BBCF131D PDF

(c) UNIT 20: Case Study
UP
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Business Accounting
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Course Design
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Advisory Council
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Chairman
Dr Parag Diwan
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Members
Dr Kamal Bansal Dr Anirban Sengupta Dr Ashish Bhardwaj
Dean Dean CIO
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Dr Satya Sheel Dr Sanjay Mittal Mr M K Goel
VP – Academic Affairs Professor – IIT Kanpur Management Consultant
SLM Development Team

Wg Cdr P K Gupta
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Dr Joji Rao
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Dr Neeraj Anand
Dr K K Pandey
for
Print Production
Mr Kapil Mehra Mr A N Sinha

Manager – Material Sr Manager – Printing
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Author
Nitin Balwani
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All rights reserved. No part of this work may be reproduced in any form, by mimeograph or any other means,
without permission in writing from Hydrocarbon Education Research & Society.
E
UP
Course Code: BBCF-131D
Course Name: Business Accounting

(c)
Version: July 2013
© MPower Applied Learning Enterprise

UNIT 20: Case Study
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Contents
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Block-I
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Unit 1 Introduction to Accounting ............................................................................................ 3
Unit 2 Principles of Accounting............................................................................................... 25
Unit 3 Accounting Standards in India .................................................................................... 43
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Unit 4 Accounting Equation and Accounting Cycle ............................................................... 57
Unit 5 Case Study .................................................................................................................... 69
Unit 6
Block-II
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Preparation of Journal, Ledger and Balancing........................................................... 75
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Unit 7 Subsidiary Books .......................................................................................................... 95
Unit 8 Trial Balance............................................................................................................... 117
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Unit 9 Financial Statements ................................................................................................. 137

Unit 10 Case Study .................................................................................................................. 161
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Block-III
Unit 11 Managerial Remuneration ......................................................................................... 165

Unit 12 Dividends & Dividends Declaration Out of Past & Current Profits ........................ 179
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Unit 13 Amalgamation, Absorption & External Reconstruction........................................... 205

Unit 14 Internal Reconstruction ............................................................................................. 227
Unit 15 Case Study .................................................................................................................. 241
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Block-IV
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Unit 16 Holding Company Accounts ....................................................................................... 247

Unit 17 Liquidation of Companies .......................................................................................... 285
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Unit 18 Accounts of Banking Companies................................................................................ 299

Unit 19 Accounts of Insurance Companies ............................................................................. 321
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Unit 20 Case Study .................................................................................................................. 337

Business Accounting
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Block-V
Unit 21 Inflation Accounting ................................................................................................... 341
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Unit 22 Human Resource Accounting ..................................................................................... 355
Unit 23 Government System Accounting................................................................................ 365
Unit 24 Responsibility Accounting .......................................................................................... 377
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Unit 25 Case Studies................................................................................................................ 387
Glossary ............................................................................................................................................ 389
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UNIT 1: Introduction to Accounting
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1
Notes
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Detailed Contents Business Accounting
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2
Notes
UNIT 1: INTRODUCTION TO ACCOUNTING
___________________ UNIT 3: ACCOUNTING STANDARDS IN INDIA
Introduction Introduction
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z z
___________________
z Meaning and Definition of Accounting z Accounting Standards
___________________
z Scope and Objectives of Accounting z Statements of Accounting Standards (AS 1)
___________________ Disclosure of Accounting Policies
z Importance and Limitations of Accounting
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___________________
z Process of Accounting UNIT 4: ACCOUNTING EQUATION AND
___________________ ACCOUNTING CYCLE
z Book-keeping
z Introduction
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z Types of Accounts
___________________
z Accounting Equation
___________________
UNIT 2: PRINCIPLES OF ACCOUNTING z Accounting Cycle
___________________
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z Introduction z Account
___________________
z Meaning and Need of Accounting Theory
UNIT 5: CASE STUDY
z Generally Accepted Accounting Principles (GAAP)
z Capital and Revenue Items

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Unit 1
3
Notes
Activity
Make a presentation to
Introduction to Accounting
___________________
explain meaning of
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management with the help of
___________________
examples.
___________________
Objectives
___________________
After completion of this unit, the students will be aware of the following
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topics: ___________________
\ Meaning and Definition of Accounting ___________________

\ Scope and Objectives of Accounting
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___________________
\ Importance and Limitations of Accounting
___________________
\ Process of Accounting
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___________________
\ Book-keeping
\ Types of Accounts ___________________
Introduction
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The main object of a business house is to earn profit. Accounting is
the medium of recording the business activities and it considered
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as a language of business. To find out the results of a business, the

information relating to the cost of the products and revenues from
the products is collected. Then the costs and revenues are
compared to find out the profit or loss of the business. If volume of
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sales of the products is high and the number of transaction of the

business is very high, it is impossible to keep all these transactions
in the mind of a business man. Thus a need of recording of all
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these business transactions rose. The recording of business

transactions or activities is done through a process of accounting.
There is an old quotation of a well known author of accounting
Prof. R.R. Gupta, First write or record before one deliver the goods
or renders the services and if there is any disagreement in future,
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use the writing or record as an evidence to resolve the

misunderstanding or rectifying the errors.
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Today the business activities are recorded not only to find out the
profit or loss of the business, but are also to judge the financial
position of the business. Accounts of the business are prepared
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from the point of view of owner and also serve the purpose of
outsiders. Creditors and investors want to know how safe their
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investment is—Labours in conducting the negotiations for wages

and government to determine the economic policies etc. Thus
Business Accounting
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4 accounts of a business are the evidence on the basis of which the
Notes
Activity financial decisions are taken.
Make student teams and work
___________________
on terminology related to the
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___________________
Accounting to be posted to the
Meaning and Definition of Accounting
class, etc.
___________________ Accounting is treated as the language of business. It records all the
___________________ transactions which can be measured in money and have occurred
in a particular period. Accounts of a business provide useful
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___________________
information to its users.
___________________
There are many definitions of accounting. Some of the most
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___________________
important definitions are given below:
___________________
1. As per Robert N. Anthony – "Accounting system is a means of
___________________ collecting, summarizing, analyzing and reporting, in monetary
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___________________ terms, information about the business".
2. The American Accounting Association (AAA) has defined
accounting as, “the process of identifying, measuring and
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communicating economic information to permit informal
judgments and decisions by users of information”.
3. The Committee on Terminology of American Institute of
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Certified Public Accountants gave a generally accepted

definition of accounting – “Accounting is the art of recording,
classifying and summarizing in a significant manner and in
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terms of money transactions and events which are, in part at

least, of a financial character, and interpreting the results
thereof.”
On the basis of above definitions we conclude that accounting is a
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science as well as an art of recording of activities of the business

which can be measured in money and analyzing and interpreting
them.
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Characteristics of Accounting
On the basis of above definitions, the characteristics of accounting
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may be drawn as follows:

1. Accounting is the art of recording of financial
transactions of the business: All those transactions of
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business which are financial in nature are recorded in

accounting and those which are not of financial nature are not
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recorded in accounting. As the honesty of the workers cannot

be measured in money, it cannot be recorded into accounting.
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2. Classifying and summarising of recorded data is done in
Notes
accounting: In accounting the financial transactions are
recorded in the journal. With the help of journal, the recorded ___________________
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data are classified into ledger under appropriate heads. Then ___________________
with the help of ledger the trial balance and financial
___________________
statements are prepared.
___________________
3. Data are recorded in terms of money: In accounting, the
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___________________
financial data are recorded in a definite term i.e. money. No
other unit is accepted to record the business transaction. If ___________________
there is sale of 100 articles at the rate of `50 per article, only
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___________________
the monetary value of these articles i.e. ` 5,000 (100 x ` 50) is
___________________
recorded.
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___________________
4. Accounting is a science also: On account of recording of
___________________
business transactions in a systematic manner, it is also called
a science. First the business transactions are recorded in the
primary books i.e. journal, for classification the ledger is
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prepared. With the help of ledger the trail balance, profit and
loss account and balance sheet is prepared. Profit and loss
account is prepared after a period to find the result of the
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business and balance sheet to know the financial position of

the business.
5. Analysing and interpretation of the results is done in
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accounting: It not only record classifies and summaries the

business data but also analyse and interprets the results for
the future decisions. On the basis of data forecasting regarding
profit, sales etc. may be done.
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Check Your Progress

Fill in the blanks:
1. ………………is the process of recording, classifying,
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summarizing in a significant manner of transactions

which are in financial character and finally results are
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interpreted.
2. The users of accounting are ………………… and
external.
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3. The primary objective of the accounting is to maintain

the records of all ………………..of the business.
(c)
Business Accounting
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Scope and Objectives of Accounting
Notes
Activity
The Scope of accounting is divided into following two parts:
Prepare a presentation
___________________
showing the scope and (a) Branches of Accounting
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___________________
objectives of accounting.
___________________ (b) Accounting as a science or an art
___________________ Branches of Accounting
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___________________ The main objectives of the accounting are to record the business
___________________ transactions and to provide the necessary information to the
internal and external users of the financial statements. For the
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___________________
said objectives, the accounting is classified into followings:
___________________
(i) Financial Accounting: It is the original form of accounting.
___________________
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It refers to the recording of daily business financial
___________________ transaction. Recording of the transaction is done in such a way
that the profit of the business may be ascertained after a
definite period and the picture of the financial position of the
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business may be presented.
(ii) Cost Accounting: As the name indicates, this accounting is
related with the ascertainment of cost of the product in a
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period. Under this system record of raw materials used in

production, wages and labour paid and other expanses
incurred on production are kept to control the costs.
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(iii) Management Accounting: The accounting which provides

the necessary information to the management is called
management accounting. Under this the analysis and
interpretation of the accounts, prepared by financial
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accounting, are done in a manner so that the managers may

forecast, plan for future and frame the policy.
(iv) Tax Accounting: Under tax accounting, the accountants
prepare the accounts as per the provisions of taxation. The
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accounts prepared as per taxation provisions may differ from

the accounts prepared as per financial accounting.
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(v) Inflation Accounting: Actually the financial statements are

prepared on the basis of historical cost which do not present
the true picture of the financial position and correct profit or
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loss of the business due to inflation. Thus the fresh financial

statements are prepared keeping in mind the price level
(c)
changes under inflation accounting.

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(vi) Human Resource Accounting: Human Resource Accounting
Notes
means the accounting for human being as now in an
organization human being is treated as an asset like other ___________________
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physical assets. It is recorded in the books like other assets. ___________________
HRA deals with the measurement of costs on recruiting,
___________________
selecting, hiring, training, placing and development of the
employees in one side and on the other side it deals with the ___________________
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present economic value of the employees. For the ___________________
determination of the value of human being different methods ___________________
are used under HRA.
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___________________
(vii) Responsibility Accounting: Responsibility accounting is a
___________________
special technique of management under which accountability
is established according to the responsibility delegated to the
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___________________
various levels of management. Management information and ___________________

reporting system is instituted to give adequate feedback in
terms of the delegated responsibility. Under this system, units
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of an organization, under a specified authority in a person, are
developed as responsibility centre and evaluated individually
for their performance.
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Accounting as Science or an Art

Accounting is both the science and art. Study of science is based on
some principles and it is systemized. It is a science because the
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business transactions are recorded on the basis of some principles

and journal of transaction, ledger posting, trial balance and
preparation of final statements are done in a sequence. Art is the
creation of practical applications and rules for the completion of
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any work. On the basis of it, accounting is an art as we do not only

study principles of accounting but also we learn to apply these
principles in practice to record the business transaction. Thus
accounting is both science and art.
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Objectives of Accounting
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The main purpose of book-keeping and accounting is to furnish the

necessary financial data to the persons interested in the business.
These persons can be the internal users of the business and
external users of the business. Among the internal users all the
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managers at lower, middle and top level are included. While

among the external users, investors, creditors, government and
(c)
public are included. The financial statements are supplied to the

Business Accounting
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8 external users for the necessary information. In brief, following are
Notes the objectives of accounting:
___________________
1. To maintain the systematic records of the business: The
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___________________ primary objective of the accounting is to maintain the records
___________________ of all transactions of the business. As the memory of human
being is very limited and short, it would be very difficult to
___________________
remember all the transactions especially if there is a huge
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___________________ amount of transaction. So it is very necessary to record all
___________________ business transactions properly to determine the amount of
profit or loss and the financial position of the business on a
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___________________
particular date.
___________________
2. To ascertain the profit or loss of the business: The main
___________________
objective of the business is to earn a profit. Exact profit can be
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___________________ ascertained with the help of financial accounting. Which helps
to determine the net profit or loss of the business over a
period? For the determination of the amount of profit or loss, a
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trading and profit and loss account is prepared at the end of a
period. If there is excess of revenue for a period over the
expenses incurred to earn that revenue, it is said to be a profit.
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And if there is excess of expenses over the revenue, it is said to

be a loss. In the case of profit the management can take the
decisions relating to selling price and output etc. In the case of
loss, the causes of such a loss are investigated and remedial
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action is taken by the management.

3. To present the financial position of the business: The
objective of the accounting is not only recording of the financial
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transactions of the business and determination of profit or loss

but also to present the financial position of the business. To
present the financial position, financial accounting helps in the
preparation of balance sheet. Balance sheet is the statement of
assets and liabilities of the business. It also gives the
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information about the borrowed capital as well as owned

capital along with different assets such as fixed assets, current
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assets and miscellaneous. Balance sheet is the reflector of the

financial position of a business (solvency and insolvency).
4. To provide the financial information to the various
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users: One more objective of the accounting is to provide the

required financial information to the different users - internal
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as well as external users. Internal users of the financial

statements are owners, shareholders, management and
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external users of the financial statements are debenture 9
holders, creditors, investors, employees, government, etc. Notes
Activity
As ___________________
per the double entry
Check Your Progress
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system of accounting what will
be ___________________
the impact of following
Fill in the blanks:
transactions on balance sheet:
___________________
1. Accounting is both the ………………. and art. a. Mr. Rakesh started
___________________
business with cash of
2. The main objective of the business is to earn a
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`___________________
1,00,000
………………. .
b. Gods sold on credit for
___________________
` 10000
Importance and Limitations of Accounting
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___________________
c. Furniture purchased for
` 5000
___________________
Appropriate and adequate accounting system plays a vital role for
the successful operation of the business. It also helps in the
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___________________
determination of cost of production, controlling internal as well as ___________________

external activities of the business, forecasting of profit, cost and
sales, etc. Accounting is also useful in locating the errors,
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distribution of dividend and bonus to shareholders. Thus,
accounting is being used as a means to achieve the objective of the
business. The other advantages of the accounting are as follows:
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(1) Replacement of human memory: As the human's memory is

limited and short, it is difficult to remember all the
transactions of the business. Therefore, all the financial
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transactions of the business are recorded in the books. By this

way the businessmen cannot only see the records at the
required time but can also remember them for a long time.
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Thus, recording of the transactions is the replacement of

human's memory.
(2) Helpful in the determination of financial results and

presentation of financial position: Accounting is very
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useful in the determination of the profit and loss of a business

and showing the financial position of the business.
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(3) Helpful in assessing the tax liability: Generally, a

businessman has to pay corporate tax, VAT and excise duty,
etc. Therefore, it is necessary that proper accounts should be
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maintained to compute the tax liability of the business.

(c)
(4) Helpful in the case of insolvency: Sometimes the

businessman becomes the insolvent. If he has properly
Business Accounting
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10 maintained the accounts, he will not face the problems in
Notes explaining few things in the court.
___________________
(5) Helpful in the valuation of business: If the business is shut
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___________________ down and sold, accounting helps the businessman to determine
___________________ the value of business. It would be possible only in that case
___________________ when the accounts of the business are properly maintained.
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___________________ (6) Helpful in the valuation of goodwill and shares: If
___________________ accounts of the business are properly maintained, it would be
quite convenient to determine the value of goodwill. Goodwill
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___________________
is very important for the determination of the value of shares
___________________
of the company.
___________________
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(7) Accounting makes comparative statement possible:
___________________
Proper and adequate accounting helps in comparing the
income, expenditure, purchase, sale of the current year with
that of the previous years. And then future plans, policies and
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forecasting may be possible.
Limitation of Accounting
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In spite of being so many uses and advantages of accounting, it has

a number of limitations which are as follows:
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(1) Recording of monetary items only: In accounting only those

transactions which have the monetary value are recorded, And
those transactions which do not have the financial value
whether those are important in business, are not recorded in
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the accounting. For example, efficiency of the management,

honesty of the workers, etc.
(2) Effect of inflation: In accounting the transactions are

recorded at the historical cost. Accordingly the assets of the
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business are shown at cost in the balance sheet. Thus the

balance sheet prepared on the basis of historical cost ignores
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the price-level changes (inflation). In this way the balance

sheet of the business does not present the true and fair picture
of the business.
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(3) Conflict between accounting principles: In accounting, one

accounting principle conflicts another. For instance, inventory
(c)
should be valued on the basis of 'least of the cost and market

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price' as per the principle of the conservatism. If in the first 11
year, inventory is valued on the basis of cost (being lower than Notes
Activity
market price) and in the second year at the market price You and your group members
___________________
are required to develop an
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(being lower than cost), this principle conflicts the accounting assignment on process of
___________________
principle of the consistency. accounting.
___________________
(4) Financial statements are affected by personal judgment ___________________
of the accountants: Personal decisions of the accountants
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___________________
regarding the adoption of accounting policies, affects the
___________________
results of the financial statements. As a result the financial
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statements lose their objectivity. ___________________
___________________
(5) Financial statements do not reflect the right picture of
the business: Sometimes the profit and loss account of the
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___________________
business does not show the accurate profit/loss and the balance ___________________
sheet does not show the true picture of the business because
the assets shown in the balance sheet are shown at the
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realizable (resalable) value which is wrong. Some worthless
figures are also shown in the balance sheet as preliminary
expenses, discount on issue of shares/debentures, etc.
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Check Your Progress

State true or false:
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1. Accounting is useful in locating the errors, distribution

of dividend and bonus to shareholders.
2. In accounting only those transactions which have the
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monetary value are recorded.
Process of Accounting
Accounting is described as origin for the creation of information
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and the continuous utility of information. Now the question is how

is this information created? For this, there is a step by step
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process, as shown in Figure 1.1.

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(c)
Business Accounting
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12
Notes
___________________
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___________________
___________________
___________________
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___________________
___________________
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___________________
___________________
___________________
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___________________
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Figure 1.1: Process of Accounting
After the creation of information, the developed information should

be appropriately recorded.
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Classifying: It is one of the most important processes of the

accounting. Under this, grouping of transactions is carried out on
the basis of certain segments or divisions. It can be described as a
method of rational segregation of the transactions. The segregation
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is generally done into two categories, viz.

1. Cash transactions, and
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2. Non-cash transactions.
The preparation of the ledger accounts and subsidiary books is
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done on the basis of rational segregation of accounting

transactions. For e.g., the preparation of cash book is involved in
(c)
the unification of cash transactions.

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Summarizing: The ledger books are appropriately balanced and
Notes
listed one after another.
___________________
The list of the name of the various ledger book accounts and their
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___________________
accounting balances is known as Trial Balance. The trial balance is
summary of all unadjusted name of the accounts and their ___________________
balances. ___________________
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Preparation: After preparing, the summary of various unadjusted ___________________
accounts are required to adjust to the tune of adjustment entries ___________________
which were not taken into consideration at the time of preparing
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___________________
the trial balance. Immediately after the incorporation of
___________________
adjustments, the final statement is readily available for
interpretations.
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___________________
Are there any scales/guides available for the recording of ___________________
information? If yes, what are they?
They are as follows:

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1. What to record: Financial Transaction is only to be recorded
2. When to record: Time relevance of the transaction at the

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moment of recording
3. How to record: Methodology of recording — It contains two

different systems of accounting viz. cash system and accrual
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system.
Cash System
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The revenues are recognized only at the moment of realization but

the expenses are recognized at the moment of payment. For
example sale of goods will be considered under this method that
only at the moment of receipt of cash out of sale of goods. The
charges which were paid only will be taken into consideration but
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the outstanding, not yet paid will not be considered.

Example: Rent paid only will be considered but not the
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outstanding of rent charges.
Accrual System
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The revenues are recognized only at the time of occurrence and

expenses are recognized only at the moment of incurring. Whether
(c)
the cash is received or not out of the sales, that will be

registered/counted as total value of the sales.
Business Accounting
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The next most important step is to record the transactions. For
Notes
Activity
recording, the value of the transaction is inevitable, to record
Do ___________________
you agree with the
values; the classification of values must be essentially done.
statement "The modern
n/S
___________________
system of book keeping is
based on the double entry Values
___________________
system”. What is your There are four different values in the business practices that
opinion?
___________________
should be followed or recorded in the system of accounting:
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___________________
1. Original Value: It is the value of the asset only at the
___________________ moment of purchase or acquisition
2. Book Value: It is the value of the asset maintained in the
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___________________
___________________ books of the account. The book value of the asset could be
computed as follows:
___________________
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Book Value = Gross (Original) value of the asset –
___________________
Accumulated depreciation
3. Realizable Value: Value at which the assets are realized
4. Present Value: Market value of the asset
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Check Your Progress
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Fill in the blanks:

1. The …………..are recognized only at the moment of
realization but the ……………….are recognized at the
moment of payment.
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2. For …………………, the value of the transaction is

inevitable, to record values; the classification of values
must be essentially done.
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3. ………………….the value of the asset only at the

moment of purchase or acquisition.
Book-keeping
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Book- keeping includes recording of journal, posting in ledgers and

balancing of accounts. All the records before the preparation of
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trail balance are the whole subject matter of book- keeping. Thus,
book- keeping many is defined as the science and art of recording
transactions in money or money’s worth so accurately and
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systematically, in a certain set of books, regularly that the true

state of businessman’s affairs can be correctly ascertained. Here it
(c)
is important to note that only those transactions related to

business are recorded which can be expressed in terms of money.
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Definition 15
Notes
“Book- keeping is the art of recording business transactions in a
systematic manner”. ___________________
n/S
—A.H. Rosenkamph. ___________________
___________________
“Book- keeping is the science and art of correctly recording in books
___________________
of account all those business transactions that result in the transfer
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___________________
of money or money’s worth”.
___________________
—R.N. Carter
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___________________
Importance of Book Keeping ___________________
Following are the importance of book keeping:
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___________________
i. Book- keeping provides a permanent record of each
___________________
transaction.
ii. Soundness of a firm can be accessed from the records of assets
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and abilities on a particular date.
iii. Entries related to incomes and expenditures of a concern
facilitate to know the profit and loss for a given period.
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iv. It enables to prepare a list of customers and suppliers to

ascertain the amount to be received or paid.
v. It is a method gives opportunities to review the business
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policies in the light of the past records.

vi. Amendment of business laws, provision of licenses, assessment
of taxes etc., are based on records.
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Methods of Accounting
Business transactions are recorded in two different ways.
z Single Entry: It is incomplete system of recording business
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transactions. The business organization maintains only cash

book and personal accounts of debtors and creditors. So the
complete recording of transactions cannot be made and trail
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balance cannot be prepared.

z Double Entry: It this system every business transaction is
having a twofold effect of benefits giving and benefit receiving
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aspects. The recording is made on the basis of both these

aspects. Double Entry is an accounting system that records the
(c)
effects of transactions and other events in at least two

accounts with equal debits and credits.
Business Accounting
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16
The modern system of book keeping is based on the double entry
Notes
system. Therefore, we are discussing this system only. The father
___________________
of this system is the Lucas Paciolo. He gave the details of this
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___________________ system in his book "De Compute Set Scripturise" in Italy in 1494
___________________ A.D. As per this system every transaction of the business has
double aspects/double effect. Therefore, every transaction must be
___________________
recorded at two places or accounts. If in a transaction someone is a
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___________________ giver, some other will be a receiver.
___________________ This system is so organized, accurate, complete and scientific that
it is now adopted universally. In the words of Keller, M.J. Keller
uc
___________________
___________________
in–Intermediate Accountancy, "The most common system of
accounting data for an enterprise is the double entry system. As
___________________
the name implies, the entry made for each transaction is composed
rod
___________________ of two parts, a 'debit' and a 'credit'.
Importance of Double Entry System

ep
As we know that double entry system of accounting is a systematic
and scientific system of accounting, so it offers a number of
advantages. The following are the most important advantages of
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the system:
1. Complete record of transactions: Under this system,
recording of all transactions is done whether related to
t fo
personal or impersonal accounts.

2. Ascertainment of profit or loss: Under this system of
accounting complete profit and loss account can be prepared by
which profit or loss of a particular period can be ascertained.
No
3. Mathematical check on accuracy: Every debit has a credit,

so it is an accurate system as far as mathematical accuracy is
concerned which may be proved by preparing trial balance.
S,
4. Check for fraud: Scope of fraud is limited as it minimizes the

chances of fraud because of scientific system.
PE
5. Ascertainment and knowledge of financial position of

the business: Under this system, it is possible to know the
financial position of the business at any time. For this purpose
Balance Sheet can be prepared any time.
U
6. Possibility of full control over business: Under this system

(c)
full information is available which enables the management to

exercise full control over the business.
ale
17
7. Easy accessibility of information: Under this system all
Notes
information is easily available and accessible which is very
helpful and useful for the management. ___________________
n/S
8. Possibility of comparative study: Under this system, it is ___________________
possible to prepare comparative statement and also compare ___________________

the previous year's results with the current year's result and ___________________
take corrective steps as and when necessary to improve the
tio
___________________
operational results.
___________________
9. Reliable information: Under this system information
uc
received is reliable. ___________________
___________________
Steps involved in Double entry system
rod
___________________
(a) Preparation of Journal: Journal is called the book of
___________________
original entry. It records the effect of all transactions for the
first time. Here the job of recording takes place.
(b) Preparation of Ledger: Ledger is the collection of all
ep
accounts used by a business. Here the grouping of accounts is
performed. Journal is posted to ledger.
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(c) Trial Balance preparation: Summarizing. It is a summary

of ledge balances prepared in the form of a list.
(d) Preparation of Final Account: At the end of the accounting
t fo
period to know the achievements of the organization and its

financial state of affairs, the final accounts are prepared.
Rules of Double Entry System

No
As per the principles of the double entry system, each

transaction of the business is recorded at two places. In other
words, two entries are made for every financial transaction of
the business. If someone is giving something in the business, it
S,
has two sides – one is giver and other is receiver. The system of
double entry can be understood easily by an equation which is
called accounting. Following are some transactions of the
PE
business to explain it.

For example
U
1. Mr. Kamlesh started business with cash of `2, 00,000.

In this transaction, one side cash is coming into business and
(c)
in the other side capital is being brought by Mr. Kamlesh.

Thus:
Business Accounting
ale
18
Capital = Assets (Cash)
Notes
___________________
` 2,00,000 = ` 2,00,000
n/S
___________________ 2. In the next transaction, if a plant of ` 50,000 is purchased in
___________________
cash, this transaction will also leave two sides. In one side
cash is going and in other side plant is coming. In this
___________________
situation, the accounting equation will be as follows:
tio
___________________
Capital = Plant + Cash (Assets)
___________________
` 2, 00,000 = ` 50,000 + (` 2,00,000 – 50,000)
uc
___________________
___________________ 3. If a loan of `1,50,000 are taken from the SBI, it will also affect
the accounting equation by two sides. On one side, cash will
___________________
rod
increase and on the other side, liabilities of the business will
___________________
increase. This may be depicted as follows:
Capital + Liability (Loan) = Plant + Cash

ep
` 2, 00,000 + 1,50,000 = ` 50,000 + (1,50,000 + 1,50,000)
` 3,50,000 = ` 3,50,000
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4. If some goods of ` 20,000 are purchased on credit, it will also

affect the accounting equation in two ways. On one side it
increases the goods and on the other side it increases the
t fo
liability (creditors). Now the changed form of the above

accounting equation will be as follows:
Capital + Loan + Creditors = Plant + Cash + Goods

No
` 2,00,000 + 1,50,000 + 20,000 = ` 50,000 + 3,00,000 + 20,000
` 3,70,000 = ` 3,70,000
Capital + Liabilities = Assets

S,
Check Your Progress

Fill in the blanks:
PE
1. ………………..is incomplete system of recording business

transactions.
U
2. ………………….system of accounting is a systematic and

scientific system of accounting, so it offers a number of
(c)
advantages.
ale
Types of Accounts 19
Notes
Activity
The object of book-keeping is to keep a complete record of all the
“The___________________
object of book-keeping is
transactions that place in the business. To achieve this object,
n/S
to keep a complete record of
business transactions have been classified into three categories: ___________________
all the transactions that place
in the business”. Elaborate
i. Transactions relating to persons. ___________________
this statement and explain the
underlying concept.
___________________
ii. Transactions relating to properties and assets
tio
___________________
iii. Transactions relating to incomes and expenses.
___________________
The accounts falling under the first heading are known as
uc
‘personal Accounts’. ___________________
The accounts falling under the second heading are known as ‘Real ___________________
Accounts’, the accounts falling under the third heading are called
rod
___________________
‘Nominal Accounts’. The accounts can also be classified as personal ___________________
and impersonal. The following chart will show the various types of
accounts:
ep
Personal Accounts: Accounts recording transactions with a
person or group of persons are known as personal accounts. These
accounts are necessary, in particular, to record credit transactions.
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Personal accounts are of the following types:

(a) Natural persons: An account recording transactions with an
individual human being is termed as a natural persons’
t fo
personal account. e.g., Kamal’s account, Mala’s account,

Sharma’s accounts. Both males and females are included in it
(b) Artificial or legal persons: An account recording financial
transactions with an artificial person created by law or
No
otherwise is termed as an artificial person, personal account,

e.g. Firms’ accounts, limited companies’ accounts, educational
institutions’ accounts, Co-operative society account.
(c) Groups/Representative personal Accounts: An account
S,
indirectly representing a person or persons is known as

representative personal account. When accounts are of a
PE
similar nature and their number is large, it is better tot group

them under one head and open a representative personal
account. e.g., prepaid insurance, outstanding salaries, rent,
U
wages etc.
When a person starts a business, he is known as proprietor. This
(c)
proprietor is represented by capital account for that entire he

invests in business and by drawings accounts for all that which he
Business Accounting
ale
20 withdraws from business. So, capital accounts and drawings
Notes account are also personal accounts.
___________________
The rule for personal accounts is:
n/S
___________________
Debit the receiver
___________________
Credit the giver
___________________
Real Accounts
tio
___________________
___________________
Accounts relating to properties or assets are known as ‘Real
Accounts’, A separate account is maintained for each asset e.g.,
uc
___________________
Cash Machinery, Building, etc.
___________________
Real accounts can be further classified into tangible and
___________________ intangible.
rod
___________________
(a) Tangible Real Accounts: These accounts represent assets
and properties which can be seen, touched, felt, measured,
purchased and sold. e.g. Machinery account Cash account,
ep
Furniture account, stock account etc.
(b) Intangible Real Accounts: These accounts represent assets
and properties which cannot be seen, touched or felt but they
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can be measured in terms of money.

e.g., Goodwill accounts, patents account, Trademarks account,
Copyrights account, etc. The rule for Real accounts is:
t fo
Debit what comes in

Credit what goes out
No
Nominal Accounts
Accounts relating to income, revenue, gain expenses and losses are
termed as nominal accounts. These accounts are also known as
fictitious accounts as they do not represent any tangible asset. A
S,
separate account is maintained for each head or expense or loss

and gain or income. Wages account, Rent account Commission
account, Interest received account are some examples of nominal
PE
account
The rule for Nominal accounts is:
U
Debit all expenses and losses

Credit all incomes and gains
(c)
ale
21
Check Your Progress
Notes
Fill in the blanks:
___________________
1. Accounts recording transactions with a person or group
n/S
___________________
of persons are known as ………………
___________________
2. An account recording transactions with an individual
___________________
human being is termed as a …………………….
tio
___________________
3. Accounts relating to properties or assets are known as
…………………. ___________________
uc
4. Accounts relating to income, revenue, gain expenses and ___________________
losses are termed as ………………….. ___________________
rod
___________________
Summary ___________________
Accounting is the medium of recording the business activities and

considered as a language of business. Identification of financial
ep
transactions, recording, classifying them into different groups,
summarizing them into trial balance and preparation of financial
statements and analyzing and interpreting them, are included in
rR
the accounting process. Financial accounting, cost accounting,

management accounting, responsibility accounting, tax accounting,
inflation accounting, etc. are the branches of accounting.
t fo
Accounting is an art as well as a science. Accounting is done for the

following objective: For maintaining the systematic records, For
ascertaining the profit/loss of the business, To present the financial
position and To provide the financial information.
No
Accounting plays an important role in the determination of profit,

financial position, tax liability, valuation of goodwill and shares
and comparative study. There are also some limitations of
S,
accounting as only monetary items are recorded, effect of inflation

is neglected, financial statements do not present the right picture
PE
of the business etc.
Lesson End Activity

U
Present the key points which make double entry accounting system
more significant than the other traditional accounting systems.
(c)
Business Accounting
ale
22
Keywords
Notes
Accounting Process: It includes the recording of financial
___________________
transactions, ledger posting, preparation of financial statements
n/S
___________________ and analyzing and interpretation of them.
___________________
Cost Accounting: Accounting relating to the ascertainment of cost
___________________ of the product.
tio
___________________ Management Accounting: Presenting of accounting information
___________________ in such a way as to assist the management in taking the important
decisions and making the policies.
uc
___________________
___________________ Basic Accounting Concept or Assumptions: These are common

basic accounting principles which are used in the preparation of
___________________
rod
financial statements.
___________________
Questions for Discussion

1. What do you mean by Accounting? Explain its different
ep
objectives.
2. Explain the characteristics of accounting.
rR
3. What are the importance and limitations of accounting

4. Briefly explain the various branches of accounting.
t fo
5. What is the accounting process? Explain each of the them.

6. Explain the meaning and importance of double entry system of
accounting.
7. What is meaning of Debit and Credit?
No
8. Explain the meaning and importance of bookkeeping.

9. Explain the various types of accounts.
S,
Further Readings
PE
Books
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
Delhi.
U
R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan

Chand, New Delhi.
(c)
Dr. S.N. Maheshwari, Sharad, K. Maheshwari. “Financial

Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi.
ale
23
Pandikumar, M. P (2007). “Management Accounting, Excel Books”.
Notes
New Delhi.
___________________
n/S
Web Readings
___________________
www.futureaccountant.com
___________________
http://www.globusz.com/ ___________________
tio
http://churmura.com/business/types-of-accounts/27737/ ___________________
http://www.netmba.com/accounting/fin/process/ ___________________
uc
___________________
___________________
rod
___________________
ep ___________________
rR
t fo
No
S,
U PE
(c)
Business Accounting
ale
24
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 2: Principles of Accounting
ale
Unit 2
25
Notes
Activity
You and your group members
Principles of Accounting
___________________
n/S
assignment on Accounting
___________________
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning and Need of Accounting Theory ___________________

\ Generally Accepted Accounting Principles (GAAP)
uc
___________________
\ Capital and Revenue Items
___________________
rod
___________________
Introduction
___________________
The transactions of the business enterprise are recorded in the
business language, which routed through accounting. The entire
ep
accounting system is governed by the practice of accountancy. The
accountancy is being practiced through the universal principles
which are wholly led by the concepts and conventions.
rR
Meaning and Need of Accounting Theory

Strong theoretical base is required for the development of any
t fo
discipline of knowledge. Similarly accounting is also having its

theory. Accounting theory is developed with the development of
commerce. In the present economic and social environment, the
importance of the study of the accounting theory has increased as
No
all the financial statements are prepared by the accountants on the

basis of this theory. These financial statements provide very useful
information to the owner of the business, creditors, financial
institutions and government. It is necessary to study the theory of
S,
accounting which provides a base of recording, analyzing and

interpreting the financial statements. In the absence of generally
PE
accepted principles and scientific assumptions, accountants will

prepare the financial statements in their own ways. They will
control and mould the accounting cycles by their ways which will
be based on their past practices. As a result, it will not be possible
U
to compare the study of one business with another concern

similarly inter-period comparison of a firm will not be possible. If
(c)
each accountant has his own approach in preparing the financial

statements, it will be difficult to understand them. Hence, there is
Business Accounting
ale
26 a need for using a standard, logical and sound reasoning language
Notes
Activity which everyone can understand in correct perspective. All this led
Distinguish between material
___________________ to the development of sound theoretical base of accounting.
and immaterial transactions of Hendriksen defined the accounting theory as "logical reasoning in
n/S
___________________
business.
the form of a set of broad principles that (i) provide a general frame
___________________
of reference by which accounting practice can be evaluated, and (ii)
___________________ guide the development of new practices and procedures". Thus
tio
___________________ theory includes the systematic principles and methodology which
are used in the practice.
___________________
So far, a universally acceptable basic accounting theory is not
uc
___________________
developed. A multiplicity of theories is found and used by the
___________________
different users. But at the international level an effort is made to
___________________ frame a generally acceptable conceptual framework of accounting
rod
___________________ i.e. International Accounting Standards and in India also
Accounting Standards. The main objective to frame these
standards is to make the accounting language more effective and
to be easily understood by all. These standards are the scientific
ep
and logical base of accounting. These standards are termed as
Accounting Principles.
rR
Check Your Progress

Fill in the blanks:
1. ……………………… includes the systematic principles
t fo
and methodology which are used in the practice.

2. The main objective to frame ………………………
standards is to make the accounting language more
No
effective and to be easily understood by all.
Generally Accepted Accounting Principles (GAAP)

Accounting principles are those rules of actions on the basis of
S,
which the transactions of the business are recorded, classified and

summarized. If the financial statements are not prepared on the
PE
basis of these principles, there will be low acceptability and

difficulty to understand them, and the comparison will be
impossible and unreliable. Therefore, the accountants recommend
U
that there should be common concepts and conventions of

accounting so that the above difficulties and problems may not
occur. These common concepts and conventions of accounting have
(c)
become the basic accounting concepts and conventions as these are

commonly accepted by the body of the professional accountants all
ale
over the world to prepare the financial statements. Therefore, they 27
are termed as Generally Accepted Accounting Principles (GAAP). Notes
___________________
Classification of Accounting Principles
n/S
___________________
Accounting principles are broadly classified into three categories,
these are: ___________________
___________________
I. Basic Assumptions
tio
___________________
II. Basic Principles (Concepts)
___________________
III. Modifying Principles (Conventions)
uc
___________________
Basic Accounting Assumptions ___________________
i. Separate Business Entity: As per this assumption, business
rod
___________________
is considered a separate entity from its owner(s). This
___________________
assumption helps in keeping the business transactions strictly
free from the effect of personal affairs of the owner. For
instance, when a person start the business with cash of
ep
`2,00,000 then this amount increases the balance of cash from
the point of business and on the other hand the owner is
rR
treated as a liability and this is shown in the liability side of

the balance sheet as owner's capital. For this transaction this
journal entry is passed -
Cash A/c Dr. 2, 00,000
t fo
To Owner's Capital A/c 2, 00,000
This concept is becoming more popular because in one sense

capital itself may be regarded as a liability — the amount due
No
from the business to the owner. This concept is applicable to

the all forms of business organizations whether it is a limited
company, partnership firm or a sole trader.
ii. Going Concern Concept: As per International Accounting
S,
Standards, it is a fundamental accounting assumption

underlying the preparation of financial statements. Under this
PE
assumption, "the enterprise is normally viewed as a going

concern, that is, as continuing in operation for the foreseeable
future. It is assumed that the enterprise has neither the
intention nor the necessity of liquidation or of curtailing
U
materially the sale of its operations". Under this assumption

the assets of the business are valued by the accountants on the
(c)
basis of going concern concept, historical cost and expected life

of the assets.
Business Accounting
ale
28
iii. Money Measurement Concept: As per this assumption, only
Notes
those transactions of the business are recorded in the
___________________
accounting which can be measured in money. Those
n/S
___________________ transactions/activities of the business which cannot be
___________________ measured in money are not recorded in accounting.
___________________ iv. Accounting Period Assumption: As per the going concern

concept, the income of the business can be measured at the
tio
___________________
time of the liquidation of the business or at the time when
___________________ business is sold. But practically it is very difficult to wait such
a long period that is also not definite. Therefore, it is agreed
uc
___________________
___________________
among the accountants that the economic life of the business is
divided into different segment for the purpose of preparing of
___________________
the financial statements and the determination of profits.
rod
___________________ Generally this segment of time is one year either calendar year
or a financial year. Sometime it may be less than twelve
months i.e., quarterly, half yearly etc. Reports made for less
ep
than twelve months are called interim reports and are less
reliable than annual reports. At the end of each segment
(period) profit and loss account and balance sheet are
rR
prepared.
Basic Accounting Principles (Concepts)

These basic accounting principles are commonly accepted/agreed
t fo
principles by the accountants to record the business financial

transactions. These are as follows:
i. Revenue Reorganization Principle: It is also called revenue
No
realization principle. As per this principle the revenue is

recorded in accounting when the sales have taken place. If
there is expectation that will be a particular transaction there
in future, that is not recorded in accounting. Revenue/sales is
S,
considered to be made when title of ownership of goods passes

from the seller to buyer and the buyer become legally liable to
pay.
PE
However, this principle has some exemptions which are as

follows:
U
a. In the case of sales made on the basis of hire purchase

system where ownership is not transferred at the time of
(c)
sales while it is transferred at time of final payment.

ale
Herewith, sales are presumed to the extent of instalment 29
received. Notes
b. In the case of contract accounts, if the contract is for long ___________________
n/S
period revenue cannot be realized until the contract is not ___________________
completed. Here, only a part of total revenue is treated as
___________________
realized.
___________________
ii. Cost Principle: This principle is closely related to the going
tio
___________________
concern concept. As per this principle every transaction of the
business should be recorded at its historical cost and not at its ___________________
market price. At the time of recording of the transactions,
uc
___________________
their market price is not considered. Sometimes its market
___________________
price may be less than or more than its actual cost but its
actual cost is recorded in accounts because of cost principle.
rod
___________________
Under this principle the historical cost of a transaction ___________________

becomes the base cost for the subsequent years. On the basis of
this cost, the depreciation is charged on the assets and the
ep
balance is shown in the balance sheet. All the fixed assets and
current assets are recorded at historical cost. Thus we observe
that the balance sheet prepared on the basis of historical cost
rR
does not give us actual results for those applicable of fixed

assets and current assets. Due to the changing in the price
level changes, the financial statements become irrelevant for
the users. This led to the inflation accounting to came into
t fo
existence.
iii. Dual Aspect Principle: This is the basic principle of
accounting. As per this principle every financial transaction of
No
the business has dual effect and recorded at two places.

Therefore, it is called double entry system. On the basis of this
principle it is said that every debit must have an equivalent
credit and every credit must have an equivalent debit because
every transaction of the business has two aspects. For
S,
instance, if Mr. Aditya Raj started a business for cash

` 2,00,000 there will be two aspects of this transaction. In one
PE
aspect cash is coming into business while in the other aspect

the business has to pay this amount to Mr. Aditya Raj.
Because Mr. Aditya Raj has given the amount to the business.
U
For this transaction the following journal entry will be passed-

Cash A/c Dr.
(c)
To Mr. Aditya Raj

Or To Capital A/c
Business Accounting
ale
30
This transaction can be expressed in the following equation:
Notes
___________________
n/S
___________________ `2, 00,000 = `2, 00,000
___________________ Here cash (assets) is the resource of the business and capital is
the claim of the proprietor as business has to return this
___________________
amount to the proprietor.
tio
___________________
If the business purchases furniture of `20, 000 on credit, the
___________________
above equation will change as follows:
uc
___________________
Capital + Creditors = Cash + Furniture
___________________
`2,00,000 + 20,000 = `2,00,000 + `20, 000
___________________
rod
___________________
Thus we find that in the above equations the total of assets is
always equal to the liabilities. Technically we can say that for
every debit there is an equivalent credit. This relationship of
ep
assets and liabilities is also called accounting equation.
iv. Full Disclosure Principle: As per this principal, the
rR
financial statements should disclose true and fair view so that

these may provide accurate and sufficient information to the
users of financial statements. Disclosure principle means to
give all the information relating to the economic activities of
t fo
the business to the owner, creditors and investors. Now-a-days

this principle is getting more importance as big business
houses are being run in the form of limited companies. As per
Companies Act 1956, the profit and loss account and the
No
balance sheet of the company must show true and fair view of
the company. Therefore, companies are giving the foot notes
regarding some items as investments, contingent liabilities
etc. along with the balance sheet.
S,
v. Matching of Cost and Revenue Principle: As per the going

concern concept, the accurate profit/loss of the business can be
PE
determined at the time of liquidation of the business or sale of

the business. But it will generate a lot of problems. Therefore,
the economic life of the business is divided into different
U
segments in order to determine the profit/loss of the business.

