to Government companies Government Department because
public money and public interest are therein involved. It is an essential function of Audit to bring to light not only
cases of clear irregularity but also every matter which in its judgement appears to involve improper expenditure
or waste of public money or stores, even though the accounts themselves may be insufficient to see that sundry
rules or orders of competent authority have been observed. It is of equal importance to ensure that the broad
principles of orthodox finance are borne in mind not only by disbursing officers but also by sanctioning authorities.
Efficiency Audit
In essence, efficiency indicates how well an organization uses its resources to produce goods and services. It
focuses on resources (inputs), goods and services (outputs), and the rate (productivity) at which inputs is used
to produce or deliver the outputs. To understand the meaning of efficiency, it is necessary to understand the
following terms: inputs, outputs (including quantity and quality), productivity, and level of service.
Inputs are resources (e.g., human, financial, equipment, material, facilities, information, energy and land) used
to produce outputs
Outputs are goods and services produced to meet client needs. Outputs are defined in terms of quantity and
quality and are delivered within parameters relating to level ofservice
Quantity refers to the amount, volume, or number of outputs produced.
Quality refers to various attributes and characteristics of outputs such as reliability, accuracy, timeliness, service
courtesy, safety, and comfort.
Productivity is the ratio of the amount ofacceptable goods and services produced (outputs) to the amount of
resources (inputs) used to produce them. Productivity is expressed in the form of a ratio such as cost or time per
unit ofoutput.
Efficiency is a relative concept. It is measured by comparing achieved productivity with a desired norm, target, or
standard. Output quantity and quality achieved and the level of service provided are also compared to targets or
standards to determine to what extent they may have caused changes in efficiency. Efficiency is improved when
more outputs of a given quality are produced with the same or fewer resource inputs, or when the same amount
of output is produced with fewer resources.
Efficiency audit refers to comparing the actual results with the desired/projected results. It is directed towards
336 FPFA&A
the measurement of whether plans have been effectively executed. It is concerned with the utilisation of the
resources in economic and most remunerative manner to achieve the objectives of the concern. It comprises
of studying the plans of organisation, comparing actual performance with plans and investigating the reasons
for variances to take remedial action
LESSON ROUND UP
In this lesson, we have discussed various types of audit such as internal audit, financial audit, secretarial
audit, cost audit, tax audit etc.
Internal Audit- Internal audit is an evaluation and analysis of the business operation conducted by the
internal audit staff. It is the part of overall system of internal control established in an organization.
Objective of Internal Audit- proper control, accounting system, help management, working review,
asset protection, internal check, fair statements, check error, detect fraud, determine liability, help in
independent audit, performance appraisal, provide suggestions, new ideas, use of resources, accounting
policies, special investigation.
Benefits of Internal Audit- proper accounting system, better management, progressive review, effective
control, assets protection, division of work, no error and fraud, fixing responsibility, helps external
auditing, performance improves, investigation, proper use of resources.
Limitations of Internal Audit- staff shortage, time lag, error, responsibility, duties.
Financial Audit- Independent financial audit is generally conducted to ascertain whether the balance
sheet and profit & loss account present a true and fair view of the financial position and working result
of the organization under audit.
Secretarial Audit- Secretarial Audit is a process to check compliance with the provisions of various
laws and rules/regulations/procedures, maintenance of books, records etc., by an independent
professional to ensure that the company has complied with the legal and procedural requirements and
also followed the due process. It is essentially a mechanism to monitor compliance with the requirements
of stated laws. A Company Secretary in Practice has been assigned the role of Secretarial Auditor
under section 2(2)(c)(v) of the Company Secretaries Act, 1980.
Cost Audit- A system of audit introduced by the Government of India for the review, examination, and
appraisal of the cost accounting records and attendant information, required to be maintained by specified
industries.
Tax Audit: The objective of such audit is to assist the tax authorities in making the correct income tax
assessment of the assesses concerned.
Bank Audit: The Banking Regulation Act, 1949 contains the provisions relating to the maintenance of
accounts and their audit.
Co-Operative Society Audit: The management of the affairs of the co-operative societies is in the
hands of only some of the elected members. This necessitates an independent financial audit of accounts
of co-operative societies.
Insurance Audit: Insurance Regulatory and Development, Act 1999 contains the provision of the
maintenance of accounts and audit of the insurance companies.
Partnership Firm Audit: At present, partnership firms in India are not legally required to get their
financial statements audited. Still, many firms get their financial statements audited
Sole Proprietorship Audit: Like partnership firms, sole proprietary concerns are also not legally required
to get their financial statements audited by independent financial auditors.
Lesson 11 Types of Auditing 337
Government Audit: It is the duty of Comptroller and Auditor General of India (C&AG) to audit the
receipts and expenditure of the Union Government and State Government.
Management Audit: It is a structured review of the systems and procedures of an organization in
order to evaluate whether they are being conducted efficiently and effectively.
Propriety Audit: Under this type of audit, the expenditure is analyzed with a view to ascertain the
cases of improper, avoidable or in fructuous expenditure even though the expenditure has been incurred
in conformity with the existing rules and regulations.
Efficiency Audit: Efficiency audit or performance audit is a form of audit which is being carried out for
ascertaining the efficiency/performance of a system/process/input.
GLOSSARY
Constructive Arm Improve or promote development
Independence Free from the influence, guidance, or control of another or others; self-reliant:
an independent mind.
Practicing Company The member of ICSI who hold certificate of practice.
