BOARD OF STUDIES

THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA (ICAI)

(SET UP BY AN ACT OF PARLIAMENT)

(Modules 1 to 2)
FOUNDATION COURSE Paper–1, Module–2

PRINCIPLES AND
PRACTICE OF

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 THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA

This study material has been prepared by the faculty of the Board of Studies. The objective of the
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Edition : July, 2017

Website : www.icai.org

E-mail : bosnoida@icai.org

Committee/ : Board of Studies

ISBN No. : 978-81-8441-871-2

Price (All Modules) : ` 500/-

Published by : The Publication Department on behalf of The Institute of Chartered

Accountants of India, ICAI Bhawan, Post Box No. 7100, Indraprastha Marg,
New Delhi 110 002, India.

Printed by : Nova Publications, Daryaganj

July/2017/P2107 (New)

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 CONTENTS

MODULE 1
CHAPTER 1 : Theoretical Framework
CHAPTER 2 : Accounting Process
CHAPTER 3 : Bank Reconciliation Statement
CHAPTER 4 : Inventories
CHAPTER 5 : Concept and Accounting of Depreciation
CHAPTER 6 : Accounting for Special Transactions

MODULE 2
CHAPTER 7 : Preparation of Final Accounts of Sole Proprietors
CHAPTER 8 : Partnership Accounts
CHAPTER 9 : Financial Statements of Not-For-Profit Organizations
CHAPTER 10 : Company Accounts
CHAPTER 11 : Basic Accounting Ratios

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© The Institute of Chartered Accountants of India
 DETAILED CONTENTS : MODULE–2
Pages
CHAPTER 7 PREPARATION OF FINAL ACCOUNTS OF SOLE PROPRIETORS ....................7.1–7.73
Unit 1 : Final Accounts of Non-Manufacturing Entities
Learning Outcomes ...................................................................................................................................................... 7.1
Unit overview.................................................................................................................................................................. 7.1
1.1 Introduction ................................................................................................................................................ 7.2
1.2 Preparation of Final Accounts ............................................................................................................... 7.3
1.3 Trading Account ......................................................................................................................................... 7.6
1.4 Profit and Loss Account .........................................................................................................................7.14
1.5 Certain Adjustments and their Treatments ....................................................................................7.27
1.6 Balance Sheet............................................................................................................................................7.32
1.7 Sequence of Accounting Procedure or the Accounting Cycle ................................................7.38
1.8 Opening Entry ..........................................................................................................................................7.39
1.9 Provisions and Reserves ........................................................................................................................7.48
1.10 Limitations of Financial Statements .................................................................................................7.52
Summary ........................................................................................................................................................................7.53
Test Your Knowledge..................................................................................................................................................7.53

Unit 2 : Final Accounts of Manufacturing Entities

Learning Outcomes ....................................................................................................................................................7.63
Unit Overview ...............................................................................................................................................................7.63
2.1 Introduction ..............................................................................................................................................7.63
2.2 Purpose .......................................................................................................................................................7.63
2.3 Manufacturing Costs ..............................................................................................................................7.64
2.4 Design of A Manufacturing Account ................................................................................................7.66
Summary ........................................................................................................................................................................7.68
Test Your Knowledge..................................................................................................................................................7.69

CHAPTER 8: PARTNERSHIP ACCOUNTS .......................................................................... 8.1–8.135

Unit 1 : Introduction to Partnership Accounts

Learning Outcomes ..................................................................................................................................................... 8.1
Unit Overview ................................................................................................................................................................. 8.1
1.1 Introduction: Why Partnership? .......................................................................................................... 8.2
1.2 Definition and Features of Partnership............................................................................................. 8.2
1.3 Limited Liability Partnership ................................................................................................................ 8.3
1.4 Distinction Between an Ordinary Partnership Firm and An LLP ............................................. 8.4
1.5 Main Clauses in A Partnership Deed.................................................................................................. 8.5
1.6 Powers of Partners.................................................................................................................................... 8.7
1.7 Accounts ...................................................................................................................................................... 8.7