Generally a segment of the economic life of the business
(c)
becomes of a year. To compute the operational profits/loss of

the business in a year, it is necessary to find the expenses and
ale
revenues relating to the period. Then all the revenues of that 31
period are matched with all the expenses/costs incurred to Notes
earn that revenue. This matching is called the principle of ___________________
matching of cost and revenue. The results of this match
n/S
___________________
becomes as follows:
___________________
Profit = Revenue - Expenses
___________________
Herewith the matching means an appropriate association
tio
___________________
between the revenues of a period and expenses/costs of that
period. In other words the incomes/loss of the business can be ___________________
determined if the revenues (incomes) of a period are compared
uc
___________________
(matched) with the expenditure of that period. For the
___________________
recognition of the revenues/expenses the accurate system of
accounting is adopted. Therefore, a proper adjustment is also
rod
___________________
made in the accounts for the outstanding expenses, prepaid ___________________

expenses, accrued incomes and unaccrued incomes. At the time
of reorganization of the revenue/expenses, the following points
ep
are kept in mind:
a. The expenses which are being spent to earn revenue must
be of the same period for which profit is being computed.
rR
b. Revenues/expenses of a period must be computed on the

basis of accrual accounting system.
c. If some revenues are received in advance, they must be
t fo
treated as the income of that period in which goods are

supplied/services are rendered.
vi. Objectivity Principle: It is also known as objective evidence
No
concept. As per this principle the transactions which are

recorded in accounting must be on the objective and factual
basis. There should be a voucher or documentary evidence
behind each entry in the accounting. The entry must be free
S,
from personal bias and based on the rational approach. If the

entries are made without evidence, it will lose the confidence
of the several users of the financial statements about their
PE
reliability. For the auditing of the financial statements, there

is also a need of objective evidence.
U
The Modifying Accounting Principles (Conventions)

Basic accounting assumptions and principles provide us the
(c)
various rules to prepare the financial statements. If these financial

statements are relevant and reliable, they will give much useful
Business Accounting
ale
32 information to the various users of the financial statements. In
Notes order to prepare the true and fair financial statements, there is a
___________________ need to modify the accounting assumptions and principles. These
n/S
___________________ modified accounting principles are as follows:
___________________ i. Conservation (Prudence): As per the law of conservatism, at

___________________ the time of preparing the financial statements, all the possible
losses must be kept in mind and all anticipated profits/gains
tio
___________________
should be left out. In other words the accounts must follow the
___________________
policy of playing safe. Likewise stock-in-trade is valued at
'market price or cost whichever is least', provision for bad and
uc
___________________
___________________ doubtful debt, provision for depreciation on fixed assets, etc.

___________________ are maintained. This principle is being criticized now-a-days
rod
on the ground that it goes against the principle of disclosure.
___________________
The accountants create a secrete reserve through the provision
of bad and doubtful debts, depreciation and the valuation of
stock. The financial statements loose their true and fair view.
ep
Profit and loss account depicts the lower income and the
balance sheet understates the assets and the liabilities of the
rR
business.
Today the law of conservatism has been replaced by prudence.
It means that conservatism is adopted only in the inevitable
t fo
uncertainties and doubts. The accountants should also give the

reasons for adopting a particular accounting techniques,
method and policies without undue conservatism.
ii. Consistency: In order to enable the management to do the
No
comparison of the results of the several years of the business,

whatever accounting policy is adopted in a year, must be
adopted in the coming years.
S,
According to Kohlar there are three forms of consistency:

(a) Vertical Consistency is used in the different financial
PE
statements of the business on the same date. For instance,

depreciation on fixed assets is used in the income
statement and the balance sheet on the same date.
U
(b) Horizontal Consistency enables the comparison of the

profit or performance of a business in a year with the
(c)
performance of another year for example the depreciation

methods.
ale
33
(c) Third Dimensional Consistency refers to the same
Notes
principles or practices of accounting adopted by the
different firms in an industry. ___________________
n/S
___________________
iii. Timeliness: Accounting information given in the financial
statements must be reliable and relevant. In order to be ___________________
relevant, this information must be supplied in time. If late and ___________________
tio
obsolete information is provided, it will hamper the ___________________
management and the users of the financial statements to take
___________________
appropriate, timely and rational decision.
uc
___________________
iv. Materiality: Herewith, the materiality means that only that
___________________
information should be disclosed and attached with financial
rod
___________________
statements which influence the decisions of shareholders,
investors and creditors, etc. and the other insignificant details ___________________
must be ignored. Moreover, an item of information may be

material for one purpose while that may be immaterial for
ep
other. This is a subjective matter. For example, the cost of the
component may be very much significant for small
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businessman while it may be insignificant for a large

businessman. In one more example, the Companies Act
permits to ignore the paise at the time of preparation of
financial statements while for the income tax purpose the
t fo
income is rounded off to the nearest ten.
v. Cost-Benefit Principle: As per this principle the cost of using

an accounting principle should not exceed its benefits. It does
No
not mean that to curtail the costs, no information or a little

information should be given to the users of the financial
statements.
vi. Industry Practice: Different accounting principle/practice is

S,
adopted in the different industries. At the time of preparing

the financial reports and presenting the accounting
PE
information the prevailing accounting practices in a particular

industry should be kept in mind. For example, disclosing of
investments and stock at the cost or market price whichever is
U
lower. Thus we see that the prevailing accounting practices in

an industry play an important role in adopting the accounting
(c)
practices.
Business Accounting
ale
34
Check Your Progress
Notes
Activity
Fill in the blanks:
___________________
showing the Capital and 1. Accounting records all the transactions which can be
n/S
___________________
Revenue Items.
expressed either in ………………… .
___________________
2. Every financial transaction of the business has
___________________
………………… and recorded at two places.
tio
___________________
3. ………………… enables the comparison of the profit or
___________________
performance of a business in a year with the
performance of another year.
uc
___________________
___________________ 4. The revenues are recognized only at the moment of

___________________ ………………… .
rod
___________________ 5. Book Value = Gross (Original) value of the asset –
………………… .
6. The ………… are the persons who owe to an enterprise
ep
an amount for receiving goods or services on credit.
7. ………………… is a liability which arises only on the
happening of an uncertain event.
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8. ………………… = total assets – total liabilities
Capital and Revenue Items

t fo
A businessman is interested to know the net result of his business

operations after a certain period. But neither the trial balance nor
the books of accounts reveal the net results of the business. For
No
this, the financial statements are prepared. But before you learn
how to prepare these statements, it is all the more necessary to
know about the nature of expenditure and receipts i.e. capital and
revenue. This will help in recording correctly the items in these
S,
statements.
Capital and Revenue Expenditures

PE
In business, there are thousands of items of expenditure. The

following are some of these expenditures which are generally
incurred in all types of business:
U
1. Purchase of goods
(c)
2. Purchase of fixed assets such as Building, Furniture, Machine,

etc.
ale
35
3. 'Carriage inwards'
Notes
4. Octroi
___________________
5. Purchase of Raw Material
n/S
___________________
6. Import duty
___________________
7. Coal, gas, water, oil, grease, fuel, heating and lighting
___________________
8. Wages paid to workers for installation of machinery
tio
___________________
9. Salaries
___________________
10. Rent, rates and taxes
uc
___________________
11. Stationery and printing
___________________
12. Postage and Telegrams
rod
___________________
13. Entertainment
___________________
14. Repairs and renewals
15. Depreciation on fixed assets
ep
16. Office expenses
17. Bank charges
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18. General expenses

19. Travelling expenses
20. Overhauling of second hand machinery purchased
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21. Major repairs affected for reconditioning a machinery/the old

assets
22. Increasing the seating capacity of a cinema hall
No
23. Constructing an additional room

24. Carriage for bringing a fixed asset to place of business
25. Shifting business to convenient premises
S,
26. Advertisement on introducing a new product in market

27. Replacement of hand driven machine by automatic machine
PE
28. Research and development

On the basis of items of expenditure, the expenditure can be
classified into three categories:
U
1. Capital Expenditure,
(c)
2. Revenue Expenditure, and

3. Deferred Revenue Expenditure.
Business Accounting
ale
36 Capital Expenditure
Notes
The expenditure incurred for acquiring a fixed asset or which
___________________
results in increasing the earning capacity of the business is known
n/S
___________________ as Capital Expenditure.
___________________ The benefits of capital expenditures are generally availed in
___________________ several accounting years. Following are some of the examples of
Capital Expenditure.
tio
___________________
___________________ 1. Expenditure incurred for the acquisition of a fixed asset

Example: Building, furniture, machinery etc.
uc
___________________
___________________ 2. Expenditure incurred for the inward carriage or erection of a

fixed asset
___________________
rod
___________________ Example:
(a) Carriage paid in connection with the purchase of fixed
asset;
ep
(b) Wages paid to labourers’ in connection with the
installation of machinery.
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These expenses form part of the cost of the fixed asset.

3. Expenditure incurred for extension or improvement of an
existing fixed asset
t fo
Example: Money spent in connection with increasing the

seating capacity of a cinema hall or constructing an additional
room.
4. Expenditure incurred for the major repairs of an old asset
No
Example: Repairs for reconditioning machinery.

5. Expenditure incurred for the replacement of an old asset with
a new asset.
S,
Example: Replacing a hand-driven machine by automatic

machine.
PE
Revenue Expenditure
An expenditure incurred in the course of regular business a
U
transaction of a concern is availed during the same accounting

year is known as Revenue Expenditure. Following are some of the
examples, of Revenue Expenditure.
(c)
1. Expenditure incurred on the purchase of raw materials.

ale
37
2. Expenditure incurred in the day-do-day running of business,
Notes
Example: Wages, salaries, rent, rates and taxes, office
___________________
expenses, interest, discount, etc.
n/S
___________________
3. Expenditure incurred for the upkeep of an asset
___________________
Example: Repairs, maintenance charges, etc.
___________________
tio
4. Expenditure incurred for the purchase of goods meant for sale ___________________
Example: Purchases, carriage inwards, import duty, octroi, ___________________

etc.
uc
___________________
5. Depreciation of fixed assets. ___________________
The above examples are not exhaustive and are not universally
rod
___________________
accepted. Whether expenditure is capital expenditure or revenue ___________________
expenditure depends upon its purpose and nature of the business.
Examples:
ep
1. Amount spent on the purchase of furniture is a capital
expenditure but it is revenue expenditure for a business
rR
dealing in furniture.
2. Amount spent on Plant and Machinery is a capital expenditure

but it is revenue expenditure for a business dealing in
t fo
engineering goods.
3. Amount spent on wages or carriage are revenue expenditure,

but when wages are paid for the installation of a new
machinery or carriage paid to bring the machine to the place of
No
business, they are capital expenditure as they increase the

value of fixed asset i.e. machinery here.
Deferred Revenue Expenditure

S,
There are certain revenue expenditures that are incurred during

one accounting year but are applicable wholly or in part in future
PE
periods such as heavy expenditure on advertisement for

introducing a new product in the market or for exploring new
markets for the product. These expenditures appear to be revenue
U
expenditure. But it is not so because the benefit from this is likely

to the enjoyed over a number of years. Such expenditure whose
(c)
benefit is enjoyed not in one year but over a number of years is

known as deferred revenue expenditure.
Business Accounting
ale
38
Examples:
Notes
1. Heavy initial expenditure incurred on Advertisement for
___________________
introducing a product in the market.
n/S
___________________ 2. Expenditure incurred in shifting business to more convenient
___________________ premises.
___________________ 3. Expenditure incurred on research and development
tio
___________________
Distinction between Capital and Revenue Expenditure
___________________
Following are the main points of difference between capital and
revenue expenditures.
uc
___________________
___________________ Basis of Difference Capital Expenditure Revenue Expenditure

___________________ Purpose It is incurred for the It is incurred for the
rod
purchase of fixed assets. maintenance of fixed
___________________ assets.
Earning capacity It increases the earning It does not increase the
capacity of the business. earning capacity of the
business.
ep
Periodicity of benefit Its benefits are spread Its benefit is only for
over a number of years. one accounting year.
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Placement in It is an item of Balance It is an item of Trading

financial statements Sheet and is shown as an and Profit and Loss
asset. Account and is shown
on the debit side of
either of the two.
t fo
Occurrence It is non-recurring It is usually a recurring

expenditure in nature. expenditure.
Capital and Revenue Receipts

No
Just as expenditures are classified into Capital or Revenue

Expenditure, in the same way receipts are classified into:
1. Capital Receipts, and
2. Revenue Receipts.
S,
Capital Receipts
PE
The receipts which do not arise out of normal course of business

are known as Capital Receipts.
Examples:
U
1. Receipts from sale of fixed assets.

2. Additional capital introduced by the Proprietor
(c)
3. Loans raised
ale
39
Revenue Receipts
Notes
The receipts which arise out of normal course of a business are
___________________
known as Revenue Receipts.
n/S
___________________
Examples:
___________________
1. Income from sale of goods
___________________
2. Rent received form letting out the business property
tio
___________________
3. Dividend received from shares
___________________
4. Interest received from investment
uc
___________________
Check Your Progress ___________________
Fill in the blanks:
rod
___________________
1. The expenditure incurred for acquiring a fixed asset or ___________________
which results in increasing the earning capacity of the

business is known as …………………..
ep
2. An expenditure incurred in the course of regular
business a transaction of a concern is availed during the
same accounting year is known as ………………………..
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3. The receipts which do not arise out of normal course of

business are known as ………………..
t fo
4. The receipts which arise out of normal course of a

business are known as ………………..
Summary
No
Accounting concepts and convention which are commonly accepted

by the accountants to record the transactions are called Generally
Accepted Accounting Principles (GAAP). Accounting principles are
classified into three categories: Basic Accounting Assumptions,
S,
Basic Accounting Concepts, Basic Accounting Conventions.

The revenues are recognized only at the moment of realization but
PE
the expenses are recognized at the moment of payment. The

charges which were paid only are taken into consideration but the
outstanding, not yet paid is not considered. The revenues are
U
recognized only at the time of occurrence and expenses are

recognized only at the moment of incurring. The financial
(c)
statements are found to be more useful to many people

Business Accounting
ale
40 immediately after presentation only in order to study the financial
Notes status of the enterprise in the angle of their own objectives.
___________________
The entire accounting system is governed by the practice of
n/S
___________________ accountancy. The accountancy is being practiced through the
___________________ universal principles which are wholly led by the concepts and
conventions. Money measurement concept tunes the system of
___________________
accounting as fruitful in recording the transactions and events of
tio
___________________ the enterprise only in terms of money. Business entity concept
___________________ treats the owner as totally a different entity from the business.
Going concern concept deals with the quality of long lasting status
uc
___________________
of the business enterprise irrespective of the owners' status,
___________________
whether he is alive or not. Matching concept only makes the entire
___________________ accounting system as meaningful to determine the volume of
rod
___________________ earnings or losses of the firm at every level of transaction. Duality
or Double entry accounting concept is the only concept which
portrays the two sides of a single transaction.
ep
Lesson End Activity
Singania Chartered Accountants Firm established in the year
rR
1956, having very good number of corporate clients. It continuously

maintains the quality in audit administration with the clients
since its early inception. The firm is eagerly looking for promising
t fo
students who are having greater aspirations to become auditors.

The firm is having an objective to recruit fresher to conduct
preliminary auditing process with their corporate clients.
For which the firm would like to select the right person who is
No
having conceptual knowledge as well as application on the

subjects. It has given the following Balance sheet to the
participants to study the conceptual applications. The participants
are required to enlist the various concepts and conventions of
S,
accounting.
(a) List out the various accounting concepts dealt in the above
PE
balance sheet.
(b) Explain the treatment of accounting concepts.
Keywords
U
Basic Accounting Principles: These are the rules of recording

(c)
the financial transactions which are adopted by the accountants

universally.
ale
41
Accounting Conventions: Customs and traditions which guide
Notes
the accountants to record the financial transactions.
___________________
n/S
transactions, ledger posting, preparation of financial statements ___________________
and analyzing and interpretation of them. ___________________
Accrual System: The revenues are recognized only at the time of ___________________
tio
occurrence and expenses are recognized only at the moment of ___________________
incurring.
___________________
Book Value: It is the value of the asset maintained in the books of
uc
___________________
the account. The book value of the asset could be computed as
follows: ___________________
rod
___________________
Book Value = Gross (Original) value of the asset – Accumulated
depreciation ___________________
Assets: The economic resources of an entity. They include such

items as cash, accounts receivable (amounts owed to a firm by its
ep
customers), inventories, land, buildings, equipment, and even
intangible assets like patents and other legal rights and claims.
Assets are presumed to entail probable future economic benefits to
rR
the owner.
Liabilities: Amounts owed to others relating to loans, extensions
of credit, and other obligations arising in the course of business.
t fo

1. What do you mean by generally accepted accounting principle
No
(GAAP)? Classify the accounting principles.

2. What is the meaning of accounting conventions? Explain them.
3. What is the dual aspect principle? Explain with five examples.
S,
4. Explain the following accounting principles:

a. Revenue Reorganization Principle
PE
b. Matching of Cost and Revenue Principle

c. Full Disclosure Principle
U
d. Cost Principle
5. Write short notes on the following (approximately 50 words
(c)
each):
(i) Conservatism Principle
Business Accounting
ale
42
(ii) Materiality Principle
Notes
___________________
(iii) Consistency Principle
n/S
___________________ (iv) Money Measurement Concept
___________________ (v) Going Concern Concept
___________________ 6. What do you mean by business entity concept? Is it different

from proprietary concept? Explain.
tio
___________________
___________________ 7. The entire accounting system is governed by the practice of

accountancy. What are the key principles used in accounting?
uc
___________________
8. What are the key assumptions of going concern concept?
___________________
___________________
9. Every debit transaction is appropriately equated with the
rod
transaction of credit. Define.
___________________
10. Classify the various kinds of values in accounting process.
Further Readings
ep
Books
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Delhi.
t fo
Chand, New Delhi.

No

New Delhi.
Web Readings
S,
http://www.principlesofaccounting.com/chapter1/chapter1.html
PE
http://www.legalzoom.com/business-management/running-your-
business/general-accepted-accounting-principles-or
http://www.ofm.wa.gov/policy/80.20.htm
U
(c)
UNIT 3: Accounting Standards in India
ale
Unit 3
43
Notes
Activity
Find out how many
Accounting Standards in India
___________________
Accounting Standards that are
n/S
given by the Institute of
___________________
Chartered Accountants of
___________________
India is made mandatory.
Objectives
___________________
tio
topics: ___________________
\ Accounting Standards ___________________

\ Need and Formulation of Accounting Standards
uc
___________________
\ Statements of Accounting Standards (AS 1) Disclosure of Accounting
Policies ___________________
rod
___________________
Introduction ___________________
For the interest of customers, investors, owners, it is necessary

that financial statement of a company should be transparent,
ep
properly disclosed, consistent and reliable. For this purpose
accounting standards are framed by ICAI in India.
rR
Accounting Standards
There are many users of financial statements as investors,
t fo
creditors, government, consumers, owners, etc. They take many

economic decisions on the basis of financial statements. If the
financial statements are not properly regulated, there is possibility
that the financial statements may mislead and provide the
No
distorted picture of the business in the place of true and fair

picture of the business. Proper regulation of the process of
accounting it is essential so that these statements should be
transparent, properly disclosed, consistent and reliable. Adequate
S,
disclosure in the accounts is also required. For this purpose,

accounting standards are prepared at the national and
international level. Actually the generally accepted accounting
PE
principles are codified by the accounting standards. Accounting

standards prepares the norms and guidelines to prepare the
financial statements and annual reports. At the international level
U
the International Accounting Standard Committee (IASC) has

issued the International Standards. In this committee, there are
(c)
leading professional bodies of UK, USA, Australia, France and

Canada. India is also a member of this committee. India has also
Business Accounting
ale
44 prepared its own accounting standards, which are prepared by the
Notes
Activity Institute of Chartered Accountant of India (ICAI).
Collect recent data
___________________ on
Accounting Standards on Meaning of Accounting Standards
n/S
___________________
India with the help of Financial
Accounting Standards Board It is a set of certain generally accepted rules, principles, concepts
___________________
(FASB) and conventions issued by the Institute of chartered Accountants
___________________ of India in consultation with other International Accounting
tio
___________________ bodies. The purpose of making uniform rules and principles is to
make the preparation and presentation of financial statement
___________________
easy, relevant, reliable, understandable and finally comparable. In
uc
___________________ other words, Accounting standards are the basis of accounting
___________________ policies and practices to facilitate the recording of transactions and
___________________
events in such a way which can change them into financial
rod
statements, to be used by the persons interested in getting the
___________________
correct and reliable information with a view to take future
decisions.
The basic objective of Accounting Standards is to remove
ep
variations in the treatment of several accounting aspects and to
bring about standardization in presentation. They intent to
rR
harmonize the diverse accounting policies followed in the

preparation and presentation of financial statements by different
reporting enterprises so as to facilitate intra-firm and inter-firm
comparison.
t fo
Need and Formulation of Accounting Standards

What is the need of adoption of accounting standards in the
accounting process? How do the accounting standards help in
No
improving the quality of the financial Statement? The answer of

these questions may be explained by an example, suppose a
company adopts LIFO method for the valuation of its closing stock
and another company adopts FIFO method for the valuation of its
S,
closing stock, valuation of the closing stock of both the companies

will differ. As a result the profit or loss of both companies will also
differ. In order to avoid such situation, AS-2 is made.
PE
Take another example of depreciation, if a company adopts

diminishing balancing method for the depreciation and another
company adopts the fixed instalment method for depreciation, the
U
amount of depreciation of both the companies will differ. As a

result profit/loss will also differ and the comparison of these
(c)
companies will not be possible. For the purpose AS-6 is prepared

by ICAI in India. Similarly, AS-1 gives guidelines for the disclosure
ale
of accounting policies, so that the users of financial statements 45
may perceive the reported profits in its correct perspective. Notes
In India, the Accounting Standards are formulated by the ___________________
n/S
Accounting Standard Board (ASB). ASB determines the broad area ___________________
requiring for formulation of AS. At the time of preparation of
___________________
Accounting Standards, ASB gets help from different groups for this
purpose a study group is made. In this group the members of ICAI ___________________
tio
participates. Then a wide discussion is held. In this discussion, the ___________________
representatives of Government, Public Sector Units, and other ___________________
organizations participate. After the discussion an Exposure Draft
uc
___________________
(ED) for AS is proposed and issued by ICAI. Then it is dispatched
to different outside bodies as ICWAI, ICSI, CBDT, SCOPE, etc. ___________________
This ED comprises the following points:
rod
___________________
i. A Statement of concepts and fundamental accounting ___________________

principles relating to the standard.
ii. Definitions of the terms used in the standard.
ep
iii. The manner in which the accounting principles have been
applied for the formulation of the standard.
rR
iv. The presentation and disclosure requirements in complying

with the standard.
v. Class of enterprises to which the standard will apply.
t fo
vi. Date from which the standard will be effective.

After the publication of ED, the comments and views are collected
from the different corners. Then ASB finalizes the proposed
No
standard and submit it to the council of the Institute of chartered

accountant of India for the approval. The council considers the ED
and, if found necessary, modifies with the consolation of the
Accounting Standard Board. Then final shape of the standard is
issued under the authority of the council. In the beginning, this is
S,
recommendatory and after some period it becomes mandatory. The

board has issued the following standards for adoption worldwide. A
PE
number of provisional standards relating to other aspects of

accounting are an anvil.
Nature
U
The Institute of chartered Accountants of India had set up

(c)
Accounting Standards Board on 22nd April, 1977 to formulate

accounting standards on a number of accounting issues, taking
Business Accounting
ale
46 into account the accounting standards developed by the
Notes International Accounting Standard Committee, prevailing laws in
___________________ India, business customs usages and conventions etc. The
Accounting Standards made were not mandatory in the beginning
n/S
___________________
but after the amendment in the Sec 211(3C) of Companies Act,
___________________
1956 Accounting Standards out of 28 have been made mandatory.
___________________ The Auditor is required to give in his report to the shareholders
tio
___________________ that accounts are prepared (drawn) in accordance with the
provisions relating to Accounting Standards in India.
___________________
The Purpose of this exercise is to make the financial statements
uc
___________________
more reliable, comparable, consistent and transparent. These
___________________
standards are made taking into account the laws of the country,
___________________ business custom, environments etc. If there is a change in any law
rod
___________________ of the country or change in business custom or environment, the
accounting standards are also changed/altered. This flexibility of
Accounting Standards is a special feature which makes them more
popular and friendly with the users.
ep
If any enterprise wants to change/modify any business
custom/practice the same must be properly disclosed along with its
rR
effects. For example—change of depreciation method, must be

disclosed along with its effect on profit or loss.
The Institute of chartered Accountants of India has issued the
t fo
following accounting standards.

z AS.1. Disclosure of Accounting policies.
z AS.2. Valuation of Inventories.
No
z AS.3. Cash Flow Statement.

z AS.4. Contingencies and Events occurring after the Balance
Sheet Date.
AS.5. Net Profit or loss for the period, prior items and changes
S,
z
in accounting policies.
AS.6. Depreciation Accounting.
PE
z AS.7. Accounting for Construction Contracts.

z AS.8. Accounting for research and development.
U
z AS.9. Revenue Recognition.

AS.10. Accounting for fixed Assets.
(c)
z
ale
47
z AS.11. Accounting for the effects of changes in foreign
Notes
Exchange rates.
___________________
z AS.12. Accounting for Government grants.
n/S
___________________
z AS.13. Accounting for Investments.
___________________
z AS.14. Accounting for Amalgamations.
___________________
tio
z AS.15. Accounting for Retirement benefits in the financial ___________________
statements of employers.
___________________
z AS.16. Borrowing Costs.
uc
___________________
z AS.17. Segment Reporting. ___________________
z AS.18. Related Party Disclosures.
rod
___________________
z AS.19. Leases. ___________________
z AS.20. Earnings Per share.

ep
z AS.21. Consolidated financial statements.
z AS.22. Accounting for Taxes on Income.

rR
z AS.23. Accounting for Investments in Associates in

Consolidated Financial Statements.
z AS.24. Discontinuing operations.

t fo
z AS.25. Interim Financial Reporting.
z AS.26. Intangible Assets.
z AS.27. Financial Reporting of Interests in Joint Ventures.

No
z AS.28. Impairment of Assets.
z AS.29. Contingent Liabilities and Contingent Assets.
z AS 30. Financial Instruments: Recognition and Measurement

S,
z AS 31. Financial Instruments: Presentation
z AS 32. Financial Instruments: Disclosures and limited revision

PE
to AS-19
According to Government of India, there are 31 accounting

standards. But 32 are also included in 31st accounting standard
U
(Financial Instrument: Presentation). So we can say that there are

32 accounting standards.AS-3, AS-6 and AS-24 are desirable but
(c)
the rest are mandatory.

Business Accounting
ale
48
Check Your Progress
Notes
Activity
Fill in the blanks:
Find___________________
out the legal status of
accounting standards in India? 1. The basic objective of …………………is to remove
n/S
___________________
variations in the treatment of several accounting
___________________
aspects and to bring about standardization in
___________________ presentation.
tio
___________________ 2. The …………………………are codified by the accounting
___________________ standards.
uc
___________________
___________________
Statements of Accounting Standards (AS 1) Disclosure
___________________
of Accounting Policies
rod
___________________ The following is the text of the Accounting Standard (AS) 1 issued
by the Accounting Standards Board, the Institute of Chartered
Accountants of India on 'Disclosure of Accounting Policies'. The
Standard deals with the disclosure of significant accounting
ep
policies followed in preparing and presenting financial statements.
In the initial years, this accounting standard will be
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recommendatory in character. During this period, this standard is

recommended for use by companies listed on a recognised stock
exchange and other large commercial, industrial and business
enterprises in the public and private sectors.
t fo
Introduction
1. This statement deals with the disclosure of significant
accounting policies followed in preparing and presenting
No
2. The view presented in the financial statements of an
enterprise of its state of affairs and of the profit or loss can be
S,
significantly affected by the accounting policies followed in the

preparation and presentation of the financial statements. The
accounting policies followed vary from enterprise to enterprise.
PE
Disclosure of significant accounting policies followed is

necessary if the view presented is to be properly appreciated.
3. The disclosure of some of the accounting policies followed in
U
the preparation and presentation of the financial statements is

required by law in some cases.
(c)
4. The Institute of Chartered Accountants of India has, in

Statements issued by it, recommended the disclosure of certain
ale
accounting policies, e.g., translation policies in respect of 49
foreign currency items. Notes
5. In recent years, a few enterprises in India have adopted the ___________________
n/S
practice of including in their annual reports to shareholders a ___________________
separate statement of accounting policies followed in preparing
___________________
and presenting the financial statements.
___________________
6. In general, however, accounting policies are not at present
tio
regularly and fully disclosed in all financial statements. Many ___________________
enterprises include in the Notes on the Accounts, descriptions of ___________________
some of the significant accounting policies. But the nature and
uc
___________________
degree of disclosure vary considerably between the corporate and
the non-corporate sectors and between units in the same sector. ___________________
7. Even among the few enterprises that presently include in their
rod
___________________
annual reports a separate statement of accounting policies, ___________________

considerable variation exists. The statement of accounting
policies forms part of accounts in some cases while in others it
ep
is given as supplementary information.
8. The purpose of this Statement is to promote better
understanding of financial statements by establishing through
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an accounting standard the disclosure of significant accounting

policies and the manner in which accounting policies are
disclosed in the financial statements. Such disclosure would
t fo
also facilitate a more meaningful comparison between

financial statements of different enterprises.
Explanation
No
Let us discuss:
Fundamental Accounting Assumptions

9. Certain fundamental accounting assumptions underlie the
preparation and presentation of financial statements. They are
S,
usually not specifically stated because their acceptance and use are
assumed. Disclosure is necessary if they are not followed.
PE
10. The following have been generally accepted as fundamental

accounting assumptions:
a. Going Concern: The enterprise is normally viewed as a

U
going concern, that is, as continuing in operation for the

foreseeable future. It is assumed that the enterprise has
(c)
neither the intention nor the necessity of liquidation or of

curtailing materially the scale of the operations.
Business Accounting
ale
50
b. Consistency: It is assumed that accounting policies are
Notes
consistent from one period to another.
___________________
c. Accrual: Revenues and costs are accrued, that is,
n/S
___________________
recognised as they are earned or incurred (and not as
___________________ money is received or paid) and recorded in the financial
___________________ statements of the periods to which they relate. (The
considerations affecting the process of matching costs with
tio
___________________
revenues under the accrual assumption are not dealt with
___________________ in this Statement.)
uc
___________________
Nature of Accounting Policies
___________________
11. The accounting policies refer to the specific accounting
___________________
rod
principles and the methods of applying those principles
___________________
adopted by the enterprise in the preparation and presentation
of financial statements.
12. There is no single list of accounting policies which are
ep
applicable to all circumstances. The differing circumstances in
which enterprises operate in a situation of diverse and
complex economic activity make alternative accounting
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principles and methods of applying those principles acceptable.

The choice of the appropriate accounting principles and the
methods of applying those principles in the specific
t fo
circumstances of each enterprise call for considerable

judgment by the management of the enterprise.
13. The various statements of the Institute of Chartered
Accountants of India combined with the efforts of government
No
and other regulatory agencies and progressive managements

have reduced in recent years the number of acceptable
alternatives particularly in the case of corporate enterprises.
While continuing efforts in this regard in future are likely to
S,
reduce the number still further, the availability of alternative

accounting principles and methods of applying those principles
PE
is not likely to be eliminated altogether in view of the differing

circumstances faced by the enterprises.
Areas in which Differing Accounting Policies are Encountered

U
14. The following are examples of the areas in which different

accounting policies may be adopted by different enterprises.
(c)
Methods of depreciation, depletion and amortisation

ale
51
Treatment of expenditure during construction
Notes
Conversion or translation of foreign currency items
___________________
n/S
Valuation of inventories
___________________
Treatment of goodwill ___________________
Valuation of investments ___________________
tio
Treatment of retirement benefits ___________________
Recognition of profit on long-term contracts ___________________
Valuation of fixed assets
uc
___________________
Treatment of contingent liabilities ___________________
rod
15. The above list of examples is not intended to be exhaustive. ___________________
___________________
Considerations in the Selection of Accounting Policies
16. The primary consideration in the selection of accounting
ep
policies by an enterprise is that the financial statements
prepared and presented on the basis of such accounting
policies should represent a true and fair view of the state of
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affairs of the enterprise as at the balance sheet date and the

profit or loss for the period ended on that date.
17. For this purpose, the major considerations governing the
t fo
selection and application of accounting policies are:

a. Prudence: In view of the uncertainty attached to future
events, profits are not anticipated but recognised only
when realised though not necessarily in cash. Provision is
No
made for all known liabilities and losses even though the
amount cannot be determined with certainty and
represents only a best estimate in the light of available
information.
S,
b. Substance over Form: The accounting treatment and

presentation in financial statements of transactions and
PE
events should be governed by their substance and not

merely by the legal form.
c. Materiality: Financial statements should disclose all
U
"material" items, i.e. items the knowledge of which might

influence the decisions of the user of the financial
(c)
statements.
Business Accounting
ale
52 Disclosure of Accounting Policies
Notes
18. To ensure proper understanding of financial statements, it is
___________________
necessary that all significant accounting policies adopted in
n/S
___________________ the preparation and presentation of financial statements
___________________ should be disclosed.
___________________ 19. Such disclosure should form part of the financial statements.
tio
___________________ 20. It would be helpful to the reader of financial statements if they
___________________ are all disclosed as such in one place instead of being scattered
over several statements, schedules and notes.
uc
___________________
21. Examples of matters in respect of which disclosure of
___________________
accounting policies adopted will be required are contained in
___________________ paragraph 14. This list of examples is not, however, intended
rod
___________________ to be exhaustive.
22. Any change in an accounting policy which has a material effect
should be disclosed. The amount by which any item in the
ep
financial statements is affected by such change should also be
disclosed to the extent ascertainable. Where such amount is
not ascertainable, wholly or in part, the fact should be
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indicated. If a change is made in the accounting policies which

has no material effect on the financial statements for the
current period but which is reasonably expected to have a
material effect in later periods, the fact of such change should
t fo
be appropriately disclosed in the period in which the change is

adopted.
23. Disclosure of accounting policies or of changes therein cannot
No
remedy a wrong or inappropriate treatment of the item in the

accounts.
Accounting Standard
S,
(The Accounting Standard comprises paragraphs 24-27 of this

Statement. The Standard should be read in the context of
PE
paragraphs 1-23 of this Statement and of the 'Preface to the

Statements of Accounting Standards'.)
24. All significant accounting policies adopted in the preparation
U
and presentation of financial statements should be disclosed.

25. The disclosure of the significant accounting policies as such
(c)
should form part of the financial statements and the

ale
significant accounting policies should normally be disclosed in 53
one place. Notes
26. Any change in the accounting policies which has a material ___________________
n/S
effect in the current period or which is reasonably expected to ___________________
have a material effect in later periods should be disclosed. In
___________________
the case of a change in accounting policies which has a
material effect in the current period, the amount by which any ___________________
tio
item in the financial statements is affected by such change ___________________
should also be disclosed to the extent ascertainable. Where ___________________
such amount is not ascertainable, wholly or in part, the fact
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___________________
should be indicated.
___________________
27. If the fundamental accounting assumptions, viz. Going
Concern, Consistency and Accrual are followed in financial
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___________________
statements, specific disclosure is not required. If a ___________________

fundamental accounting assumption is not followed, the fact
should be disclosed.
ep
Check Your Progress
Fill in the blanks:
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1. Statements of Accounting Standards (AS 1) Disclosure

of Accounting Policies deals with the disclosure of
significant accounting policies followed in preparing and
t fo
presenting ……………..
2. ……………….is made for all known liabilities and losses
even though the amount cannot be determined with
certainty and represents only a best estimate in the
No
light of available information.
Summary
S,
Accounting Standards is a set of certain generally accepted rules,

principles, concepts and conventions issued by the Institute of
chartered Accountants of India in consultation with other
PE
International Accounting bodies.

The basic objective of Accounting Standards is to remove
variations in the treatment of several accounting aspects and to
U
bring about standardization in presentation. The accounting

policies refer to the specific accounting principles and the methods
(c)
of applying those principles adopted by the enterprise in the

preparation and presentation of financial statements.
Business Accounting
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54
Lesson End Activity
Notes
Go to this site http://www.mca.gov.in/Ministry/accounting_
___________________
standards.html and prepare an assignment on 35 Indian
n/S
___________________ accounting standards.
___________________
___________________ Keywords
tio
___________________ Accounting Standards: It is a set of certain generally accepted
___________________ rules, principles, concepts and conventions issued by the Institute
of chartered Accountants of India in consultation with other
uc
___________________
___________________
Accounting Policies: The accounting policies refer to the specific
___________________
rod
accounting principles and the methods of applying those principles
___________________ adopted by the enterprise in the preparation and presentation of
Going Concern: The enterprise is normally viewed as a going
ep
concern, that is, as continuing in operation for the foreseeable
future.
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Materiality: Financial statements should disclose all "material"

items, i.e. items the knowledge of which might influence the
decisions of the user of the financial statements.
t fo

1. Write down the meaning of accounting standards.
2. What do you understand by accounting standards? Explain.
No
3. What is the legal status of Accounting Standards in India?

4. Explain the need and formulation of accounting standards.
Discuss the nature of accounting policies.
S,
5. How many Accounting Standards are given by the Institute of

Chartered Accountants of India?
PE
Further Readings
U
Books
(c)
Delhi.
ale
55
Notes
Chand, New Delhi.
___________________
n/S
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi. ___________________
___________________
New Delhi. ___________________
tio
___________________
Web Readings
___________________
http://www.mca.gov.in/Ministry/accounting_standards.html
uc
___________________
http://www.scribd.com/doc/11524125/Accounting-Standards-in-
___________________
India
rod
___________________
http://220.227.161.86/9548Indian%20Accounting%20Standards.pdf
___________________
http://www.svtuition.org/2009/05/accounting-standards-in-india-
simple.html
ep
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t fo
No
S,
U PE
(c)
Business Accounting
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56
Notes
___________________
n/S
___________________
___________________
___________________
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___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
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No
S,
U PE
(c)
UNIT 4: Accounting Equation and Accounting Cycle
ale
Unit 4
57
Notes
Activity
Accounting Equation and

Do ___________________
you agree with the
n/S
statement “The basic
___________________
accounting equation is the
Accounting Cycle foundation for the double-
___________________
entry bookkeeping system.”
What is your experience?
___________________
tio
Objectives ___________________
___________________
topics:
uc
___________________
\ Accounting Equation
\ Accounting Cycle ___________________
\ Account
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___________________
___________________
Introduction
As discussed earlier accounting is the art of recording, classifying
ep
and summarizing the business transactions of the financial nature.
Under the recording process of accounting journal and subsidiary
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books are maintained, under classification of transactions the

ledger is maintained while in the summarizing process trial
balance and final accounts (P. & L. A/c and Balance Sheet) are
prepared.
t fo
Accounting Equation
The basic accounting equation is the foundation for the double-
No
entry bookkeeping system. It shows how assets were financed:

either by borrowing money from someone (liability) or by paying
your own money (shareholders' equity).
Assets = Liabilities + (Shareholders or Owners equity)
S,
The accounting equation is also the basis for the most basic of
accounting reports, the aptly named Balance Sheet. A balance
PE
sheet reports what a business owns (assets), what it owes

(liabilities) and what remains for the owners (equity) as of a
certain date. This equation should remain in balance at all times
U
because of double-entry accounting or bookkeeping. This can be

further understood by the following illustrations.
(c)
An owner's investment into the company will increase the

company's assets and will also increase owner's equity. When the
Business Accounting
ale
58 company borrows money from its bank, the company's assets
Notes increase and the company's liabilities increase. When the company
___________________ repays the loan, the company's assets decrease and the company's
liabilities decrease. If the company pays cash for a new delivery
n/S
___________________
van, one asset (cash) will decrease and another asset (vehicles) will
___________________
increase. If a company provides a service to a client and
___________________ immediately receives cash, the company's assets increase and the
tio
___________________ company's owner's equity will increase because it has earned
revenue. If the company provides a service and allows the client to
___________________
pay in 30 days, the company has increased its assets (Accounts
Receivable) and has also increased its owner's equity because it
uc
___________________
___________________ has earned service revenue. If the company runs a radio

___________________
advertisement and agrees to pay later, the company will incur an
rod
expense that will reduce owner's equity and has increased its
___________________
liabilities.
Example: If a business has `1,000 of assets at a particular time
those assets must be matched by the total of the claims of creditors
ep
and owners. Here is one example of an infinite number of
acceptable balance sheets:
rR
Fazal-ur-Rehman and Sons

Balance Sheet
`
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Assets 1000
Liabilities 500
Equity 500
Total Liabilities and Equity 1000
No
Equity as Residual Claims

Equity is simply the difference between assets and liabilities. The
owner has positive equity only to the extent that assets exceed
S,
liabilities.
Example: If a business has `1,000 of assets and ` 600 of liabilities

PE
the ` 600 of liabilities are, in effect, a claim on the assets. Equity is

the difference between the assets and liabilities, or `400.
Equity = Assets – Liabilities

U
Equity is simply the difference between assets and liabilities. The

(c)
owner has positive equity only to the extent that assets exceed
liabilities.
ale
59
Example: If a business has ` 1,000 of assets and ` 500 of liabilities
Notes
the `500 of liabilities are, in effect, a claim on the assets. Equity is
the difference between the assets and liabilities, or ` 500. ___________________
n/S
If a business ceases operations remaining assets first go to outside ___________________
creditors. The claims of owners can be realized only after outside ___________________
creditors' claims are satisfied. So equity represents the owners'
___________________
residual claim on business assets.
tio
___________________
Rules for Accounting Equation ___________________

Following rules help in making the accounting equation:
uc
___________________
i. Assets: If there is increase in assets, this increase is debited in ___________________

assets account. If there is decrease in assets, this decrease
rod
___________________
credited in assets account.
___________________
ii. Liabilities: When liabilities are increase, outsider’s equities
are credited and when liabilities are decreased, outsider’s
equities are debited.
ep
iii. Capital: When capital is increased, it is credited and when
capital is withdrawn, it is debited.
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iv. Expenses: Owner’s equity is decreased by the amount of

revenue expenses.
v. Income or profits: Owner’s equity is increased by the amount
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of revenue income.
Effect of Transactions on the Accounting Equation

You have learnt that assets, liabilities and capital are the three
No
basic elements of every business transaction, and their

relationship is expressed in the form of accounting equation which
always remains equal. At any point of time, there can be a change
in the individual asset, liability or capital, but the two side of the
S,
accounting equation always remain equal. Let us verify this fact by

taking up some transactions and see how these transactions affect
PE
the accounting equation:

Example
1. Mr. Kamlesh started business with cash of `2, 00,000.
U
In this transaction, one side cash is coming into business and

in the other side capital is being brought by Mr. Kamlesh.
(c)
Thus:
Business Accounting
ale
60
Notes
___________________
` 2, 00,000 = ` 2, 00,000
n/S
___________________ 2. In the next transaction, if a plant of `50,000 is purchased in
cash, this transaction will also leave two sides. In one side
___________________
cash is going and in other side plant is coming. In this
___________________ situation, the accounting equation will be as follows:
tio
___________________
Capital = Plant + Cash (Assets)
___________________
` 2, 00,000 = ` 50,000 + ` (2, 00,000 – 50,000)
uc
___________________
3. If a loan of ` 1, 50,000 are taken from the SBI, it will also
___________________ affect the accounting equation by two sides. On one side, cash
___________________ will increase and on the other side, liabilities of the business
rod
will increase. This may be depicted as follows:
___________________
Capital + Liability (Loan) = Plant + Cash
` 2, 00,000 + 1, 50,000 = ` 50,000 + (1, 50,000 + 1, 50,000)
ep
` 3, 50,000 = ` 3, 50,000
4. If some goods of `20,000 are purchased on credit, it will also
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affect the accounting equation in two ways. On one side it

increases the goods and on the other side it increases the
liability (creditors). Now the changed form of the above
accounting equation will be as follows:
t fo

Capital + Loan + Creditors = Plant + Cash + Goods
` 2, 00,000 + 1, 50,000 + 20,000 = ` 50,000 + 3, 00,000 + 20,000
No
` 3, 70,000 = ` 3, 70,000
Check Your Progress

S,
Fill in the blanks

1. The basic accounting equation is the foundation for the
PE
...................... system.
2. A ..................... reports what a business owns (assets),
what it owes (liabilities) and what remains for the
U
owners (equity) as of a certain date.

3. An owner’s investment into the company will increase
(c)
the company’s assets and will also increase .....................

ale
Accounting Cycle 61
Notes
Activity
Accounting is described as origin for the creation of information Find out Describe how
___________________
and the continuous utility of information. Now the question is how technology has affected the
n/S
is this information created? For this, there is a step by step first___________________
three steps of the
accounting cycle.
process, as shown below. The major steps involved in the ___________________
accounting cycle are:
___________________
1. Analyse Transactions: The first step of an accounting cycle is
tio
___________________
to know what type of transaction we are dealing with; we also
need to verify that the information is correct and that ___________________
transactions have taken place only with proper authorization.
uc
___________________
Most accounting transactions originate with what are called
___________________
source documents, which are the invoices, invoices, orders, time
rod
cards, checks, and other “paperwork” (or now, commonly digital ___________________
files) which provide the first indication that a transaction has ___________________
taken place (or will be taking place in the future.)
2. Preparing Journals: The journal is the “book of original
ep
entry,” the place where the transactions first become part of
the official financial records of the organization. We make
journal entries which specify the accounts which are affected
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by a transaction, and the amount of money involved.