Secretary
Check An action or influence that stops motion or expression; a restraint
SELF-TEST QUESTIONS
1. What are the types of audit? Explain in brief.
2. What is meant by Internal Audit and what are its benefits and limitations?
3. What is meant by Financial Audit?
4. What is the difference between Internal Audit and Financial Audit?
5. What is Secretarial audit and who can be appointed as secretarial auditor?
6. What are the objectives of secretarial audit?
7. What do you mean by tax audit and on whom it is applicable?
8. What is cost audit and explain its usefulness in brief?
SUGGESTED READINGS
1. Fundamentals of Auditing By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
338 FPFA&A
Lesson 12 Tools of Auditing 339
Lesson 12
Tools of Auditing
LESSON OUTLINE
LEARNING OBJECTIVES
Audit Plan In the last lesson the various types of audit have
Difference between Audit Plan and Audit It is the first step of audit. After preparing an audit
Programme plan, the auditor will make an audit programme
which contains the instructions to be followed by
Review Questions
the audit staff. This helps auditor in proper
Audit evidence
supervision of the audit. While doing an audit the
Essentials of Audit evidence auditor has to collect evidences in support of his
Factors considered while obtaining opinion. The audit evidence provides grounds for
audit evidence believing that a particular thing is true or not by
providing support for a fact or a point in question.
Techniques of obtaining audit
evidence Audit working papers are used to support the
audit work done in order to provide assurance
Working papers
that the audit was performed in accordance with
Types of working paper
the relevant auditing standards.
Review Questions
In this lesson you will learn how the Audit Plan is
Lesson Round-Up important in an audit, the ways of laying down an
Its an independent audit of the work and all the contracting issues to determine whether existing procedures
were complied with and whether there should be any changes in those procedures.
John Mullen
340 FPFA&A
INTERNAL AUDIT
Internal audit is an evaluation and analysis of the business operation conducted by the internal audit staff. It is
the part of overall system of internal control established in an organization.
Internal audit is the independent appraisal activity within an organization for the review of accounting, financial
and other business practices as protective and constructive arms of management. It is a type of control which
functions by measuring and evaluating the effectiveness of other type of controls.
According to Professor Walter B. Meigs, Internal Auditing means Internal auditing consist of a continuous,
critical review of financial and operating activities by a staff of auditors functioning as full time salaried employees.
In big organization, an internal audit is carried out by the team of professionals in the organization. The internal
audit is not mandatory but organization gets the internal audit done with a view to evaluate the effectiveness of
internal control, the soundness of financial system, effectiveness of business processes etc. This provides
management an assurance about the control process in the organization and it aids in early detection of
inefficiencies/fraud etc. it helps the statutory auditors too in getting the statutory audit done effectively. As per
company audit report order, 2003, statutory auditor also requires to comment whether the company is having
sound internal audit system or not.
(x) Determine Liability: The purpose of internal audit is to determine liabilities of employees. The duties are
divided among the staff. It is easy to note the negligence on the part of employees. The internal audit can pin
point the person responsible for carelessness.
(xi) Help in Independent Audit: The purpose of internal audit is to help an independent audit. The external
auditor can rely on internal auditor and there is no need of cent percent checking. In this way there is saving of
time and money due to internal audit.
(xii) Performance Appraisal: The purpose of internal audit is to check the performance appraisal. The
management must achieve the targets fixed in budgets and plans. The internal audit is a tool to evaluate the
working of each management function.
(xiii) Provide Suggestions: The purpose of internal audit is to provide suggestions for improvement of business
activities. The internal audit staff can suggest the ways and means to remove the difficulties. Anyhow the internal
auditor cannot compel the management to implement suggestions.
(xiv) New Ideas: The purpose of internal audit is to seek new ideas relating to procedures, marketing, financing
and other business matters. The internal audit staff can provide new ideas about various business matters. The
viable ideas can be put in to practice for the benefit of business.
(xv) Use of Resources: The purpose of internal audit is to determine the proper use of resources. The misuse
of resources can increase the cost of doing the business. The proper use of resources means there is efficiency
on the part of management.
(xvi) Accounting Policies: The purpose of internal audit is to examine the accounting policies. The understanding
of accounting system and procedure is helpful to device the effective audit plans & procedures. The internal
auditor may find any weakness in the internal control. He can comment on the accounting policies.
(xvii) Special Investigation: The purpose of internal audit may be to conduct special investigation about any
business matter. Internal audit can be used as a tool to note the effectiveness of management function.
to watch the activities of all employees including management. The auditor can suggest the way and means to
improve the performance of business.
(vii) No Error and fraud: The internal audit is used to protect accounting records from errors and fraud. The
accounting and auditing go side by side when accounting work is over the audit will start. In such situation errors
and fraud committed by the accounting staff will easily be detected and rectified.
(viii) Fixing Responsibility: Internal audit is used to fix the responsibility of people having poor performance.
The management establishes the performance standards. The internal auditor can evaluate the result of all
persons. The people can be held responsible for below standard work and action can be taken against them.
(ix) Helps External Auditing: The work performed by internal auditor can help external auditor in carrying out
the audit. The audit procedure of internal and external audit is almost the same. The auditor can go through the
internal audit report at the time of starting audit work. Anyhow external auditor is responsible for external audit.
(x) Performance Improves: Internal auditor is helpful to improve the performance of the organization. The
achievements of previous year are the basis of preparing budget for the next years. The projected income
statement and balance sheet are drawn up. An attempt is made to get the positive result. Thus internal audit
improves performance of business and employees.
(xi) Proper Use of Resources: Internal audit is used to check the proper use of resources. The misuse of
resources can increase the cost of organization. The optimum use of resources can be determined to control
the cost of output. In this way internal audit is a tool to use the resources in the best interest of the business.
(xii) Investigation: Internal audit is of help to investigate in to the business matters. In case of doubt internal
auditor can be asked to examine the facts and figures to confirm or clear any doubt. The internal auditor can
investigate the matter in any manner. Such investigation can be made at the request of management or owners.
AUDIT PLAN
An audit plan lays out the strategies to be followed to conduct an audit. It includes the nature, timing and extent
of audit procedures to be performed by the engagement team members. The auditor shall develop an audit plan
while considering the following:
(a) The nature, timing and extent of planned risk assessment procedures.