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 1.8 Profit and Loss Appropriation .............................................................................................................. 8.8
1.9 Fixed and Fluctuating Capital ............................................................................................................ 8.11
Summary .......................................................................................................................................................................8.19
Test Your Knowledge................................................................................................................................................. 8.20
Unit 2: Treatment of Goodwill In Partnership Accounts
Learning Outcomes ...................................................................................................................................................8.27
Unit Overview ...............................................................................................................................................................8.27
2.1 Goodwill..................................................................................................................................................... 8.28
2.2 Methods for Goodwill Valuation ....................................................................................................... 8.29
2.3 Need for Valuation of Goodwill ......................................................................................................... 8.36
2.4 Valuation of Goodwill in Case of Admission of a Partner ......................................................... 8.36
2.5 Accounting Treatment of Goodwill in Case of Admission of a New Partner ...…………8.37
2.6 Accounting Treatment of Goodwill in Case of Change in Profit Sharing Ratio ................ 8.42
2.7 Accounting Treatment Of Goodwill in Case of Retirement or Death of a Partner ......... 8.44
Summary .......................................................................................................................................................................8.44
Test Your Knowledge .................................................................................................................................................8.45
Unit 3 : Admission of A New Partner
Learning Outcomes ...................................................................................................................................................8.49
Unit Overview ...............................................................................................................................................................8.49
3.1 Introduction ............................................................................................................................................. 8.50
3.2 Revaluation Account or Profit and Loss Adjustment Account ............................................... 8.50
3.3 Reserves in the Balance Sheet ........................................................................................................... 8.58
3.4 Computation of New Profit Sharing Ratio ......................................................................................8.60
3.5 Hidden Goodwill ..................................................................................................................................... 8.69
Summary ........................................................................................................................................................................8.71
Test Your Knowledge..................................................................................................................................................8.71
Unit 4 : Retirement of A Partner
Learning Outcomes ...................................................................................................................................................8.81
Unit Overview ...............................................................................................................................................................8.81
4.1 Introduction ............................................................................................................................................. 8.82
4.2 Calculation of Gaining Ratio ............................................................................................................... 8.82
4.3 Revaluation of Assets and Liabilities on Retirement of a Partner ......................................... 8.85
4.4 Reserve ....................................................................................................................................................... 8.86
4.5 Final Payment to a Retiring Partner ..................................................................................................8.88
4.6 Paying a Partner’s Loan in Instalment ............................................................................................. 8.99
4.7 Joint Life Policy ..................................................................................................................................... 8.102
4.8 Separate Life Policy ............................................................................................................................. 8.106
Summary .................................................................................................................................................................... 8.107
Test Your Knowledge .............................................................................................................................................. 8.107

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 Unit 5 : Death of A Partner
Learning Outcomes ................................................................................................................................................ 8.116
Unit Overview ........................................................................................................................................................... 8.116
5.1 Introduction .......................................................................................................................................... 8.117
5.2 Right of Outgoing Partner in Certain Cases to Share Subsequent Profits……………8.117
5.3 Amount Payable to Legal Representatives of Dead Partner ................................................ 8.118
5.4 Special Transactions in Case of Death: Joint Life Policy .......................................................... 8.119
5.5 Special Transactions in Case of Death: Separate Life Policy ................................................. 8.121
5.6 Special Transactions in Case of Death: Payment of Deceased
Partner’s Share ...................................................................................................................................... 8.121
Summary ..................................................................................................................................................................... 8.129
Test Your Knowledge............................................................................................................................................... 8.130
CHAPTER 9: FINANCIAL STATEMENTS OF NOT-FOR-PROFIT ORGANIZATIONS ..............91–9.38
Learning Outcomes ...................................................................................................................................................... 9.1
Chapter Overview ......................................................................................................................................................... 9.1
1. Introduction ................................................................................................................................................ 9.2
2. Nature of Receipts and Payments Account ...................................................................................... 9.2
3. Income and Expenditure Account....................................................................................................... 9.3
4. Balance Sheet.............................................................................................................................................. 9.8
5. Educational Institution ..........................................................................................................................9.23
Summary ........................................................................................................................................................................9.29
Test Your Knowledge..................................................................................................................................................9.30
CHAPTER 10 : COMPANY ACCOUNTS ........................................................................... 10.1–10.90
Unit 1: Introduction to Company Accounts
Learning Outcomes ....................................................................................................................................................10.1
Unit Overview ...............................................................................................................................................................10.1
1.1 Introduction ..............................................................................................................................................10.2
1.2 Meaning of Company ............................................................................................................................10.2
1.3 Salient Features of a Company ...........................................................................................................10.3
1.4 Types of Companies ...............................................................................................................................10.4
1.5 Maintenance of Books of Account ....................................................................................................10.6
1.6 Preparation of Financial Statements ................................................................................................10.6
Summary ..................................................................................................................................................................... 10.14
Test Your Knowledge............................................................................................................................................... 10.14
Unit 2 : Issue, Forfeiture and Re-Issue of Shares
Learning Outcomes ................................................................................................................................................. 10.17
Unit Overview ............................................................................................................................................................ 10.17
2.1 Introduction ........................................................................................................................................... 10.18
2.2 Share Capital .......................................................................................................................................... 10.18