3. Post to Ledger A/c: The ledger is the entire group of accounts
maintained by an organization. Posting refers to the transfer
t fo
of the journal entries to the ledger. In a manual system,

posting was a separate process. In computerized systems,
posting is typically accomplished contemporaneously with
recording the transaction in the journal.
No
4. Preparation of Trial Balance: A trial balance is nothing

more than a summation of the account balances to be sure that
the books do, in fact, balance.
5. Prepare financial statements: After preparing the trial
S,
balance the next step is to prepare the financial statements

like income statement, balance sheet and cash flow statement.
PE
6. Post Closing Entries: Closing entries are the entries that we

make to close the temporary accounts (the expense and
revenue accounts). In manual systems, each closing entry had
to be made individually. In computerized systems, a single
U
command closes the books.

7. Preparation of Financial Statement: Last step includes
(c)
the preparation of Trading and Profit & Loss A/c and opening
and closing balance sheet.
Business Accounting
ale
62
The following figure explains the key steps of accounting cycle:
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
Figure 4.1: Accounting Cycle
What are the purposes of preparing financial statements?

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1. Accounting provides necessary information for decisions to be

taken initially and it facilitates the enterprise to pave way for
the implementation of actions
t fo
2. It exhibits the financial track path and the position of the

organization.
3. Being business in the dynamic environment, it is required to
face the ever changing environment. In order to meet the
No
needs of the ever changing environment, the policies are to be

formulated for the smooth conduct of the business.
4. It equips the management to discharge the obligations at
every moment.
S,
5. Obligations to customers, investors, employees, to

renovate/restructure and so on.
PE
Check Your Progress

Fill in the blanks:
U
1. Accounting Equation serves as a basis for preparing

....................................
(c)
2. Liabilities = ................... – Capital

ale
Account 63
Notes
Activity
An account is a statement in which the date wise details regarding
Differentiate between
___________________
the business transactions as persons, companies, representatives,
n/S
American Approach and
assets liabilities, income and expenditures and profit and loss are ___________________
English Approach.
given. ___________________
___________________
Kinds of Accounts
tio
For the purpose of ruling of debit and credit, under double entry ___________________
system the accounts are classified on the basis of two approaches. ___________________
These are:
uc
___________________
(a) American Approach ___________________
(b) English Approach
rod
___________________
___________________
Kinds of Accounts ep
American Approach English Approach
Assets Liabilities Revenue Expenses

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Account Account Account Account
Personal Accounts Real accounts Nominal Accounts

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(Persons, Companies, (Properties and (Incomes Gains,

firms & Representatives) Assets) Expenses & Losses
Figure 4.2: Chart of Classification of Accounts
(a) American Approach: As per this approach the accounts

No
relating to financial transactions are classified as follows:

i. Assets Accounts: Under this heading those transactions
are kept which are relating to the business assets as
plant, machinery, land, building, etc.
S,
ii. Liabilities Account: Under this heading those accounts are

kept which are relating to the credit purchases and
PE
outstanding expenses, loans, capital, etc.

iii. Revenue Accounts: Revenue accounts include the
transactions relating to income, commission, interest,
U
dividend, sales, etc.

iv. Expenses Accounts: These include those accounts which
(c)
are relating to the expenses of business as repairs, rent,

maintenance, insurance and lighting, etc.
Business Accounting
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64
(b) English Approach: Under this approach accounts are
Notes
classified into following three categories:
___________________
i. Personal Account: Here those accounts are included which
n/S
___________________
are relating to persons, firms, companies, representatives
___________________ and organizations as Shiam Lal & Company's Account,
___________________ etc.
tio
___________________ ii. Real Account: Accounts which are relating to the assets
and properties of the business are counted under this
___________________
heading. Assets can be real or intangible. Real assets are
uc
___________________
as land & buildings, plant & machinery, cash and stock,
___________________ etc. While intangible assets may be as goodwill, patents
___________________ and trademarks, etc.
rod
___________________ iii. Nominal Account: Accounts which are relating to the
revenues, incomes, expenses and losses of the business are
called nominal accounts. For example, rent, commission,
interest, dividend, etc.
ep
Check Your Progress
rR
Fill in the blanks:

1. …………………… is described as origin for the creation
of information and the continuous utility of information.
t fo
2. Under …………………… heading those transactions are

kept which are relating to the business assets as plant,
machinery, land, building, etc.
No
Summary
The recording of business transactions in the books of account is
based on a fundamental equation called Accounting Equation. This
equation expresses the equality of assets on the one side and other
S,
side equity
Expenses and Revenue also affect the accounting equation. Their
PE
effect is always on the capital account. The accounting equation is

also the basis for the most basic of accounting reports, the aptly
named Balance Sheet. A balance sheet reports what a business
U
owns (assets), what it owes (liabilities) and what remains for the
owners (equity) as of a certain date. Accounting is described as
(c)
origin for the creation of information and the continuous utility of

information.
ale
Lesson End Activity 65
Notes
“Accounting equation remains intact under all circumstances”
___________________
Justify the statement with the help of example.
n/S
___________________
Keywords ___________________
___________________
Accounting Equation: The recording of business transactions in
tio
the books of account is based on a fundamental equation called ___________________
Accounting Equation. ___________________
Asset: Any physical thing or right owned that has money value is
uc
___________________
an asset.
___________________
Liability: It means the amount which the firm owes to outsiders
rod
___________________
that is, accepting the proprietors.
___________________
Stock: The goods purchased are for selling, if the goods are not
sold out fully, a part of the total goods purchased is kept with the
trader unlit it is sold out, it is said to be a stock.
ep
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1. “Accounting is described as origin for the creation of

information and the continuous utility of information.”
Discuss.
t fo
2. Why accounting equation does remains in balance?

3. “Accounting is the process of recording, classifying and
summarizing of accounting transactions.” Discuss.
No
4. Prepare accounting equation from the following Transactions:

Hemant started business with cash `3, 00,000
Purchased goods for cash `80,000

S,
Sold goods [costing `30,000] for cash `45,000
Purchased goods from Monika `70,000

PE
Salary paid `7,000
Commission received `5,000

U
Paid Cash to Monika in full settlement `69,000
Goods sold to Rahul {Costing `20,000} for cash `25,000

(c)
Business Accounting
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66
5. Prepare accounting equation on the basis of the following:
Notes
___________________
i. Anup started business with cash `250,000
n/S
___________________ ii. Purchased goods for cash `35000
___________________ iii. Purchased office furniture for cash `12000
___________________ iv. Paid rent `7000
tio
___________________ v. Sold goods (costing `30000) for `50000 for cash
___________________ 6. Show the accounting equation on the basis of the following
transactions
uc
___________________
___________________ i. Manu started business

___________________ Cash `600000
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___________________ Goods `100000
ii. Purchased office machine for cash `90000

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iii. Sold goods (costing `60000) for credit to Asha
iv. Purchased building for cash `130000

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v. Cash received from Ashu ` 80000
vi. Purchased goods on credit to M/S Ashok Trader for cash

` 70000
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vii. Salaries paid ` 000
viii. Insurance prepaid `10000
ix. Cash paid to M/s Ashok traders in full settlement `68000

No
Further Readings
Books
S,

Delhi.
PE

Chand, New Delhi.
U

(c)
New Delhi.
ale
Web Readings 67
Notes
http://www.dummies.com/how-to/content/the-eight-steps-of-the-
accounting-cycle.html ___________________
n/S
http://bizfinance.about.com/od/accountingandcash/tp/Accounting_C ___________________
ycle.htm ___________________
http://teachersites.schoolworld.com/webpages/LChytra/files/summa ___________________
tio
ry%20sheet%20of%20text1.pdf
___________________
http://www.life123.com/career-money/small-business/cpa/basic- ___________________
accounting-equation.shtml
uc
___________________
___________________
rod
___________________
ep ___________________
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No
S,
U PE
(c)
Business Accounting
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68
Notes
___________________
n/S
___________________
___________________
___________________
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___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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No
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(c)
UNIT 5: Case Study
ale
Unit 5
69
Notes
Case Study
___________________
n/S
___________________
___________________
Objectives
___________________
After analyzing this case, the student will have an appreciation of the
tio
concept of topics studied in this Block. ___________________
___________________
uc
___________________
Case Study:Rule versus Principle
___________________
Students of accounting would be well aware of the long discussed
differences between rule-based accounting and principle-based
rod
___________________
accounting. Both have their protagonists. While the US GAAP is
___________________
rule-based, the International Accounting Standards (IAS), both as
IAS and IFRS, are principle-based.
The debate on which is better will be put to rest when the US

ep
GAAP converges with IFRS eventually and becomes principle-
based. Being principle-based means that broad principles are laid
out by the standard-fixing body and the interpretation is left to
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the users of these standards.
The problem (and also the benefit) with principle-based

accounting is that most of the times, in a situation which requires
t fo
a finding, one would have to exercise a great deal of judgment

based on substance as opposed to a readymade solution being
available for a particular issue prescribed in the rule-based
accounting.
No
While the US accounting is considered to be rule-based, one can

find echoes of principle-based accounting also in it. In the widely
publicised 1969 case of Continental Vending where the auditors
were questioned for lack of professional standards, the court gave
a direction to the jury to look at the facts and the substance of the
S,
case rather than rules of accountancy and mere adherence to

GAAP.
PE
The court held that in the audit report the statement “fairly
presented … in accordance with generally accepted accounting
principles” is two statements rather than one, i.e., “fairly
presented” are principle-based and the other “in accordance with
U
generally accepted accounting principles” is rule-based.

Contd…
(c)
Business Accounting
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70 Problems for Auditors
Notes
The preparation of financial statements in accordance with the
___________________ GAAP in a rule-based environment, however, presents problems
to the auditors. If an auditor were to confront the management
n/S
___________________
over a certain treatment of a transaction, the management is
___________________ likely to ask the auditor “show me where it says I can't do that”.
___________________ In other words, in a rule-based environment, the onus is on the
tio
___________________ auditor to demonstrate clearly that the particular treatment is
not permitted and hence closes the avenues for the auditor to
___________________
develop further arguments that would be available in a principle-
based accounting environment (Principles-based Accounting, by
uc
___________________
Ronald M. Mano, Matthew Mouritsen and Ryan Pace, published
___________________
in the CPA Journal, February 2006).
___________________
rod
Since accounting standards followed in India have their origin in
___________________ the IAS, the Indian accounting standards are principle-based.
However, there are exceptions to the rule. One prime example is
the Income Recognition and Asset Classification (IRAC) norms
prescribed by the Reserve Bank of India for provisioning for non-
ep
performing assets applicable to banks.
Thus, if any asset is non-performing, based on certain prescribed

rR
criteria, a provision is created for the potential loan loss

irrespective of the security available with the bank.
Subjectivity Issue
t fo
Principle-based accounting has its own issues too. Ian Wright,

Director of Corporate Reporting at the Financial Reporting
Council of UK, writing in accountancy magazine (October 2008),
talks about the subjectivity that is present in the IFRS.
No
The IFRS is full of words and phrases that are open to

interpretation. The accompanying table has a selection of the
probabilities in IFRS literature that a user is expected to
interpret in the context of understanding what an accounting
standard requires.
S,
Ian Wright also identifies other issues that are potentially

problematic.
PE
The IFRS literature contains an increasing range of technical

terms which don't translate well into languages other than
English. Also, the standards were written in different eras and
U
sometimes by individual national standard-setters due to which

the usage of the English language differs resulting in them being
structured in disparate ways.
(c)
Contd…
UNIT 5: Case Study
ale
71
One can therefore see the potential hazards in interpreting a
principle-based accounting standard that contains highly Notes
subjective phraseology. ___________________
n/S
In this context, one can expect problems of interpretation in India ___________________
also. For instance, the word “shall” (a key word in accounting
___________________
standards) is used in a manner that is completely different from
its usage in countries where English is the mother tongue. Any ___________________
tio
user of IFRS would therefore need to be alive to these issues when
___________________
interpreting IFRS.
___________________
Question
uc
___________________
Read the case carefully and write down the case facts. Also give a
brief overview of debate between GAAP converges with IFRS. ___________________
rod
Source: www.thehindubusinessline.com ___________________
ep ___________________
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No
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(c)
Business Accounting
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72
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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No
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(c)
UNIT 6: Preparation of Journal, Ledger and Balancing
ale
73
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
rod
___________________
ep ___________________
BLOCK-II
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No
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(c)
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74
Notes
UNIT 6: PREPARATION OF JOURNAL, LEDGER
___________________ UNIT 8: TRIAL BALANCE
AND BALANCING
Introduction
n/S
z
z ___________________
Introduction
z Meaning of Trial Balance
z Books of Original Record
___________________
z Methods of Preparation of Trial Balance
z Ledger
___________________
z Types of Errors
tio
z Balancing
___________________
UNIT 9: FINANCIAL STATEMENTS
___________________
UNIT 7: SUBSIDIARY BOOKS
z Introduction
uc
z ___________________
Introduction z Meaning of Financial Statements
z Meaning of Subsidiary Books
___________________
z Final Accounts with Adjustments
z Cash Book
___________________ Balance Sheet
rod
z
z Other Subsidiary Books
___________________
UNIT 10: CASE STUDY
ep
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No
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(c)
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Unit 6
75
Notes
Activity
What is the rule for posting the
Preparation of Journal, Ledger
___________________
debit account from the journal
n/S
into___________________
the ledger account?
and Balancing ___________________
___________________
tio
Objectives ___________________
___________________
topics:
uc
___________________
\ Books of Original Record
\ Ledger ___________________
\ Balancing
rod
___________________
___________________
Introduction
Journal is a book of accounts in which all day to day business
ep
transactions are recorded in a chronological order i.e. in the order
of their occurrence. Transactions when recorded in a Journal are
known as entries. It is the book in which transactions are recorded
rR
for the first time. Journal is also known as ‘Book of Original

Record’ or ‘Book of Primary Entry’.
The accounting process does not stop here. The transactions are
t fo
recorded in number of books in chronological order. Such recording

of business transactions serves little purpose of accounting. Items
of same title in different books of accounts need to be brought at
one place under one head called an account. There are numerous
No
account titles of items/ persons or accounts. All the accounts, if

brought in one account book, will be more informative and useful.
The account book so maintained is called Ledger.
S,
Books of Original Record

The accounting process includes the identification of financial
PE
transactions, recording of them and summarizing. Thus, after

identifying the financial nature items the first step of accounting process
is the recording the transactions. The books in which these transactions
U
are recorded first time are called the books of original entries or records.
These books of original records are divided into following three:
(c)
(a) Memorandum Book: It is also called the waste book. When a

transaction takes place in the business it is first roughly
Business Accounting
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76 written in the memorandum book chronologically for the
Notes memory only. Then after some time, these transactions are
___________________ recorded in the journal and subsidiary book. After recording
these transactions, this book is destroyed. Therefore, it is
n/S
___________________
called waste book.
___________________
(b) Journal: 'Journal' word is derived from French word 'Jour'
___________________
which means a day book. Journal is a primary book of original
tio
___________________ entries for accounting data. In the Journal the business
___________________ transactions are recorded chronologically that is called
Journalising. Thus the accounting data are recorded first time
uc
___________________
in this book. In the words of Carter, "A Journal, as originally
___________________
used, is a book of primary entry in which transactions are
___________________ copied in the order of date from a memorandum or waste book.
rod
___________________ The entries are then copied and classified into debts and
credits, so far to facilitate their being correctly posted
afterwards in the ledger". The proforma of a Journal is given
here under:
ep
Pro forma of a Journal
rR
t fo
As per the above pro forma of Journal the first column is kept for
date means date of transaction is recorded, second wide column for
particulars of business transactions in which the related accounts
No
are showed along with their narrations. Third column is for ledger
folio number where the journal entry is posted in ledger. The
fourth and fifth columns are kept for debit amount and credit
amount.
S,
At the time of Journalising of the transactions, when an account is

debited it is denoted by 'Dr.' and crediting of an account by 'To'.
PE
When a transaction is recorded first of all its two aspects

(accounts) are identified, those may of the same group (same type
of account) or different groups (different types of accounts). Then
the rules of debiting and crediting are applied. On the completion
U
of a page of the Journal it is totalled and the balance is carried

forward to the next page.
(c)
ale
77
Illustration 1 (Journal)
Notes
Journalise the following transactions in the books of Mr. Ram
___________________
Krishna:
n/S
___________________
2012 `
___________________
July 1 Mr. Ram Krishna Started business with cash 2, 00,000
July 4 Goods purchased in cash 20,000 ___________________
tio
July 5 He deposited in Bank 40,000
___________________
July 7 Goods sold 15,000
___________________
July 10 Goods purchased from Mr. Kamlesh on credit 25,000
uc
July 11 Furniture purchased 18,000 ___________________
July 12 Wages paid 4,000
___________________
July 20 Interest received 500
rod
July 25 Cash paid to Mr. Kamlesh 25,000 ___________________
July 30 Additional capital brought by Mr. Ram Krishna 50,000 ___________________
Solution
Journal of Mr. Ram Krishna

ep
Instruction: convert 2007 in to 2012
Date Particulars L.F. Amount Dr. Amount Cr.
` `
rR
2007
July 1 Cash Account Dr. 2,00,000
To Capital Account 2,00,000
(Being start of business by Mr. Ram Krishna)
July 4 Purchase Account Dr. 20,000
t fo
To Cash Account 20,000

(Being purchase of goods in cash)
July 5 Bank Account Dr. 40,000
(Being deposit of cash into Bank)
July 7 Cash Account Dr. 15,000
To Sales Account 15,000
No
(Being sale of goods in cash)

July 10 Purchase Account Dr. 25,000
To Mr. Kamlesh 25,000
(Being purchase on credit from Mr. Kamlesh)
July 11 Furniture Account Dr. 18,000

S,

(Being purchase of furniture)
July 12 Wage Account Dr. 8,000
PE
(Being payment of wages in cash)

July 20 Cash Account Dr. 500
To Interest Account 500
(Being receipt of interest)
July 25 Mr. Kamlesh Dr. 25,000
U
(Being payment of credit purchases)

July 30 Cash Account Dr. 50,000
To Capital Account 50,000
(c)
(Being introduction of additional

capital in business
Total 3,97,500 3,97,500
Business Accounting
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78
For the purpose of Journalising of the transactions, the goods are
Notes
classified into purchases, sales, purchase returns and sales
___________________
returns.
n/S
___________________
When some amount is brought into to start the business it is called
___________________ Capital. Therefore, such an amount is transferred to Capital
___________________ Account.
tio
___________________
Compound Journal Entry
___________________
When two or more transactions take place in the business relating
to a same account on the same date, in the place of passing many
uc
___________________
___________________ entries for the same account a single journal entry is pass which is
called a compound journal entry. Compound entry can be of
___________________
rod
following three types:
___________________
(a) Single debit account and more than one credit account
(b) Single credit account and more than one debit accounts
ep
(c) More than one debit account and more than one credit account
Opening Journal Entry

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The closing balances of accounts of one year are transferred to the

next year. In the next year these balances become the opening
balances. After recording the opening balances, the transactions of
the year are recorded. To record the opening balances a Journal
t fo
entry is passed which is called opening entry. Suppose in a

business there are closing balances of cash of `10,000, plant
`90,000 and capital of `1, 00,000, and then opening Journal entry
No
will be as follows:
Assets Account Dr. 90,000
Cash Account Dr. 10,000
To Capital Account 1, 00,000

S,
Subsidiary Books of Original Records

PE
If all the transactions of the business are recorded in Journal it

will be too bulky to manage. Therefore, now-a-days original records
are maintained in the subsidiary books. These subsidiary books are
also called sub-division of Journal. They are classified as follows:
U
(a) Cash Book or Journal: When it is the part of ledger it is

called cash account. In the cash book all the cash transactions
(c)
are directly recorded. As per Carter, "Cash book is a book of

ale
original entry, the object of which is to record all receipts and 79
payments of money". In the cash book all the cash receipts are Notes
recorded in the left hand sides and all the cash payments are ___________________
recorded in the right hand side. And the difference of these two
n/S
___________________
sides is called the closing balance of cash. Generally, four types
of cash book are prepared. These are: ___________________
i. Simple Cash Book or One Column Cash Book ___________________
tio
___________________
ii. Cash and Discount Cash Book or Double Column Cash
Book ___________________
uc
iii. Cash, Bank and Discount Cash Book or Three Column ___________________
Cash Book ___________________
iv. Petty Cash Book
rod
___________________
The pro forma of the simple cash book is given below: ___________________
Pro forma of a Simple Cash Book

ep
Date Particulars L.F. Amount Date Particulars L.F. Amount
` `
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(b) Special Journal: This journal is the part of general journal.

Under this division of Journal, the following Journals or books
t fo
are included:
i. Purchase Book is also known as Bought Book or Purchase-
Day Book. All the credit purchase of goods is recorded in
No
this book. In this book the data wise transactions of

purchase are recorded. This book has six columns. In the
first column the date of transaction is recorded, in second
column invoice number is mentioned, in third column
details of the transactions are kept, in the fourth column
S,
ledger folio number is given, and the last two columns are
left for amount in the transaction. The proforma of the
PE
purchase day book is given below:
Pro forma of Purchase Book

Date Invoice Particulars L.F. Details Amount
U
No. ` `
(c)
Business Accounting
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80
ii. Sales Book is known by the different names as Sales-Day-
Notes
Book, or Sales Journal. In this book all the credit sales of
___________________
goods are recorded. At the time of sale of goods an invoice
n/S
___________________ is prepared. On the basis of this invoice, all the credit
___________________ sales are recorded in this book. The sale of others except
goods is recorded in the Journal Proper. Its columns are
___________________
similar to that of the Purchase book. It is given below:
tio
___________________
Pro forma of Sales Book
___________________
Date Invoice Particulars L.F. Details Amount
No. ` `
uc
___________________
___________________
___________________
rod
___________________
iii. Purchase Return Book is also called Purchase Return
Journal or Return Outward Book. In this book those goods
are entered which are returned to the suppliers. If the
ep
goods were purchased in cash and returned, then such
goods are not entered in this book. Entry for such goods is
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done in these books which were purchased on credit.

When the goods are returned to the supplier, along with
the goods a note is also sent to the supplier which carries
all the details of the goods returned, such a note is called
t fo
Debit note. It is prepared in duplicate copy. One copy is

sent to the supplier and one copy is kept safe for future
reference. This note in the hands of seller is called credit
note. In other words purchaser will dispatch a debit note
No
to the seller and seller will send a credit note to

purchaser.
S,
Pro forma of Purchase Return Book

PE
Date Debit Note Particulars L.F. Details Amount

No. ` `
U
iv. Sales Return Book is known as Sales Return Journal or

Return Inwards Book. In the case of goods sold on credit
(c)
some goods are being returned by the customers, such

goods are recorded in this book. Here same columns are
ale
maintained as in the Purchase Return Book except Debit 81
Note No. In the place of debit note no., credit note no. is Notes
given in this book. ___________________
n/S
When some goods are returned by the customer, a note is ___________________
provided to them which is called credit note. Credit note
___________________
means that his account has been credited with the amount
of goods return. This credit note works as a debit note for ___________________
tio
the party receiving back the goods. The customers debits ___________________
the account of that party from whom it has been received. ___________________
Thus
uc
___________________
___________________
rod
___________________
Pro forma of Sales Return Book
___________________
Date Credit Particulars L.F. Details Amount
Note No. ` `
ep
v. Bills Receivable Book is also called the Bills Receivable
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Journal. When a company receives various bills from its

debtors, details of all these bills are date wise recorded in
the Bills Receivable Book. The proforma of this book is
given below:
t fo
Pro forma of Bills Receivable Book

S.No. Date From whom Date of Period Due Date L.F. Amount
received Bill `
No
vi. Bills Payable Book is also known as Bills Payable Journal.

When the various bills are accepted for its various
creditors, details of such bills are recorded in this book in
S,
chronological order. The proforma of this book is given

below:
PE
Pro forma of Bills Payable Book

S.No. Date From whom given Date of Period Due Date L.F. Amount
Bill `
U
(c)
Business Accounting
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82
c. Journal Proper: According to the rules of accounting, all the
Notes
business transactions are recorded into Journal first, and then
___________________
they are posted in Ledger. If all the credit and cash
n/S
___________________ transactions are recorded into Journal, there will be a large
___________________ number of transactions and it will become too bulky.
Therefore, Journal is sub-divided into cash and credit
___________________
transactions. Cash transactions are directly recorded into cash
tio
___________________ book and credit sales and credit purchase are directly recorded
___________________ in the sales and purchase books and the remaining
transactions are recorded into Journal Proper. These
uc
___________________
transactions may be relating to:
___________________
i. Opening Entry
___________________
rod
ii. Closing Entry
___________________
iii. Transferring
iv. Rectification, and
ep
v. Adjustment
d. Other Subsidiary Books: As per the nature of the business,
rR
the entrepreneurs may maintain some other books also. These

may be:
i. Consignment Outwards Book
t fo
ii. Sale and Return Book

iii. Cash Collection Book
iv. Cash Sales Book.
No
Journalising can be generally categorized into following various

categories:
1. Taking place within the same natured accounts
S,
2. Taking part in between accounts of two different in categories.

Illustration 2 (Subsidiary Books)
PE
Record the following transactions into various Subsidiary Books

and Journal Proper of Mr. Shiv Kumar:
2012
U
January 1 Cash in hand `31,400, Cash at Bank ` 50,800 and Capital Account
`82,200.
(c)
January 2 Bought goods for cash `8,200.

ale
83
January 5 Purchased goods from Lalit Mohan & Co. for `11,600 less 10% trade
discount. Notes
January 7 Sold goods to Shobhit & Co. for `17,800 less 20% trade discount. ___________________
n/S
January 9 Withdrew `1,000 from bank for private use.
___________________
January 12 Sold goods to Karim for `12,800.
___________________
January 15 `10,000 paid to Lalit Mohan in full settlement of their claim.
January 18 Goods worth `800 returned by Karim. ___________________
tio
January 20 Received `8,000 from Karim ___________________
January 21 Purchased goods from Krishna & Co. for `17,400. ___________________
January 23 `12,000 paid to Krishna & Co. by cheque, discount allowed `600.
uc
___________________
January 24 Purchased furniture for `1,600 from Sardar Furniture House on
credit. ___________________
January 26 Paid into bank `4,400.
rod
___________________
January 28 Karim declared insolvent, a first and final dividend of 50 paise in a
rupee is received from him. ___________________
January 29 Goods worth `1,200 returned to Krishna & Co.
January 31 Interest on capital provided `822.
ep
January 31 Goods worth `800 taken by Mr. Shiv Kumar for his personal use.
January 31 Paid salaries to staff `3,600.
January 31 Paid into bank `40,000.
rR
January 31 Bought 200 shares in Dehradun Chemicals Ltd. at ` 11, per share
Brokerage paid `50.
January 31 Received `11,800 from Shobhit & Co. discount allowed ` 200.
Solution
t fo
Journal Proper
Instruction: Change 2008 to 2012
Date Particulars L.F. Amount Amount
(Dr.) (Cr.)
No
2008 ` `
January 01 Cash Account Dr. 31,400
Bank Account Dr. 50,800
To Capital Account 82,200
(Entry made for opening balances)
January 24 Furniture Account Dr. 1,600
To Sardar Furniture House 1,600
S,
(Being purchase of furniture on credit from

Sardar Furniture House)
January 28 Bad Debts Account Dr. 2,000

To Karim 2,000
(On the insolvency of Karim 50 paise in a
PE
rupee received and balance treated as bad

debts)
January 31 Interest on Capital Account Dr. 822
To Capital Account 822
(Interest on capital charged)
January 31 Drawing Account Dr. 800
U
To purchase Account 800

(Proprietor took goods for personal use)
January 31 Capital Account Dr. 1,800
To Drawing Account 1,800
(c)
(Balance of drawing account transferred to

Capital account)
Total 89,222 89,222

Business Accounting
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84 Sales Book
Notes Date Particulars L.F. Details Amount
` `
___________________
n/S
___________________ 2008
Jan. 7 Shobhit & Co.: Sale of goods 17,800
___________________ (–) 20% discount 3,560 14,240
Jan. 12 Karim: Sale of goods 12,800
___________________
Jan. 31 Total: Sale – Credit balance 27,040
tio
___________________
Purchase Book
___________________
Date Particulars L.F. Details Amount
` `
uc
___________________
___________________
2008
___________________ Jan. 5 Lalit Mohan & Co.: Goods purchased 11,600
rod
(-) 10% Discount 1,160 10,440
___________________ Jan. 21 Krishna & Co. 17,400
Jan. 31 Total: Purchases debited 27,840
Sales Return Book

ep
` `
2008
Jan. 18 Karim: Sales return 800
rR
Jan. 31 Sales Return debited 800
Purchase Return Book

` `
t fo
2008
Jan. 29 Krishna & Co.: Returns 1,200
Jan. 31 Purchase Returns Credited 1,200
Cash Book
No
Date Particulars L.F. Discount Cash Bank Date Particulars L.F. Discount Cash Bank
` ` ` ` ` `
2008 2008
Jan 1 To balance - 31,400 50,800 Jan 2 By Purchases A/c - 8,200 -
b/d - Jan 9 By Drawings A/c - - 1,000
Jan 20 To Karim - 8,000 Jan 15 By Lalit Mohan 440 10,000 -
S,
Jan 26 To cash A/c c - - 4,400 Jan 23 By Krishna & Co. 600 - 12,000
Jan 28 To Karim - 2,000 - Jan 26 By Bank A/c c 4,400
Jan 31 To sales A/c - 43,600 Jan 31 By Advertisement A/c - - 1,000
Jan 31 To cash c - - 40,000 Jan 31 By Salaries A/c - 3,600 -
Jan 31 To Shobhit & 200 11,800 Jan 31 By Bank A/c - 40,000
Co. Jan 31 By Investment A/c c - 2,250 -
PE
Jan 31 By Balance C/d - 28,350 81,200

200 96,800 95,200 1,040 96,800 95,200
Feb 1 To balance 28,350 81,200
b/d
The points to be observed at the moment of journalizing:

U
1. The nature of the accounts to be identified

2. The accounts to be correlated to the golden rules
(c)
3. The entry to be passed through proper debiting and crediting

of the accounts respectively.
ale
85
Check Your Progress
Notes
Activity
Fill in the blanks:
What are the key steps in
___________________
1. Journalising is the process of entering transactions in
n/S
balancing a ledger a/c?
___________________
.....................
___________________
2. Another name for Journal is .....................
___________________
3. Transactions, when recorded in Journal, are known as
tio
___________________
.....................
___________________
4. The explanation of a Journal entry is known as
uc
..................... ___________________
___________________
5. In a Journal entry preposition ..................... is used
before the name of the account to be credited.
rod
___________________
6. Journal is a ………………… of original entries for ___________________

accounting data.
7. The journal is known as the ………………… .
ep
8. The process of transferring the entries from Journal to
Ledger accounts is called ………………
rR
Ledger
Journal of a business is very useful but it does not reply the
t fo
different queries as how much amount is due from debtors, how

much is to be paid to creditors and what is the balance of a
particular account etc. For the reply of all these queries the ledger
is prepared from the Journal entries. Ledger is the set of accounts
No
in which all types of account (personal, real or nominal) are kept.

There can be two forms of ledger:
(a) Bound Ledger
(b) Loose Leaf Ledger
S,
Posting
PE
The process of transferring the entries from Journal to Ledger

accounts is called posting. In other words account wise selection of
debit or credit items and recording them into the relevant side of
the relevant account is called posting. The process of posting is
U
done after a period as week, fortnight or a month. For example, if

rent as an expense is shown in the debit in Journal, this will be
(c)
posted in the debit side of the Rent (Expenses) A/c in the Journal.
The proforma of a Ledger account is given below:
Business Accounting
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86 Proforma of An Account
Notes Name of Account………
___________________ Date Particulars L.F. Amount Date Particular L.F. Amount

(Dr.) ` (Cr.) `
n/S
___________________
___________________
___________________
In the above proforma of an account, there are two sides of an
tio
___________________
account. Left hand side is debit side and right hand side is credit
___________________ side. In both the sides, the first column is for date and second
column for details, third column for the Journal folio number and
uc
___________________
in the last column the amount of the transaction is recorded.
___________________
___________________ Rules of Posting in Ledger Account
rod
___________________ At the time of posting of transactions from Journal to ledger the
following points/rules should be kept in mind:
1. In the debit side of a ledger account, the word 'To' be used
ep
while in the credit side word 'By' is used.
2. All those accounts are opened in the Ledger which is given in
the Journal.
rR
3. All the debit items of an account given in Journal are posted in

the debit side of the respective account. And all the credit
items of an account given in Journal are posted in the credit
t fo
side of the respective account in ledger.

4. The name of the account, in which posting is being made, is
not written. But the posting is done by the name of other
No
account given in the opposite side of that entry in the Journal.

5. At the time of posting if the page is full and account is not
complete, its total is carried to the next page and then
remaining posting is done.
S,
Check Your Progress

Fill in the blanks:
PE
1. Ledger contains various ...................... in it.

2. The process of transfer of entries from Journal and
U
special purpose books to ledger is called......................

3. Ledger is also called......................
(c)
ale
Balancing 87
Notes
Activity
There can be several transactions relating to a particular account
Identify nature
___________________of the
in the different places in the Journal. Such transactions are
n/S
transactions:
collected and recorded in the concerned account. At the end of the ___________________
Ramchander has purchased
accounting period, the businessman becomes interested to know goods on credit from M/s
___________________
the position of these accounts. The position of an account is Royals Aventis for `15,000.
determined by calculating the net balance of the account for which The___________________
portions of the goods
tio
were___________________
found to be damaged
debit and credit sides of the account are totalled separately. If total which worth of `5,000.
of debit side is greater than the total of credit side, difference is ___________________
Ramchander immediately
written in the credit side of the account and that is carried to next returned the damaged goods
uc
___________________
to Royals. Identify the various
year. And if the total of credit side is greater than the total of debit
ypes___________________
of accounts involved in
side, difference is written in debit side and carried to next year. the above illustrated
Thus totals of both the sides become equal and account is closed.
rod
___________________
transactions. Pass the journal
entries with regards to the
___________________
Balancing of Different types of Accounts nature of accounts involved.
Assets: All asset accounts are balanced. These accounts always

ep
have a debit balance.
Liabilities: All Liability accounts are balanced. All these accounts
have a credit balance.
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Capital: This account is always balanced and usually has a credit

balance.
Expense and Revenues: These Accounts are not balanced but are
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simply totalled up. The debit total of Expense/Loss will show the
expense/Loss. In the same manner, credit total of Revenue/
Income will show increase in income. At the time of preparing the
No
Trial Balance, the totals of these are taken to the Trial Balance.
Illustration 3 (Journal and Posting in Ledger)
Record the following transactions in the Journal and post them
into Ledger of Mr. Aditya Raj:
S,
2012 `
March 1 Purchase of Goods from Ramautar 3,20,000
PE
March 10 Paid Rent for the month 2,000

March 11 Purchase of Plant 1,00,000
March 12 Paid Salaries 12,000
March 15 Paid Ramautar 1,00,000
U
March 20 Sold Goods to Shyam 20,000

March 25 Received from Shyam 30,000
(c)
March 31 Reserved Cash from Cash Sales 2,50,000

March 31 Wages Paid 5,000
Business Accounting
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88
Solution:
Notes
___________________
Change all 2008 to 2012
n/S
___________________ Journal of Mr. Aditya Raj
Date Particulars L.F. Amount (Dr.) Amount (Cr.)
___________________ ` `
___________________
2008
tio
___________________ March 1 Purchase Account Dr. 3,20,000
To Ramautar 3,20,000
___________________ (Being purchase of goods on credit)
March 10 Rent Account Dr. 2,000
uc
___________________
___________________ (Being payment of rent)
March 11 Plant Account Dr. 1,00,000
___________________
rod
To Cash Account 1,00,000
(Being purchase of plant)
___________________
March 12 Salaries Account Dr. 12,000
(Being payment of salaries)
ep
March 15 Ramautar Dr. 1,00,000
To Cash Account 1,00,000
(Being payment to Ramautar)
March 20 Shyam Dr. 20,000
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To Sales Account 20,000

(Being goods sold on credit)
March 25 Cash Account Dr. 30,000
To Shyam 30,000
t fo
(Being receipts of cash)

March 31 Cash Account Dr. 2,50,000
To Sales Account 2,50,000
(Being goods sold in cash)
March 31 Wages Account Dr. 5,000
No

(Being payment of wages)
Total 8,39,000 8,39,000
Ledger
S,
Cash Account
Date Particulars L.F. Debit Date Particulars L.F. Credit
` `
PE
2008 2008
March 25 To Shyam 30,000 March 10 By Rent A/c 2,000
March 31 To Sales A/c 2,50,000 March 11 By Plant A/c 1,00,000
March 12 By Salaries A/c 12,000
March 15 By Ramautar 1,00,000
U
March 31 By Wages 5,000

March 31 By Balance c/d 61,000
2,80,000 2,80,000
(c)
2008
April 1 To Balance b/d 61,000
ale
Purchase Account 89
2008 ` 2008 ` Notes
March 1 To Ramautar 3,20,000 March 31 By Balance c/d 3,20,000
3,20,000 3,20,000 ___________________
n/S
___________________
2008
April 1 To Balance b/d 3,20,000
___________________
Ramautar's Account ___________________
tio
2008 ` 2008 `
___________________
March 15 To Cash A/c 1,00, 000 March 1 By Purchase 3,20,000
March 31 To Balance c/d 2,20,000 A/c ___________________

3,20,000 3,20,000
uc
___________________
April 1
By Balance b/d 2,20,000
___________________
Rent Account
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___________________
2008 ` 2008 `
___________________
March 10 To Cash A/c 2,000 March 31 By Balance c/d 2,000
2,000 2,000
2008
ep
April 1 To Balance 2,000
b/d
Plant Account
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2008 ` 2008 `
March 11 To Cash A/c 1,00,000 March 31 By Balance c/d 1,00,000

1,00,000 1,00,000
2008
t fo
April 1 To Balance b/d 1,00,000
Salaries Account
2008 ` 2008 `
No

12,000 12,000
2008
S,
Shyam's Account
2008 ` 2008 `
PE
March 20 To Sales A/c 20,000 March 31 By Balance c/d 30,000
March 31 To Balance b/d 10,000

30,000 30,000
April 1 By Balance b/d 10,000

U
(c)
Business Accounting
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90 Sales Account
Notes ` `
2008 2008
March 1 To Balance b/d 2,70,000 March 20 By Shyam 20,000
___________________
March 31 By Cash A/c 2,50,000
n/S
___________________ 2,70,000 2,70,000
April 1 By Balance b/d 2,70,000

___________________
___________________ Wages Account
tio
2008 ` 2008 `
___________________
___________________ 5,000 5,000
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___________________
2008
___________________
___________________
Check Your Progress
rod
___________________
Fill in the blanks:
1. Ledger is a ...................... book of accounting system.
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2. Classification of transactions is being done only on the
basis of preparing the......................
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Summary
Journal is the first book of the original entries in which all the
business transactions of the financial nature are recorded, then
t fo
posted to ledger accounts. Subsidiary Books of Original Entries are

classified into - Cash Book, Special Journal, Journal Proper and
Others. Posting is the process of selecting of transactions from
Journal on the basis of accounts and writing them into ledger
No
accounts.
To test the arithmetical accuracy of the ledger accounts, the Trial
Balance is prepared. Trial Balance is the list of accounts taken
from ledger. Ledger is nothing but preliminary book of accounting
S,
transactions at which, each account is separately maintained

through the allotment of various pages for exclusive recording.
PE
Posting is the process of selecting of transactions from Journal on

the basis of accounts and writing them into ledger accounts.
U
Lesson End Activity

Visit this site http://college.cengage.com/accounting/mcquaig/
(c)
college _acc/8e/students/demo/ch03.pdfand provide a solution to the

G. Bell fitness center.
ale
Keywords 91
Notes
Process of Accounting: It includes the recording of transactions
___________________
into Journal, classifying into Ledger and summarizing into Trial
n/S
Balance and Final Accounts. ___________________
Double Entry System: Accounting which is based on the two ___________________
aspects of the transactions. ___________________
tio
Personal A/cs.: Accounts which are related to person, firms, ___________________
companies and representatives. ___________________
Real A/cs: All the assets accounts are included into it.
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___________________
Nominal A/cs.: Accounts of incomes, expenses and gains or losses. ___________________
Debit: Receiver in Personal Account, Coming Assets in Real
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___________________
Account and Expenses in Nominal Accounts. ___________________
Credit: Giver in Personal Account, Going assets in Real Accounts
and Incomes in Nominal Accounts.
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Journal: The primary book in which the transactions are recorded
first time.
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Ledger: It is the classification of accounts in which various

accounts are maintained.

t fo
1. What do you mean by Posting? Give the rules of posting.

2. State the relation between journalizing and ledger posting
with suitable examples.
No
3. Why is ledger known as the primary book or the principal -

book of accounts? Can profit of the business and its financial
position be known without maintaining ledger?
S,
4. Why is ledger prepared?

5. Enumerate the various types of ledgers which may be
PE
maintained by a business.
6. Mr. Kamal Nath was doing a business as a cloth merchant. On
1st July, 2012 his assets were : Furniture and Office
U
Equipment = `12,500, Stock `1,25,000 Cash in Hand `3,000,

Bank Balance `42,500, Amounts due from Brijesh `6,000,
(c)
Amount due from Girijesh `7,500. On the date he owed

`10,000 to Manish and `7,250 to Naresh. His transactions
Business Accounting
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92 during the month were as follows. You have to Journalise
Notes these transactions and from that information prepare his
___________________ Ledger.
2012 `
n/S
___________________
July 2 Sold cloth on credit to Xavier 2,500
___________________ July 3 Purchased cloth from Yogesh 10,000
July 4 Paid Rent by cheque 4,000
___________________
July 5 Purchase of cloth by cheque 10,000
tio
___________________ July 7 Cash sales 2,250
July 8 Received cheque from Brijesh 5,900
___________________ allowed him discount 100
July 9 Paid for stationery 250
uc
___________________
July 10 Drawn cash for private use 1,250
___________________ July 11 Purchased cloth on credit from Manish 12,500
July 12 Sent cheque to Manish (in full settlement for July
___________________
rod
1 transactions) 9,750
___________________ July 13 Sold cloth on credit to Girijesh 9,000
July 14 Paid telephone charges 400
July 15 Cash Sales 1,500
July 18 Paid for Advertisement 1,750
ep
July 19 Cash Purchases 3,000
July 30 Paid Salaries for July
4,000
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7. Prepare the account of X & Co. from the following:

2012 `
Feb 1 Balance due from X & Co. 1,000
Feb 3 Cash sales to X & Co. 700
t fo
Feb 4 Bought furniture from X & Co. 250

Feb 6 Murthy returned goods to us 200
Feb 9 X & Co. Purchased goods from us 1,200
Feb 10 Return of goods from X & Co. 150
No
Feb 20 X & Co. settled his account by cheque and received discount 20
8. How do we balance the following types of accounts?

(a) Assets
S,
(b) Expense
(c) Capital
PE
(d) Revenue
Further Readings
U
Books
(c)

Delhi.
ale
93
Notes
Chand, New Delhi.
___________________
n/S
Accounting”. Vikas Publishing Co. Pvt. Ltd., New Delhi. ___________________
___________________
New Delhi. ___________________
tio
___________________
Web Readings
___________________
http://www.kkhsou.in/main/EVidya2/BPP%20Commerce%20Rerint
uc
ed/journal.html ___________________
___________________
http://www.futureaccountant.com/accounting-process/study-
notes/ledger-preparation-balancing-illustration.php
rod
___________________
http://college.cengage.com/accounting/mcquaig/college_acc/8e/stude ___________________
nts/demo/ch03.pdf
http://www.theglobaltutors.com/financial-accounting/book-keeping-
ep
preparation-of-journals-ledger-accounts-and-trial-balance.aspx
rR
t fo
No
S,
U PE
(c)
Business Accounting
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94
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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t fo
No
S,
U PE
(c)
UNIT 7: Subsidiary Books
ale
Unit 7
95
Notes
Activity
Subsidiary Books
Make the proforma
___________________ of
n/S
purchase return book and
___________________
sales return book and explain
it.
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning of Subsidiary Books ___________________

\ Cash Book
uc
___________________
\ Other Subsidiary Books
___________________
rod
___________________
Introduction
___________________
Before we list various books into which the journal is sub-divided,
let us understand the’ basis for its subdivision. You may adopt any
ep
basis. But, the principle generally followed is that transactions of
the same nature are to be recorded at one place. For example, the
cash receipts and cash payments may be grouped into one category
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and recorded in a separate book. Similarly, all credit purchases of

goods may be grouped into one category, all credit sales of goods
into another category and recorded in separate books.
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Meaning of Subsidiary Books

In the past, traders use to keep record of the transaction in the
journal. But it was later found not convenient. If all the
No
transaction is recorded in the journal then the journal book

becomes more thick and difficult to handle it. In big business
houses, it becomes impossible to carry on the work of recording
business transaction. Therefore now a day’s large scale business
S,
firms like to keep record of transaction in subsidiary books instead

of journal. Subsidiary books are the book of original entry and it is
PE
also called primary records because the first entry of transaction is

made in subsidiary books. Subsidiary Books refers to books meant
for specific transactions of similar nature. Subsidiary Books are
also known as Special journals or day books. To overcome
U
shortcoming of the use of the journal only as a book of original

entry, the journal is subdivided into specific journals or subsidiary
(c)
books. In practice, the journal is sub-divided in such a way that a

separate book is used for each category of transactions which are
Business Accounting
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96 repetitive in nature and are sufficiently large in number. In any
Notes large business the following subsidiary books are generally used.
___________________
1. Cash Book: It is used for recording all receipts and payments
n/S
___________________ of cash, including cash purchases and cash sales of goods.
___________________ 2. Purchases Journal: It is used for recording credit purchases
___________________ of goods only.
tio
___________________ 3. Purchases Returns Journal: It is used for recording goods
returned to suppliers.
___________________
4. Sales Journal: It is used for recording credit sales of goods
uc
___________________
only.
___________________
5. Sales Returns Journal: It is used for recording goods
___________________
rod
returned by the customers.
___________________
6. Bills Receivable Journal: It is used for recording bills of
exchange and promissory notes received from the debtors.
ep
7. Bills Payable Journal: It is used for recording bills of
exchange and promissory notes accepted by the business in
favour of creditors.
rR
8. Journal Proper: This book is used for recording all such

transactions which are not covered by any of the above
mentioned special journals, for example, credit purchases of
t fo
fixed assets, opening entry, rectification entries, etc.