(b) The nature, timing and extent of audit procedures at the assertion level.
(c) Other planned audit procedures that are required to be carried out so that the engagement complies
with Standard on Auditing (SAs).
Lesson 12 Tools of Auditing 343
The objective of the auditor is to plan the audit so that it will be performed in an effective manner.
The auditor should consider the following matters before planning for an audit:
(i) Terms of Engagement and any Statutory Responsibilities: While framing an audit plan auditor should
ascertain his terms of appointment and responsibilities cast by various legislations on him. The auditor
should then prepare his audit plan based on what he is required to do.
(ii) Nature and Timing of Report or other Communications: Auditor should determine the form and the
timing of the report. This will help auditor in determining the scope and time schedule of the audit.
(iii) Accounting Policies followed by the Enterprise and Change in those Policies: Accounting policies
followed by the enterprise affect the audit plan. While preparing an audit plan due consideration may be
given to the areas where there is any change in accounting policies.
(iv) Effect of New Accounting or Auditing Requirements: Any change in accounting and auditing standards
may affect the scope of audit or the manner in which it is conducted. Therefore these should be carefully
considered while drawing up the audit plan.
(v) Identification of Significant Audit Areas: It is important for the auditor to identify the areas which
involves greater audit risk, so that the audit can be planned in such a way that overall audit risk will be
less. More risky areas should be checked in detail and vice-versa.
(vi) Setting of Materiality Levels for Audit Purposes: At the planning stage the auditor sets the materiality
levels. For example the auditor may decide that in the case of audit of sales he will examine all sales
transactions above Rs.5000.
(vii) Degree of Reliance Expected to be placed on Accounting System and Internal Control: While
laying down an audit plan the auditor shall assess the effectiveness of accounting systems and internal
controls. On the basis of assessment, the auditor has to decide whether he will do test checking or more
extensive checking of transaction and balances.
(viii) Nature and Extent of Audit Evidence: The nature and extent of audit evidence will vary in different
auditing situations. For example in one situation the auditor may rely more on physical examination,
confirmation from third parties whereas in another situation he may rely more on examination of
documentary evidence.
(ix) Work of Internal Auditors: Statutory auditor has to review the work done by the internal auditors to
determine the extent of reliance they can place on. It will help the auditor in determining the scope of
work under the audit plan.
(x) Establishing and Coordinating Staffing Requirements: Auditor shall determine the exact requirements
of the staff along with the broad estimate of time required by each staff members. So that the audit work
will be completed on time.
AUDIT PROGRAMME
An audit programme is a set of instructions which are to be followed for proper execution of audit. After the
development of audit plan a detailed written audit programme containing the various steps and procedures shall
be required. The audit programme contains the measures that are generally employed to determine what, and
how much evidence must be collected and evaluated. It also lays down the responsibilities for the whole audit
team for carrying out different tasks.
The prepared audit program may be revised if needed in accordance with the prevailing circumstances. An audit
program largely depends on the size of the organization and other relevant factors. Minimum essential work to
be done is Standard Programme and rest is according to circumstances. There is no standard audit programme
applicable for all situations.
344 FPFA&A
Audit programme is documented in the Audit Working Papers, which are the official record that contains the
planning and execution of the audit agreement.
REMEDY OF DISADVANTAGES
1. The remedy in such situations is that audit programme should be flexible must be always opens to
changes and improvements.
2. The audit staff should be encouraged to draw attention of the auditor to any defects in the programme.
3. The staff should be encouraged to explore fully unusual transaction and do not get restricted with the
audit programme.
REVIEW QUESTION
1. At the ___________ stage the auditor sets the materiality levels.
2. While laying down an audit plan the auditor shall assess the effectiveness of
accounting systems and __________ _____.
3. An audit programme is a set of __________ which are to be followed for proper
execution of audit.
4. Audit programme is documented in the ______________, which are the official
record that contains the planning and execution of the audit agreement.
AUDIT EVIDENCE
The auditor has to obtain sufficient and appropriate evidence to substantiate his opinion on the financial statements.
The audit evidence provides grounds for believing that a particular thing is true or not by providing support for a
fact or a point in question. The evidences collected by the auditor must support the contents of the auditors
report.
WORKING PAPERS
Audit working papers are the documents prepared or obtained by the auditors and retained by him in connection
with the audit. Audit working papers are used to support the audit work done in order to provide assurance that
the audit was performed in accordance with the relevant auditing standards. Working papers include all the
evidence gathered by auditor indicating what work has been done by him and the procedure he has followed in
verifying a particular asset or a liability and also provide information that whether:
audit was properly planned;
audit was carried out;
audit was adequately supervised;
the appropriate review was undertaken;
the evidence is sufficient and appropriate to support the audit opinion.
Working papers are the connecting link between the clients records and the audited accounts. These provide
permanent historical record. These also serve as a great guide to the staff to whom the work of audit has been
assigned after the previous year audit. These would come to the help of the auditor in future in case the client
files a suit against the auditors negligence. The working papers are the property of the auditor and the client
cannot ask the auditor for their custody. However it is the duty of the auditor to maintain confidentiality of the
client information. Further, if audit working papers are disclosed than it will amount to professional misconduct.
AUDIT WORKING
PAPERS
Permanent File
The data in these file are the information, which is of continuous interest and relevant to succeeding audits.
Data in this file can include the following:
Articles of incorporation
348 FPFA&A
Loan agreements
Documents related to understanding internal control
Leases
Significant audit observation of earlier years
Notes regarding significant accounting policies
REVIEW QUESTIONS
1. The working papers are the property of the __________.
2. The auditor can divide his working papers into ________.
3. Current audit file contains information related to audit of _________.
4. ___________ refers to the extent to which the information bears a clear and logical
relationship to the audit criteria and objectives.