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 2.3 Types of Shares ...................................................................................................................................... 10.21
2.4 Issue of Shares for Cash ...................................................................................................................... 10.22
2.5 Subscription of Shares ........................................................................................................................ 10.25
2.6 Shares Issued at Discount .................................................................................................................. 10.30
2.7 Shares Issued at Premium ................................................................................................................. 10.31
2.8 Over Subscription and Pro-Rata Allotment................................................................................. 10.34
2.9 Calls-In-Arrears and Calls-In-Advance ........................................................................................... 10.36
2.10 Interest on Calls-in-Arrears and Calls-in-Advance .................................................................... 10.38
2.11 Forfeiture of Shares .............................................................................................................................. 10.41
2.12 Re-issue of Forfeited Shares ............................................................................................................. 10.45
2.13 Issue of Shares for Consideration other than Cash................................................................... 10.50
Summary ..................................................................................................................................................................... 10.52
Test Your Knowledge............................................................................................................................................... 10.53
Unit 3 : Issue of Debentures
Learning Outcomes ................................................................................................................................................. 10.61
Unit Overview ............................................................................................................................................................ 10.61
3.1 Introduction ........................................................................................................................................... 10.62
3.2 Meaning ................................................................................................................................................... 10.62
3.3 Features of Debentures ...................................................................................................................... 10.62
3.4 Distinction Between Debentures and Shares ............................................................................ 10.63
3.5 Types of Debentures ........................................................................................................................... 10.63
3.6 Issue of Debentures ............................................................................................................................. 10.64
3.7 Issue of Debentures as Collateral Security .................................................................................. 10.77
3.8 Issue of Debentures in Consideration other than for Cash ….. …...................................... 10.79
3.9 Treatment of Discount/Loss on Issue of Debentures .............................................................. 10.81
3.10 Interest on Debentures ...................................................................................................................... 10.82
Summary ..................................................................................................................................................................... 10.84
Test Your Knowledge............................................................................................................................................... 10.85

CHAPTER 11 : BASIC ACCOUNTING RATIOS ................................................................ 11.1–11.49

Learning Outcomes ....................................................................................................................................................11.1
Chapter Overview .......................................................................................................................................................11.1
1. Introduction ..............................................................................................................................................11.2
2. Ratio and Ratio Analysis ........................................................................................................................11.2
3. Objectives of Ratio Analysis .................................................................................................................11.3
4. Advantages of Ratio Analysis ..............................................................................................................11.3
5. Limitations of Ratio Analysis................................................................................................................11.4
6. Limitations of the Ratios .......................................................................................................................11.5
7. Types of Ratios ..........................................................................................................................................11.5
Summary ..................................................................................................................................................................... 11.38
Test Your Knowledge............................................................................................................................................... 11.42

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