It must, however, be noted that there is no rigidity as to the
number of special journals. Depending on the necessity, the
number of journals may be increased or decreased.
No
9. Non-cash transaction: A Non-cash transaction is a

transaction in terms of credit and conditions of the enterprise.
The Non-cash transactions shall include the following transactions
of the enterprise, which do not involve any cash; they are as
S,
follows:
PE
1. Credit sales Book

2. Credit purchases Book
3. Credit Sales Return Book
U
4. Credit Purchases Return Book

(c)
5. Bills Payable Book- Outcome of Credit transaction, and

6. Bill Receivable Book - Outcome of Credit transaction
ale
Advantages of Subsidiary Books 97
Notes
The following are the advantages of having a number of subsidiary Activity
books: Prepare a Cash Book with
___________________
n/S
Bank column only:
i. Classification of transactions becomes automatic: As ___________________
Change 2009 to 2012
there is a separate book for each type of transactions, the ___________________
transactions of same nature are automatically brought at one
___________________
place. For example, all credit purchases of goods are recorded
tio
Subsidiary Books: Cash Book in the Purchases Book. ___________________
___________________
ii. Reference becomes easy: If any reference is required, it can
uc
be traced easily by referring to the appropriate subsidiary Hint:___________________
Total of Cash Book
book. You do not have to go through all the transactions ` 24,700, Closing Balance
___________________
` 16,400.
recorded in the journal.
rod
___________________
iii. Facilitates division of work: The division of journal into
___________________
various subsidiary books facilitates division of work among
many persons. This, in turn, facilitates prompt recording of
transactions and saves a lot of time.
ep
iv. More particulars: More details about the transactions can be
given-in subsidiary books than would be possible in one book.
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v. Responsibility can be fixed: The work of maintaining a

particular book can be entrusted to a particular person. He
will be responsible for keeping it up-to-date and in order.
t fo
vi. Facilitates checking: When the Trial Balance does not

agree, the location of errors will be relatively easy.
Check Your Progress

No
Fill in the blanks:

1. ……………….. is used for recording all receipts and
payments of cash, including cash purchases and cash
sales of goods.
S,
2. A ……………….. is a transaction in terms of credit and

conditions of the enterprise.
PE
Cash Book
U
Having outlined various subsidiary books, we shall now discuss the

most important subsidiary book called 'Cash Book'. Cash book is
(c)
the book of accounts where most of the transactions are generally

related with the receipts and payment of cash. It may be either
Business Accounting
ale
98 purchase of goods for cash or sale of goods for cash or it may be
Notes either payment of expenses or receipts of income. In any business
___________________ there would be numerous cash transactions which involve either
receipts or payments of cash. Cash sales, receipt of cash from
n/S
___________________
debtors, cash purchases, and payments to creditors, payment of
___________________
various expenses such as salaries, wages, rent, taxes, etc., are
___________________ some examples of transactions involving cash. AU these are
tio
___________________ recorded in cash book, receipts on one side and payments on the
other.
___________________
‘Every business unit, small or big, maintains a cash book. It
uc
___________________
enables the businessman to know and verify the amount of cash in
___________________
hand from time to time. As a matter of fact, cash book plays a dual
___________________ role. It is a book of prime entry and also serves the purpose of a
rod
___________________ Cash Account. It is designed in the form of a ledger account and
records cash receipts on the debit side and payments on credit side.
It is also balanced in the same way. Hence, when cash book is
maintained, there is no need to have a Cash Account in the ledger.
ep
Kinds of Cash Book
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There are different types of cash books maintained by the business.

They are:
1. Simple or Single Column Cash Book
t fo
2. Two or Double Column Cash Book

3. Three or Triple Column Cash Book
4. Petty Cash Book
No
We shall now consider them one by one and learn how they are
prepared and posted into ledger.
Single Column Cash Book

S,
Look at the pro forma of a Single Column Cash Book shown in

table 7.1 Doesn't it look like a ledger account? Yes, it does. In fact a
Single Column Cash Book is nothing but a Cash Account. It is used
PE
for recording all cash receipts and cash payments and serves the
purpose of Cash Account as well. It is called Single Column Cash
Book just because it has only one amount column on each side.
U
(c)
ale
Table 7.1: Single Column Cash Book 99
Dr. Cr. Notes
Date Particulars L.F. Amount Date Particulars L.F. Amount
(Receipts) (`) (Payments) (`) ___________________
n/S
___________________
___________________
___________________
tio
___________________
Note: ___________________
1. c/d stands for Carried Down whereas b/d stands for Brought
uc
___________________
Down. ___________________
2. One thing which is very important to remember while
rod
___________________
recording a transaction in the Cash Book is that no distinction
___________________
is adopted about capital or revenue nature of transactions i.e.,
all the transactions are recorded in the Cash Book.
ep
Recording in Single Column Cash Book
You know that Cash Account is a real account. According to rules,
rR
Cash Account is to be debited when cash is received and credited

when cash is paid. Hence, the debit side of the cash book is used for
recording all cash receipts and the credit side for all cash
payments. Let us now discuss how entries are made in this book.
t fo
As explained above, whenever cash is received, it is to be recorded

on the debit side. The date on which it is received is recorded in the
date column. The name of the account from which it is received is
mentioned in the particulars column. In the L.F. (Ledger Folio)
No
column the page number of the account in the ledger, where the
posting is made, is to be recorded at the time of posting. The
amount column is meant for recording the amount received.
Similarly, whenever cash is paid, it is recorded on the credit side.
S,
Here, in particulars column we write the name of the party to

whom payment is made, and complete the other columns in the
PE
same manner as on the debit side.
Posting the Single Column Cash Book

U
As said earlier, Cash Book also serves the purpose of a Cash

Account, so there is no need to open a Cash Account in the ledger.
(c)
When a cash transaction is recorded in the cash book, posting of

the cash aspect of the transaction in Cash Account stands fully
Business Accounting
ale
100 covered. What remains to be posted is the other aspect of the
Notes transaction. The posting of this aspect will complete the double
___________________ entry. The rules of posting therefore are:
n/S
___________________ i. for all transactions entered on the debit side of the cash book,
___________________ credit the concerned Subsidiary Books: C accounts in the
ledger individually by writing 'By Cash Account';
___________________
ii. for all transactions entered on the credit side, debit the
tio
___________________
concerned accounts in the ledger individually by writing T o
___________________ Cash Account'.
uc
___________________
Thus, the posting into the ledger accounts is completed. The
___________________ transactions entered on the debit side of the cash book are to be
___________________ posted on the credit side of the accounts in the ledger and vice
rod
versa.
___________________
Balancing of Single Column Cash Book

You have already learnt how to balance a ledger account. The cash
ep
book is balanced just like any other ledger account. The cash book
will always show a debit balance. This is because the cash
payments can never exceed the amount of cash available. For
rR
example, if you have ` 10 in your pocket, can you pay ` 15? You
cannot. So the total of the debit side in the cash book will always
be more than the total of the credit side his difference indicates the
t fo
cash in hand. It shall be entered on the credit side by writing 'By

Balance c/d' in particulars column and showing the amount in the
amount column. Now total the amount columns and you will find
that the two sides are equal.
No
After closing the cash book, the balance is shown on the debit side
by writing 'To Balance b/d'. It becomes the opening balance of cash
for the next period. Note that the cash book shall generally show a
debit balance and occasionally a nil balance. Look at Illustration 1.
S,
It shows the recording, posting and balancing of a Single Column

Cash Book.
PE
Example: Prepare a cash book from the following:

U
(c)
Contd…
ale
101
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
Solution:
uc
___________________
Cash Book
Dr. Cr. ___________________
Date Particulars L.F. ` Date Particulars L.F. `
rod
2010 2010 ___________________
June 1 To Balance b/d 7,850 June 2 By Purchases a/c 2,300
___________________
June 3 To Sales a/c 6,250 June 4 By Wages a/c 25
June 7 To Mohan’s a/c 2,260 June 6 By Ram’s a/c 1,220
June 14 To Sales a/c 2,670 June 8 By Creditor’s a/c 4,410
June 17 To Sales a/c 7,500 June 9 By Cartage 15
ep
June 18 To Amit a/c 2,500 June 17 By Bank a/c 5,700
June 18 By Bank a/c 2,500
June 24 By Rent a/c 500
June 29 By Electricity a/c 1,210
rR
June 30 By Purchases a/c 2,450

June 30 By Balance a/c 8,700
July 1 To Balance b/d 29,030 29,030
Notes:
t fo
1. Cheque issued on June 10 to a creditor is not recorded in the

Cash Book.
2. Goods purchased from Arun on June 11 is also not recorded as
No
per rule no credit transaction is recorded.

3. Similarly goods sold to Amit on credit are also not recorded.
4. Cheque received from a debtor is recorded treating it as cash
received as it is banked immediately.
S,
Two Column Cash Book

PE
When cash is received from a debtor, some discount may be

allowed to him. Similarly, when payment is made to a creditor,
some discount may be allowed by him. This is termed as Cash
Discount and it has to be recorded in the books of account. While
U
making compound journal entries for such transactions, you learnt

that cash and discount go together. You know that receipts from
(c)
debtors and payments to creditors are to be recorded in the cash

book. Now the question arises as to how to record the cash
Business Accounting
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102 discount. One method is to record the discount aspect separately in
Notes the journal. But this would be cumbersome, and the possibility of
___________________ failing to record can also happen. Hence accountants have
developed a practice of recording the discount aspect in tile cash
n/S
___________________
book itself. For this, an extra amount column is added on both
___________________
sides of the cash book. Look at the proforma shown in Table 7.2.
___________________ The discount glowed to debtors is recorded on the debit side and
tio
___________________ the discount received from creditors is recorded on the credit side.
Thus, now there are two amount columns on both sides of the cash
___________________
book, one for discount and the other for cash. It is called 'Two
Column Cash Book'.
uc
___________________
___________________
Discount is of two types:
___________________
1. Trade Discount: It is given for increasing the volume of sales
rod
___________________ and it is adjusted in the invoice, hence no entry is passed in
the books of the business, as it is always deducted from the
catalogue price. It is usually allowed by a whole seller to a
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retailer.
For example, if the printed price of a book is `200 and 10% is
offered as a trade discount, then it is `20/- and the net price
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would be `180/- i.e., (`200 – `20) accordingly entries are to be

made by the seller as well as the buyer for ` 180 in their books.
2. Cash Discount: It is given for prompt payment; hence, it is

t fo
recorded in the Cash Book. When discount is given for prompt

payment, it is a loss, hence, it is to be shown on the debit side
of the Cash Book whereas discount received is to expedite
payment to the outsiders, hence, it is shown on the credit side
No
of the Cash Book.

No balance of discount columns is taken; simply the total of both
the sides is given. The following is the form of Double Columns
Cash Book.
S,
Table 7.2: Two Column Cash Book

PE
Dr. Cr.
Date Receipts L.F. Discount Cash Date Payment L.F. Discount Cash
(`) (`) (`) (`)
U
(c)
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Recording in Two Column Cash Book 103
Notes
Recording of cash transactions in a Two Column Cash Book is
similar to Single Column Cash Book. As for cash discount, it is ___________________
n/S
entered on the debit side if allowed to the debtor and on the credit ___________________
side if received from the creditor.
___________________
For example, Roop owes `1000 to M/s. Goyal Traders of Muzaffar ___________________
Nagar. The firm offers a discount of 1% if payment is made within
tio
___________________
one month. Roop makes the payment within stipulated time. So he
is offered ` 10 as discount and he makes the payment of ` 990 to ___________________
the firm. The following entry is required to be passed in the
uc
___________________
Journal if no Cash Book is used in the books of M/s. Goyal Traders.
___________________
Dr. Cr.
rod
___________________
Date Particulars L.F. ` `
Cash A/c Dr. 990 ___________________
Discount A/c Dr. 10
To Roop 1000
(Cash received and discount allowed.)
ep
If Cash Book is used, then both the accounts namely cash and
discount are to be recorded on the debit side of the Cash Book.
rR
Similarly, if discount is received for making prompt payment then

such items are to be recorded on the credit side of the Cash Book,
i.e., amount received or paid in the Amount/Cash column and
discount allowed/received in the discount column.
t fo
Posting the Two Column Cash Book

The entries in the cash columns of Two Column Cash Book are
posted to the ledger accounts in the same way as we did in the case
No
of single column cash book. The entries in the discount columns

are also to be posted to the respective personal accounts. The
entries in discount allowed column will be posted to the credit side
of the respective personal accounts by writing 'By Discount
S,
Allowed A/c'. Similarly, the entries in the discount received column

will be posted to the debit side of the respective personal accounts
PE
by writing 'To Discount Received A/c'.

For example: Cash received from Devi Traders ` 490 and discount
allowed ` 10: This transaction will be entered in particulars
U
column on the debit side of the cash book by writing 'To Devi
Traders A/c'. An amount of ` 10 will be shown in discount allowed
(c)
column and ` 490 in cash column. Its posting into Devi Traders'
Account in the ledger will be made as follows:
Business Accounting
ale
104 Devi Traders Account
Notes
___________________
n/S
___________________
___________________ As for the transactions relating to cash, the double entry is

___________________ complete as soon as postings have been made to the respective
personal accounts. But it is not so for the discount aspect. The cash
tio
___________________
book does not serve the purpose of discount account. We have to
___________________ open 'Discount Allowed Account' and 'Discount Received Account'
in the ledger. The total of discount allowed columns on the debit
uc
___________________
side of the cash book is posted to the debit side of the 'Discount
___________________
Allowed Account' in the ledger by writing 'To Sundries'. Similarly,
___________________ the total of discount received column on the credit side of the cash
rod
___________________ book is posted to the credit side of the 'Discount Received Account'
in the ledger by writing 'By Sundries'. This will complete the
double entry in respect of discount allowed and discount received.
The postings in the two discount accounts are made only for the
ep
totals and not for the individual transactions. Thus we save time
and labour.
rR
Balancing the two Column Cash Book

In case of Two Column Cash Book, only the cash columns are
balanced. Procedure is similar to Single Column Cash Book. The
t fo
discount columns are not balanced, they are simply totalled. This
is because the two discount columns relate to two separate
accounts-the Discount Allowed Account and the Discount Received
Account.
No
Example of Two Column Cash Book:

From the following transactions write up a two column cash
book and post into ledger:
S,
2012
Jan. 1 Cash in hand ` 2,000
PE
" 7 Received from Riaz & Co. ` 200; discount allowed ` 10

" 12 Cash sales ` 1,000
" 15 Paid Zahoor Sons ` 500; discount received ` 15
" 20 Purchased goods for cash ` 300
U
" 25 Received from Salman ` 500; discount allowed ` 15

" 27 Paid Hussan & Sons ` 300.
(c)
" 28 Bought furniture for cash ` 100

" 31 Paid rent ` 100
ale
Solution: 105
Notes
Cash Book
Debit Side Credit Side ___________________
n/S
Date Particulars V.N. L.F. Discount Cash Date Particulars V.N. L.F. Discount Cash ___________________
2012 2012
Jan.1 To Balance 2,000 Jan.5 By Zahoor & 15 500 ___________________
" 7 b/d 10 200 " 20 Sons 300
" 12 To Riaz & 1,000 " 27 By purchase 300 ___________________
" 25 Co. 15 500 " 28 a/c 100
tio
To Sales a/c " 31 By 100 ___________________
To Salman Hussan&Sons 2,400
25 3,700 By Furniture 15 3,700 ___________________
a/c
2012 2,400 By Rent a/c
uc
Feb1 By Balance c/d ___________________
To Balance ___________________
b/d
rod
___________________
Riaz & Co.
___________________
2012 `
Jan. By Cash 200
7 By Discount 10
ep
Sales Account
2012 `
rR
Jan. By Cash 1,000

12
Salman Account
t fo
2012 `
Jan. By Cash 500
25 By Discount 15
Babar Account
No
2012 `
Jan. To Cash 1,000
18
Zahoor Account
S,
2012 `
Jan. To Cash 500
PE
15 To Discount 15
Purchases Account
2012 `
U
Jan. To Cash 300

20
(c)
Business Accounting
ale
106 Hussan & Sons
Notes 2012 `
Jan. To Cash 300
___________________
27
n/S
___________________
Furniture Account
___________________
2012 `
___________________ Jan. To Cash 100
28
tio
___________________
___________________ Rent Account

2012 `
uc
___________________
Jan. To Cash 100
___________________ 31
___________________
rod
Discount Account
___________________
2012 ` 2012
Jan. To Sundries as Jan. By Sundries as
31 per Cash book 25 31 per cashbook 15
ep
Three or Triple Column Cash Book
rR
This type of Cash Book is used by the big business organisations

because (i) there is large number of transactions and (ii) receipts
and payments are through cheques. Under these Cash Book three
columns meant for (A) Discount, (B) Cash, and (C) Bank, are
t fo
shown on both the sides of the Cash Book. Other columns remain
as usual. This Cash Book contains three columns; hence it is
termed as Three Column Cash Book.
In the debit side of Triple Column Cash Book, cash receipt, cheque
No
receipts and cash discount columns respectively. Similarly in the

credit side of Triple Column Cash Book payment of cash, payment
by cheque and cash discount received are recorded in Cash, Bank
and Discount columns respectively. The transactions which affect
cash and bank account at a time are called contra entries and are
S,
recorded in both sides of Triple Column Cash Book. The balance of

cash column is the closing cash in hand; the balance of bank
column is the cash at bank or bank overdraft. The discount column
PE
is not balanced but only totalled.

Following is the form of Three Columns Cash Book:
U
Three Columns Cash Book

Date Particulars L.F. Discount Cash Bank Date Particulars L.F. Discount Cash Bank
(`) (`) (`) (`) (`)
(c)
(`)
ale
107
Important points to be noted while recording the transactions:
Notes
z When opening cash and bank balances are given, record on the
___________________
debit side of cash and bank columns
n/S
___________________
z When opening bank balance is given as overdraft, it should be
___________________
recorded on the credit side in the bank column
___________________
z When cash is received, it should be recorded on the debit side
tio
cash column, in the same way cash payments made by the firm ___________________
shown in the cash column on credit side. ___________________
When cash or Cheque is received from debtors through cash
uc
z ___________________
sales or any other sources, it is recorded in the cash column on
___________________
debit side, if the Cheque is deposited into bank on the same
rod
___________________
day or assumed to be deposited on the same day; it is recorded
in the bank column on the debit side. ___________________
z If any payment is made or debt is cleared in the form of

Cheques, it is recorded in the bank column on the credit side.
ep
z If the firm allows discount, it is recorded in the discount
column on the debit side.
rR
z If the discount is received, it is recorded on the discount

column on the credit side.
z If the Cheques sent to bank for collection are dishonoured,
t fo
these should be recorded in the bank column on the credit side.

Similarly, if we receive any information that the Cheques
issued by us are dishonoured, it should be promptly noted in
the bank column on the debit side.
No
z If cash is withdrawn from the bank for the business use, it

should be recorded in the cash column on debit side and bank
column on the credit side.
If we deposit cash into bank it should be recorded in the bank
S,
z
column on debit side and credit side in the cash column. This
type of transaction is called as contra entry. Where both the
PE
sides are affected. To indicate that is a contra entry, the

alphabet ‘C” is mentioned in the Ledger folio column on the
both sides.
U
Contra entries will appear in the following occasions:

When an account is opened with a bank
(c)
z The firm’s cash is deposited in the bank

Business Accounting
ale
108
z The cash is withdrawn from bank for office use
Notes
___________________
z The Cheques received from debtors, are deposited in the bank.
n/S
___________________ Example: From the following particulars, write up the Cash Book
of M/s K.K. of Chennai with Cash and Bank columns and bring
___________________
down the final balance.
___________________
Change 2009 to 2012
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
rR
Solution:
t fo
Three Columns Cash Book

Date Particulars L.F. Discoun Cash Bank Date Particulars L.F. Discount Cash Bank
(`) (`) (`) (`) (`) (`)
2009 2009
Oct. 1 To Balance b/d 100 3,500 Oct. 5 By Salaries A/c – 250
Oct. 9 To B & Co. – 2,500 Oct. 7 By K & Co. – 260
No
Oct. 15 To S. Chand 1,500 Oct. 12 By Purchase A/c – 750

Oct. 17 To Cash A/c (C) – 1450 Oct. 17 By Bank A/c (C) 1450 –
Oct. 19 To Debitors 1,780 – Oct. 18 By S. Creditors – 1250
Oct. 22 A/c 2,500 – Oct. 20 By B & Co. – 2,500
Oct. 24 To B & Co. 30 470 Oct. 27 By Shyam Lal 5 395
Oct. 31 To R & Co. (C) 2,200 Oct. 31 By Bank A/c (C) 2,200
To Cash A/c By Balance c/d 4,885 5,110
30 5,880 10,120 5 5,880 10,120

S,
Petty Cash Book

PE
The Petty Cash Book records all the transactions which are very
small in terms of money. In such situation, a fixed amount of cash
in the beginning of the month is given to a person who is known as
petty cashier. After a fixed period say a week or month, he is again
U
reimbursed or paid back the amount whatever he has spent at the

end of week or period. Such a system is known as imprest system.
(c)
ale
109
Thus, this type of system (the Imprest System) is very useful. It
Notes
contains one column to record the receipt of cash to be taken from
the head cashier and other column to record payments of various ___________________
n/S
counts. All such payments are to be totalled to know the total ___________________
amount spent, so that necessary accounts are debited. The
___________________
following is the proforma of Petty Cash Book:
___________________
Analytical Petty Cash Book
tio
___________________
Receipts Date Particulars Voucher No. Total Amount Printing & Cartage Postage
(Rs.) (`) Stationery ___________________
uc
___________________
___________________
Example: Enter the following transactions in Analytical Petty
rod
___________________
Cash Book.
ep ___________________
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t fo
Solution:
Analytical Petty Cash Book

No
S,
U PE
(c)
Business Accounting
ale
110
Check Your Progress
Notes
Activity
Enter the following Fill in the blanks:
___________________
transactions in the Purchases
1. Only ................................. are recorded in the cash book.
n/S
Book___________________
and post the same in the
relevant ledger accounts.
___________________ 2. Cash payments are recorded on the .............................. of
2012 ` the cash book.
___________________
Aug. 1 Bought 1,500
3. According to the rules of accounting, all the business
tio
goods from
___________________
S transactions are firstly recorded in journal and then
___________________
Aug. 4 Bought 1,000 posted in.........................................
goods from
uc
___________________
N 4. The .................................. is an incentive given or
___________________
Aug. 8 Bought 500 received for prompt payment.
goods from
___________________
rod
A
___________________ Other Subsidiary Books
Following are other subsidiary books:
ep
Purchases Day Book
All credit purchases are recorded in this book which are either
used for resale or raw materials used for production. The
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purchases which are made for cash are not at all recorded in this
book. Similarly, the assets which are bought for running the
business are also not recorded such as machinery, furniture, etc.
t fo
All these assets and cash purchases are separately recorded in the
journal Cash Book. Following is the form of Purchases Day Book:
Purchases Day Book
Date Particulars Invoice No. L.F. Amount ( ` )

No
I II III IV V
(a) Column is meant for date.

S,
(b) Column is meant for writing details regarding name of

supplier, name of articles purchased & number i.e., quantities.
PE
(c) Invoice No.: An Invoice is given to the seller when purchases

are made on credit
(d) Ledger Folio
U
(e) Amount of the purchase

Thus, all the credit purchases are totalled which give us the
(c)
amount of total credit purchases made during the period.

ale
Sales Day Book 111
Notes
The goods which are sold on credit are recorded in this book but if
sales are made for cash or assets are sold either for cash or on ___________________
n/S
credit, they are not at all recorded in this book, but are recorded ___________________
either in the cash book or in the journal. The form of this book is
___________________
similar to that of purchases book. Following is the form of Sales
Day Book. ___________________
tio
___________________
Date Particulars Invoice No. L.F. Details (`) Amount (`)
___________________
I II III IV V VI
uc
Details of goods-sold-trade discount if ___________________
any total
___________________
Thus, all the credit sales are totalled which give us the amount of
total credit sales made during the period.
rod
___________________
Invoice: An Invoice is given to the buyer when sales are made on ___________________
credit.
ep
Purchase Returns Book
This book is also known as Returns Outward Book. This book
records all the returns to the suppliers which are made during the
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period. The return is of goods or raw materials purchased from the

Suppliers and Return is on account of difference in quantity or
quality. This book is used when the returns are in sufficient
t fo
number. If returns are not much, then it may be recorded in the

Journal. The form of Purchase Returns Book is similar to that of
Purchase Day Book.
Form of Purchase Returns Book

No
Date Particulars L.F. Debit Note No. Amount (`)

I II III IV V
S,
Debit Note: Whenever goods are returned to the supplier, a letter

PE
which is known as the debit note is also sent along with returned
goods. The purpose of this note is to inform the supplier about this
deduction or debit given to his account. This note contains the
following particulars such as:
U
(a) Name and address of the supplier

(c)
(b) Description of the goods returned

(c) Rate and total value
Business Accounting
ale
112
(d) Invoice No., along with date
Notes
___________________
(e) ignature
n/S
___________________ Sales Returns Book
___________________ This is also known as Returns Inward Book. This book records all
___________________ the transactions related to the return of goods by the customers. As
and when goods are returned by the customers, a credit note is
tio
___________________
issued and the entry is made in this book. This book again contains
___________________
the same columns which a Purchases Returns Book contains.
There is only one difference i.e. in place of Debit Note No. the
uc
___________________
___________________ column is used to note the Credit Note No. The form of sales
Returns Book is as follows:
___________________
rod
Sales Returns Book
___________________
Date Particular Credit Note No. L.F. Amount (`)
I II III IV V
ep
Credit Note: As and when goods are returned by the customers, a
rR
credit note is being sent to him. Credit note means that his account
has been credited with the amount of goods return.
Bills Receivable Book

t fo
A bill of exchange accepted by a customer is called bills receivable.

When bills are received from debtors and number of such bills
received is larger (big) then such bills are recorded in a separate
book, known as bills Receivable Book. All such bills are totalled for
No
a particular period and are posted in the accounts of the debtors

from whom such bills are received. Following is the form of Bills
Receivable Book.
Bills Receivable Book

S,
Date Date From Drawer Acceptor Endorser Date Tenor or Due Where L.F. Cash Amount Re-
of of Whom (s) of Terms of date payable Discount of bill marks
Receipt Receipt Received Bill Bill allowed (`)
U PE
Bills Payable Book

Where either purchase is made for credit or loans are taken, then
(c)
Bills are issued which are termed as Bills Payable. The book in
which these bills are recorded is termed as Bills Payable Book. All
ale
such Bills are totalled after a lapse of a certain period and are 113
posted in the accounts of the creditors to whom such bills are Notes
issued. Following is the form of Bills Payable Book: ___________________
n/S
Bills Payable Book ___________________
Date To Term Drawer Acceptor Endorser Due Where L.F. Amount Remarks ___________________
Whom (s) Date payable (`)
Payable
___________________
tio
___________________
___________________
Check Your Progress
uc
___________________
Fill in the blanks: ___________________
1. The ………………….. records all the transactions which
rod
___________________
are very small in terms of money.
___________________
2. An ………………….. is given to the buyer when sales are
made on credit
ep
3. Purchase return book is also known as ………………….. .
Summary
rR
The regular/frequent occurrence of transactions are recorded only

in the separate books which are known as subsidiary book of
t fo
accounts or subsidiary journals, instead of being recorded in the

regular journal. Subsidiary books are classified on the basis of
transactions viz. Cash transactions and Non-cash transactions.
The purchases book is known in other words as purchase journal.
No
It is a book meant for credit purchases only for resale. Purchase

return book is a book of goods returned to the supplier which are
out of credit purchases. Sales book is a book maintained by the
enterprise only during the moment of selling the goods on credit. It
S,
is known in other words as a sales journal. Sales return is a book

that registers the goods sold on credit and received from the
PE
buyers.
Lesson End Activity

U
Illustrate the preparation of records for non cash transactions with

suitable examples.
(c)
Business Accounting
ale
114
Keywords
Notes
Bill of Exchange: A bill of exchange is an unconditional order
___________________
signed by the maker which directs the recipient to pay a fixed sum
n/S
___________________ of money to a third party at a future date.
___________________
___________________ first time.
tio
___________________ Ledger: It is the classification of accounts in which various
___________________ accounts are maintained.
Subsidiary book: It is a book maintained for routine transactions
uc
___________________
___________________ of the enterprise.
___________________ Trial Balance: Trial balance is a list in which all the balances of
rod
the accounts of Ledger are showed to test the arithmetical
___________________
accuracy of the posting in ledger.
Non-cash Transactions: A Non-cash transaction is a transaction
in terms of credit and conditions of the enterprise.
ep
Purchase Book: It is known in other words as purchase journal.
It is a book meant for credit purchases only for resale.
rR
Sales Book: It is a book maintained by the enterprise only during

the moment of selling the goods on credit. It is known in other
words as a sales journal.
t fo
Sales Return Book: Sales return is a book that registers the

goods sold on credit and received from the buyers.

No
1. Explain the nature of petty cash book.

2. What is the difference between a petty cash book and a simple
cash book?
S,
3. Prepare a Cash Book form the transactions given below:

U PE
(c)
ale
115
4. Compose three columns Cash Book from the following
Notes
transactions:
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
rod
___________________
ep ___________________
rR
5. What are the different types of trade bills books?

6. Write a short note on the following:
(a) Debit Note
t fo
(b) Credit Note

7. Enter the following transactions in Analytical petty Cash
Book:
No
S,
PE
8. Explain the significance of preparing subsidiary books of

U
accounts.
(c)
Business Accounting
ale
116
Further Readings
Notes
___________________ Books
n/S
___________________ T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
___________________
Delhi.
___________________ R.L. Gupta, M. Radhaswami. “Advanced Accountancy”. Sultan

Chand, New Delhi.
tio
___________________
___________________
uc
___________________
___________________
New Delhi.
___________________
rod
Web Readings
___________________
http://www.careerride.com/fa-subsidiary-books.aspx.
http://bookkeepingaccounting.blogspot.in/2010/07/subsidiary-
books.html
ep
http://www.scribd.com/doc/22575438/Subsidiary-Books
http://www.wisegeek.com/what-are-subsidiary-books.htm
rR
t fo
No
S,
U PE
(c)
UNIT 8: Trial Balance
ale
Unit 8
117
Notes
Activity
Trial Balance
___________________
n/S
showing the Trial Balance.
___________________
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning of Trial Balance ___________________

\ Methods of Preparation of Trial Balance
uc
___________________
\ Types of Errors
___________________
rod
___________________
Introduction
___________________
Every transaction which takes place in the business is recorded
either in the journal or in the subsidiary books. It is posted in the
ep
concerned accounts. After posting is over, final accounts are
prepared in order to know the operational results of the business
during a particular or fixed period and also to depict financial
rR
position of the business on a particular date. Final accounts can be

prepared only if information relating to balances of all accounts are
available. This function of supplying necessary and accurate
balances is performed by Trial Balance so it is very much
t fo
necessary to know the meaning of Trial Balance.
Meaning of Trial Balance

No
Trial balance is a list in which all the balances of the accounts of

Ledger are showed to test the arithmetical accuracy of the posting
in ledger. It is prepared after the end of a particular period - year,
half year or quarter. Trial balance prepares a base for the
S,
preparation of final accounts. After the completion of trial balance,

the financial accounts - P. & L. Account and Balance Sheet are
PE
prepared to disclose the overall results of the business after a

period. The proforma of a trial balance is given hereunder:
Proforma of Trial Balance

U
Particulars Amount Dr. Amount Cr.

` `
(c)
Business Accounting
ale
118
Generally three columns are made in the trial balance. The first
Notes
Activity wide column is kept for the particulars of accounts and the two
Rectify the following Errors:
___________________ columns for debit amount and credit amount are made.
n/S
Sales to Vinod `143
(i) ___________________
posted to his account as ` Objects and Functions of Trial Balance
___________________
134.
The main objectives of preparing a trial balance are to check the
Sales to Vinod ` 143
(ii) ___________________
debited to his account as
arithmetical accuracy of all transactions. In every trial balance,
tio
` 134.
___________________ the total of debit balances must agree with the total of credit
Sales to Vinod ` 143
(iii) ___________________ balances. It is a proof of arithmetical accuracy of postings but it is
credited to his account as not a conclusive evidence of correctness of the books of accounts.
uc
___________________
` 134.
The other objects and functions of a trial balance are as under:
___________________
1. It serves as a summary of all accounts.
___________________
rod
2. It helps in locating errors if any.
___________________
3. It acts as a base for the preparation of final accounts.
Check Your Progress

ep
Fill in the blanks
1. …………….. is a statement which shows balances of all
rR
accounts on a particular date.

2. The balances of all the liabilities and capital accounts
are recorded in the …………….. of the Trial Balance.
t fo
Methods of Preparation of Trial Balance

A trial balance is prepared by the following three methods:
No
a. Balance Method
b. Total Method
c. Balance and Total Method
S,
Among the above methods the balance method is the most popular
and statutory method to prepare the Trial Balance. Under this
method the balance of all the accounts are recorded. If an account
PE
shows a debit balance in the ledger, this balance is recorded in the

debit side of the trial balance and if it has a credit balance, in the
credit side of it is written. If any account has no balance means its
U
total of debit side is equal to the total of credit side, it is not

recorded in the Trial Balance. After recording the balances of all
(c)
accounts of the Ledger, the amounts of both the sides are totalled
to check the arithmetical accuracy of the ledger. If the total of debit
ale
side agrees with the total of credit side, it proves that books are at 119
least arithmetically correct. However, the trial balance is not the Notes
sole proof of accuracy of the books of Ledger. ___________________
n/S
Illustration (Trial Balance) ___________________
Prepare a Trial Balance on the basis of the ledger accounts as ___________________

given in illustration No. 3.
___________________
tio
Solution ___________________
In the Books of Aditya Raj ___________________

Trial Balance
uc
___________________
(as on 31st March, 2012)
Particulars Amount (Dr.) Amount (Cr.)
___________________
` `
rod
___________________
Cash Account 61,000 -
Purchase Account 3,20,000 - ___________________
Ramautar’s Account - 2,20,000
Rent Account 2,000 -
Plant Account 1,00,000 -
Salaries Account 12,000 -
ep
Shyam’s Account - 10,000
Sales Account - 2,70,000
Wages Account 5,000 -
Total 5,00,000 5,00,000
rR
Preparation of Trial Balance with the Help of Balances

In the examination problems the Ledger accounts are not given but
a list of balances of accounts is given. With the help of these
t fo
balances the students are asked to prepare the Trial Balance.

Students should keep in mind the following rules to prepare a Trial
Balance:
(a) The balances of all the assets accounts and drawing accounts
No
are recorded in the debit side of the Trial Balance.

(b) The balances of all the liabilities and capital accounts are
recorded in the credit side of the Trial Balance.
S,
(c) The balances of all expenses and losses of the business are
showed in the debit side of the Trial Balance.
PE
(d) The balances of all incomes and gains are disclosed in the
credit side of the Trial Balance.
(e) The balances of sales and sale returns are disclosed in the
U
credit side and debit side of Trial Balance respectively.

(f) The balances of purchases and purchase returns are disclosed
(c)
in the debit side and credit side of the Trial Balance

respectively.
Business Accounting
ale
120
Illustration (Preparation of Trial Balance)
Notes
___________________
Mr. Akshey Kumar furnishes the following balances as on 31st
March, 2012. You have to prepare a Trial Balance with the
n/S
___________________
following information:
___________________
Particulars ` Particulars `
___________________ 24,000 1,28,000
Interest on Capital Salaries
tio
Creditors 6,00,000 Capital 8,00,000
___________________
Discount Received 23,000 Drawings 2,46,000
Loan 1,74,000 Machinery 3,00,000
___________________
Purchase Returns 40,000 Bills Payable 20,000
6,000 6,00,000
uc
___________________ Sales Return Furniture
Advertisement 1,63,000 Debtors 5,00,000
___________________ Commission Received 20,000 Bank Loan 2,00,000
Rent 10,000 Patents 60,000
___________________
rod
Purchases 19,00,000
Sales 32,60,000
___________________
Opening Stock 12,00,000
Solution:
ep
Trial Balance
(as on 31st March, 2012)
rR
Particulars Amount (Dr.) Amount (Cr.)

` `
Interest on Capital 24,000 -
Creditors - 6,00,000
Discount Received - 23,000
Loan - 1,74,000
t fo
Purchase Returns - 40,000

Sale Returns 6,000 -
Advertisement 1,63,000 -
Commission Received - 20,000
Rent 10,000 -
No
Purchases 19,00,000 -
Sales - 32,60,000
Opening Stock 12,00,000 -
Salaries 1,28,000 -
Capital - 8,00,000
Drawings 2,46,000 -
Machinery 3,00,000 -
S,
Bills Payable - 20,000

Furniture 6,00,000 -
Debtors 5,00,000 -
PE
Bank Loan - 2 00 000

Patents 60,000 -
Total 51,37,000 51,37,000
From the above trial balances it is clear that the total of debit side
U
will agree with the total of credit side if Ledger accounts are
arithmetically correct. If these totals do not tally with each other,
(c)
there will be some error in the ledger accounts.

ale
121
Check Your Progress
Notes
Activity
Fill in the blanks:
You___________________
and your group members
1. The balances of all incomes and gains are disclosed in
n/S
___________________
assignment on types of errors.
the ……………… of the Trial Balance.
___________________
2. . ……………… is found when one account is debited or
___________________
credited in the place of another account.
tio
___________________
3. …………………. occur when any business transaction is
completely or partially omitted from the recording in the ___________________
books of original records.
uc
___________________
___________________
Types of Errors
rod
___________________
There are two types of errors: ___________________
Errors which cannot be located by Trial Balance

The following errors cannot be detected by the trial balance means
ep
in spite of agreeing the totals of debit side and credit side, these
errors occur in the accounts.
rR
1. Error of Omission: These errors occur when any business

transaction is completely or partially omitted from the
recording in the books of original records.
t fo
Example: As goods, sold of Rs.10, 000 to Mr. Ram is entered

nowhere in the original books then will its effect also not come
on the ledger and trial balance. Thus such type of errors
cannot be located by trial balance.
No
2. Error of Commission: such types of errors are found when

one account is debited or credited in the place of another
account.
Example: As cash received from Shyam Rs.1, 000 has been
S,
credited in the name of Ram. Such type of errors do not affect

the agreement of the totals of the debit and credit side of the
PE
trial balance but they affect the result of the business.

3. Error of Principle: These errors occur when there is wrong
classification between the capital and revenue nature incomes
U
or expenditures.
Example: As the purchases of furniture of Rs.20, 000 are
(c)
entered in the book of purchases while it should be in furniture

account. Such errors cannot be located by trial balance.
Business Accounting
ale
122
4. Compensating Error: When two errors of the same account
Notes
occur and the effect of one error is compensated by the effect of
___________________
other error, it is called compensating error.
n/S
___________________
Example: if purchase of ` 10, 000 from Ajay is credited only
___________________ by ` 1, 000 while the purchases from Vijay for ` 1, 000 is
___________________ credited by ` 10, 000. Thus, such type of errors do not affect on
the agreement of the Trial Balance.
tio
___________________
___________________ Errors which can be located by Trial Balance

The error which affects the agreement of the totals of the Trial
uc
___________________
___________________ balance can be located easily. These errors may be relating to:
___________________ 1. Totals of the subsidiary books or ledger accounts.
rod
___________________ 2. Balancing of an account of the ledger.
3. Wrong posting of any amount in any account.
4. Posting of any account may be in the wrong side of the
ep
account.
5. Balance of any account may be omitted in writing in the Trial
rR
Balance.
6. Wrong total of the Trial Balance.
Errors are of two types:
t fo
1. Errors which are disclosed by the trial balance.

2. Errors which are not disclosed by the trial balance.
1. Errors which are disclosed by the Trial Balance:
No
Sometimes the trial-balance does not agree, it is because of the

following reasons:
The balancing of an account is not O.K.
S,
The amount has been wrongly posted.

Totalling of subsidiary books is wrong.
PE
Any amount which is left out from posting to ledger

accounts.
Any balance of an account is left out from trial balance.
U
Thus, we see that it is very important to detect the errors

which are disclosed by the trial balance, so that correct results
(c)
can be depicted by the ledger accounts, but sometimes it

happens that the trial balance is OK even then there may be
ale
certain errors which are not disclosed by the trial balance. So 123
it is also very much desirable and necessary to know such Notes
errors which are not disclosed by the Trial Balance. ___________________
n/S
2. Errors which are not disclosed by the Trial Balance: ___________________
Following are the 4 types of errors: ___________________
Error of Omission ___________________
tio
Error of Commission ___________________
Error of Principle ___________________
uc
___________________
Compensatory Error
___________________
Now we can explain the above errors one by one in detail:
rod
___________________
1. Error of Omission: If any transaction is completely omitted,
then it is an error of omission. For example, if goods worth ` ___________________
100 are sold to Ram on credit and if this transaction is omitted

completely or left out, then it would not affect the trial balance
ep
but the results given by the final accounts would not be
accurate. The omission may be of the entire transaction or a
part of the transaction. If it is of a part of the transaction, then
rR
it would affect the trial balance.

2. Error of Commission: When any account is either debited or
credited in place of some other account then it is termed as an
t fo
error of commission. Though this would not affect the trial

balance, but the overall results would not be correct. For
example, if goods worth ` 100 are sold to Ram on credit, but in
place of Ram, Shyam’s account is debited then the error is
No
committed which must be rectified to maintain accuracy.

3. Error of Principle: As we know that the expenses are of two
types- namely (a) Capital expenses and (b) Revenue expenses.
A. Capital Expenses: When benefits can be / are derived for
S,
more than one year or for a longer period, such expenses

are termed as Capital expenses, such as purchases of
PE
building / machinery, etc. These assets are not for sale but
are the permanent assets of the business.
B. Revenue Expenses: Where benefits are derived only for a
U
shorter period or less than one year such expenses are

known as Revenue expenses, such expenses are also form
(c)
the part of the current year's profit and loss account.