5. Documentary evidence is usually better than __________ evidence
LESSON ROUND UP
An audit plan lays out the strategies to be followed to conduct an audit. It includes the nature, timing
and extent of audit procedures to be performed.
The auditor should consider the following matters while laying out an audit plan:
(a) Terms of engagement and any statutory responsibilities.
(b) Nature and timing of report or other communications.
(c) Accounting policies followed by the enterprise and change in those policies.
(d) Effect of new accounting or auditing requirements.
(e) Identification of significant audit areas.
Lesson 12 Tools of Auditing 349
GLOSSARY
Standard of SAs are standard on auditing issued by the Institute of Chartered Accountants of India.
Auditing (SAs) They are the guidelines to conduct an audit.
Documentary Evidence in the form of written papers or documents.
350 FPFA&A
Evidence
Testimonial Something that recommends a person or thing as worthy or desirable.
Evidence
Audit Risk Audit risk is the risk of the auditor providing an inappropriate opinion on the financial
statements, particularly when those financial statements contain a material misstatement.
Analytical Any process by which a person or company looks at an account or financial statement
Review and attempts to identify any irregularities. This may involve comparing financial and
non-financial information. An analytical review is less thorough than an audit.
SELF-TEST QUESTIONS
1. What is audit plan and what are the factors to be considered while preparing an audit plan?
2. Write short notes on
(a) Permanent Audit File
(b) Current Audit File
3. What is Audit Programme and how it helps in performing an audit?
4. Explain briefly the utility of working papers?
5. Describe briefly the various techniques which an auditor applies to collect evidence?
SUGGESTED READINGS
1. Fundamentals of Auditing By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
Lesson 13 Auditor and Related Provisions 351
Lesson 13
Auditor and Related Provisions
LESSON OUTLINE
LEARNING OBJECTIVES
Who is an Auditor
These days the focus of the government is on
Appointment of Auditor
self regulation by the business community.
First Auditors
Society also wants less intervention of the
Subsequent Auditors
government in the functioning of the business.
Filling of Casual Vacancy
Therefore various laws and legislation provide
Power of the Central Government to
appoint Auditors for the appointment of independent auditor. The
Laws continue to be enacted, and the regulatory environment has become more complex due to unacceptable
conduct remediation. Consequently, entities continue to be compelled to demonstrate compliance with legal
mandates through documented assurance assessments.
Robert E. Davis
352 FPFA&A
WHO IS AN AUDITOR
A person who conducts an audit is an auditor. An auditor is a professional that accumulates and evaluates
evidence to report whether the company complies with the established set of procedures or standards. An
auditor may function as an employee or an independent professional. When the auditor works for the organization,
he or she is usually referred to as an internal auditor. The internal auditor often conducts periodic audits that may
encompass several areas on a rotating basis. As an example, the internal auditor may focus on the manufacturing
process during one quarter of the year, while devoting a second quarter to evaluating the financial record
keeping of the company. Often, the internal auditor will set up a schedule to ensure that audits are conducted on
each critical portion of the company at least once per calendar. So many acts require the organizations to get
their accounts audited by an independent external agency. This independent external agency is known as
External auditor of the organization. The external auditor has to check the accounts of the organization, and
their compliances to various rules and regulations. The idea behind using an external auditor is that the audit will
be free of bias and not influenced by office politics or internal relationships that exist among the employees of
the company. No connection to the company is permitted, as it may be construed as biasing the auditors report.
To be fair and equitable, an external auditor should familiarize himself with the nature of the business he is
auditing prior to starting the job.
APPOINTMENT OF AUDITOR
Section 139 of the Companies Act 2013 contains provisions regarding the appointment of the auditor. As per this
section the auditor of any company can be appointed by the shareholders however in some cases the auditor
can be appointed by the directors or the central government.
The provisions with regard to the appointment of an auditor can be divided into three categories:
First auditor
Subsequent auditor
Filling of casual vacancy
The company shall inform the auditor concerned of his or its appointment, and also file a notice of such appointment
with the Registrar within fifteen days of the meeting in which the auditor is appointed.
Qualification of Auditor
Section 141 (1) and Section 141(2) of Companies Act, 2013 contains provision as regards to qualifications of
auditors. As per section 141(1) of the Companies Act, 2013, a person shall be eligible for appointment as an
auditor of a company only if he is a chartered accountant. A firm whereof majority of partners practising in India
are qualified for appointment as aforesaid may be appointed by its firm name to be auditor of a company. Where
a firm including a limited liability partnership is appointed as an auditor of a company, only the partners who are
chartered accountants shall be authorised to act and sign on behalf of the firm.
Disqualification of Auditor
Section 141(3), of the companies act, 2013 defines disqualification of the auditor in a negative sense. As per this
section none of the following shall be qualified for appointment as auditor of a company:
The following persons shall not be eligible for appointment as an auditor of a company, namely:
(a) a body corporate other than a limited liability partnership registered under the Limited Liability Partnership
Act, 2008;
(b) an officer or employee of the company;
(c) a person who is a partner, or who is in the employment, of an officer or employee of the company;
(d) a person who, or his relative or partner
(i) is holding any security of or interest in the company or its subsidiary, or of its holding or associate
company or a subsidiary of such holding company: Provided that the relative may hold security or
interest in the company of face value not exceeding Rs. One lakhs;
(ii) is indebted to the company, or its subsidiary, or its holding or associate company or a subsidiary of
such holding company, in excess of Rs. 5 Lakhs; or
(iii) has given a guarantee or provided any security in connection with the indebtedness of any third
person to the company, or its subsidiary, or its holding or associate company or a subsidiary of such
holding company, in excess of rupees one lakhs ;
(e) a person or a firm who, whether directly or indirectly, has business relationship with the company, or its
subsidiary, or its holding or associate company or subsidiary of such holding company or associate
company of such nature as may be prescribed;
(f) a person whose relative is a director or is in the employment of the company as a director or key
managerial personnel;
354 FPFA&A
(g) a person who is in full time employment elsewhere or a person or a partner of a firm holding appointment
as its auditor, if such persons or partner is at the date of such appointment or reappointment holding
appointment as auditor of more than twenty companies;
(h) a person who has been convicted by a court of an offence involving fraud and a period of ten years has
not elapsed from the date of such conviction;
(i) any person whose subsidiary or associate company or any other form of entity, is engaged as on the
date of appointment in consulting and specialised services as provided in section 144..
As per Section 141(4) of the Companies Act, where a person appointed as an auditor of a company incurs any
of the disqualifications mentioned in section 141(3) after his appointment, he shall vacate his office as such
auditor and such vacation shall be deemed to be a casual vacancy in the office
himself of all information which is material to enable him to make his report and from fulfilling his statutory
duties to the shareholders. In case the information is not supplied to the auditor, he can report the same
to the members.
(iii) Right to Sign the Audit Report: Only the person appointed as auditor of the company, or where a firm is
so appointed, only a partner in the firm practicing in India, may sign the auditors report, or sign or
authenticate any other document of the company required by the law to be signed or authenticated by
the auditor.
(iv) Right to Receive Notice of and Attend General Meeting: The auditors have the right to attend any
general meeting and to receive any notice and other communications relating thereto which members
are entitled to receive and to be heard at any general meeting on any part of the business which
concerns them as auditors.
(v) Right to visit Branch Office and right of Access to Books: Where the accounts of any branch office are
audited by a person other than the companys auditor, the companys auditor
(a) shall be entitled to visit the branch office, if he deems it necessary to do so for the performance of
his duties as auditor; and
(b) Shall have a right of access at all times to the books and accounts and vouchers of the company
maintained at the branch office.
(vi) Right to Receive Remuneration: The auditor shall have the right to receive remuneration for auditing the
accounts of the company.
DUTIES OF AUDITOR
The duties of an auditor are many and varied. He must examine the original books of account, kept by the
company to discover any inaccuracies or omissions therein, to examine the companys balance sheet and profit
and loss account, and report on the original books of account and the annual accounts to the members.
Section 143(1) of the Companies Act requires an auditor to inquire:
(a) Whether loans and advances made by the company on the basis of security have been properly secured
and whether the terms on which they have been made are prejudicial to the interests of the company or
its members;
(b) Whether transactions of the company which are represented merely by book entries are prejudicial to
the interests of the company;
(c) where the company not being an investment company or a banking company, whether so much of the
assets of the company as consist of shares, debentures and other securities have been sold at a price
less than that at which they were purchased by the company;
(d) Whether loans and advances made by the company have been shown as deposits;
(e) Whether personal expenses have been charged to revenue account;
(f) Where it is stated in the books and documents of the company that any shares have been allotted for
cash, whether cash has actually been received in respect of such allotment, and if no cash has actually
been so received, whether the position as stated in the account books and the balance sheet is correct,
regular and not misleading
Auditor will report on these points only if he has a special comment to make otherwise will not make any comment.
The auditor should also ensure the adherence of Auditing Standards as specified by the Institute of Chartered
Accountants of India.
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AUDITORS REPORT
Under Section 143(2) of the Companies Act, 2013, the auditor shall make a report to the members of the
company on the accounts examined by him and on every financial statements which are required by or under
this Act to be laid before the company in general meeting and the report shall after taking into account the
provisions of this Act, the accounting and auditing standards and matters which are required to be included in
the audit report under the provisions of the Act or any rules made thereunder or under any order made under
sub-section (11) and to the best of his information and knowledge, the said accounts, financial statements give
a true and fair view of the state of the companys affairs as at the end of its financial year and profit or loss and
cash flow for the year and such other matters as may be prescribed.
The auditors report shall also state under Section 143(3) of Companies Act, 2013
(a) Whether he has sought and obtained all the information and explanations which to the best of his
knowledge and belief were necessary for the purpose of his audit and if not, the details thereof and the
effect of such information on the financial statements;
(b) Whether, in his opinion, proper books of account as required by law have been kept by the company so
far as appears from his examination of those books and proper returns adequate for the purposes of his
audit have been received from branches not visited by him;
(c) Whether the report on the accounts of any branch office of the company audited under sub-section (8)
by a person other than the companys auditor has been sent to him under the proviso to that sub-section
and the manner in which he has dealt with it in preparing his report;
(d) Whether the companys balance sheet and profit and loss account dealt with in the report are in agreement
with the books of account and returns;
(e) Whether, in his opinion, the financial statements comply with the accounting standards;
(f) the observations or comments of the auditors on financial transactions or matters which have any
adverse effect on the functioning of the company;
(g) Whether any director is disqualified from being appointed as a director under sub-section (2) of section
164;
(h) Any qualification, reservation or adverse remark relating to the maintenance of accounts and other
matters connected therewith;
(i) Whether the company has adequate internal financial controls system in place and the operating
effectiveness of such controls;
(j) The auditors report shall also include their views and comments on the following matters, namely:-
(a) Whether the company has disclosed the impact, if any, of pending litigations on its financial position
in its financial statement;
(b) Whether the company has made provision, as required under any law or accounting standards, for
material foreseeable losses, if any, on long term contracts including derivative contracts;
(c) Whether there has been any delay in transferring amounts, required to be transferred, to the Investor,
Education and Protection Fund by the company.
As per Section 143(4) of the Companies Act, 2013, where any of the above matters is answered in the negative
or with a qualification, the auditors report must state the reason for the same.
Lesson 13 Auditor and Related Provisions 357
Auditors report is the experts opinion expressed by the auditor as to the fairness of financial statements.