Business Accounting
ale
124
After understanding the nature of expenses, it is very much
Notes
essential to have a distinction between Revenue and Capital
___________________
expenses, but if it is not observed strictly or ignored, there
n/S
___________________ would be an error of principle. Though this type of error would
___________________ not affect the trial balance, but the results given would not be
correct, hence rectification of such errors is must to have the
___________________
accuracy of ledger accounts.
tio
___________________
4. Compensatory Errors: Compensatory errors are the errors
___________________ which are committed while posting or recording of a
transaction, an error is committed and the same error is again
uc
___________________
___________________
committed in another recording or posting. Such error is
termed as compensatory error. For example, Goods sold to Mr.
___________________
Jai Bhagwan for ` 500 on credit though the recording is
rod
___________________ correctly done, but posting is done only for Rs. 50. Similarly
Goods sold to Bhagwan Das for ` 50 on credit is posted in
Bhagwan Das's A/c as ` 500. This would be compensatory error
ep
without affecting the trial balance.
Thus we see that it is very much essential to rectify such errors in
order to maintain the accuracy of the financial results.
rR
Thus we see that errors are of two types:

1. Error of Principle.
t fo
2. Clerical errors which are of the following types:

(i) Error of Omission.
(ii) Error of Commission.
No
(iii) Compensatory errors.
Steps to point out errors

If the trial balance does not agree, the following steps can be taken
S,
in order to point out the errors. These are based on hit and trial
method.
PE
1. To see whether the total of both the columns agree or does not
agree. In order to see it, it must be again totalled.
2. It is also necessary to see whether the balances of all the
U
accounts including cash and bank have been properly recorded

or not.
(c)
3. Difference of both the sides must be checked carefully and if

possible see whether any such item is there which is exactly of
ale
the same amount being omitted/left out. If it is not then have 125
half of the difference and again compare it with the amount of Notes
any item of the same amount which is being left out or wrongly ___________________
put.
n/S
___________________
4. Subsidiary books must also be checked again, so that if any
___________________
error has taken place could be rectified.
___________________
5. Still, if there is any error, thorough and complete checking of
tio
___________________
all ledger accounts is required.
___________________
Rectification of Errors
uc
___________________
Errors are/can be rectified if the correcting entries are passed in ___________________
the books of account. For this, care and alertness is exercised to see
rod
___________________
whether error is in both the accounts or is in one account only. If
the error affects both the accounts, then a fresh entry is to be ___________________
passed and if it affects only one account, the rectification is done by

recording in one account only.
ep
1. Rectification of Errors when error affects only one
account: If it is so, no journal entry is required to pass; it is
corrected by debiting or crediting the concerned account. For
rR
example, Sales book was overcasted by ` 250 [As the sales

book was overcasted by ` 250]; hence sale account is to be
debited by ` 250 in order to rectify the error. This error affects
t fo
only one account. Similarly, if the Purchases Day Book is

undercasted by ` 100 then the error also affects only one
account and this can be corrected by debiting purchases
account by ` 100. Likewise paid ` 20 as repairs were recorded
No
` 25 in Repairs account again the error is in one account i.e.,

repair account. It may be corrected by crediting repair a/c by
` 5 i.e. the difference (` 25 - ` 20).
2. Rectification of Errors when it affects both the accounts:

S,
If it is so, it is rectified by passing a journal entry. For

example, received ` 150 from Shri Bhagwan was credited to
PE
sales account. This error affects both the accounts i.e., (i) Shri
Bhagwan A/c and (ii) Sales A/c.
Journal entry for correction would be:
U
Dr. Cr.
S.No. Particulars L.F. ` `
1. Sales a/c Dr. 150
(c)
To Shri Bhagwan a/c 150

Error in Sales a/c and
Shri Bhagwan a/c rectified
Business Accounting
ale
126
Similarly, if Building is purchased for ` 2 lac is recorded in the
Notes
Purchases Book, again the error affects both the accounts i.e. (1)
___________________
Building a/c (2) Purchases a/c.
n/S
___________________
Though the error is of principle, in the above case Purchases a/c is
___________________ unnecessarily debited and Building a/c is wrongly left out. In order
___________________ to rectify the error the following entry (correcting the error) is to be
passed:
tio
___________________
___________________ Journal Entry for Correction (Rectification)

S.No. Particulars L.F. ` `.
uc
___________________ 1. Building a/c Dr. 2,00,000
To Purchases a/c 2,00,000
___________________ Error in Building a/c and
Purchases a/c rectified
___________________
rod
___________________
Journal Entry already passed which was a wrong entry
1. Purchases a/c Dr. 2,00,000
ep
To Cash / Creditor a/c 2,00,000
Building Purchased
Correct entry required to pass

rR

1. Building a/c Dr. 2,00,000
To Cash/Creditor a/c 2,00,000
Buildings purchased
t fo
Thus, we see that if the error affects both the accounts, then it can
be rectified by passing a journal entry as explained above.
Suspense Account
No
Sometimes, it is not possible to point out errors easily, and then

the difference is put to an account, known as suspense account.
Suspense a/c is shown in the trial balance. As and when Errors are
located, the same is debited or credited for rectifying the error and
S,
the other account which is credited or debited is the suspense

account. Thus, the suspense account is automatically closed.
PE
Illustration
Rectify the following Errors:
U
(a) A sale of goods to Raja Ram for ` 2500 was passed through the
Purchases book.
(c)
(b) Salary ` 800 paid to Hari Babu was wrongly debited to his
personal account.
ale
127
(c) Furniture purchased on credit from Mohan Singh for ` 1000
Notes
was entered in the Purchases book.
___________________
(d) ` 5000 spent on the extension of building was debited to the
n/S
buildings repairs account. ___________________
___________________
(e) Goods returned by Mani Ram ` 1200 were entered in Returns
outward book. ___________________
tio
Solution: ___________________
___________________
Journal Entries to rectify the errors
uc
Dr. Cr. ___________________
S.No. Particulars L.F. Amount Amount
` ` ___________________
(a) Raja Ram Dr. 5,000
rod
To Purchases a/c 2500 ___________________
To Sales a/c 2500
A sale of goods to Raja Ram through the Purchases book is rectified ___________________
(b) Salary a/c Dr. 800
To Hari Babu 800
Salary wrongly debited in his personal a/c is rectified.
ep
(c) Furniture a/c Dr. 1,000
To Purchases a/c 1000
Furniture purchased was wrongly entered in the Purchases book is rectified.
(d) Buildings a/c Dr. 5,000
To Buildings Repairs a/c 5000
rR
Spent on extension of building was wrongly debited to Building repairs a/c is

rectified.
(e) Returns Inward a/c (Sales Returns) Dr.
Returns Outward a/c (Purchases Returns a/c) Dr. 1,200
To Mani Ram 1,200
Goods returned by Mani Ram were entered in returns outward book. 2400
t fo
Illustration
Rectify the following errors:
(a) Sales book was overcasted by ` 200.

No
(b) ` 100 received as rent from the tenant was debited to rent
account.
(c) Received ` 500 from Sudan Mittal was credited to Sales book.
S,
(d) Paid ` 200 as salary, but were debited ` 20 in Salary account.
(e) Paid ` 20 as repairs were recorded ` 25 in Repairs account.

PE
Solution:
(a) As the sales book was overcast by ` 200, so sales a/c is to be
U
debited by ` 200 in order to rectify the error, this error affects

only one account.
(c)
Business Accounting
ale
128 Dr. Cr.
Notes S.No. Particulars L.F. Amount Amount
` `
___________________ (b) Suspense a/c Dr. 200
n/S
To Rent a/c 200
___________________ Rent a/c was wrongly debited, hence rectified by Rs. 200.
(c) Sales a/c Dr. 500
___________________
To Sudan Mittal 500
___________________ Sales a/c was wrongly credited in place of Sudan Mittal, rectified.
(d) Salary a/c Dr. 180
tio
___________________ To Suspense a/c 180
Salary a/c was debited less by Rs. 180, hence rectified.
___________________ (e) Suspense a/c Dr. 05
To Repairs a/c 05
uc
___________________
Excess in repairs a/c credited to rectify the error.
___________________
Illustration
___________________
rod
___________________ Rectify the following errors:
1. ` 700 paid for the purchase of new office furniture charged to
office expenses a/c.
ep
2. Goods worth ` 174 were sold to Roop but latter a/c was
actually credited by ` 147.
rR
3. Sales Day book was undercasted by ` 200.
4. The total of the discount column on the debit side of the Cash
book was short by ` 30.
t fo
5. An amount of ` 1000 withdrawn by the proprietor for his

personal use was debited to Trade expenses a/c.
6. ` 200 was received on account of rent but was credited to
dividend a/c.
No
7. Goods sold to Mr. Rakesh for ` 705 but entry was made for `
570.
8. An amount of ` 325 owing by Mukesh was omitted from the

S,
list of Sundry debtors.

Solution
PE
Journal Entries to Rectify the Errors

Dr. Cr.
S.No. Particulars L.F. Amount Amount
U
` `
(i) Office Furniture a/c Dr. 700
To Office expenses a/c 700
(c)
Error in office expenses a/c rectified.
Contd…
ale
(ii) Roop Dr. 321 129
To Suspense a/c 321
Error in Roop a/c rectified. Notes
(iii) Suspense a/c Dr. 200
___________________
To Sales a/c 200
n/S
Error in sales a/c rectified. ___________________
(iv) Discount a/c Dr. 30
To Suspense a/c 30 ___________________
Discount columns on debit side short by Rs. 30 corrected.
___________________
(v) Proprietor Drawings a/c Dr. 1000
tio
To Trade expenses a/c 1000
___________________
Error in trade expenses a/c rectified.
(vi) Dividend a/c Dr. 200 ___________________
To Rent a/c 200
uc
Error in dividend a/c rectified. ___________________
(vii) Rakesh Dr. 135
___________________
To Sales a/c 135
Error in Rakesh and Sales a/c rectified (Rs. 705 – 570).
rod
___________________
(viii) Mukesh (Sundry Debtors) Dr. 325
To Suspense a/c 325 ___________________
Error in Mukesh a/c rectified.
Effects of errors on the profits and losses (profit and loss a/c
ep
and Balance Sheet) (Final Accounts): If the error/errors are
there or committed, the effect of such errors would be either
decrease or increase in the Gross Profit/Net Profit. The Profit/Loss
rR
depicted by profit and loss account would not be correct, so it is

necessary to rectify the errors and arrive at the correct amount of
profit/loss of the period. Similarly, financial position as given by
t fo
the Balance Sheet would also not be correct if some errors are
there/committed. Again, it is also must to rectify the errors at the
earliest, so that Balance Sheet can depict a true and fair view of
the business. The following illustrations would clarify the above
No
points.
Illustration
On 31st Dec, 2012 the Trial balance of Sunil & Co balanced after
inserting a suspense account in the nominal ledger. In the course
S,
of audit, the following facts were discovered:
1. ` 120 received from A had been posted to B's account in the

PE
sales ledger.
2. ` 50 paid for postage stamps had been entered correctly in the
cash book, but not posted.
U
3. In casting the Sales Day Book ` 878 were carried forward as `

(c)
787.
Business Accounting
ale
130
4. An Invoice of ` 960 in respect of Motor Car debited to Motor
Notes
Car a/c included the cost of licence ` 60.
___________________
5. ` 540 credited to Partners' current Account for interest on
n/S
___________________
capital had been debited to Bank Interest account.
___________________
6. Discount received from Mittal & Co. ` 200 had not been posted
___________________ to Discount a/c. Pass entries necessary to correct the errors
tio
___________________ and prepare the suspense account. Also find out what effect
___________________
these errors would have on the profit for the year ending 31st
Dec, 2012.
uc
___________________
Solution
___________________
Journal Entries to rectify the errors
___________________
rod
Dr. Cr.
___________________ S.No. Particulars L.F. Amount Amount
` `
(a) B Dr. 120
To A 120
Error in B’s a/c Corrected.
ep
(b) Postage a/c Dr. 50
To Suspense a/c 50
Postage a/c Omission corrected.
(c) Suspense a/c Dr. 91
rR
To Sales a/c 91
Sales Day Book balance
Wrongly carried forward
Hence corrected 878 - 787
(d) Motor licence a/c Dr. 60
To Motor Car a/c 60
t fo
Error in Motor Car a/c corrected.

(e) Suspense a/c Dr. 1080
To Partner’s Current a/c 540
To Bank Interest a/c 540
Error in Bank Interest a/c corrected and partners’ a/c credited.
(f) Suspense a/c Dr. 200
To Discount a/c 200
No
Omission in Discount a/c corrected.
Suspense A/c
Dr. Cr.
S.No. Particulars J.F. Amount S.No. Particulars J.F. Amount
` `
S,
(c) To Sales a/c 91 (b) By Postage a/c 50

(e) To Partners’ current a/c 540 By Balance 1321
To Bank Int. a/c 540
PE
(f) To Discount a/c 200

1371 1371
Effects on the profit for the year 2012:

U
(a) No effect.
(b) Net profit is higher by ` 50.

(c)
(c) Gross profit and Net profit is reduced by ` 91.

ale
131
(d) Net profit is higher by ` 60.
Notes
(e) Net Profit is reduced by ` 540.
___________________
n/S
(f) Net profit is lower by ` 200.
___________________
The total effect of all errors on profit is ` 721.00 i.e. profit is lower ___________________
to the extent of ` 721 and if corrected, Net profit increases by `
___________________
721.
tio
___________________
Fill in the blanks:
uc
___________________
1. …………………. occur when there is wrong classification ___________________
between the capital and revenue nature incomes or
rod
___________________
expenditures.
___________________
2. Suspense A/c is shown in the ………………….
3. The balances of all the assets accounts and drawing
ep
accounts are recorded in the ………………. of the Trial
Balance.
4. The balances of all incomes and gains are disclosed in
rR
the ……………. of the Trial Balance.
Summary
t fo
Trial Balance is a list of accounting balances and their names; of

the enterprise during the specified period which includes debit and
credit balances of the various balanced ledger accounts out of the
journal entries. Purposes of preparing the Trial Balance are to
No
prepare a statement of disclosure of final accounting balances of

various ledger accounts on a particular date.
There can be certain errors in recording the accounting
S,
transactions in primary and secondary books of accounts. The

following errors cannot be detected by the trial balance means in
spite of agreeing the totals of debit side and credit side: Error of
PE
omission, Error of commission, Error of principle and

Compensating error.
The errors which can be located in the trial balance are wrong
U
total, balancing error, positioning error etc. Sometimes, it is not

possible to point out errors easily, and then the difference is put to
(c)
an account, known as suspense account.

Business Accounting
ale
132
Lesson End Activity
Notes
Is the agreement of a Trial Balance a conclusive proof of accuracy
___________________
of ledger accounts? If not, what are the errors which remain
n/S
___________________ undetected by the Trial balance?
___________________
___________________ Keywords
tio
___________________ Bill of exchange: A bill of exchange is an unconditional order
___________________ signed by the maker which directs the recipient to pay a fixed sum
of money to a third party at a future date.
uc
___________________
___________________ Suspense account: Sometimes, it is not possible to point out

errors easily, and then the difference is put to an account, known
___________________
rod
as suspense account.
___________________
Trial balance: It is the list of accounts taken from the ledger.
Error of Omission: These errors occur when any business
transaction is completely or partially omitted from the recording in
ep
the books of original records.
Error of Commission: Such types of errors are found when one
rR
account is debited or credited in the place of another account.

Error of Principle: These errors occur when there is wrong
classification between the capital and revenue nature incomes or
t fo
expenditures.

No
1. What is a Trial Balance? Name the errors that are disclosed by

Trial Balance.
2. What is Trial Balance? Is it true to say that results are
accurate if Trial Balance tallies?
S,
3. What do you mean by a Trial Balance? Discuss its main objects

& show how it is prepared.
PE
4. Give two examples each of the one sided and doubles sided
errors. How are they corrected?
5. Explain the errors (i) which are revealed by the Trial Balance
U
and (ii) the errors which are not revealed by the trial balance.
(c)
6. Discuss the errors which do not affect the agreement of a trial

balance.
ale
133
7. Distinguish between -
Notes
(a) Balance Sheet and a Trial Balance
___________________
n/S
(b) Errors of commission and errors of omission.
___________________
8. Write short-notes on the following: ___________________
(i) Error of Principle ___________________
tio
(ii) Compensatory errors ___________________
(iii) Factors affecting disagreement of Trial Balance. ___________________
9 The following balances are extracted from the books of Mr.
uc
___________________
Rakesh as on 31.12.2005 ___________________
` `
rod
Capital 15,000 Purchases 7 ,200 ___________________
Land & Building 15,600 Provision for bad debts 370
Bank overdraft 2,500 Sales 17,000 ___________________
Cash in hand 680 Wages 1250
Stock in Trade as on 1.1.04 6,000 Salaries 700
Advertisement 210 Insurance 40
ep
Rent & Taxes 160 Discount allowed 300
Interest & Discount received 300 Repairs to building 210
Debtors 6420 Creditors 4,100
General Expenses 500
rR
Prepare a trial balance

10. Give the journal entries necessary to rectify the following
errors:
t fo
(i) A payment of Rs. 250 for purchase of a Typewriter for

office use has been debited to Purchases a/c.
(ii) A credit sale of ` 127 to Mr. Chandra has been posted to

No
the debit of Mr. Kuchhal's account from the Sales Day

book.
(iii) A payment of ` 96 for white washing the office has been
charged to Buildings accounts.
S,
11. Rectify the following Errors:

(i) Wages paid for the construction of office debited to wages
PE
account ` 1,500.
(ii) Cartage paid for the newly purchased furniture ` 10

posted to cartage account.
U
(iii) Furniture purchased on credit from Ram for ` 300 posted

as ` 30.
(c)
(iv) Sales to X ` 400 posted to Y's account.

Business Accounting
ale
134
(v) Wages paid ` 2,550 were recorded in the cash book as Rs.
Notes
2,505.
___________________
(vi) Purchases from Y ` 1,002 were omitted from the books.
n/S
___________________
12. There was difference in the trial balance of Sri Arihant which
___________________
was put to a newly opened suspense account. Subsequently the
___________________ following mistakes were discovered. Pass journal entries to
tio
___________________ rectify them and ascertain the difference in the trial balance.
___________________ (i) Materials Costing ` 1700 in the erection of the machinery
and the wages for it amounting to ` 1,400 were included in
uc
___________________
the purchases account and the wage account respectively.
___________________
(ii) Goods sold under credit terms ` 16,900 to music were
___________________
rod
recorded properly in the sales book but were debited to his
___________________
account as ` 19600 and carriage outward and freight paid
` 700 chargeable from him were posted to sales expenses
account.
ep
(iii) Sales return by Yogeshwar ` 2300 was correctly recorded
in the sales return book from where they were debited to
rR
Yogeshwar's account by ` 32.
(iv) Old furniture originally purchased for ` 1800 written

down to ` 1100 was sold for ` 1700 and was credited to
furniture account.
t fo
(v) Machinery purchased on credit ` 17000 was recorded in

purchases book and transport charges for the machine `
1200 were debited to trade expenses account.
No
13. From the following transactions, pass journal entries, prepare

ledger accounts and also prepare Trial Balance under:
`
1. Anil started business with 8,000

S,
2. Purchased furniture 1,000

3. Purchased goods 6,000
PE
4. Sold goods 7,000

5. Purchased from Raja 4,000
6. Sold to Somu 5,000
U
7. Paid to Raja 2,500

8. Received from Somu 3,000
(c)
9. Paid rent 200

10. Received commission 100
ale
Further Readings 135
Notes
Books ___________________
n/S
T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New ___________________
Delhi.
___________________
___________________
Chand, New Delhi.
tio
___________________
___________________
uc
___________________
New Delhi. ___________________
rod
___________________
Web Readings
___________________
http://www.cliffsnotes.com/study_guide/The-Trial-
ep
Balance.topicArticleId-21081,articleId-21014.html
http://www.futureaccountant.com/accounting-process/study-
notes/trial-balance.php
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http://www.lapasserelle.com/online_courses/accounting/from_trial_
balance_to_balance_sheet/index.html
t fo
No
S,
U PE
(c)
Business Accounting
ale
136
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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t fo
No
S,
U PE
(c)
UNIT 9: Financial Statements
ale
Unit 9
137
Notes
Activity
Financial Statements
___________________
n/S
showing the meaning and
___________________
persons interested in financial
statements.
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning of Financial Statements ___________________

\ Final Accounts with Adjustments
uc
___________________
\ Manufacturing Account
___________________
\ Balance Sheet
rod
___________________
___________________
Introduction
In the present unit, you will study about the final accounts with
ep
adjustments. After studying this unit, you will be able to
understand the trading and profit and loss account, balance sheet
and key adjustments related to them. Every organisation prepares
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its final accounts after a particular period to know its financial

results and financial position. Final accounts mean profit and loss
account and the balance sheet. Profit and loss account also
contains one more account, known as trading account, and if the
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business is manufacturing any item or article, then Manufacturing

account is also there. All these accounts are prepared only after
preparing trial balance.
No
Meaning of Financial Statements

Financial statements mean (i) Balance sheet, (ii) profit and loss
account, and (iii) several other schedules. Now-a-days one more
S,
statement is also prepared that is funds flow statement or cash

flow statement.
PE
Whatever business activities are done, it is essential to know its

operational results i.e. whether business is running at profit or
loss, for this purpose balances of all ledger accounts are taken and
U
a statement of balances is prepared which is known as trial

balance. Final accounts are prepared from such balances.
(c)
Therefore, it is necessary to know the meaning and object of final

accounts.
Business Accounting
ale
138
Final accounts mean profit and loss account and the balance sheet.
Notes
Profit and loss account also contains one more account, known as
___________________
trading account, and if the business is manufacturing any item or
n/S
___________________ article, then Manufacturing account is also there. All these
___________________ accounts are prepared only after preparing trial balance.
___________________ Objective of Preparing Final Accounts
tio
___________________ There are two objectives of preparing Final accounts- 1) know the
___________________ operational results i.e. profit or loss during a particular period
through the profit and loss account which is also known as income
uc
___________________
statement, and 2) ascertain the financial position of the business
___________________
on a particular date through the balance sheet, also known as
___________________ position statement.
rod
___________________
Persons Interested in Financial Statements
There are two types of persons interested in financial statements—
1. Internal users and 2. External users.
ep
1. Internal Users: These are a) Shareholders, b) Management,
and c) Trade unions employees etc.
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a. Shareholders are very much interested in the financial

statements. They are very much interested in the welfare
of the business. They can know the operational results
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through such financial statements and the financial

position of the business along with the earning capacity of
the business.
b. Management is interested to take important decisions
No
relating to fixing up the selling prices and making future

policies.
c. Trade unions and employees are interested to know the
operational results because their bonus etc. is dependent
S,
on the profit earned by the business. Financial Statements

also help in their negotiations for wages/salaries.
PE
2. External Users: There are number of persons interested in

financial statements. They are termed as external users. The
following are most important external users of financial
U
statements.
3. Investors: They are interested to know the earning capacity of
(c)
business which can be known through financial statements.

ale
They can also know the financial soundness of the business 139
through financial statements. Notes
Activity
4. Creditors, Lenders of Money etc: The creditors and lenders Find___________________
out the requirement of
n/S
Schedule VI (Part I&II) of the
of money etc. can also know the financial soundness through ___________________
Companies Act, 1956 in
financial statement. They have to see two things (i) Regularity respect of:
___________________
of income and (ii) solvency of the business so that their (i) Fixed Assets
investment is risk free. ___________________
(ii) Investments
tio
5. Government: Government is interested to formulate laws to (iii) ___________________
Turnover
regulate business activities and also law relating to taxation (iv) ___________________
Contingent Liabilities
etc. Financial statements help while computing National (v) ___________________
Debtors
uc
Income statistics etc.
___________________
6. Taxation authorities: Financial Statements provide
rod
___________________
information relating to operational results as well as financial
___________________
position of the business. Tax authorities decide the amount of
tax as per financial statement. It is very useful to other
taxation authorities such as sales tax etc.
ep
7. Stock Exchange: Stock Exchange is meant for dealing in
share/securities. Purchase and sale of such shares and
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securities are possible through stock exchanges which provide

financial information about each company which is listed with
them.
Thus, we see that financial statements are very helpful and useful.
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Check Your Progress

Fill in the blanks:
No
1. ……………….. mean profit and loss account and the

balance sheet.
2. There are two types of persons interested in financial
statements—(a) ……….. users and (b) ………………..
S,
users.
PE
Final Accounts with Adjustments

Final accounts are prepared from the various balances depicted by
the Trial Balance. Some balance of the Trial Balance accounts are
U
used to prepare the Trading Account and some for the preparation
of the Profit and Loss Account and the remaining balances are
(c)
transferred to the Balance Sheet. Thus all the balances of accounts

Business Accounting
ale
140 of the Trial Balance are used in the final accounts. Therefore the
Notes preparation of final accounts is the final stage of accounting.
___________________
Trading and Profit & Loss Account
n/S
___________________
In the Trading and Profit & Loss Account all those accounts are
___________________
disclosed which affect the profit or loss of the business. In other
___________________ words all the nominal accounts of the Trial Balance are used to
tio
___________________ prepare the Trading and Profit & Loss Account. In the left hand
side, all the expenses incurred during a period and in the right
___________________
hand side all the incomes earned during a period are disclosed.
uc
___________________ This account contains two parts:
___________________
z Trading Account
___________________
rod
z Profit & Loss Account
___________________
Trading Account
Trading account is the comparison of sales and purchase. This
ep
account is prepared to determine the amount of gross profit or
gross loss on sales. The proforma of Trading Account is given
below:
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Proforma of Trading Account

IN THE BOOKS OF …………….
Trading Account
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(for the year ending …………….)
Particulars Dr. Particulars Cr.

Amount Amount
(`) (`)
To Opening Stock ------- By Sales ----------
No
To Purchases --------- Less : Returns ---------- -------

Less: Returns --------- ------- By Closing stock -------
To Wages & Salaries ------ By Gross Loss (if any)
To Carriage Inwards ------- Transferred to P/L A/c -------
To Cartage ------
To Frieght -------
To Light Power & Heating in
S,
factory ------
To Factory Insurance -------
To Works Manager’s Salary ------
PE
To Foreman’s Salary -------

To Factory Rent & Taxes ------
To Motive Power -------
To Factory Repairs ------
To Factory Expenses -------
To Octroi duty ------
U
To Custom Duty -------

To Manufacturing Exps. ------
To Consumable Stores -------
(c)
To Gross Profit ------

Transferred to P/L A/c. -------
------ -------
ale
Note: 141
Notes
z There is no particular proforma of the Trading Account. The
___________________
above proforma given is traditional one. That is not as per law.
n/S
Here the students are advised to follow this proforma. ___________________
z If the total of credit side is more than the total of debit side, ___________________
difference is called gross profit or vice versa gross loss. ___________________
tio
Illustration ___________________
From the following information, calculate the stock at the end: ___________________
uc
___________________
`
Opening stock 62,000 ___________________
Purchases 4, 20,000
rod
___________________
Sales 6, 00,000
___________________
1
Rate of Gross Profit on Cost = 33
3
Solution
ep
1
Gross profit on cost = 33
3
rR
1
33
Hence Gross profit on Sales = 3 = 1 or 25%
1 4
133
t fo
Trading Account
(for the year ended………)
Particulars Rs. Particulars Rs.

No
To opening stock 62,000 By sales (given) 6,00,000

To purchases 4,20,000 By closing stock
To gross profit (Balancing figure) 32,000
1 1,50,000
On cost 33 % or
S,
25% on sales which is Rs. 6,00,000

PE
6,32,000 6,32,000
Thus, we can say that the value of stock at the end was ` 32,000.
U
Profit & Loss Account

(c)
Profit & Loss Account is the second part of Trading and Profit &
Loss Account. Trading Account depicts the gross profit which is the
Business Accounting
ale
142 difference of sales and cost of sale. Thus the gross profit cannot
Notes treated as net profit while the businessman wants to know how
___________________ much net profit he has earned from the operating activities during
a period. For this purpose Profit & Loss Account is prepared
n/S
___________________
keeping in mind all the operating and non-operating incomes and
___________________
losses of the business. In the debit (left hand side) side all the
___________________ expenses and losses are disclosed and in the credit side (right hand
tio
___________________ side) all the incomes are disclosed. The excess of credit side over
debit side is called net profit while the excess of debit side over
___________________
credit side shows net loss. Net profit increases the net worth of the
business; therefore, it is added to the capital of owner. Net loss
uc
___________________
___________________ decreases the net worth of business so it is subtracted from capital.

___________________
The proforma of Profit & Loss Account is given below:
rod
___________________ Proforma of Profit & Loss Account
ep
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t fo
No
S,
U PE
(c)
Contd…
ale
143
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
Illustration
___________________
Compute operating profit and net profit from the following
rod
___________________
information:
___________________
Particulars `. Particulars `
Gross profit 2,50,000 Donation 4,250
Salaries 77,000 Rent received 2,300
Advertizing 4,000 General Expenses 550
Rent and taxes 26,500 Interest on investment 4,300
ep
Insurance charges 3,720
Audit fee 2,700
Carriage outward 1,210
Loss on sale of plant 3,100
Printing and stationery 1,100
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Interest on loans 15,000

Loss by theft 12,500
Profit on sale of Machinery 41,000
Solution:
t fo
Statement showing operating profit & Net profit

Particulars ` `.
Gross Profit 2,50,000
Less
Office and administrative expenses
Salaries 77,000
No
Rent and taxes 26,500

Insurance charges 3,720
Audit fee 2,700
Printing and stationery 1,100
General expenses 550 1,11,570
Less
Selling and distributive expenses 1,210
S,
Carriage outwards 4,000 5,210 -1,16,780
Advertising 1,33,220
Operating profit
Add-
PE
Non operating Income-

Interest on investments 4,300
Rent received 2,300
Profit on sale of Machinery 41,000 47,600 +47,600
Less 1,80,820
Non operating expense-
U
Interest on loans 15,000

Loss on sale of plant 3,100
Donations 4,250
Loss by theft 12,500 34,850 – 34,850
(c)
Net profit 1,45,970

Business Accounting
ale
144 In case of Net loss reverse entry is to be passed i.e.
Notes
Capital a/c (Net loss) Dr.
___________________ To profit and loss a/c
n/S
Net loss transferred
___________________
___________________ Illustration:
___________________ Following is the trial balance of R. Prasad on 30 June 2012.
tio
___________________ Dr. Cr.
Particulars ` `
___________________ Capital - 15,000
Purchases 20,000 -
uc
___________________ Sales - 30,000
Wages 1,200 -
___________________ Furniture 800 -
Salaries 900 -
Traveling Expenses 700 -
___________________
rod
Commission 300 -
Cash in hand 1,000 -
___________________ Cash at Bank 3,400 -
Buildings 16,000 -
Debtors & Creditors 4,500 4,000
Bills Payable & Bills Receivable 600 800
Telephone 100
ep
Returns 500 200
50,000 50,000
On 30th June 2012 stock was valued at ` 7,500. Prepare Trading

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and Profit and Loss account for the year ended on 30th June 2010
Solution:
t fo
Trading and Profit and Loss account of Mr. R. Prasad

(for the year ended on 30th June 2012)
To Purchases 20,000 By sales 30,000
-Returns 200 19,800 -Returns 500 29,500
No
To Wages 1,200 By Closing stock 7,500

To Gross Profit c/d 16,000
37,000 37,000
To Salaries By Gross profit b/d
To Travelling Expenses 900 16,000
To Commission 700
To Telephone 300
S,
To Net Profit 100

14,000
16,000 16,000
PE
Manufacturing Account
If in the business some goods are being manufactured along with
the trading activities, a manufacturing account is also prepared. In
U
the case of trading activities (selling and purchasing of goods) only,

the Trading and Profit and Loss Account is prepared to compute
(c)
the net profit which is discussed in the preceding pages. In case

ale
there is a manufacturing unit in the business with the trading, 145
such a businessman's income statement will include: Notes
(i) Manufacturing Account ___________________
n/S
(ii) Trading Account ___________________
___________________
(iii) Profit and Loss Account
___________________
Manufacturing Account is prepared to know the results of
tio
manufacturing unit i.e. cost of production. This account is prepared ___________________
before the trading account. The balance of this account is ___________________
transferred to Trading Account. The proforma of Manufacturing
uc
___________________
Account is given hereunder:
___________________
Pro forma of Manufacturing Account
rod
___________________
(for the year ending ………) ___________________
ep
To Opening Stock By Closing Stock
Raw Materials -------- Raw Materials ------
Work-in-progress -------- ---- Work-in-progress ------ ----
To Purchase of materials ----- By Sale of Scrape ----
rR
Less returns ----- ---- By Cost of Production (Transferred ----

To Manufacturing Wages ---- to Trading A/c)
To Carriage Inwards ----
To Factory Expenses ----
To Stores Consumed ----
t fo
To Factory Rent ----

To Electricity ----
To Depreciation on Plant ----
To Repairs of Plant ----
To Works Manager’s Salary ----
To Coal and Fuel ----
No
To Other Factory exps. ----

---- -----
Illustration (Manufacturing, Trading and Profit & Loss A/c)

From the following particulars of Mr. Amit Agrawal, prepare a
S,
Manufacturing Account, Trading and Profit and Loss Account for

the year ended 31st March, 2012.
PE
`
Purchase of Raw Material 39,58,500
Return Inwards 21,000
U
Stock on 31st March, 2010:

Raw Materials 3,63,000
(c)
Work-in-Progress 3,00,000
Finished Goods 4,11,000
Business Accounting
ale
146 Productive Wages 6,00,and 000
Notes Factory Expenses 5,52,000
___________________ General Office Expenses 90,000
n/S
___________________ Salaries 1,80,000
Distribution Expenses 30,000
___________________
Selling Expenses 2,10,and 000
___________________
Purchase Expenses 1,80,000
tio
___________________
Export Duty 90,000
___________________
Import Duty 60,000
uc
___________________ Interest on Bank Loan 1,80,000
___________________ Stock on 1st April, 2009:
___________________ Raw Material 1,20,000
rod
___________________ Work-in-Progress 90,000
Finished Goods 1,23,000
Sales 58,50,000
ep
Return Outwards 25,500
Carriage Inwards 31,500
Discount allowed 3,000
rR
Sale of Scrap 6,000

Depreciation on Plant 1,50,000
Depreciation on Furniture 12,000
t fo
Solution:
(for the year ending 31st march, 2012)
No
To Opening Stock
Materials 1,20,000 By Sale of Scrap 6,000
Work-in-Progress 90,000 By Closing Stock:
To Purchase less Returns Materials 3,63,000
S,
(39,58,500- 25,500) 39,33,000 Work-in-Progress 3,00,000

To Productive Wages 6,00,000 By Cost of Production
To Factory Exps 5,52,000 (Transferred to Trading A/c) 50,76,000
To Purchase Exps. 1,80,000
PE
To Import Duty 60,000

To Carriage Inwards 30,000
To Depreciation on Plant 1,50,000
To Repairs to Machines 30,000
57,45,000 57,45,000
U
(c)
ale
Trading and Profit & Loss Account 147
(for the year ending 31st march, 2012) Notes
Activity
Particulars Amount Particulars Amount List___________________
the five items which
` `
n/S
appear in the liability side of
the___________________
Balance Sheet of a
To Opening Stock of Finished By Sales less Returns
Goods 1,23,000 (58,50,000 – 21,000) 58,29,000 company.
___________________
To Cost of Production By Closing Stock 4,11,000
(Transfer from Manufacturing
A/c)
___________________
tio
50,76,000
To Gross Profit c/d
10,41,000 ___________________
62,40,000 62,40,000
90,000 By Gross Profit b/d 10,41,000 ___________________
To General Office Exps.
1,80,000
uc
To Salaries
___________________
To Depreciation on Furniture 12,000
To Discount Allowed 9,000
___________________
To Carriage Outwards 25,500
To Interest on Bank Loan 1,80,000
rod
___________________
To Export Duty 90,000
To Selling Expenses 2,10,000 ___________________
To Distribution Expenses 30,000
Not Net Profit (Transferred to
Capital A/c.) 2,14,500
10,41,000
ep
10,41,000
Check Your Progress

rR
Fill in the blanks:

1. In the …………………………all those accounts are
disclosed which affect the profit or loss of the business.
t fo
2. …………………..is the comparison of sales and purchase.

3. …………………..is prepared to know the results of
manufacturing unit i.e. cost of production.
No
Balance Sheet
After the determination of the net profit of the business through
the Trading and Profit and Loss Account, the businessman wants
S,
to know the financial position of the business. For this purpose he

prepares a statement which is called the Balance Sheet. The
PE
Balance Sheet depicts the financial position of the business on a

fixed date. Balance Sheet is prepared with those balances of Trial
Balance which are left out (personal and real accounts) after
U
taking out the nominal accounts' balances to prepare the Trading

and Profit and Loss Account. A Balance Sheet has two sides–assets
(c)
side and liabilities side. The assets and liabilities are shown in a
particular order.
Business Accounting
ale
148 Definition of Balance Sheet
Notes
1. "The Balance Sheet is a statement at a given date showing on
___________________
one side the traders' property and possessions and on the other
n/S
___________________ hand his liabilities".
___________________ - Palmer
___________________ 2. "Balance Sheet is a screen picture of the financial position of a
tio
___________________ business at a certain moment."
___________________ - R. Stead
3. "Balance Sheet is a list of balances in the assets and liability
uc
___________________
___________________ accounts. This list depicts the position of assets and liabilities
of a specific business at a specific point of time".
___________________
rod
- American Institute of Certified Public Accountants
___________________
Marshalling of Assets and Liabilities

Order of presenting the assets and liabilities in the Balance Sheet
ep
is called marshalling of assets and liabilities. A Balance Sheet may
be prepared by marshalling the assets and liabilities in the
following orders:
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(a) Balance Sheet prepared in Liquidity Order: Here liquidity

means conversion of assets into cash. When a Balance Sheet is
prepared on the basis of liquidity order, more easily
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convertible assets into cash are shown first and those assets
which cannot be easily converted into cash are shown later and
so on. In the case of liabilities, first those liabilities are shown
which are payable earlier and then those liabilities are shown
No
which are payable later. The proforma of such a Balance Sheet

is given below:
Proforma of Balance Sheet in Order of Liquidity

S,
(as on ………………….. )
Liabilities Amount Assets Amount
` `
PE
Current Liabilities Current Assets

Sundry Creditors ------ Cash in Hand ------
Bank Overdraft ------ Cash at Bank ------
Short-term Loan ----- Short-term Investment ------
Outstanding Expenses ----- Prepaid Expenses ------
U
Unaccrued Income ----- Bills Receivable ------

Bills Payable ----- Accrued Incomes ------
Long-term Liabilities Debtors ------
Capital ------- Closing Stock ------
(c)
+ Net Profit ------- Fixed Assets

------- Land & Building -----
- Drawings ------- ----- Plant & Machinery -----
Contd…
ale
Long-term Loans ----- Furniture ----- 149
Contingent Liabilities Investments (Long-term) -----
-------- Goodwill ------ Notes
-------- Patents & Trademarks ------
Livestock ------ ___________________
n/S
------- -------
___________________
(b) Balance Sheet prepared in Permanency Order: Balance ___________________
Sheet prepared under this order is the reverse of the Balance
___________________
Sheet prepared in liquidity order. In this case first those assets
tio
are shown which are more permanent means fixed assets and ___________________
then less permanent assets (Current Assets) are shown. ___________________

Similarly, first long-term liabilities (more permanent) are
uc
___________________
shown then less permanent (short-term on current) liabilities
___________________
are shown. The proforma of such type of Balance Sheet is
given below:
rod
___________________
Proforma of Balance Sheet in Permanency Order ___________________
(as on ……………. )
ep
` `
Long-term Liabilities Fixed Assets

Capital ------ Land & Building -----
+ Net Profit ------ Plant & Machinery -----
rR
------ Furniture -----

- Drawings ------ ------ Long-term Investment -----
Long-term Loans ------ Goodwill -----
Current Liabilities Patents & Trademarks -----
Sundry Creditors ------ Livestock etc. -----
Bank Overdraft ------ Current Assets
Bill Payable ------ Cash in Hand -----
t fo
Short-term Loan ------ Cash in Bank -----

Outstanding Expenses ------ Short-term Investments -----
Unaccrued Incomes ------ Bill Receivable -----
Prepaid Expenses -----
Accrued Incomes -----
Debtors -----
Closing Stock -----
No
------ -----
Illustration (Manufacturing, Trading and Profit and Loss

Account and Balance Sheet)
From the following Trial Balance of Mr. Aditya, prepare a Trading
S,
Manufacturing and Profit and Loss Account and Balance Sheet as

on 31st December, 2012.
PE
Trial Balance
(as on 31 December, 2012)
Amount Amount
U
Particulars
` `
(c)
Stock on 1.1.2007:
Raw Materials: 8,000 ---
Work-in-Progress 20,000 ---
Contd…
Business Accounting
ale
150
Finished Goods 40,000 ---
Notes Manufacturing Wages 40,000 ---
Purchases of Raw Materials 1,20,000 ---
___________________
Factory Rent 20,000 ---
n/S
___________________ Carriage of Raw Materials 12,000 ---
Salary of the Works Manager 8,000 ---
___________________ Office Rent 8,000 ---
Printing and Stationary 4,000 ---
___________________ Bad Debts 4,000 ---
tio
Sales --- 2,40,000
___________________
Land and Buildings 1,20,000 ---
___________________ Plant and Machinery 80,000 ---
Depreciation on Plant 8,000 ---
uc
___________________ Sundry Debtors 20,000 ---
Sundry Creditors --- 1,20,000
___________________ Cash in Hand 20,000 ---
Capital --- 1,72,000
___________________
rod
5,32,000 5,32,000
___________________
Closing stock on 31st December, 2012 were as follows:
`
ep
Raw Materials 20,000
Work-in-Progress 16,000
Finished Goods 40,000
Solution:
rR
In the Books of Mr. Aditya

(for the year ended 31 December, 2012)
t fo
To Opening Stock: By Closing Stock:
To Raw Materials 8,000 By Raw Material 20,000
To Work-in-Progress 20,000 28,000 By Work-in-Progress 16,000 36,000
No
To Purchase of Materials 1,20,000 By Cost of Production

To Carriage on Raw Materials 12,000 (Transfer to Trading A/c.) 2,00,000
To Depreication on Plant 8,000
To Manufacturing Wages 40,000
To Factory Rent 20,000
To Salary of Works Manager 8,000
S,
2,36,000 2,36,000

PE
(for the year ending 31st December, 2012)
Particulars Amount Amount

` `
To Opening Stock: By Sales

U
Finished Goods By Closing Stock 2,40,000

To Cost of Production 40,000 Finished Goods
2,00,000 40,000
(c)
(Transfer from Manufacturing A/c)

To Gross Profit
Contd…
ale
(carried to P. & L. A/c)
151
40,000
Notes
To Office Rent 2,80,000 By Gross Profit (brought 2,80,000
To Printing & Stationary 8,000 from Trading A/c) ___________________
n/S
To Bad Debts 4,000 40,000
4,000 ___________________
To Net Profit (carried to Capital A/c)
___________________
24,000
40,000 40,000 ___________________
tio
Balance Sheet ___________________
(as on 31st December, 2012) ___________________

uc
` ` ___________________
Capital 1,72,000 Land and Buildings 1,20,000

___________________
+ Net Profit 24,000 1,96,000 Plant and Machinery 80,000
rod
Sundry Creditors 1,20,000 Sundry Debtors 20,000 ___________________
st
Stock on 31 Dec., 2007:
Raw Materials 20,000 ___________________
Work-in-Progress 16,000
Finished Goods 40,000
Cash in Hand 20,000
3,16,000 3,16,000
ep
Adjustment Entries
rR
Final accounts are prepared from the balances of Trial Balance.

The final account will show the true and proper picture of the
business only when all the transactions of the business are
properly recorded. Therefore, before the preparation of final
t fo
accounts the accountant must see that all the transactions of the
current year have been recorded properly in the books or not. If the
accountant finds that some transactions are not incorporated in
the books or wrongly incorporated in books or partially
No
incorporated in books, to complete the records and rectifying the

errors done, some adjustments are done. These adjustments
entries are made in accounts through passing the adjustment
entries. Usually adjustment entries are made in the books before
S,
preparing the final accounts for the following items:
(1) For Outstanding Expenses of the business

PE
Relating Expenses Account Dr.

To Outstanding Expenses Account
U
The outstanding expenses at the time of preparation of final

account are shown in the liability side and on the other hand it
(c)
is added in the relating expenses in the Trading and Profit &

Loss Account.
Business Accounting
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152
Notes (2) For Prepaid Expenses of the Business
___________________ Prepaid Expenses Account Dr.
n/S
___________________ To Relating Expenses Account
___________________
The prepaid expenses are disclosed in the assets side of the
___________________ Balance Sheet and subtracted from the relating expenses in
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___________________ the debit side of Trading and Profit & Loss Account.
___________________ (3) For Accrued Incomes of the Business
uc
___________________
Accrued Income Account Dr.
___________________
To Relating Income Account
___________________
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The accrued incomes are disclosed in the assets side of the
___________________
Balance Sheet and showed in the credit side of the Trading
and Profit & Loss Account.
(4) For Unaccrued Incomes of the Business

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Relating Income Account Dr.
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To Unaccrued Income Account
Unaccrued incomes are disclosed in the liability side of the

Balance Sheet and subtracted from the relating incomes in the
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credit side of the Trading and Profit & Loss Account.
(5) For the Depreciation on Assets
Depreciation Account Dr.

No
To Relating Assets Account
Depreciation is subtracted from the relating assets in the

assets side of the Balance Sheet and disclosed in the debit side
of Trading and Profit & Loss Account.
S,
(6) Interest on Capital and Drawings:

PE
(i) For Interest on Capital
Interest on Capital Account Dr.

U
To Capital Account
Interest on Capital is added to the capital of owner in the

(c)
liabilities side of the Balance Sheet and disclosed in the

debit side of the Trading and Profit & Loss Account.
ale
153
(ii) For Interest on Drawings
Notes
Drawings Account Dr. ___________________
n/S
To Interest on Drawings Account ___________________
Interest on Drawings is subtracted from the amount of capital ___________________
along with the drawings and also shown in the credit side of ___________________
tio
Trading and Profit & Loss Account. ___________________
(7) Interest on Loan and Investments: ___________________
uc
(i) For Interest on Loan Payable ___________________
___________________
Profit & Loss Account Dr.
rod
___________________
To Interest on Loan Account
___________________
Interest on Loan payable is added to the amount of Loan
in the liability side of the Balance Sheet and also shown in
the debit side of Profit & Loss Account.
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(ii) For Interest on Investment Receivable
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Interest on Investment Account Dr.
To Profit & Loss Account
Interest on Investment Receivable is added to investment in

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the assets side of the Balance Sheet and also shown in the
credit side of Profit & Loss account.
8. For Bad Debts

No
Bad Debts Accounts Dr.
To Sundry Debtors Account
Bad Debts are deducted from the sundry debtors in the assets
S,
side of the Balance Sheet and shown in the debt side of Profit
and Loss Account.
PE
9. For Provision for Bad and Doubtful Debts
(i) When the provision is created:

U
To Provision for Bad and Doubtful Debts Account

(c)
Business Accounting
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154
Such a provision is subtracted from the debtors in the
Notes
assets side of Balance Sheet and also shown in the debt
___________________
side of Profit and Loss Account.
n/S
___________________
(ii) When Bad Debts are written off against the Provision
___________________
for Bad and Doubtful Debts :
___________________
Provision for Bad and Doubtful Debts Account Dr.
tio
___________________
To Bad Debts Account
___________________
(iii) When excess amount of the provision is transferred:
uc
___________________
___________________
Provision for Bad and Doubtful Debts Account Dr.
___________________ To Profit & Loss Account
rod
___________________ 10. For Discount Provision on Debtors
(i) When the provision for discount on debtors is created:

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To Provision for Discount on Debtors Account
Provision for discount on Debtors is subtracted from

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Sundry Debtors in the assets side of Balance Sheet and

shown in the debit side of Profit and Loss Account.
(ii) When the amount of discount is written off against the

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Provision for Discount Account:
Provision for Discount on Debtors Account Dr.
To Discount on Debtors Account

No
(iii) When excess amount of provision is transferred:
Provision for Discount on Debtors Account Dr.
To Profit and Loss Account

S,
11. For Discount Provision on Creditors

PE
(i) When provision for discount on creditors is created:
Provision for Discount on Creditors Account Dr.