The audit report is the end product of every audit. It is the medium through which an auditor expresses his
opinion on the financial statements. Audit report is an important part of audit process since it summarize the
results of the examination work conducted by the auditor. The report shows the scope of the work done and the
responsibility assumed by the auditor regarding the fairness or otherwise of the financial statements. The auditor
draws appropriate conclusions by examining the various statements and accounts, which he conveys through
the audit report. It is a formal communication by the auditor to the shareholders throwing light on the state of
affairs of the company. Audit report is addressed to the members of the company and is considered at the
Annual General meeting of the company. Audit reports should be so drafted that they remain simple and intelligible
to a common man. The audit report should be explicit so as to provide greater information and protection to the
interest of shareholders and others.
AUDITORS OPINION
In financial accounting, an auditors opinion is the published outcome an auditors review of a companys or
organizations financial statements. The auditors opinion does not pass judgment on the organizations financial
position or financial performance or otherwise interpret the financial data.
In the audit opinion, the auditor states that he or she has examined the clients financial statements for the year
358 FPFA&A
ended in accordance with the generally accepted accounting principles including tests of the accounting records
and other necessary auditing procedures. The auditor then indicates whether in his or her opinion the clients
financial statements present fairly the financial position, results of operations, and changes in financial position
for the year-ended in conformity with Accounting Principles applied on a consistent basis. The Auditors opinion
may be of the following types:
Unqualified opinion
Adverse opinion
Qualified opinion, and
Disclaimer of opinion
Unqualified Opinion
Where auditor does not have any reservation, objection regarding the information under audit, then he issues
an unqualified opinion. This opinion signifies that the auditor accepts the accounting treatment given to the
various transactions and the profit and loss account shows the true and fair view of the transaction entered by
the organization during the period and the balance sheet shows the true and fair view of the state of affairs of the
organization at that point of time. It is also known as Clean report
Qualified Opinion
In a situation where neither the unqualified, nor adverse opinion is appropriate the auditor gives the qualified
opinion. This is a situation where the auditor has some reservation about the financial statements which though
significant but not that significant so as to warrant adverse opinion and auditor agrees to a large extent with the
true and fair view of the financial statement then he gives qualified opinion. As per this opinion subject to certain
reservation or qualification stated, the auditor agrees with the proposition stated in the financial statements.
Where auditor expresses a qualified opinion, he should also state in his report the reason for the same, so that
the readers can assess their significance and effect. The words Subject to are written to show qualification. If
the qualification are quantifiable (measurable) then the auditor has to quantify it. And if these are not quantifiable,
Auditor has to clearly state that quantification is not possible.
Disclaimer of Opinion
The above three are the opinions which the auditor expresses but the disclaimer of opinion is a situation when
auditor is not in a position to give his opinion. Where there is a situation where auditor is not in a position to
collect sufficient appropriate audit evidence which enables him to draw his conclusion then it is proper for the
auditor to disclaim an opinion due to lack of sufficient appropriate audit evidence.
Where auditor expresses a disclamer of opinion, he should also state in his report the reason for the same, so
that the readers can assess their significance and effect.
Lesson 13 Auditor and Related Provisions 359
LESSON ROUND UP
An auditor is a professional that accumulates and evaluates evidence to report whether the company
complies with the established set of procedures or standards. When the auditor works for the
organization, he or she is usually referred to as an internal auditor. Where as independent external
agency is known as External auditor of the organization.
The provisions with regard to the appointment of an auditor can be divided into three categories:
First auditor- By the Board of directors within one month of the date of the registration of the company.
Subsequent Auditor- every company must appoint an auditor or auditors at each annual general meeting
Filling of Casual Vacancy- casual vacancy in the office of auditor may be filled by the Board. But where
the vacancy is caused by resignation of auditor, such vacancy shall only be filled by the company in
general meeting.
Power of the Central Government to Appoint Auditors- If no auditors are appointed or re-appointed at
the annual general meeting, the Central Government may appoint a person to fill the vacancy
Qualification of Auditor- Only a Chartered Accountant in practice within the meaning of Chartered
Accountants Act, 1949 can act as an auditor of a limited company. A firm whereof all the partners are
practicing Chartered Accountants can be appointed by its firm name as auditor in such case any
partner may act in the name of the firm.
Disqualification of Auditors- None of the following shall be qualified for appointment as auditor of a
company: A body corporate; An officer or employee of the company (officer includes director, manager
or secretary); A person who is a partner or who is in the employment, of an officer or employee of the
company; A person who is indebted to the company for more than Rs. 1,000/- or who has guaranteed
the repayment of any debt of more than Rs. 1,000/- due to the company by a third person; A person
holding any security of that company after a period of one year from the date of commencement of the
Companies (Amendment) Act, 2000 i.e. 13 December, 2000; A person who is disqualified for appointment
as auditor of the companys subsidiary or holding company, or a subsidiary of its holding company;
Statutory auditor cannot act as internal auditor of the company.
Right and powers of Auditors- Right to access to books, accounts and vouchers; Right to obtain
information and explanation; Right to sign the audit report; Right to receive notice of and attend General
Meeting; Right to receive remuneration; Right to visit branch office and right of access to books.
Duties of Auditors- An auditor to inquire: whether loans and advances made by the company are
properly secured and the terms on which they have been made are not prejudicial to the company;
book entries transactions are not prejudicial to the interests of the company; in case of non-investment
or a banking company, whether shares, debentures and other securities have been sold at a price less
than its purchase price; whether loans and advances made by the company have been shown as
deposits; no personal expenses has been charged to profits; whether cash has actually been received
in respect of any shares shown in the books to have been allotted for cash; Whether the books are not
misleading.
Auditors Report- The report must expressly state: Whether, in his opinion the accounts give the
information required by the Act and in required manner; Whether the balance sheet and profit and loss
account gives a true and fair view; Whether he has obtained all the information and explanations
required; Whether, in his opinion, proper books of account as required by law have been kept by the
company, and proper returns for the purposes of his audit have been received from the branches not
visited by him; Whether the companys balance sheet and profit and loss account are in agreement
with the books; Whether in his opinion, the profit and loss account and balance sheet comply with the
360 FPFA&A
AS; Auditors observation or comments; Whether any director is disqualified from appointment; reason
for negative answers.
Essentials of Audit Report- Title; Addressee; Identification; Reference to Auditing Standards; Opinion;
Signature; Auditors Address; Date of Report.
Types of auditor opinion- Unqualified opinion; Adverse or Negative Opinion; Qualified Opinion; Disclaimer
of opinion.
SELF-TEST QUESTIONS
1. Who can be appointed as the auditor of a company?
2. How the first auditor of the company is appointed?
3. What is a casual vacancy? What are the rules regarding appointment for the casual vacancy on account
of resignation?
4. What are the powers of the company auditor?
5. Can a company restrict the rights of its statutory auditor?
SUGGESTED READINGS
1. Fundamentals of Auditing By Kamal Gupta
2. Auditing: principles and practice - By Ravinder Kumar, Virender Sharma
3. An Insight into Auditing- By Dr. B. K. Basu
Practice Test Papers 361
FOUNDATION PROGRAMME
(This Test Paper is for practice and self study only and not to be sent to the Institiute)
PART A
Students are advised to read instruction on Computer based examinations available on ICSI website www.icsi.edu
362 FP-FA&A
12. Interest on capital will be paid to the partners if provided for in the agreement but only from________
(a) Profits.
(b) Reserves.
(c) Accumulated Profits.
(d) Goodwill.
13. Present liability of uncertain amount, which can be measured reliably by using a substantial degree of
estimation, is termed as ________
(a) Provision
(b) Liability
(c) Contingent liability
(d) Reserve
14. If a purchase return of A94 has been wrongly posted to the debit of the sales return account, but had been
correctly entered in the suppliers account, the total of the trial balance would show
(a) the credit side to be A94 more than debit side.
(b) the debit side to be A94 more than credit side.
(c) the credit side to be A188 more than debit side.
(d) the debit side to be A188 more than credit side.
15. X and Y are partners with the capital A1,50,000 and A1,40,000 respectively. They share profits and losses
equally. Z is admitted on bringing A1,50,000 as capital only and nothing was brought against goodwill.
Goodwill in Balance sheet of A20,000 is revalued as A35,000. What will be value of goodwill in the books
after the admission of Z?
(a) A55,000.
(b) A35,000.
(c) A20,000.
(d) A15,000
16. The profits of last three years are A43,000; A38,000 and A45,000. Find out the goodwill if it is valued at two
years purchase of average profits.
(a) A42,000.
(b) A84,000.
(c) A1,26,000.
(d) A36,000.
17. If capital employed by a partnership firm is A1,00,000 and its average profit is A20,000 normal rate of return
is 15%, then find goodwill if it is valued on the basis of one year purchase of super profits.
(a) A30,000
(b) A5,000
(c) A1,33,333
(d) A33,333
364 FP-FA&A
18. Total capital employed by a partnership firm is A1,00,000 and its average profit is A25,000. Normal rate of
return is 20% in similar firms working under similar conditions. The firms earns super profit of:
(a) A3,000
(b) A5,000
(c) A4,000
(d) A2,000
19. In the absence of any provision in the partnership agreement, profits and losses are shared
(a) In the ratio of capitals.
(b) Equally.
(c) In the ratio of loans given by them to the partnership firm.
(d) None of the above.
20. A company forfeited 2,000 shares of A10 each (which were issued at par) held by Mr. X for non-payment of
first & final call money of A4 per share. The called-up value per share was A9. On forfeiture, the amount
debited to share capital will be
(a) A10,000
(b) A8,000
(c) A20,000
(d) A18,000
21. Abacus Ltd. issued shares of A10 each at a discount of 10%. Mr. Mahesh purchased 30 shares and paid A2
on application but did not pay the allotment money of A3. The company forfeited his entire shares, the
forfeiture account will be credited by
(a) A90
(b) A81
(c) A60
(d) A54
22. A company cannot issue redeemable preference shares for a period exceeding
(a) 6 years
(b) 7 years
(c) 8 years
(d) 20 years
23. A200 paid as wages for erecting a machine should be debited to
(a) Repair account.
(b) Machine account.
(c) Capital account.
(d) Furniture account
Practice Test Papers 365
24. If sales are A2,000 and the rate of gross profit on cost of goods sold is 25%, then the cost of goods sold will
be
(a) A2,000.
(b) A1,500.
(c) A1,600.
(d) None of the above.
25. If cost of goods sold is A80,700, Opening stock A5,800 and Closing stock A6,000. Then the amount of
purchase will be
(a) A80,500
(b) A74,900
(c) A74,700
(d) A80,900.
26. Under the straight line method of depreciation, the amount of yearly depreciation _____________
(a) Remains the same
(b) Fluctuates
(c) Increases year after year
(d) Decreases year after year.
27. A Bank Reconciliation Statement is prepared to know the causes for the difference between:
(a) the balances as per cash column of Cash Book and the Pass Book.
(b) the balance as per bank column of Cash Book and the Pass Book.
(c) the balance as per bank column of Cash Book and balances as per cash column of Cash Book
(d) None of the above.
28. In case of redemption of preference shares out of distributable profits, an amount equal to the nominal
value of preferences shares redeemed must be transferred to the
(a) Development rebate reserve
(b) Investment allowance reserve
(c) Capital redemption reserve
(d) Premium on redemption of preference shares
29. When preparing a Bank Reconciliation Statement, if you start with a debit balance as per the Cash Book,
cheques issued but not presented within the period should be:
(a) Added
(b) Deducted
(c) Not required to be adjusted
(d) None of the above.