U
To Profit and Loss Account
Provision for discount on creditors is deducted from

(c)
Creditors in the liability side of Balance Sheet and shown

in the Credit side of Profit and Loss Account.
ale
155
(ii) When discount on creditors is written off against the
Notes
provision:
___________________
Discount on Creditors Account Dr.
n/S
___________________
To Provision for Discount on Creditors Account
___________________
Illustration (Final Accounts with Adjustment)
___________________
Prepare final accounts from the following balances of Mr. Ankit as
tio
___________________
on 31st December, 2012.
___________________
Extracts of Balances
uc
___________________
As on 31st December, 2012
Debit Balances ` Credit Balances ` ___________________
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Drawings 45,000 Capital Account 6,09,000 ___________________
Goodwill 90,000 Bills Payable 41,400
Land and Building 1,80,000 Sundry Creditors 91,500
___________________
Plant and Machinery 1,20,000 Purchase Returns 7,950
Loose tools 9,000 Sales 3,45,000
Bills Receivable 6,000
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Stock 1.1.2007 1,20,000
Purchase 1,53,000
Wages 60,000
Carriage Inwards 3,600
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Carriage Outwards 4,500

Coal and Gas 16,800
Salaries 12,000
Rent, Rates and Taxes 8,400
Discount allowed 4,500
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Cash at Bank 75,000

Cash in Hand 4,200
Sundry Debtors 1,35,000
Repairs 5,400
Printing and Stationery 1,500
Bad Debts 3,600
No
Advertisments 10,500
Sales Returns 6,000
Furniture and Fittings 3,600
General Expenses 15,750
Adjustments
S,
(a) Closing stock on 31st December, 2007 was `1,80,and 000.
(b) Depreciate Plant and Machinery at 5%, Loose Tools at 15%

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and Furniture and Fittings at 5%.

(c) Provide 21/2% for Discount on Sundry Debtors and Creditors
and 5% for Bad and Doubtful Debts.
U
(d) Outstanding Wages `4,500 and Rent and Taxes `2,550.

(c)
Business Accounting
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156 Solution:
Notes
In the Book of Mr. Ankit
___________________
n/S
___________________ (for the year ending on 31st December, 2012)
Particulars Amount Particulars Amount
___________________ ` `
___________________ To Opening Stock 1,20,000
tio
To Purchases Less Returns By Sales Less Returns 3,39,000
___________________ (Rs.1,53,000 – 7,950) 1,45,050 (Rs.3,45,000 – 6,000) 1,80,000
Wages 60,000 By Closing Stock
___________________ + O/s Wages 4,500 64,500
To Carriage Inwards 3,600
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___________________ To Coal and Gas 16,800
To Gross Profit C/d 1,69,050
___________________ 5,19,000 5,19,000
To Carriage Outwards 4,500 1,69,050
___________________ To Salaries 12,000 By Gorss Profit b/d
rod
To Rent, Rates & Taxes 8,400 By Reserve for Discount on 2,250
1
+ Outstanding 2,550 10,950 Creditors @2 /2%
___________________
To Discount Allowed 4,500
To Repairs 5,400
To Printing & Stationary 1,500
To Bad Debts 3,600
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+ New Provision (D/D) 6,750
10,350
+ Provision for Discount 3,206 13,556
To Advertisement 10,500
To General Expenses 15,750
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To Depreciation on:
Plant & Machinery 6,000
Loose tools 1,350
Furniture & Fittings 180 7,530
To Net Profit
(transferred to Capital A/c) 85,114
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1,71,300 1,71,300
Balance Sheet
(as on 31st December, 2012)
Amount Amount
No
Liabilities Assets
` `
Capital 6,09,000 Goodwill 90,000

Add: Net Profit 85,114 Land & Buildings 1,80,000
6,94,114 Plant & Machinery 1,20,000
S,
Less: Drawings 45,000 6,49,114 Less: Depreciation 6,000 1,14,000

Bills Payable 41,400 Furniture & Fittings 3,600
Creditors 90,000 Less: Depreciation 180 3,420
Less: Provision for Loose Tools 9,000
PE
Discount 2,250 87,750 Less: Depreciation 1,350 7,650

Outstanding Wages 4,500 Sundry Debtors 1,35,000
Outstanding Rent 2,550 Less: Prov. for D/D 6,750
1,28,250
Less: Prov. for
U
Discount 3,206 1,25,044

Bills Receivable 6,000
Closing Stock 1,80,000
(c)
Cash in Hand 4,200

Cash at Bank 75,000
7,85,314 7,85,314
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157
Check Your Progress
Notes
Fill in the blanks:
___________________
1. The ………………….. will show the true and proper
n/S
___________________
picture of the business only when all the transactions of
the business are properly recorded. ___________________
___________________
2. ………………….. prepared under this order is the
tio
reverse of the Balance Sheet prepared in liquidity order. ___________________
3. Order of presenting the assets and liabilities in the ___________________

Balance Sheet is called ………………….. of assets and
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___________________
liabilities.
___________________
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___________________
Summary
___________________
Final accounts include the Trading and Profit & Loss Account and
Balance Sheet. Trading and Profit and Loss Account is prepared to
calculate the net profit earned by business during a period.
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Balance Sheet of a business is prepared to disclose the financial
picture of the business. The Trading Account shows the gross profit
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which is the difference of sales and cost of sales. Profit & Loss
Account shows the net profit which is computed by matching the
total revenues and expenses of the business.
Balance Sheet is a statement which has two sides - Liability side
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and Assets side. Before preparing the final accounts of the

business some adjustments are also done (if required).
No
Lesson End Activity

Prepare a Proforma of Balance Sheet in horizontal form as per
requirement of the Schedule VI of the Companies Act, 1956.
S,
Keywords
Trial Balance: It is the list of accounts taken from the ledger.
PE
Financial Statements: These include the Trading and Profit and

Loss Account, and Balance Sheet of the business.
U
Gross Profit: It is calculated by comparing the sales and cost of

sales. It is the excess of sales over cost of sales.
(c)
Gross Loss: It is the excess of cost of sales over sales.

Business Accounting
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158
Net Profit: It is the excess of revenues over expenses. It is
Notes
depicted by P. & L. A/c.
___________________
Net Loss: Excess of expenditures over revenues is called net loss.
n/S
___________________
___________________ Final Account: Final accounts include the Balance Sheet and
Profit & Loss Account.
___________________
Balance Sheet: The balance sheet of a company is a statement
tio
___________________
which shows the total value of assets owned and total of the
___________________ company's liabilities owed by of trading on a particular date or at
the end of trading period.
uc
___________________
___________________ Dividend: Dividend is that part of the profit which is divided

___________________ among the shareholders of the company.
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___________________
Preliminary Expenses: Cost of formulation of a company is
treated as preliminary expenses.

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1. What do you mean by errors? Which type of errors can not be
detected by Trial Balance? Explain.
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2. What do you mean by Trading Account? Give the proforma of

Trading Account and explain why it is prepared.
3. What is the importance of Balance Sheet? Give a form of
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Balance Sheet in Liquidity order with imaginary examples.

4. What do you mean by adjustment? Explain the different
adjustment entries.
No
5. From the following balances draw up a Trading and Profit and

Loss Account and Balance Sheet:
`
Amit Joseph's Capital 30,000
S,
Bank Overdraft 7,500

Machinery 20,100
Cash in hand 1,500
PE
Fixture & Fitting 8,250

Opening stock 67,500
Bills Payable 10,500
Creditors 60,000
U
Debtors 94,500
Bill receivable 7,500
Purchases 75,000
(c)
Sales 1, 93,500
Returns from customers 1,500
ale
Returns to Creditors 1,650 159
Salaries 13,500 Notes
Manufacturing Wages 6,000
Commission 8,250 ___________________
n/S
Trade Expenses 2,250
___________________
Discount (Cr.) 6,000
Rent 3,300 ___________________
The Closing Stock amounted to `78,000. ___________________
tio
6. The following balances are extracted on 31st March, 2012 from ___________________
the book of Mr. Rajesh Pratap. ___________________
` `
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4,90,000 1,57,600
___________________
Capital Loan
Drawing 40,000 Sales 13,07,200
General Expenses 50,000 Purchases 9,40,000 ___________________
Buildings 2,20,000 Motor Car 40,000
rod
Machinery 1,86,800 Prov. for Bad Debts 18,000 ___________________
Opening Stock 3,24,000 Commission (Cr.) 26,400
Coal and Power 44,800 Car Expenses 36,000 ___________________
Taxes and Insurance 26,300 Bills Payable 77,000
Wages 1,44,000 Cash in Hand 1,600
Debtors 1,25,600 Bank Overdraft 66,000
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Creditors 50,000 Donation 2,100
Discount (Dr.) 11,000
Prepare the Final Accounts for the year ending 31st March,
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2012, after taking into accounts the following adjustments:

a. Write off `3,200 for bad debts and make provision for Bad
debts @5% on debtors.
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b. Depreciate Machinery by 10% and Motor Car by 12%.

c. Interest `15,000 is outstanding of Loan.
d. It was decided to transfer `5,000 every year to charity

No
fund.
e. 1/3 of car expenses and depreciation amount is to be
transferred to owner's account.
f. Stock valued on 31st March, 2012 was ` 4,70,000.
S,
Further Readings
PE
Books
U
Delhi.
(c)
Chand, New Delhi.

Business Accounting
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160
Notes
___________________
n/S
___________________
New Delhi.
___________________
___________________
Web Readings
www.b-u.ac.in/sde_book/dip_fintally.pdf
tio
___________________
___________________
www.egyankosh.ac.in/bitstream/123456789/35031/1/Unit19.pdf
www.futureaccountant.com/final-accounts-financial-accounting/
uc
___________________
___________________ www.sgbau.ac.in/accounting-for-managers.pdf
___________________ http://www.cashiksha.com/Material/CPT/Quick%20Revision%20No
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___________________
tes/Accounts/Lecture%2011.%20Final_Accounts_Part_2.pdf
ep
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No
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(c)
UNIT 10: Case Study
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Unit 10
161
Notes
Case Study
___________________
n/S
___________________
___________________
Objectives
___________________
tio
___________________
uc
___________________
Case Study: Singania Charted Accountants Firm
___________________
Singania Charted Accountants Firm established in the year 1956,
has very good number of corporate clients. It continuously
rod
___________________
maintains quality in audit administration with the clients since
___________________
its early inception. The firm is eagerly looking for promising
students who are having greater aspirations to become auditors.
The firm has an objective of recruiting freshers to conduct
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preliminary auditing process with their corporate clients.
For this, the firm would like to select the right person who is
having conceptual knowledge as well as application on the
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subjects. It has given the following balance sheet to the

participants to study the conceptual applications. The
participants are required to enlist the various concepts and
conventions of accounting.
t fo
Balance Sheet
as on date 31st March 2012
Liabilities Assets
No
Capital(A.Pandit) 1,00,000 Building 80,0000

(+) Commission 4,925 Depreciation 2,000
2.5%
1,04,925 78,000
(+) Net profit 11,869 Furniture 23,000
1,16,794 Depreciation 2,050
S,
10%
(-) Drawings 16,000 20,950
1,00,794 Closing stock 1,14,500
Capital ( B.Pandit) 1,00,000 Sundry Debtors 25,000
PE
(+)Commission 1,187 Cash in hand 400

1,01,187
(+) Net profit 11,869
1,13,056
U
(-)Drawings 16,000 97,056

Bank overdraft 29,000
Sundry creditors 12,000
(c)
2,38,850 2,38,850
Contd…
Business Accounting
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162
Question:
Notes
1. List out the various accounting concepts dealt in the above
___________________
balance sheet.
n/S
___________________
2. Explain the treatment of accounting concepts.
___________________ Source: Pandikumar M P (2010). “Management Accounting: Theory and Practice”. Excel Books.
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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No
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(c)
UNIT 11: Managerial Remuneration
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163
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
rod
___________________
ep ___________________
BLOCK-III
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No
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(c)
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164
Notes
UNIT 11: MANAGERIAL REMUNERATION
___________________ UNIT 13: AMALGAMATION, ABSORPTION &
EXTERNAL RECONSTRUCTION
Introduction
n/S
z
___________________ z Introduction
z Meaning of Managerial Remuneration
___________________ z Amalgamation and Absorption of Companies
z Provisions Regarding Overall Maximum and
Minimum Limits
___________________ z Reconstruction of Companies
tio
z Remuneration to Directors
___________________ z Calculation of Purchase Consideration
z Remuneration to Manager
___________________ z Accounting Treatment
uc
___________________ UNIT 14: INTERNAL RECONSTRUCTION
UNIT 12: DIVIDENDS & DIVIDENDS
DECLARATION OUT OF PAST & CURRENT
___________________ z Introduction
PROFITS
___________________ z Reconstruction of Companies
rod
z Introduction
z Accounting Treatment for Reduction of Capital
___________________
z Disposal of Profit and Divisible Profits
z Dividends UNIT 15: CASE STUDY
Declaration of Dividend out of Capital Profit

ep
z
z Issue of Bonus Shares

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No
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U PE
(c)
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Unit 11
165
Notes
Activity
Make an honest assessment
Managerial Remuneration
___________________
of your organisation and
n/S
prepare a brief write up about
___________________
the managerial remuneration
___________________
in your organization.
Objectives
___________________
tio
topics: ___________________
\ Meaning of Managerial Remuneration ___________________

\ Provisions Regarding Overall Maximum and Minimum Limits
uc
___________________
\ Remuneration to Directors
___________________
\ Remuneration to Manager
rod
___________________
___________________
Introduction
The managerial personnel include the director, managing director
ep
and manager. The remuneration which is paid to these personnel
is called managerial remuneration. The provisions regarding the
maximum and minimum limits of the managerial remuneration
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are given in the Schedule XIII Part II of the Company Act. The
chapter discusses the provisions and methodology to compute the
managerial remuneration.
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Meaning of Managerial Remuneration

The remuneration which is paid to the managerial personnel
(directors, managing directors and managers) by the company is
No
called managerial remuneration. This remuneration is shown in

the debit side of profit and loss account of the company. Besides
salary, dearness allowance perquisites, commission and other
allowances, the managerial remuneration includes the following as
S,
per Section 198:

(a) expenditure incurred by the company in providing any rent-
PE
free accommodation, or any other benefits or amenity in

respect of accommodation free of charge,
(b) expenditure incurred by the company in providing any other
U
benefit or amenity free of charge or at a concessional rate,

(c) expenditure incurred by the company in respect of any
(c)
obligation or service which but for such expenditure by the

company, would have been incurred by them, and;
Business Accounting
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166
(d) expenditure incurred by the company to affect any insurance
Notes
on the life of, or to provide any pension, annuity, or gratuity
___________________
for any of the managerial personnel, or his spouse or child.
n/S
___________________
Managerial Personnel
___________________
The management and administration of a company is delegated to
___________________
the managerial personnel as per the provisions of the Company
tio
___________________ Act. The managerial personnel include the following personnel:
___________________
(a) Director: Directors are the representatives of the company.
They manage and control the company. Directors are also the
uc
___________________
___________________ trustees for the company's property. Therefore, it is their duty

to use company's property for its benefit alone. It is
___________________
rod
compulsory for every company to have a board of directors.
___________________ Board of directors is a group of directors. A contract signed by
the directors on the behalf of the company is binding on the
company and the concerned third party. If the directors use
ep
their reasonable care and skill to perform their duties and yet
the company suffers a loss, the directors will not be
responsible for such a loss. But if the loss is due to the
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negligence of directors and breach of trust, they must have to

compensate the loss suffered by the company. There can be
two types of directors in a company i.e. full-time director and
part-time directors. A whole-time director is not a new
t fo
category of managerial personnel. But a director who is in the

whole-time employment of the company is called a whole-time
director. Managing directors are also called the whole-time
directors. Part-time directors are those who devote part of
No
their time in the affairs of the company. There can be more

than one part-time director in a company.
(b) Managing Director: A company can have one or more than
one managing director. The board of directors may appoint one
S,
of themselves as the managing director of the company by

giving more powers to manage the company. According to
PE
Section 2(26) of the Companies Act, a managing director is a

director who (i) by virtue of an agreement with the company,
or (ii) of a resolution passed by the company in general
U
meeting, or (iii) by its board of directors, or (iv) by virtue of its

Memorandum or Articles of Association is entrusted with
(c)
substantial powers of management which would not otherwise

be exercisable by him and includes a director occupying the
ale
position of a managing director, by whatever name called. 167
Without unanimous approval of the board of directors, a Notes
Activity
managing director cannot manage more than one company at Give___________________
the main provisions of
a time.
n/S
Company Law regarding
___________________
managerial remuneration.
(c) Manager: There cannot be a manager and a managing
___________________
director both in a company. Like managing director, a
manager is also appointed by board of directors. His tenure ___________________
tio
cannot be more than five years at a time. According Section ___________________
2(24) of the Companies Act, a manager means a person who, ___________________
subject to the superintendence, controls and manages the
uc
___________________
company according to the direction of the board of directors,
has the management of the whole or substantially the whole of ___________________
the affairs of a company, and includes a director or any other
rod
___________________
person occupying the position of a manager by whatever name
___________________
called and whether under a contract of service or not. A
company cannot have more than one manager at a time. The
same disqualifications and restrictions will be applicable for
ep
the manager which exists for a managing director.
Check Your Progress

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Fill in the blanks:

1. The remuneration which is paid to these personnel is
called ………………….. .
t fo
2. ……………. are the representatives of the company.
Provisions Regarding Overall Maximum and

No
Minimum Limits
As per Section 198 of the Companies Act 1956, these are several
restrictions on the managerial remuneration. These are as below:
S,
Maximum Limit
The managerial remuneration of the managerial personnel (as
PE
director, manager and managing director) should not more than

11% of the net profit of that company as per Section 198 of the
Companies Act 1956. Any fees payable to the directors for
U
attending the meeting of board of directors will not be included in

the above ceiling of the remuneration. For this purpose the profit
(c)
of the company will be calculated as per Sections 349, 350 and 351
of the Companies Act.
Business Accounting
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168
Minimum Limit
Notes
In case a company has no profit or its profits are inadequate in any
___________________ financial year, the company will pay the minimum amount of
n/S
___________________ remuneration to the director, managing director, manager or
whole-time director. This minimum amount will vary from ` 75,000
___________________
to ` 2,00,000 p.m., which will depend on the effective capital of the
___________________
company as specified in Part II of Schedule XIII of the Companies
tio
___________________ Act as given below.
___________________
Schedule XIII, Part II
uc
___________________
Section I: Remuneration Payable by Companies having Profits–
___________________
Subject to the provisions of Sections 198 and 309, a company
___________________
rod
having profits in a financial year may pay any remuneration by
___________________ way of salary, dearness allowance, perquisites, commission and
other allowances, which shall not exceed 5% of its net profit for one
such managerial person and if there is more than one such
ep
managerial person, 10% for all of them together.
Section II: Remuneration payable by companies having no profit

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or inadequate profit:
Notwithstanding anything contained in this part, wherein any
financial year during the currency of tenure of the managerial
person, a company has no profits or its profits are adequate, it may
t fo
pay remuneration to a managerial person, by way of salary,

dearness allowance, perquisites and any other allowance, as per
scale prescribed in Part II which have been revised vide
notification GSR No. 215(E) dated 2-3-2000. These revised scales
No
are as below:
Where the effective capital of the company is Monthly salary

payable shall
not exceed
S,
(i) Less than ` 1 crore. ` 75,000

(ii) Rupees 1 crore or more but less than ` 5 crore. ` 1, 00,000
(iii) ` 5 crore or more but less than ` 25 crore. ` 1, 25,000
PE
(iv) ` 25 crore or more but less than ` 100 crore. ` 1, 50,000

(v) ` 100 crore or more. ` 2, 00,000
Explanation I: For the purpose of Section II of this Part,

U
"effective capital" means the aggregate of:

(i) Paid up share capital (excluding share application money or
(c)
advances against shares).

ale
169
(ii) Credit balance of share premium account.
Notes
(iii) Reserve and Surplus (excluding revaluation reserve).
___________________
n/S
(iv) Long-term loans and deposits repayable after one year
___________________
(excluding working capital, loans, overdrafts, interest due on
___________________
loans unless funded, bank guarantee etc., and other short-term
arrangements) as reduced by: ___________________
tio
(a) aggregate of any investments (except in the case of ___________________
investment by an investment company whose principal ___________________
business is acquisition of shares, stock, debentures, or
uc
___________________
other securities).
___________________
(b) accumulated losses not written off.
rod
___________________
(c) preliminary expenses not written off.
___________________
Explanation II:
(a) Where the appointment of the managerial person is made in

ep
the year in which the company has been incorporated, the
effective capital shall be calculated as on the date of such
appointment.
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(b) In any other cases, the effective capital shall be calculated as

on the last date of the financial year preceding the financial
year in which the appointment of managerial person is made.
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Perquisites
1. A managerial person shall be eligible to the following
perquisites which shall not be included in the computation of
No
the ceiling on the remuneration specified in the paragraph 1 of

this Section.
(i) Contribution to provident fund, superannuation fund or
annuity fund to the extent these either single or put
S,
together are not taxable under the Income Tax Act 1961.
(ii) Gratuity payable at a rate not exceeding half a month's
PE
salary for each completed year of service.

(iii) Encashment of leave at the end of the tenure.
U
Perquisites for expatriates

2. In addition to the perquisites specified in paragraph 2 of this
(c)
Section, an expatriate managerial person (including non-

resident Indians) shall be eligible to the following perquisites
Business Accounting
ale
170 which shall not be included in the computation of the ceiling
Notes on remuneration specified in paragraph 1 of this Section:
___________________
(a) Children's education allowance: In case of children
n/S
___________________ studying in or outside India, an allowance limited to a
___________________ maximum of ` 5,000 per month per child or actual
expenses incurred whichever is less. Such allowance is
___________________
admissible up to a maximum of two children.
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___________________
(b) Holiday passage of children studying outside India or
___________________ family studying abroad: Return holiday passage once in a
year by economy class or once in two years by first class to
uc
___________________
___________________
children and to the members of the family from the place
of their study or stay outside India, if they are not residing
___________________
in India with the managerial person.
rod
___________________
(c) Leave travel concession: Return passage for self and family
in accordance with the rules specified by the company
where it is proposed that the leave be spent in home
ep
country instead; anywhere in India.
Explanation: For the purpose of this part, family means the
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spouse, dependent children and dependent parents of the

managerial person.
Formula for Computation of Effective Capital `

Paid up Share Capital .................
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+ Credit balance of Premium A/c. (securities) .................

+ Reserve & Surplus (excluding Revaluation Reserve) .................
+ Long-term Loans and Deposit repayable after one year .................
Total .................
No
– Investments
Accumulated losses .................
Preliminary expenses ................. .................
Effective Capital .................
S,
Check Your Progress

Fill in the blanks:
PE
1. The managerial remuneration of the managerial

personnel should not more than ………………. of the net
profit.
U
2. In case a company has no profit or its profits are

inadequate in any financial year, the company will pay
(c)
the minimum amount of remuneration to ………………. .

ale
Remuneration to Directors 171
Notes
Activity
Remuneration to directors including managing directors, is
You___________________
determined either by the Articles of Association or by a resolution
n/S
or, if the articles so required, by a special resolution, passed by the ___________________
assignment on remuneration
company in general meeting subject to the provisions of the Section to directors.
___________________
309 of the Companies Act. Section 309 governs the remuneration of
___________________
directors, including managing directors or whole- time director of a
tio
public company and a private company which is a subsidiary of a ___________________
public company. Provisions of this section are as under: ___________________
(a) Remuneration to whole-time director or managing
uc
___________________
director: As per the provision of Section 309(3), a whole-time ___________________
director or a managing director may be paid remuneration
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___________________
either by way of a monthly payment or at a specified
percentage of the net profits of the company or partly by one ___________________
way and partly by the other. But except with the approval of
the Central Government, such remuneration shall not exceed:
ep
(i) 5% of the net profit for one whole-time or managing
director,
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(ii) 10% of the net profit for more than one whole-time
director.
(b) Remuneration of part-time directors: As per the provision
t fo
of Section 309(4) a part-time director (who is neither whole-

time nor managing director) may receive monthly, quarterly or
annual payment of remuneration with the approval of Central
Government or by way of commission, if a special resolution of
No
the company authorizes such payment. But except with the

approval of the Central Government, total remuneration shall
not exceed:
(i) 1% of the net profit of the company if the company has
S,
managing directors or whole- time directors or;

(ii) 3% of net profit of the company if the company has no
PE
manager, managing directors or whole-time director.

It is to be noted that these rates of 1% and 3% respectively can
be increased by the company by a special resolution in a
U
general meeting with the approval of the Central Government.

This special resolution will be valid for a period of five years.
(c)
(c) Director's Fees: In addition, a director may receive

remuneration by the way of a fee for each meeting of board of
Business Accounting
ale
172 directors or a committee thereof attended by him according to
Notes the Companies Act, but the government has decided that in
___________________ case of whole-time directors or managing directors, no sitting
fee will be payable. As per notification of the Central
n/S
___________________
Government dated, 27.8.1993 a company can pay fees up to `
___________________
2,000 to its each director for attending the meeting of board of
___________________ directors or a committee thereof. As stated earlier, director's
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___________________ fees a not included in the managerial remuneration for the
purpose of overall limit.
___________________
(d) Whole-time director or managing director shall not get
uc
___________________
any remuneration or commission from subsidiary
___________________
company: As per Section 309(6) a whole-time or managing
___________________ director who is in receipt of any commission from a company is
rod
___________________ not entitled to receive any commission or remuneration from
the subsidiary company of such company.
(e) As per Section 309(1) remuneration to a director will include
ep
any remuneration paid to him for services rendered by him in
any capacity except when:
(i) the services rendered by him are of a professional nature.
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(ii) In the opinion of the Central Government, the director

possesses the requisite qualifications for the practice of
the profession.
t fo
(f) The above-mentioned provision of Section 309 regarding the

remuneration of the managerial personnel will not be
applicable to a private company unless it is a subsidiary
company of a public company. [309(9)]
No
(g) As per Section 310 of the Companies Act, if a public company

or a private company, which is the subsidiary of a public
company, increases the remuneration payable to directors,
S,
such an increase requires the approval of Central Government,

except in the following cases:
PE
(i) if Schedule XIII is applicable and the increase is in

accordance with the conditions specified in that schedule
and
U
(ii) if the increase is in the fee payable for attending each

meeting of the board of directors or a committee thereof
(c)
and the increased rate does not exceed such sum as may
be prescribed.
ale
173
(h) The net profit of the company for the purpose of calculating
Notes
director's remuneration would be computed as per the Activity
provisions of Sections 349 and 350 of the Companies Act. Collect recent updates on
___________________
n/S
remuneration to manager.
(i) As per Section 200, no company will pay its officers or ___________________
employees any remuneration free of any tax. ___________________
___________________
Check Your Progress
tio
___________________
___________________
1. As per the provision of Section 309(4) a part-time
uc
director may receive monthly, quarterly or annual ___________________
payment of remuneration with the approval of Central ___________________

Government.
rod
___________________
2. Director’s fees a not included in the managerial ___________________
remuneration for the purpose of overall limit.
ep
Remuneration to Manager
Provisions regarding remuneration to manager are given in the
Section 387 of the Companies Act 1956. According to this section, a
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company can pay the remuneration to a manager by the way of a

monthly payment or by way of a specific percentage of the net
profits of the company or partly by way of monthly payment and
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partly by way of specific percentage of the net profits. The net

profit of the company is calculated according to Sections 349 and
350 of the Companies Act. The total remuneration to the manager
cannot exceed 5% of the net profit of the company, except with the
No
approval of the Central Government.
Determination of Net Profit for Managerial Remuneration

Determination of Net Profit of a public company for the purpose of
S,
calculating the managerial remuneration will be as per the

provision of the Section 349 and Section 350 of Indian Companies
Act. These provisions are summarized as under:
PE
1. The following items are added to the gross profit of the

company:
U
Bounties and subsidies received from any government or any

public authority constituted or authorized in this behalf, by
(c)
any government, unless and except in so far as the Central

Government otherwise directs.
Business Accounting
ale
174
2. The following items are not considered to calculate the net
Notes
profit of the company:
___________________
(a) Profit by way of premium on the issue of shares or
n/S
___________________
debentures of the company.
___________________
(b) Profits on the sale of forfeited shares.
___________________
(c) Profits in capital nature.
tio
___________________
(d) Profit arising from the sale of immovable property or fixed
___________________
assets, if company's business is not the sale and purchase
of such type of assets. In other words if the company is
uc
___________________
___________________ engaged in buying and selling of any assets of capital

nature, profit arised from such a sale is added to for gross
___________________
rod
profit of the company.
___________________
Under Section 350 if amount of sale of any such assets exceeds
the written down value thereof, credit shall be given for so
much of the excess as is not higher than the difference
ep
between the original cost of the fixed assets and its written
down value. For example- Gujarat Ltd. acquired fixed assets
for ` 80,000 two years ago and now its written down value is
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`60,000. The Company sold these assets for ` 85,000. In this

case, total profit is ` 25,000 (` 85,000-` 60,000) Profit of `
20,000 (difference of original cost and written down value of
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the assets) will be added to gross profit and the excess of profit
of ` 5,000 (` 25,000 - ` 20,000) will be excluded in computing
the net profit for the purpose of remuneration.
3. The following items shall be deducted from the gross profit of
No
the company:
(a) all the usual working charges.
(b) bonus or commission paid or payable to any member of the
S,
company's staff or to any engineer, technician or person

employed or engaged by the company whether on a whole-
time or a part-time basis.
PE
(c) any tax notified by the Central Government as being in

the nature of a tax on the excess or abnormal profits.
U
(d) any tax on business profits imposed for special reason or

in special circumstances and notified by Central
(c)
Government in this behalf.

(e) interest on debentures issued by the company.
ale
175
(f) interest on mortgages executed by the company and on
Notes
loans and advances secured by a charge on its fixed or
floating assets. ___________________
n/S
(g) interest on secured loans and advances. ___________________
___________________
(h) expenses on repairs if the repairs are not of capital nature.
___________________
(i) outgoings inclusive of contribution made to charitable and
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other funds not directly relating to the business of the ___________________
company or welfare of its employees. ___________________
(j) depreciation as per Section 350 of the Companies Act.
uc
___________________
Under this Section, the amount of depreciation is
___________________
calculated as per rates specified in the Schedule XIV
rod
___________________
(which is discussed in the chapter of Final A/cs) on the
written down value of the assets. The amount of ___________________
depreciation includes normal depreciation, which includes
extra and multiple shift allowance but excludes special
ep
depreciation, initial depreciation and any development
rebate. If any assets are sold, discarded, demolished or
destroyed before the expiry date of the assets, excess of
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W.D.V. of the assets over the sales proceeds of the assets

or scrap value of the assets as the case may be, is written
off in that financial year in which the assets are sold,
discarded or demolished. This excess of W.D.V. will be
t fo
computed as below:
Excess of W.D.V. = W.D.V. - sale proceeds - scrap value.
(k) the excess of expenditure over income which had arisen in
No
computing the net profit in accordance with the Section

349 of the Companies Act in any year which begins at or
after the commencement of this Act insofar as such excess
has not been deducted in any subsequent year preceding
S,
the year in which the net profits have to be ascertained.

(l) any compensation or damages to be paid by virtue of any
PE
legal liability including a liability arising from a breach of

contract.
(m) any sum paid by way of insurance against the risk of
U
meeting any liability such as referred to in clause (l); and

(n) debts considered bad and written off or adjusted during
(c)
the year of account.

Business Accounting
ale
176
4. But the following items shall not be deducted from the gross
Notes
profits of the company:
___________________
(a) the income tax and super tax payable by the company
n/S
___________________
under the Indian Income Tax Act, 1961 or any other tax
___________________ on the income of the company not covered under clauses
___________________ (c) and (d) above.
tio
___________________ (b) any compensation or damage paid by the company
voluntarily.
___________________
(c) loss of capital nature including loss on sale of undertaking
uc
___________________
or any part thereof not including any excess of written
___________________
down value over its sale proceeds or scrap value of any
___________________ excess of written down value of any assets sold, discarded,
rod
___________________ demolished or destroyed as this excess is written off
against P & L A/c.
Note:* The profit calculated as per above provision is considered
ep
profits for the purpose of remuneration to directors, managing
directors and manager. On the basis of this profit, the managerial
remuneration is computed.
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Check Your Progress

Fill in the blanks:
t fo
1. The …………………… of the company is calculated

according to Sections 349 and 350 of the Companies Act.
2. If the company is engaged in buying and selling of any
assets of capital nature, profit arised from such a sale is
No
added to for …………………… of the company.
Summary
S,
The remuneration which is paid to the managerial personnel

(directors, managing directors and managers) by the company is
called managerial remuneration. This remuneration is shown in
PE
the debit side of profit and loss account of the company. As per
Section 198 of the Companies Act 1956, these are several
restrictions on the managerial remuneration. Remuneration to
U
directors including managing directors, is determined either by the

Articles of Association or by a resolution or, if the articles so
(c)
required, by a special resolution, passed by the company in general

meeting subject to the provisions of the Section 309 of the
ale
Companies Act. Section 309 governs the remuneration of directors, 177
including managing directors or whole- time director of a public Notes
company and a private company which is a subsidiary of a public ___________________
company. Provisions regarding remuneration to manager are given
n/S
___________________
in the Section 387 of the Companies Act 1956. According to this
section, a company can pay the remuneration to a manager by the ___________________
way of a monthly payment or by way of a specific percentage of the ___________________
tio
net profits of the company or partly by way of monthly payment
___________________
and partly by way of specific percentage of the net profits.
___________________
uc
Lesson End Activity ___________________
___________________
Visit this site http://www.lexvidhi.com/article-details/managerial-
rod
remuneration-under-companies-act-1956-26.html and prepare a ___________________
report on Managerial Remuneration Under Companies Act, 1956. ___________________
Keywords
ep
Managerial Personnel: The managerial personnel include the
director, managing director and manager.
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Managerial Remuneration: The remuneration paid to

Managerial Personnel is called managerial remuneration.
Remuneration: Remuneration is the total compensation that
t fo
an employee receives in exchange for the service they perform for

their employer.
Director: Directors are the representatives of the company. They
manage and control the company.
No

1. What do you mean by managerial remuneration?
S,
Explain
2. How is the profit calculated for managerial remuneration?
PE
Describe in detail.
3. What are the provisions regarding the maximum limit of
managerial remuneration? Explain.
U
4. Determine the maximum remuneration available to the part-

time Directors and Managers of Babli and Bunti Ltd. under
(c)
Sections 309 and 387 of the Companies Act, 1956 from the
following particulars:
Business Accounting
ale
178
5. Before charging any such remuneration the Profit and Loss
Notes
A/c, showed a credit balance of ` 57,75,000 for the year ended
___________________
31st March, 2012 after taking into account of following
n/S
___________________ balances:
___________________ `
___________________ i. Capital Expenditure 13, 12,500

ii. Subsidiary received from Government 10, 50,000
tio
___________________
iii. Special Depreciation 1, 75,000
___________________
iv. Multiple Shift Allowance 2, 62,500
v. Bonus to foreign technicians 7, 87,500
uc
___________________
___________________ vi. Provision for Taxation 70, 00,000

___________________ vii. Compensation paid to an injured workman 1, 75,000
rod
viii. Ex-gratia payment to an employee 87,500
___________________
ix. Loss on sale of fixed assets 1, 75,000
x. Profit on sale of investment 5, 25,000
ep
Company is providing depreciation as per Section 350 of the
Companies Act, 1956.
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Further Readings
Books
t fo

Delhi.
Chand, New Delhi.
No

New Delhi.
S,
Web Readings
www.caclubindia.com › Discussion › Accounts › Others
PE
http://www.lexvidhi.com/article-details/managerial-remuneration-
under-companies-act-1956-26.html
www.svtuition.org/2009/10/how-to-calculate-managerial.html
U
http://www.indiankanoon.org/search/?formInput=managerial%20re
muneration
(c)
www.slideshare.net/gswapnil/managerial-remuneration-9648039
UNIT 12: Dividends & Dividends Declaration Out of Past & Current Profits
ale
Unit 12
179
Notes
Activity
Dividends & Dividends
___________________
showing the Disposal of Profit.
n/S
___________________
Declaration Out of Past & Current ___________________
Profits ___________________
tio
___________________
Objectives ___________________
uc
After completion of this unit, the students will be aware of the following ___________________
topics:
___________________
\ Disposal of Profit and Divisible Profits
rod
___________________
\ Dividends
___________________
\ Declaration of Dividend Out of Reserve
\ Declaration of Dividend out of Capital Profit
\ Issue of Bonus Shares
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Introduction
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Dividend is that part of the profit which is divided among the

shareholders of the company. Dividend is divided among the
shareholders as per the legal provisions of the Company Act.
t fo
Dividend can be paid in cash or shares. For the declaration of

dividend and bonus among shareholders, a company must satisfy
the different conditions. In the present unit the legal provisions
and different conditions for the declaration of dividend are
No
discussed.
Disposal of Profit and Divisible Profits

The question of disposal, distribution or appropriation of profit
S,
arises only when a company earns the net profit. Under the
disposal of profit, we consider distribution of profit to shareholder
PE
in the form of dividend and bonus shares and transfer of profit into
adequate reserves and funds for keeping sound financial position of
the company.
U
Divisible Profits
(c)
Divisible profits are also known as profits available for dividends

for shareholders. In other words, net profits which can be
Business Accounting
ale
180
distributed among the shareholders are called divisible profits. In
Notes normal course, that profit is distributed among the shareholders as
___________________ dividend which has been calculated after deducting all expenses,
losses, depreciation on fixed assets, fall in the price of current
n/S
___________________
assets, taxation, past losses and transferring a reasonable amount
___________________ to reserve. Profit on revaluation of fixed assets and profit of
___________________ extraordinary nature should not be included into divisible profits.
In the absence of profit the company cannot declare the dividend.
tio
___________________
___________________
Provision of Section 205 of the Companies Act for the
ascertainment of divisible profit is as follows:
uc
___________________
1. For any financial year, dividend can be declared or paid by a
___________________
company out of the profit of the current year which have been
___________________ derived after considering the depreciation in accordance with
rod
___________________ the provision of Section 205(2), or
2. The company can make a payment or declared a dividend out

of the undistributed profits of the previous financial year
ep
which have been calculated after providing depreciation in
accordance with Section 205(2).
3. Dividend can be declared or paid by the company out of the

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aggregate of profit as mentioned in (1) and (2) above.
4. Dividend can be declared or paid out of subsidy provided by

the Central Government or state government for the payment
t fo
of dividend.
5. If a company has failed to redeem its preference shares in

accordance the provision of the Section 80(A), it cannot, as
long as such failure continues, declare or pay any dividend on
No
its equity shares.
In order to understand the provisions of this section

completely, it is necessary to understand the following points:
S,
(a) Calculated of Depreciation
(b) Past Losses

PE
(c) Transfer of Profit to Reserve
(a) Calculated of Depreciation: Herewith, depreciation will be

U
provided as the provision of Section 205(2) of the

Companies Act, 1956 and the rate of depreciation will be
(c)
applicable as given in Part III of the Schedule XIV of the

Companies Act. The provision or Section 205(2) and Part
ale
III of the Schedule XIV have been discussed under the 181
heading of Profit and Loss Account of this chapter. Notes
(b) Past Losses: If a company suffers a loss in any financial ___________________
n/S
year after 28th December, 1960, the amount of loss or ___________________
amount of depreciation for that year, whichever is less,
___________________
must be set off against the profit of the company before
declaration of dividend. ___________________
tio
___________________
(c) Transfer of Profit to Reserve: Generally, the rules
regarding the disposal of profits are given in the Articles ___________________
of Association. As per Section 205(2A) of the Companies
uc
___________________
Act, before the declaration of dividend out of the current
___________________
year's profit, the company has to transfer such percentage
if its profit for the current year to the various reserves,
rod
___________________
not exceeding 10%, as may be prescribed. The Central
___________________
Government has prescribed the following percentages to
be transferred to Reserves:
ep
Minimum percentage of current
Rate of proposed dividend
profit to be transferred to reserves
(i) More than 10% but less 2.5%
than 12.5% of the paid up
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capital.
(ii) More than 12.5% but less 5%
than 15% of the paid up
capital
t fo
(iii) More than 15% but less 7.5%

than 20% of the paid up
capital
(iv) More than 20% of the paid 10%
up capital
No
Note: If the rate of the proposed dividend does not exceed, it is not
obligatory on a company to transfer any profit to its reserves. The
directors, however can exercise their discretion, and transfer some
amount to reserve from out of profit. But such transfer should not
S,
exceed the ceiling of 10% prescribed in the Act referred to above

where:
PE
(a) Reserve means free reserve

(b) Current profit means profit after tax
(c) Dividend means dividends on equity shares
U
Transfer of Higher Percentage: Although there is a ceiling of 10% of

(c)
profit to transfer reserve, a company may transfer a higher

percentage of profits to reserves in accordance with the rules made
Business Accounting
ale
182
by the Central Government for this purpose [Section 205(2A)].
Notes
Activity These rules are as follows:
Give___________________
the various provisions of
Indian Companies Act
(a) Where a dividend is declared, the minimum distribution of
n/S
___________________
governing the declaration and dividend equal to the average rate of the rates for the three
payment of dividend.
___________________ preceding years immediately proceeding the financial year.
___________________ (b) Where bonus shares have been issued in the financial year in
which the dividend is declared, or in the three years
tio
___________________
immediately proceeding the financial year, a minimum
___________________ distribution of dividend declared for the three years.
uc
___________________
However, the minimum distribution in the above two cases
___________________ need not to be ensured if net profits after tax have fallen by at
___________________ least 20% of the average net profits after tax of two preceding
rod
financial years.
___________________
(c) Where no dividend is declared, the amount proposed to be
transferred to its reserve from current profit should be lower
than the average amount of dividends to the shareholders
ep
declared by it over three preceding financial years.
Check Your Progress

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Fill in the blanks:

1. Dividend is divided among the …………………. as per
the legal provisions of the Company Act.
t fo
2. …………………. are also known as profits available for

dividends for shareholders.
No
Dividends
Dividend is that portion of divisible profit which is divided among
the shareholders of the company. After complying with the
provisions of the Companies Act and the Articles of Association the
S,
profit of the company is distributed to the shareholders by the way

of return on their investment in shares. The rate of dividend is
PE
decided by the board of directors in the annual general meeting of

the shareholders. The legal provisions regarding the dividend are
summarized below:
U
1. Dividend can be paid only out of profits. Payment of dividend

is ruled out if there is a loss except where the Central or State
(c)
Government has guaranteed the payment of dividends by the

company.
ale
183
2. Shareholders are entitled to claim the dividend only when it
Notes
has been declared by the company in the general meeting.
Shareholders can sue the company for the recovery of ___________________
n/S
dividend. ___________________
3. Dividend shall be payable only in cash, by cheque, draft or by ___________________

dividend warrant.
___________________
tio
4. In any manner the operations of Section 208 shall not be ___________________
affected by the provision of Section 205.
___________________
5. For the purpose of this section:
uc
___________________
(a) The word "Specified Period" used in this section will mean
___________________
the number of years at the end of which at least 95% of
rod
___________________
the original cost of the assets of the company would have
been provided for by way of depreciation, if depreciation ___________________
were to be calculated in accordance with provision of
Section 350.
ep
(b) Any dividend payable in cash may be paid by cheque or
warrant sent through the post directed:
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(i) To the registered address of any shareholder entitled

to the payment of the dividend; or
(ii) In the case of joint shareholder, to the registered
t fo
address of that one of the joint shareholder, who is the

first named on the register of the member; or
(iii) To such person and to such address as the shareholder
or joint shareholder may have directed in writing.
No
6. Dividend is calculated at the recommended rate by the

directors on the paid up capital. If the Articles of Association
specifically permits, dividend can be declared on the nominal
value of shares.
S,
7. No dividend will be payable on calls-in-advance as it does not

have the nature of share capital and has a nature of advance.
PE
8. In the case of calls-in-arrear, dividend will be paid on the

amount actually paid by the shareholders. The company is,
however, authorized to make provision in the Articles of
U
Association prohibiting the payment of dividend to such a

shareholder.
(c)
9. Interim dividend can also be declared by the directors during

the financial year.
Business Accounting
ale
184
10. Dividend including interim dividend must be paid within 30
Notes
days of its declaration as per Section 93 of Companies
___________________
Amendment Act 2000. If company fails to pay the dividend
n/S
___________________ with 30 days, it has to pay interest @ 18% p.a., to the
___________________ shareholder as per Section 207.
___________________ 11. As per the provision of Section 205(C) of the Companies

(Amendment) Act, 1999, the Central Government shall be set
tio
___________________
up an Investor Education and Protection Fund. The following
___________________ amounts shall be deposited into this fund:
uc
___________________
(a) The balance lying in the unpaid Dividend Account of the
___________________ Company.
___________________ (b) The application money received by the company for the
rod
___________________ allotment of shares debentures or any other securities
which is now to be refunded.
(c) Matured deposits with companies.
ep
(d) Matured debentures with companies.
(e) The interest accrued on the amounts mentioned in the
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clauses (a) to (d) above.