366 FP-FA&A
30. The assumption underlying the fixed instalment method of depreciation is that of ________ of the asset
over different years of its useful life.
(a) Increasing Usage
(b) Equal Usage
(c) Decreasing Usage
(d) None of the above
31. Original cost = A1,26,000. Salvage value = A6,000. Useful Life = 6 years. Annual depreciation under Stragiht
Line Method will be
(a) A21,000
(b) A20,000
(c) A15,000
(d) A14,000
32. Preference shares amounting to A1,00,000 are redeemed at a premium of 5% by issue of shares amounting
to A50,000 at a premium of 10%. The amount to be transferred to capital redemption reserve account will
be
(a) A55,000.
(b) A50,000.
(c) A45,000.
(d) A57,500.
33. Brave Ltd. issued 60,000 shares of A10 each at a discount of A1 per share. The application money was A2,
allotment money was A4, and first call was of A1. The amount of final call will be
(a) A3
(b) A2
(c) A1
(d) A4
34. Discount on issue of debentures is shown as _________on the liabilities side of balance sheet:
(a) Surplus
(b) Negitive Surplus
(c) Non-current liability
(d) None of the above
35. Which of the following expenses are debited in trading account?
(a) Surplus
(b) Negative Surplus
(c) Non-current liability
(d) Rent of office premises
Practice Test Papers 367
61. In the absence of any provision in the partnership agreement, the partners have right to receive interest on
loan at
(a) 12% p.a
(b) 6 % p.a
(c) 20% p.a
(d) Nil
62. Total capital employed by a partnership firm is A1,00,000 and its average profit is A25,000. Normal rate of
return is 20% in similar firms working under similar conditions. The firms earns super profit of:
(a) A3,000
(b) A5,000
(c) A4,000
(d) A2,000
63. A, B and C are equal partners. D is admitted to the firm for one-fourth share. D brings A20,000 capital and
A5,000 for goodwill. The value of goodwill of the firm is
(a) A10,000
(b) A40,000.
(c) A20,000.
(d) A50,000
64. A company issued 5,000 10% Debentures of A100 each at 10% discount. All the debentures were subscribed
and allotted by crediting 10% Debentures account with
(a) A10,00,000.
(b) A12,00,000.
(c) A5,00,000.
(d) A4,50,000.
65. Bajaj Ltd. issued 5,000 equity shares of A10 each payable as A2 on application, A3 on allotment, A2 on first
call and the balance in the final call. The amount to be debited to bank account at the time of receipt of first
call money will be
(a) A30,000
(b) A10,000
(c) A40,000
(d) A50,000.
66. Mr. Verma holding 1000 equity shares of A10/- each issued at a discount of 10% could not pay final call of
A3.50 and his shares were forfeited. In the books of the company, shares forfeited account will be credited by
(a) A2,500.
(b) A5,500.
(c) A3,500.
(d) A2,000.
372 FP-FA&A
67. Making provision for bad debts in respect of doubtful debts is based on the convention of ______________
(a) Consistency
(b) Disclosure
(c) Conservatism
(d) Materiality
68. Preference shares can be redeemed only if they are
(a) Partly paid up
(b) Fully paid up
(c) Both of the above
(d) None of the above
69. If sales revenues are A4,00,000; cost of goods sold is A3,10,000, the gross profit is
(a) A90,000.
(b) A4,00,000.
(c) A3,10,000.
(d) A7,10,000
70. If Average Stock = A24,000. Closing stock is A6,000 more than opening stock then the value of closing
stock will be
(a) A24,000
(b) A48,000
(c) A20,500
(d) A27,000.
PART B
71. Which of the following is not corroborative evidence?
(a) Minutes of meetings;
(b) Confirmations from debtors;
(c) Information gathered by auditor through observation;
(d) Worksheet supporting consolidated financial statements.
72. In case the directors fail to appoint first auditor(s), the shareholders shall appoint them at.by passing
a resolution:
(a) A general meeting
(b) First annual general meeting
(c) Statutory meeting
(d) Annual general meeting.
73. Balance sheet audit does not include:
(a) Vouching of income expense accounts related to assets and liabilities;
(b) Examination of adjusting and closing entries;
Practice Test Papers 373
ANSWERS
Part A Part B
1. (d) 37. (a) 71. (d)
2. (d) 38. (c) 72. (a)
3. (c) 39. (c) 73. (c)
4. (c) 40. (a) 74. (d)
5. (c) 41. (b) 75. (b)
6. (b) 42. (d) 76. (a)
7. (a) 43. (c) 77. (c)
8. (a) 44. (d) 78. (d)
9. (c) 45. (d) 79. (c)
10. (b) 46. (a) 80. (d)
11. (c) 47. (a) 81. (c)
12. (a) 48. (b) 82. (b)
13. (c) 49. (b) 83. (d)
14. (d) 50. (a) 84. (b)
15. (b) 51. (a) 85. (c)
16. (b) 52. (d) 86. (d)
17. (b) 53. (a) 87. (c)
18. (b) 54. (c) 88. (c)
19. (b) 55. (a) 89. (d)
20. (d) 56. (c) 90. (d)
21. (c) 57. (a) 91. (c)
22. (d) 58. (a) 92. (d)
23. (b) 59. (a) 93. (b)
24. (c) 60. (b) 94. (b)
25. (d) 61. (b) 95. (a)
26. (a) 62. (b) 96. (a)
27. (b) 63. (c) 97. (d)
28. (c) 64. (c) 98. (c)
29. (a) 65. (b) 99. (a)
30. (b) 66. (b) 100. (a)
31. (b) 67. (c)
32. (b) 68. (b)
33. (b) 69. (a)
34. (b) 70. (d)
35. (c)
36. (a)
378 FP-FA&A