(f) Grants and donations received by the companies for this
fund from the Central Government, State Governments or
t fo
other institutions for the purpose of this fund.

(g) The interest or other income on the investment made from
this fund, by the companies.
The above mentioned (a) to (d) amounts shall be transferred to
No
this fund only if such amount is unpaid or unclaimed for seven

years. In case any claimant makes his claim within seven
years from the due date, this amount will not be transferred to
this fund. The amount of this fund will be utilized for the
S,
promotion of awareness among investors and for protecting the

interest in investor in accordance with the prescribed rules.
PE
Different Terms Relating to Dividend

Following are the different terms which are used in relation to
dividend:
U
1. Proposed Dividend: The dividend which is recommended for

(c)
the shareholders by the directors is called proposed dividend.

If this dividend is approved in the annual general meeting of
ale
the shareholders it is called final dividend. In the annual 185
general meeting declaration of final dividend cannot be more Notes
than the proposed dividend. However, final dividend can be ___________________
lesser than the proposed dividend. Proposed dividend is shown
n/S
___________________
in the debit side of Profit and Loss Appropriation Account and
in the liabilities side of the Balance Sheet. ___________________
___________________
2. Final Dividend: Final dividend is declared and approved at
tio
the annual general meeting. It is approved by the ___________________
shareholders by looking at the financial position and the ___________________
divisible profits of the company. Final dividend is declared
uc
___________________
only at the annual general meeting and not at the
extraordinary general meeting. Approval of the final dividend ___________________
is based on the recommendation of the directors of the
rod
___________________
company. After the declaration of final dividend, no further
___________________
dividend for that year can be declared. When a dividend is
declared, it becomes the debts of the company to the
registered shareholders.
ep
3. Interim Dividend: The dividend that is declared between
two annual general meetings is called interim dividend. In
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other words, it can be paid by directors to the shareholders at

any time before closing the final accounts. The Articles of
Association of the company empower the directors to declare
the interim dividend. Interim dividend is declared by the
t fo
directors in the anticipation of sufficient profits to be made by

the company during the accounting period. Generally, the
interim dividend is declared after preparing the final accounts
of the first half of the year. If it is found that dividend is paid
No
by the directors without sufficient profit, directors will be

liable to make good the amount of such dividend as dividend
can be paid legally out of profit and not out of capital. No
interim dividend can be declared by the directors without
providing the depreciation for the full year, any accumulated
S,
losses and transfer to reserve.
Dividend can be paid by the directors by the mere passing of a

PE
resolution by the board of directors. There is no need of

approval of the shareholders. The resolution of the directors
for interim dividend does not create a debt between the
U
company and the shareholder, as it is always open to the

directors to subsequently rescind the resolution before the
payment of it.
(c)
Business Accounting
ale
186
Notes 4. Scrip Dividend: Before the passing of the Companies
Amendment Act 1960, some companies used to distribute
___________________
dividend in the form of shares or debentures or any other
n/S
___________________ securities of any other companies. These shares, debentures or
___________________ other securities may have been held by the shareholder as
investment. Dividend so paid was known as scrip dividend.
___________________
Generally, a shareholder had to bear a loss on such type of
tio
___________________ dividend (shares, debentures etc.) because amount of dividend
___________________
in the form of shares, debentures etc. was worthless for
shareholder. But nowadays, such type of unhealthy practice
uc
___________________
has been stopped by the Section 205 of the Companies
___________________ Amendment Act 1960 i.e. not dividend shall be payable except
in cash.
___________________
rod
___________________ 5. Unclaimed or Unpaid Dividend: When some shareholders
are unable to encash or claim the dividend warrants within 30
days from the date of declaration of the dividend amount,
dividend of such a shareholder is called unclaimed/unpaid
ep
dividend. There is a provision in Section 205(A) of the
Companies Amendment Act 2000 regarding such an
unclaimed/unpaid dividend, that the company shall within
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seven days, transfer such amount of dividend which remains

unpaid/unclaimed, to a special account. This account will be
called "Unpaid Dividend Account of .......... Company Ltd.
/Company Pvt. Ltd." This account can be held with any
t fo
Scheduled Bank. If the company has not transferred the

amount of dividend to the above account, it has to pay interest
@12% p.a. on such amount. If the amount deposited in this
account and is not claimed or paid within seven years of its
No
deposit, the company shall transfer this amount to a fund

established u/S 205(C) of the Companies Amendment Act
2000. The same provision will also be applicable to interim
dividend. As per the provisions of this section the person who
S,
is entitled to get dividend may apply to the Central

Government. The Central Government for its own satisfaction
may demand company's certificate or may otherwise ensure
PE
that the applicant is entitled to receive the dividend. After the

Central Government is satisfied, it passes an order for the
payment of the related amount against security of such value
U
from the applicant. If the provision of this Section 205 is

violated as per Section 205(3A) as penalty of ` 5,000 per day
will be imposed on the company.
(c)
ale
187
6. Dividend on Preference Shares: Preferential shareholders
Notes
have been a preferential right in respect of dividend as
compared to the equity shareholder. They can claim dividend ___________________
n/S
only out of profit at a fixed rate on the nominal value of shares. ___________________
If nothing is stated, preference shares are always treated as
___________________
cumulative. If, due to inadequacy of profits they have not been
paid for some years, the whole of the dividend (including the ___________________
tio
arrears of dividend of past years) will be paid first to ___________________
preference shareholders before making any payment of ___________________
dividend to equity shareholder. But the holder of non-
uc
___________________
cumulative preference share cannot claim dividend in
subsequent years if their dividend is not paid due to ___________________
inadequacy of profit. Arrears of dividend of cumulative
rod
___________________
preference share are shown as a contingent liability by the
___________________
way of a footnote to the balance sheet. It may be noted that the
preference shareholders cannot compel the company to pay the
entire dividend (including arrears). They can only force the
ep
company to pay them before any dividend is paid to the equity
shareholder. If there are some participating preference shares,
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shareholders will have a right to share the balance of profits

with the equity shareholders. Herein, one more point is to be
noted that in case of inadequate profit, the company may pay
dividend on preference shares at a rate less than the fixed
t fo
rate. In this case, the company will not declare any dividend
on the equity shares.
Source of Dividend
No
As per Section 205, following are the sources of dividend from

which a company can declare and pay the dividend:
(i) Current year's profit after providing depreciation.
(ii) Previous years profit after providing depreciation.
S,
(iii) Aggregation of the above (i) & (ii)

(iv) Money provided by the Central or State Government for the
payment of dividend.
PE
Procedure of Dividend
The procedure of dividend can be understood by the following
U
steps:
(c)
1. After the preparation of final accounts, the rate of dividend is

proposed in the meeting of board of directors.
Business Accounting
ale
188
Notes 2. If the proposed of board of directors regarding dividend is
Activity
approved in the annual general meeting, the rate of dividend
Collect recent updates on
___________________
declaration of dividend out of
is declared.
n/S
___________________
reserve.
3. After the declaration of dividend, the dividend list is prepared.
___________________
4. With the help of the dividend list, dividend warrants are
___________________
prepared and sent to the registered addresses of the
tio
___________________ shareholders.
___________________
5. For the payment of dividend, the company opens a Dividend
Bank A/c with a Scheduled Bank.
uc
___________________
___________________ 6. After receiving the dividend warrants, the shareholders get

___________________ the payment from the banker of the company.
rod
___________________ Check Your Progress
Fill in the blanks
1. ……………….. is that portion of divisible profit which is
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divided among the shareholders of the company.
2. Dividend is calculated at the recommended rate by the
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……………….. on the paid up capital.
Declaration of Dividend Out of Reserve

t fo
In case of inadequate of profits or absence of profit as per Section

205(A), a company can declare and pay dividend out of revenue
reserves (which were made during the years of heavy profit) to
maintain a uniform and steady rate of dividend. Only free and
No
uncommitted reserves can be utilized for the declaration of

dividend. But there are some restrictions which are given in the
Section 205(3A) of the Companies Act, on the utilization of these
reserves. If a company wants to utilize these reserves or post-
accumulated profit for the declaration of dividend, it will have to
S,
comply with the prescribed rules framed by the Central

Government which are known as Companies (Declaration of
PE
Dividend out of Reserve) Rules 1975. According to Rule 2 of these

rules, a company has to satisfy the following conditions:
(a) The rate of dividend declared should be 10% of the paid up

U
capital or average of rates of dividend which was declared and

paid by the company in the five preceding years to that year,
whichever is less.
(c)
ale
189
(b) The amount to be drawn from such reserve (accumulated past
Notes
profits) for the declaration of dividend should not be more
than 10% of the sum of paid up capital and free reserves. In ___________________
n/S
addition to this, the amount so drawn must first be utilized to ___________________
set off the losses incurred in those financial years for the
___________________
declaration and payment of dividend.
___________________
(c) The balance of reserve account after such withdrawal should
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not be less than 15% of its paid up capital. ___________________
___________________
Illustration
uc
___________________
(i) Calculated the maximum amount that can be distributed as
___________________
dividend for the year 2012 according to Companies
(Declaration of Dividend out of Reserve) Rules 1975 from the
rod
___________________
following data: ___________________
`
Paid up equity capital 25, 00,000
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Free Reserves 12, 50,000
Loss in 2012 1, 25,000
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Dividend
2000, 2008, 2009, 2010 & 2011.
declared in
15%, 12.5%, 16%, 13%, 13.5%.
(ii) Due to inadequacy of profits during the year, the company

t fo
proposes to declare dividend out of general reserves. From the

following particulars you are to ascertain the amount that can
be drawn applying the Companies (Declaration of Dividend
out of Reserve) Rules 1975:
No
(a) 17,500 8% Preference shares of ` 100

each fully paid 17, 50,000
(b) 7, 00,000 Equity shares of ` 10 each
S,
fully paid 70, 00,000

(c) General Reserve 21, 00,000
PE
(d) Securities Premium 3, 50,000

(e) Capital Reserve on revaluation
of assets 3, 50,000
U
(f) Credit balance of P&L A/c. 63,000

(g) Net Profit for the year 3, 75,000
(c)
(h) Average rate of dividend during the

last five year 15%
Business Accounting
ale
190
Notes Solution:
___________________ (a) Average Rate of Dividend:
n/S
___________________ 15 +12.5 +16 +13 +13.5
during the last five years = = 14%
___________________ 5
___________________ Condition of Rule 2 of the Companies (Declaration of Dividend

of Reserve) Rule, 1975 will be applicable for the declaration of
tio
___________________
dividend out of reserves:
___________________
First Condition: Average rate of dividend of the last five years
uc
___________________
i.e. 14% (calculated above) or maximum rate of dividend i.e.
___________________ 10% whichever is less can be declared for dividend. Here, 10%
___________________ is the lower rate.
rod
___________________ Second Condition: Maximum amount which can be withdrawn
for the declaration of dividend i.e. 10% of paid up Capital +
Free reserve.
ep
` 3, 75,000 first will be used to set off the losses of 2005.
Now amount left after writing off the losses for Dividend
rR
= (` 3, 75,000 - ` 1, 25,000) = ` 2, 50,000

Third Condition: After withdrawing the amount for dividend
i.e. ` 3, 75,000, the balance of reserve account should not be
2,500,000 × 15
t fo
less than 15% of paid up capital ( = 3,75000).

100
Here, the balance of the reserve a/c is (` 12, 50,000 - ` 3,
75,000) is more than ` 250,000.
No
Thus ` 2, 50,000 can be paid and declared as dividend.

2,50,000
Rate of Dividend = ×100 = 10%
25,00,000
S,
(b) Amount available for dividend on equity shares

`
PE
Credit balance of P & L A/c. 63,000

+ Net Profit for the year 3, 57,000
U
Total profit 4, 20,000

– 8% Dividend on Preference Shares 1, 40,000
(c)
Profit for Equity Shareholder 2, 80,000

ale
191
First Condition: Maximum rate of dividend i.e. 10% or average
Notes
Activity
rate 15% whichever is lower, will be declared the rate of
You___________________
dividend. Thus, the rate of dividend will be 10%.
n/S
70,00,000 × 10 ___________________
assignment on declaration of
Amount of Dividend = = ` 7,00,000
100 dividend out of capital profit.
___________________
Amount required for dividend = ` 7,00,000 – 2, 80,000 =
___________________
` 4,20,000
tio
___________________
Second Condition: Maximum amount which can be withdrawn
for the declaration of dividend i.e. 10% of paid up Capital + ___________________
Free reserve.
uc
___________________
Third Condition: After withdrawing the amount for dividend, ___________________
the balance of reserve account should not be less then 15% of
17,50,000 + 70,00,000 × 15
rod
___________________
paid up capital i.e. = 13,12,500.
100 ___________________
The balance left in the reserve account = 21, 00,000 - 4, 20,000
= ` 16, 80,000, which is more than 15% of the paid up capital.
ep
Thus, on the basis of above three conditions, 10% dividend can
be declared and paid.
rR
Check Your Progress

Fill in the blanks:
1. In case of inadequate of profits or absence of profit as
t fo
per Section 205(A), a company can declare and pay

dividend out of ………………….. to maintain a uniform
and steady rate of dividend.
2. The balance of reserve account after withdrawal should
No
not be less than ………………. of its paid up capital.
Declaration of Dividend out of Capital Profit

S,
Capital profits are those profits which are earned by the company
on the transactions not related to its normal course of business.
For example, profit on sale of fixed assets. Capital profit can be
PE
utilized for the payment of dividend only if:

(i) They have been realised in cash.
U
(ii) The Memorandum and Articles of Association permit the

payment of dividend out of capital profit.
(c)
(iii) Surplus remains after revaluation of all assets.

Business Accounting
ale
192
The following types of capital profit are not at all available for
Notes
dividend:
___________________
(i) Securities shares premium account.
n/S
___________________
(ii) Balance of profit after the reissue of forfeited shares.
___________________
(iii) Balance of capital redemption reserve account.
___________________
The following types of capital profit are also not available for
tio
___________________
dividend:
___________________
(a) Profit on sale of fixed assets
uc
___________________
(b) Profit on the redemption of debentures
___________________
___________________
(c) Pre-incorporation profits
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___________________ (d) Profit on redemption of debentures
(e) Profit on acquisition of building
Although there are several restrictions on the payment of dividend
ep
out of capital profit in the Companies Act, but no restriction will be
imposed in respect of the following uses-
rR
(i) Issue of bonus shares (fully paid).

(ii) Writing off capital losses and fictitious assets as preliminary
expenses, goodwill, discount or commission on the issue of
share or debentures.
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(iii) Providing for premium payable on redemption of preference

share/debentures.
(iv) Writing off losses on the revaluation of the assets of the
No
company.
It is to be noted that capital profits transferred to capital reserve
shall not be utilized for the payment of dividend. If the capital
profits are used for the declaration of dividend, those should not be
S,
transferred to capital reserves.

PE
Accounting Entries Regarding Dividend

1. When dividend is proposed/recommended by the directors:
Profit and Loss Appropriation A/c. Dr.
U
To Proposed Dividend A/c.

(c)
Note: If the balance in the P/L Appropriation A/c is not

sufficient for the payment of dividend, the directors may
ale
utilize the balance lying in the Dividend Equalization Reserve 193
or General Reserve. For this purpose, the required amount is Notes
transferred from these reserves to Profit and Loss ___________________
Appropriation A/c. Then the following entry will be passed
n/S
___________________
before passing the above entry:
___________________
Dividend Equalization Reserve A/c. Dr.
___________________
or
tio
___________________
General Reserve A/c. Dr.
___________________
To Profit and Loss Appropriation A/c.
uc
___________________
2. When dividend is declared after the approval of shareholder-
___________________
Proposed Dividend A/c Dr.
rod
___________________
To Dividend Payable A/c. ___________________
3. When amount is deposited in the Dividend Bank A/c for the

payment of dividend-
ep
Dividend Bank A/c. Dr.
To Bank A/c.
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4. When the amount of dividend is paid to the shareholder:

Dividend Payable A/c. Dr.
To Dividend Bank A/c.
t fo
5. When there is some balance in the dividend payable account at

the end of the year, that is transferred to Unclaimed Dividend
A/c.
No
For the purpose the following entry will be passed:

Dividend Payable A/c. Dr.
To Unclaimed Dividend A/c.
S,
6. When unclaimed dividend becomes time-barred, it is

transferred to a Special A/c. For that entry will be:
PE
Unclaimed Dividend A/c. Dr.

To Dividend Bank A/c.
U
7. If unpaid dividend is not claimed by the shareholders within

seven years form the date of declaration, it is transferred of
Investor Education and Protection Fund A/c.
(c)
Business Accounting
ale
194
For that entry will be:
Notes
___________________
Unclaimed Dividend A/c. Dr.
n/S
___________________ To Unpaid Dividend Bank A/c.
___________________ Illustration
___________________ Lucky Limited has a credit balance of profit and loss account of
` 2,50,000 on 1st April 2012. The net profit for the year is
tio
___________________
` 15,50,000. During the year, a half-year's dividend was paid on
___________________
10% preference shares capital of ` 14,00,000. It was decided that
following appropriation be made:
uc
___________________
___________________ (i) Provision for taxation ` 7,80,000

___________________
(ii) Dividend equalization reserve account ` 50,000.
rod
___________________
(iii) To pay the final dividend on preference shares.
(iv) To pay the dividend 15% on the ` 20,00,000 equity capital.
ep
(v) Transfer to general reserve ` 40,000
(vi) Transfer to debentures redemption reserve ` 80,000.
rR
Prepare Profit and Loss Appropriation A/c and give journal entries
for payment of dividend. Tax is deducted on preference dividend @
10%.
Solution:
t fo
Profit and Loss Appropriation Account

(For the year ended 31st March, 2012)
No
To General Reserve 40,000 By Balance b/d

(last year balance) 2, 50,000
To Debentures: To Balance b/d
(current year balance) 15, 50,000
S,
Redemption Fund 80,000

To Proposed Equity dividend 3,00,000
To Dividend Equalization
PE
Reserve 50,000
To Dividend on Preference
share
Paid 70,000
U
Proposed 70,000 1, 40,000

To Provision for Taxation 7, 80,000
(c)
To balance c/d 4, 10,000

18, 00,000 18, 00,000
ale
Journal Entries in the books of Lucky Ltd. 195
Date Particulars L.F. ` ` Notes
At the Profit and Loss Appropriation A/c Dr. 70,000
___________________
end of
n/S
To Preference Dividend Payable 63,000
1st half
A/c ___________________
To Income Tax A/c. 7,000
___________________
(Being to declaration of Preference
Dividend for half year at tax deducted ___________________
at source).
tio
Dividend Bank A/c Dr. 63,000 ___________________
To Bank A/c. 63,000 ___________________
(Being opened a special account, for
uc
the payment of Preference Dividend) ___________________
Preference Dividend Payable A/c. Dr. 63,000
___________________
To Dividend Bank A/c. 63,000
rod
(Being the payment of Preference ___________________
Dividend)
___________________
Income Tax A/c. Dr. 7,000
To Bank A/c. 7,000
(Being payment of tax in the
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Government A/c)
At the Profit and Loss Appropriation A/c Dr. 3,70,000
end of
To Proposed Equity Dividend A/c 3, 00,000
2nd
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half. To Proposed Preference Dividend 70,000

A/c
(Being recommendation of equity and
preference dividend)
Proposed Equity Dividend A/c Dr. 3, 00,000
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Proposed Preference Dividend A/c. Dr. 70,000

To Equity Dividend Payable A/c. 3, 00,000
To Pref. Dividend Payable A/c. 63,000
To Income Tax A/c. 7,000
No
(Being the declaration of equity

and preference dividend and tax
deducted at source on Preference
Dividend)
Dividend Bank A/c. Dr. 3, 63,000
To Bank A/c. 3, 63,000
S,
(Being opened a Special account for

the payment of dividend)
Dividend Bank A/c Dr. 3, 00,000
PE
Pref. Dividend Payable A/c Dr. 63,000

To Dividend Bank A/c 3, 63,000
(Being the payment of dividend)
U
Income Tax A/c. Dr. 7,000

To Bank A/c. 7,000
(Being payment of Income Tax)
(c)
Business Accounting
ale
196
Check Your Progress
Notes
Activity
Fill in the blanks:
___________________
of your organisation and 1. …………………… are those profits which are earned by
n/S
___________________
prepare a brief write up about
the company on the transactions not related to its
the ___________________
issue of bonus shares in
your organization. normal course of business.
___________________
2. Capital profits transferred to capital reserve shall not be
tio
___________________ utilized for the payment of ……………………
___________________
Issue of Bonus Shares
uc
___________________
___________________ When a company has a large amount of accumulated profit in its

___________________ different revenue reserve and the company wants to distribute it to
rod
its shareholders in addition to regular dividend, such a distribution
___________________
is called 'bonus'. Bonus may be paid in the following ways:
(i) In case
ep
(ii) In the share capital:
(a) by the issue of new shares to the existing shareholders.
rR
(b) by making partly paid shares as fully paid shares.

(i) Bonus in Cash: When a company has a large accumulated
profit and a large amount in cash, it can pay bonus in cash. By
t fo
making the payment of bonus in cash, the position of working

capital should not be adversely affected. If there is a shortage
of liquid assets or there is requirement of working capital for
development in the future, cash payment of bonus may be
No
stopped. Cash bonus is paid only in that situation when the

company has earned a huge amount of profit in a particular
year and does not want to increase its rate of dividend or it is
not possible for the company to issue the bonus due to the limit
of authorized capital.
S,
(ii) Bonus in Shares: Payment of bonus into shares is also known

as capitalization of profit. In other words, conversion of
PE
accumulated profit or reserve into shares capital is the

capitalization of profit. A company can issue bonus shares into
two ways- (1) issue of fully paid bonus shares to the existing
U
shareholder. (2) By utilizing the bonus into making the partly-

paid shares into fully-paid shares. When new shares are
(c)
issued to pay the bonus to the existing shareholders the

number of shares increase and accumulated profits and
ale
reserves decrease. In the second case, when amount to bonus 197
is utilized to make the already issued partly paid shares into Notes
fully paid shares, paid up value of the existing shares ___________________
increases without increasing the number of shares and paying
n/S
___________________
the extra amount by the shareholder.
___________________
Sources of the Issued of Bonus Shares ___________________
tio
These sources are also known as the source of capitalization. They
___________________
are as follows:
___________________
(i) Credit balance of Profit and Loss A/c.
uc
___________________
(ii) General Reserve
___________________
(iii) Any other reserve made from profit
rod
___________________
(iv) Investment Allowance Reserve ___________________
(v) Development Rebate Reserve
(vi) Shares Premium
ep
(vii) Capital Redemption Reserve
(viii) Capital Reserve
rR
Here, it is to be noted that above Capital Redemption Reserve

shares premium and Capital Reserve can be utilized only for the
issue of fully paid bonus shares while the others can be used to
t fo
make partly paid shares into fully paid.
Advantage of the Issue of Bonus Shares

There are following advantages to a company due to the issue of
No
bonus shares-
(i) As the company does not have to pay the bonus in cash, the
liquidity position of the company does not affect.
S,
(ii) For the expansion of business, it is the cheapest method to

raise the capital.
PE
(iii) It is an easy method to reduce the high rate of dividend.

(iv) By the issue of bonus shares, the capital structure of the
company becomes more realistic.
U
Latest Guidelines for the Issue of Bonus Shares

(c)
After the abolition of Control of Capital Issue Act through

ordinance No. 9, in May 1992, new guidelines for bonus shares
Business Accounting
ale
198 have been issued by the Securities Exchange Board of India
Notes (Primary Market Department) vide its press release dated
___________________ 13.4.1994. These modified guidelines are as follows:
n/S
___________________ i. These guidelines are applicable to existing listed companies
___________________ which shall forward a certificate duly signed by the issuer and
duly countersigned by its statutory auditor or by a company
___________________
secretary in practice, to the effect that the terms and
tio
___________________ conditions for issue of bonus shares as laid down in these
___________________ guidelines have been complied with.
ii. Issue of bonus shares after any public right issue is subject to
uc
___________________
___________________
the condition that no bonus issue shall be made which will
dilute the value or right of the holder of debentures.
___________________
Convertible fully or partly.
rod
___________________
In other words, no company shall, pending conversion of
FCDs/PCDs, issue any shares by way of bonus, unless similar
benefit is extended to the holder of such FCDs/PCDs, through
ep
reservation of shares in proportion to such convertible part of
FCDs/PCDs. The shares so reserved may be issued at the time
of conversion(s) of such debentures on the same terms on
rR
which the bonus issues were made.

iii. The bonus issue is made out of free reserves built out of the
genuine profits or share premium collected in cash only.
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iv. Reserves created by revaluation of fixed assets are not

capitalized.
v. The declaration of bonus issue, in lieu of dividend, is not made.
No
vi. The bonus issue is not made unless the partly-paid shares, if
existing, are made fully-paid up.
vii. The company:
S,
1. Has not defaulted in payment of interest or principal in

respect of fixed deposits and interest on existing
debentures or principal on redemption thereof; and
PE
2. Has sufficient reason to believe that is has not defaulted

in respect of the payment of statutory dues of the
employees, such as contribution to provident fund,
U
gratuity, bonus etc.

(c)
viii. A company which announces its bonus issue after the approval
of the Board of Directors must implement the proposal within
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a period of six months from date of such approval and shall not 199
have the option of changing the decision. Notes
ix. There should be a provision in the Articles of Association of the ___________________
n/S
company for capitalisation of reserves, etc. and if not the ___________________
company shall pass a resolution at its General Body Meeting
___________________
provision in the Articles of Association for capitalization.
___________________
x. Consequent to the issue of bonus shares, if the subscribed and
tio
___________________
paid up capital exceeds the authorized shares capital, a
resolution shall be passed by the company at its General Body ___________________
Meeting for increasing the authorized capital.
uc
___________________
Accounting Treatment Regarding Bonus Shares ___________________
rod
___________________
(A) When already issued partly paid shares are made fully
paid: ___________________
(i) On declaring the bonus:

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Or
Or
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Any other Reverse Reserve A/c. Dr.

To Bonus to shareholders A/c.
(ii) On making the final call on existing shares:

t fo
Shares Final Call A/c Dr.

To Shares Capital A/c.
(iii) On adjusted the bonus with final call:

No
Bonus to Shareholder A/c. Dr.

To Shares Final Call A/c.
(B) When fully paid bonus shares are issued:
(i) On declaring the Bonus:

S,

Or
PE

Or
Any other Reverse Reserve A/c. Dr.
To Bonus shareholder A/c.
U
(ii) On issuing the Bonus shares:

Bonus to shareholder A/c Dr.
(c)
To Share Capital A/c.

Business Accounting
ale
200
(C) When Bonus is paid in cash
Notes
___________________
(i) On declaring the bonus:
Profit and Loss Appropriation A/c Dr.
n/S
___________________
Or
___________________
___________________ Or
tio
___________________ Any other Reverse Reserve A/c. Dr.
___________________ To Bonus shareholder A/c.
uc
___________________
(ii) On the payment of bonus:
___________________ Bonus to shareholder A/c. Dr.
___________________
To Cash A/c.
rod
___________________
Illustration
Following were the balance in the books of Victory Company

ep
Limited as at 30th June, 2012:
(i) Authorised Capital: 1, 00,000 share of ` 100 each.

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(ii) Issued Capital: 80,000 shares of ` 90 per share paid up.
(iii) General Fund ` 36, 00,000

t fo
(iv) Profit and Loss A/c ` 16, 00,000
The following resolutions were passed on annual general

meeting of the company, which was held on 17th August,
No
2012:
(a) To pay ` 15 cash dividend for each share.
(b) To declare capital bonus @ ` 50 per share. It was used in

S,
making partly paid up share as fully paid and the

balance was used in issuing fully paid bonus shares at a
PE
premium of 60%.
(c) ` 2, 00,000 was to be paid as bonus to the employees of

the company. These resolutions were carried out.
U
Pass the necessary journal entries in the books of the

company.
(c)
ale
Solution: 201
Notes
Journal entries in the books of
Victory Company Limited ___________________
n/S
Date Particulars L.F. ` ` ___________________
(i) Profit and Loss Appropriation A/c Dr. 12, 00,000
___________________
To Dividend A/c 12, 00,000
(Being the declaration of dividend ___________________
on 80,000 shares @ ` 15 per share)
tio
(ii) General Reserve A/c Dr. 36, 00,000 ___________________
Profit and Loss Appropriation A/c Dr. 6, 00,000
To Bonus to shareholders A/c 40, 00,000 ___________________
To Staff Bonus A/c 2, 00,000
uc
___________________
(Being declaration of bonus to
shareholders and employees) ___________________
(iii) Dividend A/c Dr. 12, 00,000
rod
Staff Bonus A/c Dr. 2, 00,000 ___________________
To Bank A/c 14, 00,000
___________________
(Being the payment of bonus and
dividend)
(iv) Shares Final Call A/c Dr. 8, 00,000
ep
To Shares Capital A/c 8, 00,000
(Being final call due on 80,000
equity shares @ ` 10 each)
(v) Bonus to shareholder A/c Dr. 8, 00,000
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To Shares Final Call A/c 8, 00,000

(Being adjustment of bonus with
final call A/c.)
(vi) Bonus to shareholder A/c Dr. 32, 00,000
To Share Capital A/c 20, 00,000
t fo
To Share Premium A/c 12, 00,000

(Being issue of fully paid bonus
shares at a premium of 60%)
Check Your Progress

No
Fill in the blanks:

1. When a company has a large accumulated profit and a
large amount in cash, it can pay ……………….. in cash.
S,
2. Payment of bonus into shares is also known as

……………….. of profit.
PE
Summary
Dividend can be paid in cash or shares. For the declaration of
U
dividend and bonus among shareholders, a company must satisfy

the different conditions. Divisible profits are also known as profits
(c)
available for dividends for shareholders. In other words, net profits

which can be distributed among the shareholders are called
Business Accounting
ale
202 divisible profits. In normal course, that profit is distributed among
Notes the shareholders as dividend which has been calculated after
___________________ deducting all expenses, losses, depreciation on fixed assets, fall in
the price of current assets, taxation, past losses and transferring a
n/S
___________________
reasonable amount to reserve.
___________________
Dividend is that portion of divisible profit which is divided among
___________________
the shareholders of the company. After complying with the
tio
___________________ provisions of the Companies Act and the Articles of Association the
___________________ profit of the company is distributed to the shareholders by the way
of return on their investment in shares. In case of inadequate of
uc
___________________
profits or absence of profit as per Section 205(A), a company can
___________________
declare and pay dividend out of revenue reserves (which were
___________________ made during the years of heavy profit) to maintain a uniform and
rod
___________________ steady rate of dividend. Only free and uncommitted reserves can
be utilized for the declaration of dividend. Capital profits are those
profits which are earned by the company on the transactions not
related to its normal course of business. When a company has a
ep
large amount of accumulated profit in its different revenue reserve
and the company wants to distribute it to its shareholders in
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addition to regular dividend, such a distribution is called 'bonus'.
Lesson End Activity

t fo
Discuss the sources from which bonus shares can be issued by a

company. Briefly state the main guidelines issued by SEBI for the
issue of bonus shares.
No
Keywords
Divisible Profits: Divisible profits are also known as profits
S,
divisible profits.
Proposed Dividend: The dividend which is recommended for the
PE
shareholders by the directors is called proposed dividend.

Final Dividend: Final dividend is declared and approved at the
annual general meeting. It is approved by the shareholders by
U
looking at the financial position and the divisible profits of the

company.
(c)
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203
Interim Dividend: The dividend that is declared between two
Notes
annual general meetings is called interim dividend. In other words,
it can be paid by directors to the shareholders at any time before ___________________
n/S
closing the final accounts. ___________________
Bonus: When a company has a large amount of accumulated profit ___________________

in its different revenue reserve and the company wants to
___________________
distribute it to its shareholders in addition to regular dividend,
tio
___________________
such a distribution is called bonus.
___________________
uc
___________________
___________________
1. Explain the term 'Dividend'.
rod
___________________
2. What do you mean by Divisional Profits?
___________________
3. What are the different sources of Dividend?
4. What are the different sources for the issue of bonus
ep
shares?
5. Lucky Limited has a credit balance of profit and loss account
of ` 2, 50,000 on 1st April 2012. The net profit for the year is `
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15, 50,000. During the year, a half-year's dividend was paid on

10% preference shares capital of ` 14, 00,000. It was decided
that following appropriation be made:
t fo
(i) Provision for taxation ` 7, 80,000

(ii) Dividend equalization reserve account ` 50,000.
(iii) To pay the final dividend on preference shares.
No
(iv) To pay the dividend 15% on the ` 20, 00,000 equity

capital.
(v) Transfer to general reserve ` 40,000
S,
(vi) Transfer to debentures redemption reserve ` 80,000.

Prepare Profit and Loss Appropriation A/c and give journal
PE
entries for payment of dividend. Tax is deducted on preference

dividend @ 10%.
6. Following were the balance in the books of Victory Company
U
Limited as at 30th June, 2012:

(i) Authorised Capital: 1, 00,000 share of ` 100 each.
(c)
(ii) Issued Capital: 80,000 shares of ` 90 per share paid up.

Business Accounting
ale
204
(iii) General Fund ` 36, 00,000
Notes
___________________
(iv) Profit and Loss A/c ` 16, 00,000
n/S
___________________ The following resolutions were passed on annual general
meeting of the company, which was held on 17th August, 2012:
___________________
(a) To pay ` 15 cash dividend for each share
___________________
(b) To declare capital bonus @ ` 50 per share. It was used in
tio
___________________
making partly paid up share as fully paid and the balance
___________________
was used in issuing fully paid bonus shares at a premium
of 60%.
uc
___________________
___________________ (c) ` 2, 00,000 was to be paid as bonus to the employees of the

___________________ company. These resolutions were carried out.
rod
___________________ Pass the necessary journal entries in the books of the company.
Further Readings
ep
Books
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Delhi.
Chand, New Delhi.
t fo

No
New Delhi.
Web Readings
http://beginnersinvest.about.com/od/dividendsdrips1/ss/dividends-
S,
and-dividend-investing-101_2.htm
http://www.cliffsnotes.com/study_guide/Dividends.topicArticleId-
PE
21248,articleId-21194.html
www.taxmann.com/taxmannflashes/articles/flashart23-12-
10_1.htm
U
www.icsi.edu/WebModules/Publications/SSONDIVIDEND(SS3).pd
f
(c)
UNIT 13: Amalgamation, Absorption & External Reconstruction
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Unit 13
205
Notes
Activity
What do you mean by
Amalgamation, Absorption &
___________________
amalgamation of companies?
n/S
Explain its objectives, merits
___________________
External Reconstruction and demerits.

___________________
___________________
tio
Objectives ___________________
___________________
topics:
uc
___________________
\ Amalgamation and Absorption of Companies
\ Reconstruction of Companies ___________________
\ Calculation of Purchase Consideration
rod
___________________
\ Accounting Treatment ___________________
Introduction
ep
In order to get the advantages of large scale business and to
abolish the cut-throat competition, two or more companies combine
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their undertakings. This combination of undertakings may be in

the form of amalgamation and absorption. In the chapter we
discuss the legal provisions which are considered at the time
preparation of accounts on the combination of business and
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reconstruction of business.
The modern age is the age of competition and large-scale business.
In order to derive the economies of large scale production and to
eliminate or reduce the competition, two or more than two
No
companies engaged in the similar nature of business, may combine

their undertakings. Combination of the undertakings reduces the
duplication of expenditures, decreases the amount of risk of
competition and also reduces cost per unit of the production.
S,
Combination of the companies may be in the form of

Amalgamation, Absorption and Reconstruction of Companies.
PE
Amalgamation and Absorption of Companies

When two or more companies having similar nature of business
U
merge their businesses in order to form a new company, such a

merging is known as amalgamation of companies. In other words,
(c)
two or more existing companies will liquidate themselves and a

new company will be formed to take over the business of these
Business Accounting
ale
206 companies. For example, suppose there are two companies X
Notes Limited and Y Limited engaged in the similar nature of business.
___________________ In the case of amalgamation, these two companies will liquidate
themselves and a new company (assume X Y Ltd.) will be formed
n/S
___________________
to take over the business of these two existing companies.
___________________
According to Halsburry's Laws of England "Amalgamation is a
___________________
blending of two or more existing undertakings into one
tio
___________________ undertaking, the shareholder of each blending company becoming
___________________ substantially the shareholders in the company which is to carry on
the blended undertakings. There may be amalgamation either by
uc
___________________
transfer of two or more undertakings to a new company or by the
___________________
transfer of one or more undertakings to an existing company."
___________________
rod
Absorption of Companies
___________________
In absorption, an existing company takes over the business of one
or more existing companies, which dissolve their businesses. In
other words, no new company will be formed to take over the
ep
business of the liquidating companies. Only an existing company
will acquire the business of these companies. For example: If A
rR
Limited (an existing company) acquires the business of B Limited

(an existing company), it will be a case of absorption. In this case,
B Limited has to dissolve itself.
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Objectives of Amalgamation & Absorption

1. To eliminate or reduce cut-throat competition.
2. To reap the economies of the production of goods and services
No
on a large scale.
3. To gain control over the market.
4. To gain the benefits of the service of the experts.
5. To promote research and development schemes.
S,
6. To derive the other advantage of the amalgamation.

PE
Types of Amalgamation
According to AS-14 for the purpose of accounting, the
amalgamation of companies is divided into two categories:
U
1. Amalgamation in the nature of merger.

(c)
2. Amalgamation in the nature of purchase.

ale
Amalgamation in the Nature of Merger 207
Upon the satisfaction of the following conditions of AS-14, the Notes
amalgamation of the companies is considered as merger: ___________________
n/S
(i) All the assets and liabilities of the transferor company become, ___________________
after amalgamation, the assets and liabilities of the transferee
___________________
company.
___________________
(ii) Shareholders holding not less than 90% of the face value of the
tio
equity shares of the transferor company (other than equality ___________________
shares already held therein, immediately before the ___________________

amalgamation of the transferee company or its subsidiaries or
uc
___________________
their nominees) become equity shareholders of the transferee
___________________
company by virtue of amalgamation.
rod
___________________
(iii) The consideration for the amalgamation receivable may those
equity shareholders of the transferee company is discharged by ___________________
the transferee company wholly by the issue of equity shares in
the transferee company, except that cash may be paid in
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respect of any fractional shares.
(iv) The business of the transferee company is intended to be
carried on, after the amalgamation by the transferee company.
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(v) No adjustment is intended to be made to the book values of the

assets and liabilities of the transferor company when they are
incorporated in the financial statements of the transferee
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company, except to ensure uniformity of accounting policies.
Amalgamation in the Nature of Purchase

If an amalgamation does not satisfy any one or more of the
No
conditions mentioned above for amalgamation in the nature of

merger, such an amalgamation is called the amalgamation in the
nature of purchases. For example, if X Ltd. purchases the business
of Y Ltd. with an intention not to continue the business of Y Ltd., it
S,
will be an amalgamation in the nature of purchase and not merger.
Merits of Amalgamation
PE
(1) After the amalgamation of two or more companies, the

prevailing competition among themselves is eliminated.
(2) On the amalgamation of two or more companies, certain
U
expenses are reduced.

(3) When two or more companies amalgamate themselves, it is
(c)
easy for them to control the market through the supply of

goods.
Business Accounting
ale
208
(4) If there is an amalgamation of two or more companies, there
Notes
will be more capital and the problem of finance will be
___________________ removed.
n/S
___________________ (5) After amalgamation of companies, there will be greater control
___________________ on the business.
(6) Production on a larger scale is possible through the
___________________
amalgamation of two or more companies.
tio
___________________
(7) In the case of amalgamation, it is possible to avail of the
___________________ services of experts otherwise, heavy remuneration has to be
paid to experts.
uc
___________________
___________________ (8) After the amalgamation of companies, distribution channel of

the products becomes easy.
___________________
rod
___________________ Demerits of Amalgamation
(1) Amalgamation of companies may give rise to problems of over-
capitalization.
ep
(2) Amalgamation of companies reduces the expenditure, cost and
price of the products of the bigger companies, smaller
businessmen therefore, cannot last for long when confronted
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by the bigger players.

(3) Upon increasing the size of the business after amalgamation,
managerial problems multiply.
t fo
(4) The possibilities of exploitation of customers by amalgamated

companies are manifold.
(5) There is also one more danger of monopoly by the
amalgamation of company.
No
(6) Increased production by the amalgamated companies may give

rise to problems of proper distribution and over-production.
(7) The event of non-cooperation between the managerial staff of
the amalgamated companies may retard the growth of the
S,
business.
Check Your Progress

PE
Fill in the blanks:

1. When two or more companies having similar nature of
business merge their businesses in order to form a new
U
company, such a merging is known as …………………

2. In …………………, an existing company takes over the
(c)
business of one or more existing companies, which

dissolve their businesses.
ale
Reconstruction of Companies 209
Notes
Activity
Reorganization or rearrangement of the capital structure of a
Collect recent data
___________________ on
business unit is called reconstruction of the company. The
n/S
reconstruction of companies
objectives of the reconstruction of a company are not the same as and ___________________
prepare a presentation.
those of business combination. In the case of severe financial ___________________
problems as overcapitalization, heavy losses and over valuation of
___________________
fixed assets, reconstruction of the financial structure becomes
tio
necessary. Reconstruction of the financial structures of the ___________________
company is expressed to alter the rights and interest of the ___________________

shareholders, debenture-holders and creditors or outsider's
uc
___________________
liability. On the reconstruction of the company it may or may not
___________________
go into liquidation.
rod
___________________
Reconstruction of companies may be of two types:
___________________
(a) Internal Reconstruction
(b) External Reconstruction
ep
Internal Reconstruction
Internal reconstruction means the reorganization of the capital
rR
structure of a company without forming a new company and

without liquidating the existing company. Internal reconstruction
of a company is done to alter the share capital or to reduce the
share capital without going into liquidation. It means the
t fo
reorganized form of the company will run the business of the

existing company. The claims of the shareholders, creditors and
outsiders are adjusted towards the amount of writing off the losses
and fictitious assets. This is further discussed in the following
No
pages.
External Reconstruction
When the capital structure of a company is reorganized through
S,
the liquidation of the existing company and formation of the new

company, it is called external reconstruction. Thus, in the case of
PE
external reconstruction, one existing company will go into

liquidation and a new company will be formed in order to purchase
the business of the existing company. For example, when Ankit
Limited goes into liquidation and a new company Ankit Mohan
U
Limited is formed to purchase the business of Ankit Limited, it is a

case of external liquidation. In this way, the shareholders and
(c)
persons interested and business will be same in the newly formed

company as were in the old company.
Business Accounting
ale
210
The different features of the Amalgamation Absorption and
Notes
Activity
External Reconstruction are given in the following table:
Give___________________
the meaning of purchase
consideration and list the Basis of External
n/S
Amalgamation Absorption
___________________
different methods to calculate Difference Reconstruction
the purchase consideration. 1. Liquidation Two or more One or more One and only one
___________________ companies go into companies go into company goes into
liquidation. liquidation. liquidation.
___________________
2. Formation of A new company is Only the existing A new company is
tio
___________________ Company formed to take company acquires the New formed to
over the business acquire the business of liquidated company.
___________________ of the wound up the business of the
company. wound up company.
3. Shareholders The shareholders There will be the The shareholders of
uc
___________________
of the new shareholders of the the new company
___________________ company are purchasing company are those who were
those who were in only. in the old company.
___________________ the old company.
rod
4. Level of The level of the The economic status of The economic
___________________ Companies amalgamating the purchasing condition of the old
companies is company is, enhanced company is found to
generally same. in comparison to that be unsound, and a
of the liquidating. new company is
formed to rectify
ep
the situation.
Here, we shall deal with the accounting treatment of

amalgamation, absorption and external reconstruction of
rR
companies only, because there is quite similarity. Accounting

treatments of the internal reconstruction are discussed in the
following pages separately.
t fo
Check Your Progress

Fill in the blanks:
1. ……………….. of the capital structure of a business unit
No
is called reconstruction of the company.

2. ……………….. means the reorganization of the capital
structure of a company without forming a new company
and without liquidating the existing company.
S,
Calculation of Purchase Consideration

PE
The purchase consideration is that amount which is determined at

the time of amalgamation. In other words, it is that amount which
is payable by the transferee company (purchasing company) to the
U
transferor company (vendor company) for the purchase of business.

Purchase consideration may be paid in cash, shares, debentures or
(c)
other securities. As per Accounting Standard (AS)-14

"consideration is the aggregate of the shares and the other
ale
securities issued and the payment made in the form of cash or 211
other assets by the transferee company to the shareholders of the Notes
transferor company." ___________________
n/S
Mode of Payment is generally decided by the mutual agreement ___________________
between Transferor Company and Transferee Company. Fair value
___________________
of the different elements of the consideration is also considered as
the market value of assets. It is to be noted that purchase ___________________
tio
consideration must be paid directly to the shareholders of the ___________________
transferor company. If any amount is directly paid to the creditors ___________________
or debenture-holders of the transferee company, it will not be
uc
___________________
included in the amount of purchase consideration.
___________________
The following methods are used to determine the amount of
purchase consideration:
rod
___________________
___________________
(a) Lump Sum Method
(b) Net Assets Method
ep
(c) Net Payment Method
(d) Intrinsic Worth Method or Share Proportion Method
rR
(a) Lump Sum Method: It is the simplest method among the

above four methods. Under this method, no calculation is
required. The amount of purchase consideration is clearly
given as a lump sum in the examination problems. For
t fo
example, if A Ltd. acquires the business of B Ltd., for ` 35,

00,000 will be the purchase consideration in lump sum.
(b) Net Assets Method: Under this method, the purchase
No
consideration is calculated by adding the agreed value of all

the assets which have been taken over by the transferee
(purchasing) company and deducting there from the total of
agreed value of those liabilities, which have been taken by the
transferee company.
S,
In the form of formula:

PE
Purchase consideration = Total of agreed value of assets taken

over - Total of agreed value of liabilities taken over.
At the time of calculating the purchase consideration by this
U
method, the students should consider the following points:

(i) Only those assets are aggregated which have been taken
(c)
over by the transferee company.

Business Accounting
ale
212
(ii) The fictitious assets and miscellaneous expenditure such
Notes
as preliminary expenses, debit balance of profits and loss
___________________
account etc., are never included in the total of assets.
n/S
___________________
(iii) In the absence of any contrary information, the book value
___________________ of the assets and liabilities taken by Transferee Company
___________________ is treated as agreed value.
tio
___________________ (iv) Only those liabilities are considered, which have been
taken over by the transferee company. In the absence of
___________________
contrary information, all the liabilities belonging to third
uc
___________________
party are assumed to be taken by the transferee company.
___________________
(v) Accumulated profits appearing in the liability sides are
___________________ not considered in calculating the consideration.
rod
___________________ (vi) Payments directly made to the debenture holders and
outside liabilities of the transferor company by the
transferee company are not considered.
ep
(c) Net Payment Method: Under this method, the purchase
consideration is calculated by aggregating the payments made
by the transferee company to the shareholders of transferor
rR
company in the form of cash, shares, debentures and agreed

value of assets given. There is a point for the students to be
noted that all the payments made by the transferee company
t fo
only to the shareholders of the transferor company are the

parts of purchase consideration. And the payments made by
the transferee company to the outside liabilities, creditors and
debenture holders of the transferor company are not
No
considered into the above aggregation of payments because it

is presumed that outside liabilities are taken over and paid by
the transferor company. If the liquidation expenses of the
transferor company are paid by the transferee company that
S,
must also be added in the purchase consideration. The

transferee company may issue the shares and debentures to
the transferee company at par at premium or a discount. In
PE
the absence of instruction, the transferee company must issue

the shares, to the transferor company at par in the case of
amalgamation of the companies in the nature of merger, and
U
at market price in case of amalgamation of companies in the

nature of purchase.
(c)
(d) Intrinsic Worth Method: Under this method, first of all the
intrinsic value of the shares of the transferor is calculated on
ale
the basis of net assets. The net assets are calculated according 213
to net assets method. Therefore, purchase consideration Notes
Activity
calculated under this method becomes equal to the purchase Tom___________________
Company Limited agrees
consideration calculated under net assets method. To find out
n/S
to take over the business of
___________________
the intrinsic value of the shares, the net assets of the company Jerry Company Limited, the
consideration being the
are divided by the number of shares. After finding this value, ___________________
assumption of trade liabilities
the rate of exchange of shares between Transferor Company ` 62,500, the payment of the
___________________
tio
and Transferee Company is determined. If, in the examination cost of liquidation ` 2,500, the
___________________
redemption of the 'Y'
problem, the agreed values of the shares of both the companies
Debentures of ` 2,50,000 at a
___________________
are given, there is no requirement to calculate the intrinsic premium of 10%, the
values of the shares. Suppose there are two companies Ankit
uc
___________________
discharge of 'X' Debentures of
Limited and Shobhit Limited carrying on business in the same ` 5,00,000 at a premium of
___________________
8% by the issue of 10%
line of activities. Their capitals are `24, 00,000 and ` 8, 00,000
Debentures in the Tom
rod
___________________
(value of each share, ` 100). The two companies decided to Company Limited and the
amalgamate in Akshaye Limited. If each share of Ankit ___________________
payment of ` 10 per share in
Limited and Shobhit Limited is valued at ` 150 and ` 250 cash and exchange of 2 fully
paid ` 10 in Tom Co. Ltd., at
respectively for the purpose of amalgamation, then purchase the market price of ` 15 per
ep
consideration will be as follows: share for every share in the
Jerry Co Ltd. The share
Ankit Ltd. Shobhit Ltd. capital of the Jerry Company
rR
Ltd. consists of 25,000 shares

24,000 shares @ ` 150 each 36, 00,000 – of ` 25 each fully paid.
Calculate the purchase
8,000 shares @ ` 250 each – 20, 00,000 consideration by net payment
At the time of issuing the shares to the individual shareholders, method.
t fo
there may be fraction of shares. However, the fractional shares

cannot be issued by the company. In such a situation, the company
can issue the fractional certificate or pay cash for the fractions.
No
Check Your Progress

Fill in the blanks:
1. Under ………………. method, no calculation is required.
S,
2. Under ………………. method, first of all the intrinsic

value of the shares of the transferor is calculated on the
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basis of net assets.
Accounting Treatment
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Let us discuss the:

z Journal Entries in the Books of Transferor Company
(c)
z Journal Entries in the Books of Transferee Company

Business Accounting
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214
Journal Entries in the Books of Transferor Company
Notes
In any of the conditions-either amalgamation in the nature of
___________________ purchase, in the nature of merger, absorption, or external
n/S
___________________ reconstruction-the transferor company has to wind up its business.
Hence all the accounts have to close in the same way as the
___________________
accounts of partnership firm are closed on dissolution. All assets
___________________
are disposed, liabilities are paid off and the surplus (if any) is
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___________________ distributed among its shareholders. Following are the journal
___________________ entries, which are passed in the books of Transferor Company:
(1) For transferring the assets taken over by the transferee
uc
___________________
company:
___________________
Realization A/c. Dr.
___________________
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To Various Assets A/c.
___________________
(Being the transfer of various assets to Realization A/c).
Note:
ep
(a) Various assets will be shown individually
(b) Assets will be shown at book value
(c) Fictitious assets and miscellaneous expenses will not be
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transferred to Realization A/c.

(d) If cash balance and bank balance are not taken over by
the transferee company, these will not be transferred to
t fo
the Realization A/c.

(2) For transferring the liabilities taken over by the purchasing
company:
No
Various liabilities A/c. Dr.

To Realization A/c.
(Being transfer of various liabilities to the Realization A/c)
Note:
S,
(a) All liabilities will be shown individually.

(b) Accumulated profits are not transferred to Realization A/c.
PE
(c) If the transferee company agrees to pay some liabilities

directly, such liabilities will not be transferred to the
realizations A/c.
U
(d) Those liabilities, which have not been taken by the

transferee company, will also not be transferred to the
(c)
Realization A/c.
ale
215
(3) For recording the purchase consideration due:
Notes
Transferee Company A/c. Dr.
___________________
n/S
To Realization A/c.
___________________
(Being purchase consideration receivable) ___________________
(4) For selling the assets which are not taken over by the ___________________
transferee company:
tio
___________________
Bank or Cash A/c. Dr.
___________________
To Realization A/c.
uc
___________________
(Being the realization of assets) ___________________
(5) For liquidness expenses of the transferee company:
rod
___________________
(a) When the payment of liquidation expenses or realization ___________________

expenses is made by the transferor company itself.
ep
To Bank A/c.
(Being payment of liquidation expenses)
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(b) If liquidation expenses are borne and paid by the

transferee company, it would be better not to pass any
entry. Alternatively, the following two entries may be
t fo
passed:
(i) When expenses are paid:
Transferee Company A/c. Dr.
No
To Bank A/c.
(Being payment of liquidation expenses on the behalf
of Transferee Company)
(ii) When the expenses are reimbursed:
S,
Bank A/c. Dr.

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To Transferee Company's A/c.

(c) If the transferee company pays the liquidation expenses
with purchase consideration and not pay separately:
U

(c)
To Bank A/c.
(Being payment of Realization Expenses)
Business Accounting
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216
(6) For the discount or premium to the debenture-holders or
Notes
preference shareholders: At the time of amalgamation,
___________________
absorption and external reconstruction shares may be repaid
n/S
___________________ at premium or discount. Such a premium or discount is first
___________________ transferred to the realization account. Entries would be:
___________________ (a) For discount:
tio
___________________ Debenture-holders Account Dr.
___________________ Preference Shareholders Account Dr.

To Realization A/c.
uc
___________________
___________________ (Being transfer of discount to realization A/c)
___________________ (b) For Premium:
rod
___________________ Realization Account Dr.
To Debenture-holders A/c.
To Preference Shareholders A/c
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(Being transfer of premium to realization A/c)
(7) For gain or loss on the payment of liabilities not taken
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over: If there are some liabilities which are not taken over by
the transferee company, those will not be transferred to the
realization account. But if any profit or loss may occur on the
redemption of such liabilities, such a profit or loss will be
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transferred to the realization account. Then, journal entries

would be:
(a) If there is loss:
No

To Relative Liability A/c
(Being transfer of loss on repayment of the liability)
S,
(b) If there is a profit:

Relative Liability A/c Dr.
PE
To Realization A/c
(Being transfer of profit on repayment of liability)
(8) For receiving the purchase consideration from
U
transferee company:
(c)
Bank A/c Dr.

Shares in Transferee Company A/c Dr.
ale
217
Debentures in Transferee Company A/c Dr.
Notes
To Transferee Company's A/c
___________________
n/S
(Being receipt of purchase consideration in cash, shares
___________________
and debentures)
___________________
(9) For closing the realization A/c:
___________________
(a) On closing the Realization a/c if there is profit:
tio
___________________
Realization A/c Dr.
___________________
To Equity shareholders' A/c
uc
___________________
(Being transfer of profit on realization A/c to the equity ___________________
shareholder's A/c)
rod
___________________
(b) On closing the realization accounts, if there is a loss:
___________________
Equity shareholders' A/c Dr.
To Realization A/c
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(Being transfer of loss on Realization A/c to the equity
shareholder's A/c)
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(10) For transferring the fictitious assets and accumulated

losses:
Equity Shareholders' A/c Dr.
t fo
To Profit and Loss A/c

To Preliminary Expenses A/c
To Underwriting Commission A/c
No
To Discount on issue of Shares A/c

To Discount on issue of Debentures A/c
(Being transfer of fictitious assets and accumulated losses to
S,
shares to shareholders A/c)

(11) For transferring equity share capital and accumulated
PE
profits:
Equity Share Capital A/c Dr.
General Reserve A/c Dr.
U
Profit and Loss A/c Dr.

(c)
Capital Reserve A/c Dr.

To Equity shareholders capital A/c
Business Accounting
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218
(Being transfer of share capital and accumulated profits to
Notes
equity shareholders A/c)
___________________
(12) For the payment of debenture-holders:
n/S
___________________
(a) Debentures A/c Dr.
___________________
To Debenture-holders A/c
___________________
(Being transfer of debentures to debenture-holders A/c)
tio
___________________
___________________ (b) On payment:

Debenture-holders A/c Dr.
uc
___________________
___________________ To Bank A/c

___________________ To Debentures in Transferee company
rod
___________________ (Being payment of debenture-holders)
(13) For the payment of preference share capital:
(a) Preference shares Capital A/c Dr.
ep
To Preference Share Capital A/c
(Being transfer of preference share capital to preference
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shareholders A/c)
(b) On payment:
t fo
Preference Shareholders A/c Dr.

To Bank A/c
To Debentures in Transferee company
No
To Equity Shares in Transferee company

To Preference Shares in Transferee company
(Being payment of preferences shareholders in cash, shares
and debentures)
S,
(14) For the Final payment of equity shareholders:

PE
Equity shareholders A/c Dr.

To Bank A/c
To Equity Shares in Transferee Company
U
To Debentures in Transferee Company

(c)
(Being payment of equity shareholders)

ale
Note: After passing this entry, not a single account would have 219
any balance. All the accounts will be closed. Notes
___________________
Journal Entries in the Books of Transferee Company
n/S
___________________
As per the Accounting Standard (AS)-14, there are two methods of
accounting for the amalgamation of companies in the books of ___________________
Transferee Company. These are given below: ___________________
tio
(a) Pooling of Interests Methods ___________________
(b) Purchase Method ___________________
uc
(a) Pooling of Interests Methods: When amalgamation is in the ___________________
nature of merger, this method of accounting is adapted. The ___________________

main features of the pooling of interests method are given
rod
___________________
below:
___________________
(1) In preparing the transferee company's financial
statements, the assets, liabilities and reserves (whether
capital or revenue or arising on revolution) of the
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transferor company should be recorded at their existing
carrying accounts and in the same form as at the date of
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amalgamation.
(2) The balance of the Profit and Loss Account of the
transferor company should be aggregated with the
corresponding balance of the transferee company, or
t fo
transferred to the general reserve, if any.

(3) The difference between the amount recorded as share
capital issued (plus any additional consideration in the
No
form of cash or other assets) and the amount of share

capital of Transferor Company should be adjusted in
reserves.
(4) If, at the time of amalgamation, the transferor and
S,
transferee companies have conflicting accounting policies,

a uniform set of accounting policies should be adopted
PE
following the amalgamation. The effects on the financial

statements of any changes in the accounting policies
should be reported in accordance with Accounting
Standard (AS)-5, Prior Period of Extraordinary Item and
U
Changes in Accounting Policies.

Accordingly, the following entries are passed in the books of
(c)
Transferee Company to incorporate the financial statements of

company:
Business Accounting
ale
220
1. For recording the purchase consideration:
Notes
___________________
Business Purchase A/c Dr.
To Liquidators of Transferor Company
n/S
___________________
(Being purchase consideration due to the liquidators of
___________________
Transferor Company)
___________________
2. For recording the assets, liabilities and reserves taken
tio
___________________
over:
___________________ Sundry Assets (Individually) A/c Dr.
To Sundry Liabilities (individually) A/c
uc
___________________
___________________ To Various Reserves A/c

___________________ To Business Purchase A/c
rod
___________________ (Being sundry assets, liabilities and reserves of transferor
company taken over)
Note:
ep
(a) All the assets and liabilities will be shown
individually at the book value.
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(b) The difference between debit and credit an account of

purchase consideration will be adjusted in the General
Reserve of the transferee company. If the credit side is
greater than the debit side, the following entry will be
t fo
passed.
Various Assets A/c Dr.
General Reserve (Balancing figure) A/c Dr.
No
To Various Liabilities A/c

To Reserve & Funds A/c
To Business Purchase A/c
3. For making the payment of purchase consideration to the
S,
liquidation of transferor company:

Liquidator of Transferor Company A/c Dr.
PE
To Bank A/c
To Debentures A/c
U
To Equity Share Capital A/c

To Preference Share Capital A/c
(c)
(Being discharge of purchase consideration in cash,

debentures and shares)
ale
221
If shares or debentures are issued on discount, discount
Notes
account will also debited and if shares or debentures are
issued at premium, premium account will be credited in ___________________
n/S
the above entry. ___________________
4. For the payment of liquidation expenses of transferor ___________________

company:
___________________
tio
Goodwill/Liquidation Expenses A/c Dr. ___________________
To Bank A/c ___________________
uc
___________________
5. For the payment of preliminary/formation expenses of the ___________________

transferee company:
rod
___________________
Preliminary Expenses A/c Dr. ___________________
To Bank A/c
(Being payment of preliminary expenses)
ep
6. For discharging the debentures of the transferor company:
Debentures of the Transferor Company A/c Dr.
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To Bank A/c
To Debentures of the Transferor Company
t fo
To Shares of the Transferor Company.

(Being discharges of debentures of the transferor
company)
No
(b) Purchase Method: Purchase method of amalgamation is

adapted by the transferee Company, when amalgamation is in
the nature of purchase. The following points are kept in mind
at the time of passing of accounting entries under this method:
S,
(1) In preparing the transferee company's financial

statements, the assets and liabilities of the transferor
company should be incorporated at their existing carrying
PE
accounts or, alternatively, the consideration should be

allocated to the individual identifiable assets and
liabilities on the basis of their fair values at the date of
U
amalgamation.
(2) The reserves (whether capital or revenue or arising on
(c)
revaluation) of the transferor company, other than the

Business Accounting
ale
222 statutory reserves, should not be included in the financial
Notes statements of the transferee company.
___________________
(3) Any excess of the amount of the consideration over the
n/S
___________________ value of net assets of the transferor company acquired by
___________________ the transferee company should be recognized in the
transferee company's financial statements as goodwill
___________________
arising on amalgamation. If the amount of the
tio
___________________ consideration is lower than the value of the net assets
___________________ acquired, the difference should be treated as capital
reserve.
uc
___________________
___________________
(4) The goodwill arising on amalgamation should be
amortised to income on a systematic basis over its useful
___________________
life. The amortization period should not exceed five years
rod
___________________ unless a somewhat longer period can be justified.
(5) Where the requirements of the relevant statute for
recording the statutory reserves in the books of the
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transferee company are complied with, statutory reserves
of the transferor company should be recorded in the
financial statements of the transferee company. The
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corresponding debit should be given to a suitable account

head (e.g. Amalgamation Adjustment Account), which
should be disclosed as a part of 'Miscellaneous
t fo
Expenditure' or other similar category in the balance

sheet. When the identity of the statutory reserves is no
longer required to be maintained, both the reserves and
the aforesaid account should be reversed.
No
Accordingly, the following journal entries are made in the

books of transferee company to incorporate the financial
statements of the transferor company:
1. For recording the purchase consideration:
S,
Business Purchase Account Dr.

PE
To Liquidator of Transferor Company

(Being purchase price due to the liquidator of the
transferor company)
U
2. For recording the assets, liabilities and reserves taken

over:
(c)
Sundry Assets (individually) A/c Dr.

ale
223
To Sundry Liabilities (individually) A/c
Notes
To Various Reserve A/c
___________________
n/S
To Business Purchase A/c
___________________
(Being sundry assets, liabilities and reserves of Transferor ___________________
Company taken over)
___________________
(a) All the assets and liabilities will be shown
tio
___________________
individually at the book values.
___________________
(b) If debit side is greater than credit side, difference will
uc
___________________
be credited to the Capital Reserve A/c and if credit
side is greater than the debit side, difference will be ___________________
debited to the Goodwill A/c.
rod
___________________
3. For making the payment of purchase consideration to the ___________________
liquidator of the transferor company:
Liquidator of Transferor Company A/c Dr.
ep
To Bank A/c
To Debentures A/c
rR
To Equity Share Capital A/c

To Preference Capital A/c.
(Being discharge of purchase consideration in cash,
t fo
debentures and shares)

Note: If shares or debentures are issued on discount,
discount account will also be debited and if shares or
No
debentures are issued at premium, premium account will

be credited in the above entry.
4. For the payment of liquidation expenses of the transferor
company:
S,
Goodwill A/cDr.
To Bank A/c
PE

5. For maintaining the statutory reserve:
U
Amalgamation Adjustment A/c Dr.

To statutory Reserve A/c
(c)
Business Accounting
ale
224
(Being incorporation of statutory reserves of the transferor
Notes
company)
___________________
6. For the payment of preliminary expenses:
n/S
___________________
Preliminary Expenses Account Dr.
___________________
To Bank A/c
___________________
(Being payment of preliminary expenses)
tio
___________________
___________________ 7. For the payment of various liabilities of the transferor

company:
uc
___________________
Various Liabilities A/c Dr.
___________________
___________________
To Bank A/c
rod
___________________ To Debentures A/c
To Share capital A/c
(Being payment of liabilities of the transferor company)
ep
8. For writing off the goodwill against Capital reserves:
Capital Reserve A/c Dr.
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To Goodwill A/c
(Being goodwill written off against capital reserves)
t fo
Check Your Progress

Fill in the blanks:
1. At the time of ……………………, absorption and
No
external reconstruction shares may be repaid at

premium or discount.
2. If there are some liabilities which are not taken over by
the transferee company, those will not be transferred to
S,
the ……………………
PE
Summary
In the modern age, to eliminate the cut throat competition, to reap
the economies of production at large scale, amalgamation and
U
absorption of companies are adopted. Amalgamation can be in the

nature of merger and in the nature of purchase.
(c)
Reconstruction of companies is the rearrangement of financial

structure of the company. It is of two types (i) Internal
ale
Reconstruction and (ii) External Reconstruction As per AS 14 there 225
are two methods of accounting for amalgamation i.e. .Pooling of Notes
Interest Methods and Purchase Method. ___________________
n/S
Purchase consideration is the amount which is paid by the ___________________
transferee company to the transferor company on the
___________________
amalgamation. It is computed by (a) Lump Sum Method , (b) Net
Assets Method, (c) Net Payment Method and (d) Intrinsic Worth ___________________
tio
Method. At the time of Amalgamation of Companies, the inter- ___________________
company Owings/ transactions are eliminated. ___________________
uc
___________________
Lesson End Activity
___________________
“To eliminate the cut throat competition, to reap the economies of
rod
___________________
production of large scale, amalgamation and absorption of
___________________
companies are adopted.” Discuss in detail.
Keywords
ep
Amalgamation: When two or more companies having similar
nature of business merge their businesses in order to form a new
rR
company, such a merging is known as amalgamation of companies.

Absorption: In absorption, an existing company takes over the
business of one or more existing companies, which dissolve their
t fo
businesses.
Internal Reconstruction: Internal reconstruction means the
reorganization of the capital structure of a company without
forming a new company and without liquidating the existing
No
company.
External Reconstruction: When the capital structure of a
company is reorganized through the liquidation of the existing
company and formation of the new company, it is called external
S,
reconstruction.
Accounting Treatment: Cancellation of the unissued shares
PE
capital does not require any journal entry in the books of the
company because it does not have any effect on the issued shares
capital.
U

(c)
1. What do you understand by purchase consideration? How is it

determined? Explain.
Business Accounting
ale
226
2. What do you mean by the term amalgamation? Explain any
Notes
four Objectives of it.
___________________
3. Define Amalgamation and give its merits and demerits.
n/S
___________________
4. What do you mean by Reconstruction of Companies? Explain
___________________
its different types.
___________________
5. Give a brief overview of calculation of purchase consideration.
tio
___________________
___________________
Further Readings
uc
___________________
___________________
Books
___________________
rod
Delhi.
___________________
Chand, New Delhi.
ep
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New Delhi.
Web Readings
t fo
www.rkmvc.ac.in/evecol/dept/bcs/syl20092010/syllabus_sem4.pdf
http://www.scribd.com/doc/51198074/AMALGAMATION-
ABSORPTION-RECONSTRUCTION
http://www.scribd.com/doc/9295098/Amalgamation-Absorption-
No
and-External-Reconstructions
220.227.161.86/19017comp_sugans_pe2_ accounting_cp9_ 4.pdf
S,
U PE
(c)
UNIT 14: Internal Reconstruction
ale
Unit 14
227
Notes
Activity
In how many ways the Share
___________________
Capital may be altered? Write
n/S
names.
___________________
___________________
Objectives
___________________
tio
topics: ___________________
\ Reconstruction of Companies ___________________

\ External Reconstruction
uc
___________________
\ Internal Reconstruction
___________________
\ Accounting Treatment for Reduction of Capital
rod
___________________
___________________
Introduction
Internal Reconstruction of the companies is the rearrange of the
ep
financial structure of the companies. In the internal reconstruction
of company, the alteration of share capital and reduction of share
capital are included. In the unit the procedure for these two and
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their accounting treatment is given.
Reconstruction of Companies
t fo
The word reconstruction of a company implies the reorganization

of the financial structure of the company. It is different from
amalgamation and absorption. In the case of heavy losses, over
capitalization or several financial problems, the reconstruction of a
No
company is adopted to remove these defects and to reorganize the

financial structure. Thus term 'reconstruction of a company' is
used to reorganize the financial structure. During the
reconstruction of a company, several changes take place such as
S,
change in shareholders' rights and interests, debenture- holders'

rights, creditors' rights etc. Reconstruction of a company may be of
PE
two type’s viz., (a) External Reconstruction (b) Internal

Reconstruction.
External Reconstruction
U
In the case of external reconstruction, an existing company goes

into liquidation and a new company is formed in order to buy its
(c)
business. Thus, shareholders of the old existing company become

the shareholders of the newly formed company.
Business Accounting
ale
228
Notes
In the case of internal reconstruction, the financial structure of a
___________________ company is reorganized without forming a new company and
n/S
___________________ liquidating an existing company. In order to avoid the tedious
affairs of forming a new company and liquidation of a company and
___________________
to avail of the tax advantages of set off past losses against future
___________________
profits, internal reconstruction of the company is adopted. In other
tio
___________________ words, internal reconstruction is adopted to alter the share capital
___________________ or to reduce the share capital. In the internal reconstruction the
reorganized form of the company runs the business of the existing
uc
___________________
company. The claims of the shareholders, creditors and outsiders
___________________ are adjusted towards the amount of writing off the accumulated
___________________ losses and fictitious assets. Thus, in the internal reconstruction,
rod
___________________
the following two are included:
1. Alteration of share capital
2. Reduction of share capital
ep
1. Alteration of Share Capital: According to Section 94 of the
Companies Act, a limited company having a share capital may,
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if so authorized by its Articles of Association, alter the capital

clause of its Memorandum of Association by the ordinary
resolution in the general meeting. These alterations do not
require the approval of the Company Law Board. Alteration in
t fo
the capital clause may be in any of the following ways:

(a) Increase in its share capital by the issue of fresh shares of
such amount as it thinks expedient.
No
(b) Consolidation of all or part of its existing shares of smaller

denomination into shares of larger denomination.
(c) Conversion of all or part of its fully paid shares into stock
and vice-versa.
S,
(d) Sub-division of its shares or part of them of larger

denominations into smaller denominations.
PE
(e) Cancellation of those shares which have not been issued.

(a) Increase in Share Capital by Issue of Fresh Shares: A
limited company may increase its nominal or subscribed
U
capital by making fresh issue of shares. To increase its

nominal capital, the company has to alter its capital
(c)
clause in its Memorandum of Association. On the passing

of the resolution for increasing of the nominal capital, the
ale
Registrar of the Companies must be informed within 229
thirty days of passing such resolution. The offer for the Notes
issue of fresh shares must first be made to existing ___________________
shareholders in the proportion of their holdings, unless
n/S
___________________
the company has decided otherwise by a special resolution
or by an ordinary resolution approved by the Central ___________________
Government. If the existing shareholders fail to exercise ___________________
tio
their option within fifteen days, the Board of Directors
___________________
will be free to issue such shares.
___________________
Accounting treatment for the issue of such shares will be
uc
___________________
same as is adopted for the issue of new shares explained
earlier. ___________________
(b) Consolidation of Shares: As per Section 94 of the
rod
___________________
Companies Act, 1956, a limited company may consolidate ___________________

its shares of smaller denomination (value) into larger
denomination (value). Generally, consolidation is done
ep
when the value of shares is in very small amount.
On consolidation of shares, the amount of paid up share
capital remains at old figure, but the number of shares
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decreases.
For example: XYZ Limited having a share capital of
` 10, 00,000 divided into 1, 00,000 shares of ` 10 each on
t fo
which ` 8 per share are paid up, resolve to consolidate 10

shares of ` 10 each into one share of ` 100. On
consolidation the paid up value of the shares will be same
but the number of shares will reduce.
No
On consolidation, the company will pass the following

journal entry:
Share Capital (` 10) Account Dr. 8, 00,000
S,
To Share Capital (` 100) Account 8, 00,000
(Being consolidation of 10 shares of ` 10 each, ` 8 paid up

PE
into one share of ` 100).

(c) Sub-Division of Shares: Section 94 of the Companies Act,
1956, also provides that a company may sub-divide its
U
shares of larger amount into shares of smaller amount if

so authorised by the Articles of Association. If the shares
(c)
are not fully paid up, the proportion between the amount
Business Accounting
ale
230 paid and the amount unpaid on each reduced share must
Notes be the same as it was before sub-division.
___________________
On the sub-division of shares, the amount of paid up
n/S
___________________ capital remains the same, but the number of shares
___________________ increases.
___________________ For example: XYZ Limited having a share capital of `

10,00,000 divided into 10,000 equity shares of ` 100 each,
tio
___________________
resolves to split up one equity share of ` 100 each into 2
___________________ equity shares of ` 50 each. After sub-division, the company
will have the same amount of capital and it will pass the
uc
___________________
___________________
following journal entry:
___________________ Equity Share Capital (` 100) Account Dr. 10, 00,000
rod
___________________ To Equity Share Capital (` 50) Account 10, 00,000
(Being sub-division of 10,000 shares of ` 100 each into

20,000 shares of ` 50 each).
ep
(d) Conversion of Shares into Stock and Vice-Versa: As per
Section 94 of the Companies Act 1956, a company is also
allowed to convert its fully paid up shares into stock or to
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reconvert that stock into fully paid up shares. Stock is the

set of fully paid shares of a number merged into one fund
having equal value. It is a point to be noted that stock is
t fo
always made from fully paid up share, it is never made

from partly paid up shares and shares cannot be
transferred into fractions, while stock can be transferred
into any fraction.
No
On the conversion of shares into stock, the shareholder

becomes stockholders. The stockholders have the same
rights, privileges and advantages as to dividends and
voting as were carried by the shares before conversion into
S,
stock took place. On conversion of shares into stock, the

work of maintaining register and issuing certificate is very
PE
simplified.
Accounting treatment: On conversion of fully paid up
shares into stock, the company has to pass the following
U
journal entry:
Equity Share Capital Account Dr.
(c)
To Equity Stock Account

ale
231
(Being conversion of fully paid up equity shares into
Notes
equity stock).
___________________
On the conversion of equity stock into fully paid up equity
n/S
shares, the above journal entry will be just reverse. ___________________
___________________
(e) Cancellation of Unissued Share Capital: As per Section
94(1) (e) of the Companies Act, 1956, a company is ___________________
tio
permitted to decrease the amount of its nominal capital by ___________________
cancellation of shares. Cancellation will be of those shares
___________________
which at the date of passing of the resolution for
uc
cancellation of shares in general meeting in that behalf ___________________
have not taken or agreed to be taken by any person and ___________________

thus diminish the amount of its nominal share capital.
rod
___________________
Diminution of share capital is different from the reduction
___________________
of share capital. Diminution of capital is unissued share
capital, while reduction of share capital is for
subscribed/paid up capital. For the reduction of capital,
ep
sanction of the court is mandatory while cancellation of
unissued capital does not require the sanction of court.
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Accounting Treatment: Cancellation of the unissued

shares capital does not require any journal entry in the
books of the company because it does not have any effect
on the issued shares capital.
t fo
2. Reduction of Share Capital: Capital reduction of a company

takes place strictly in accordance with the legal provisions of
Section 100 to 105 of the Companies Act, 1956. If the company
is authorised by its Articles of Association, it may, by a special
No
resolution and on its confirmation by the court on petition,

reduce its shares capital by the following ways:
(a) Reducing or extinguishing the liability of shareholders in
S,
respect of share capital not paid up.

(b) Writing off or cancelling any paid up capital which is lost
PE
by available assets.
(c) Paying off paid up capital in excess of the requirements of
the company.
U
(d) Any other method approved by the court.

As per Section 100, reduction (b) and (c) may be made either in
(c)
addition to or without extinguishing or reducing the liability of

shareholders for uncalled capital.
Business Accounting
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232
Any reduction of capital is dangerous for creditors, as issued
Notes
capital of a company represents the security on which the
___________________
creditors rely. Generally, companies do not call the full value of
n/S
___________________ shares at one time. The uncalled capital acts as a future security
___________________ for the creditors of the company. Therefore, any reduction in
___________________ capital reduces the security of the creditors. In such a situation
the creditors are entitled to object to the reduction. For this
tio
___________________
purpose the court shall settle a list of creditors and hear their
___________________
objections, if any, and on being satisfied that either the creditors
consent to the reduction or that their debts have been
uc
___________________
___________________ discharged or secured by the company, may confirm the

___________________
reduction on any terms it thinks fit. As per Sections 101 & 102
rod
the court may direct the company to add the words "and
___________________
reduced" to its name for a fixed period and to publish the
reasons for reduction for the information of the public.
ep
As per Section 103, the order of the court and minutes as approved
by the court have to be filed with the Registrar who will register
them and issue a certificate of registration which will be a
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conclusive evidence that everything is in order.
Reduction of capital is purely democratic and is decided by

securing the consent of the holders of at least three-fourth of the
t fo
shares concerned in separate class meetings by means of special

resolution. If at least one-tenth of the issued shareholders are not
satisfied with the resolution of reduction of capital, they may apply
to the court within 21 days after the resolution is passed. In this
No
case the decision of the court will be final.
Following are some exceptional cases in which reduction may take

place without the sanction of the court:
S,
(a) when shares are forfeited by the company for non-payment of

calls on instalments.
PE
(b) when redeemable preference shares are redeemed in

accordance with the provisions of Section 80.
(c) when shares are surrendered to the company.

U
(d) when the company cancels any share of its nominal capital
(c)
which has not been taken or agreed to be taken by any person.

ale
233
Check Your Progress
Notes
Activity
Fill in the blanks:
On ___________________
the reconstruction of ABC
1. The term ……………….. is used to reorganize the
n/S
Ltd. the following terms were
___________________
agreed upon:
financial structure.
The___________________
shareholders to receive in
2. ……………….. do not require the approval of the lieu of their present holding
Company Law Board. (viz.___________________
1, 00,000 shares of ` 10
tio
each) the following:
___________________
3. In the case of ……………….. reconstruction, an existing
(a) Fully paid equity shares
company goes into liquidation and a new company is ___________________
equal to 2/5th of their
formed in order to buy its business. holding.
uc
___________________
(b) 10% preference shares
4. On the sub-division of shares, the amount of ___________________
fully paid to the extent of
……………….. remains the same, but the number of 1/5th of the above new
rod
___________________
shares increases. equity shares.
___________________
Accounting Treatment for Reduction of Capital

ep
The accounting treatment of all the above cases is mentioned below
separately:
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Case I: Reducing the Liability of Shareholders in Respect of

Uncalled/Unpaid Amount
When unpaid amount of the share capital is reduced/extinguished

t fo
by the company, shareholders are benefited as they do not have to

pay the amount to that extent in future. On the other side the
security of the creditors is reduced. As a result, the partly paid up
shares become the fully paid up shares and the face value of the
No
shares reduced. The required journal entry to cancel the uncalled

amount will be as follows:
Share Capital (Partly paid up) Account Dr. (with paid up amount of shares)
S,
To Share Capital (fully paid up) Account
Case II: Reduction in Capital by Refunding the Excess Capital

PE
If the company is facing a problem of overcapitalization owing to

more than one reason, such as closure of a particular line of
production, it may reduce the capital by refunding the excess
U
capital to its shareholders. As the reduction of paid up capital

reduces the creditors' security, the creditors may object to such a
(c)
scheme. Therefore, the scheme of reducing of capital by refunding

of excess capital should be sanctioned by the court after meeting
Business Accounting
ale
234
out the creditors' objections for the purpose the following journal
Notes
entries are recorded:
___________________
(a) When refunded amount of capital is due to shareholders:
n/S
___________________
Share Capital Account Dr. (amount to be refunded)
___________________
To Shareholders' Account.
___________________
(b) When excess amount of capital is to be refunded:
tio
___________________
___________________
Shareholders' Account Dr. (amount of refund)
To Bank Account
uc
___________________
___________________ Case III: Reduction in Capital by Reducing the Paid up Capital

___________________ If a limited company suffers losses continuously over a number of
rod
___________________ years, the assets side of its balance sheet will show accumulated
losses in the form of deferred expenses, intangible assets, discount
on issue of shares and debentures, underwriting commission, cost
ep
of issue of shares and debentures, debit balance of P & L A/c etc. In
the case of such companies, goodwill appearing in the assets side of
the balance sheet is also a form of accumulated loss. Further, such
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companies may show the fixed assets, both tangible and intangible,
at more than reasonable value due to writing off minimum amount
of depreciation. It means that the capital of such companies
t fo
(suffering losses continuously over a number of years) is not

represented by its assets in the balance sheet. For the true
representation of the assets by capital. A capital reduction
programme is adopted. Under this programme that portion of
No
capital which is already lost by assets is washed out. It is carried

out by eliminating the lost capital and using the same for writing
off the accumulated losses, overvaluation amount of assets and
miscellaneous expenses appearing in assets side. This procedure is
S,
adopted by opening a new account 'Capital Reduction Account' or

'Reorganization Account' or 'Reconstruction Account' with the
PE
amount of Capital Reduction in the books of the company.
Accounting Treatment: For this purpose, the following journal

entries are recorded:
U
1. When capital is reduced by writing off the paid up value (face

value) of shares, it means the change the category of shares.
(c)
For this purpose, old share capital is closed by debiting and

new share capital account is opened by crediting and the
ale
difference between these two is transferred to Capital 235
Reduction Account. The journal entry will be: Notes
Share Capital (Old) Account Dr. (paid up value of old ___________________
n/S
shares) ___________________
To Share Capital (New) Account ___________________
(paid up value of new shares) ___________________
tio
To Capital Reduction Account ___________________
___________________
(amount of reduction)
uc
___________________
Note: If capital is reduced by writing off the paid up amount of
shares capital which is lost, it means face value of the shares ___________________
remains uncharged and the category of the share capital does
rod
___________________
not change. The journal entry will be:
___________________
Share Capital Account Dr.(amount of reduction of Capital)
To Capital Reduction Account

ep
or
To Reconstruction Account
2. If some debenture-holders or creditors have been agreed to

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sacrifice their claims against company towards reconstruction:

Debentures Account Dr. (amount of sacrifice)
Creditors Account Dr.

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To Reconstruction Account
Sometimes new debentures are issued in the exchange of old

debentures:
No
Old Debentures Account Dr. (amount of old debentures)
To New Debentures Account (amount of new debentures)
To Reconstruction Account (amount of sacrifice)
3. When the amount of Reconstruction A/c is utilized in writing

S,
off accumulated losses, fictitious assets and bringing down the

assets to their rational value:
PE
Reconstruction Account Dr. (Total amount written off)
To Profit and Loss A/c
To Discount on Issue of Shares A/c

U
To Discount on Issue of Debentures A/c
To Preliminary Expenses A/c

(c)
To Patents A/c (as case may be)

Business Accounting
ale
236
To Goodwill A/c
Notes
To Trade Marks A/c
___________________
To Unrecorded Liabilities A/c
n/S
___________________
To Other Assets A/c
___________________ 4. If there is any appreciation in the value of any assets:
___________________
Particular Assets Account Dr. (amount of appreciation)
tio
___________________
To Capital Reduction Account
___________________ 5. If any contingent liability arises and is paid immediately,
journal entry will be:
uc
___________________
___________________ (i) Reconstruction (Capital Reduction) A/c Dr.
___________________ To Contingent Liability A/c
rod
___________________ On payment:
(ii) Contingent Liability A/c Dr.
To Bank A/c
ep
6. If there remains some credit balances in the reconstruction
account that will be transferred to Capital Reserve Account.
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Reconstruction Account Dr.
To Capital Reserve Account
7. If the amount of writing off the assets, accumulated losses and

deferred expenses is more the capital reduction, excess will be
t fo
adjusted against the reserves appearing in the liability side.

The journal entry will be:
Reserve Account Dr.

No
To Reconstruction/Capital Reduction Account.
Illustration
Ravi Raghav Co. Ltd. passed the necessary resolution and received
sanction of the court for the reduction of its share capital by
S,
` 2,50,000 for the purposes enumerated hereunder: (a) To write off

the debit balance of profit and loss account ` 1,05,000. (b) To
PE
reduce the value of plant and machinery by ` 45,000 and of

goodwill by ` 20,000. (c) To reduce the value of investment to
market value by writing off ` 40,000.
U
The reduction was made by converting 25,000 preference shares of

` 20 each fully paid to the same number of preference shares of
(c)
` 15 each fully paid and by converting 25,000 equity shares of ` 20

each, ` 15 paid up into 25,000 equity shares of ` 10 each fully paid.
ale
Give journal entries necessary in relation to the reduction of share 237
capital and show how you would deal with the balance of the Notes
reduction of share capital account. ___________________
n/S
Solution: ___________________
Journal of Ravi Raghav Co. Ltd. ___________________
Date Particulars L.F. ` ` ___________________
tio
Preference Shares (` 20) Capital Account Dr. 5, 00, 000 ___________________
To Preference Shares (` 15) Capital Account 3, 75,000
___________________
To Capital Reduction Account 1, 25,000
uc
(Being reduction in capital by converting 25,000 Pref. ___________________
Shares of ` 20 each fully paid in 25,000 Preference
Shares of ` 15 each fully paid) ___________________
Equity Share Capital (` 20) Account Dr. 3, 75,000
rod
___________________
To Equity Share Capital (` 10) Account 2, 50,000
To Capital Reduction Account 1, 25,000

___________________
(Being reduction in capital by converting 25,000 shares of

` 20, ` 15 Paid up into 25,000 shares of ` 10 each)
ep
Capital Reduction Account Dr. 2, 10,000
To Profit and Loss Account 1, 05,000

To Goodwill Account 20,000
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To Plant & Machinery Account 45,000

To Investment Account 40,000
(Being utilization of capital reduction into writing off
debit balance of P & L A/c, Goodwill, overvaluation of
t fo
Plant & Machinery and Investment)

Capital Reduction Account Dr. 40,000
To Capital Reserve Account 40,000
(Being transfer of balance of capital reduction to

capital reserve account)
No
Check Your Progress

Fill in the blanks:
1. When unpaid amount of the share capital is …………..
S,
by the company, shareholders are benefited as they do

not have to pay the amount to that extent in future.
PE
2. When capital is ………….. by writing off the paid up

value (face value) of shares, it means the change the
category of shares.
U
3. Under ………….. programme that portion of capital

which is already lost by assets is washed out.
(c)
Business Accounting
ale
238
Summary
Notes
Internal reconstruction is the reorganization of the financial
___________________
structure of a company without forming a new company and
n/S
___________________ liquidating an existing company. Internal reconstruction of a
___________________ company is done by - (i) Alteration of share capital (ii) Reduction of
___________________
share capital.
tio
___________________
Lesson End Activity
___________________
Explain the various ways of ‘reduction of share capital method’ for
uc
___________________
internal reconstruction of a company.
___________________
___________________
Keywords
rod
___________________
Reduction of share capital: Diminution of capital is unissued
share capital, while reduction of share capital is for
subscribed/paid up capital.
ep
Consolidation of Shares: As per Section 94 of the Companies
Act, 1956, a limited company may consolidate its shares of smaller
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denomination (value) into larger denomination (value).

Reconstruction: The word reconstruction of a company implies
the reorganization of the financial structure of the company.
t fo
Internal Reconstruction: In the case of internal reconstruction,

the financial structure of a company is reorganized without
forming a new company and liquidating an existing company.
No

1. Explain various legal provisions of the Companies Act 1956 for
the reduction of capital.
S,
2. Write short note on:

(a) External Reconstruction
PE
(b) Internal Reconstruction.

3. XYZ Industries Ltd. whose Balance Sheet as on 31st March,
2012 appears below, formulated a scheme of reconstruction,
U
details of which follows and sacred approval of all concerned:

(c)
ale
Balance Sheet of XYZ Industries Ltd. 239
Liabilities ` Assets `
Notes
Equity Shares Capital: Fixed Assets 11, 20, 000 ___________________
n/S
1, 00,000 Shares of ` Patents & Copyrights 80,000
___________________
20 each, ` 10 paid up 10, 00,000 Investment at cost 65,000
___________________
8% preference shares 8,000
shares of ` 100 each, ` 75 paid up 6, 00,000 (Market value ` 55,000) ___________________
tio
Secured Loans: Current Assets 8, 49,000
___________________
9% Debentures 6, 00,000 Profit and Loss A/c 4, 28,000
+ Interest 1, 08,000 7, 08,000

___________________
uc
Bank Overdraft 1, 50,000 ___________________
Sundry Creditors
(Including interest of ` 15,000
___________________
due to Bank) 84,000
rod
___________________
25, 42, 000 25, 42,000
___________________
Preference dividend is in arrear for one year.
(a) Preference shareholders to give up their claims, inclusive
ep
of dividends, to the extent of 30% and desire to be paid off.
(b) Debenture-holders agreed to give up their claims to
interest in consideration of their rate of interest being
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enhanced to 10%.
(c) Bank agrees to give up 50% of their interest outstanding
in consideration of their being paid off at once.
t fo
(d) Sundry creditors would like to grant a discount of 5% if

they were to be paid off immediately.
(e) Balances on Profit and Loss A/c, Patents and Copyrights
No
and 25% of the total Sundry Debtors of ` 1, 20,000 to be

written off. Fixed assets to be written down by ` 14,000.
Investments to reflect their market value.
(f) To the extent not specifically stated, equity shareholders
S,
suffer on reduction of their rights.

(g) Cost of reconstruction ` 3,350.
PE
Pass journal entries in the books of the company, assuming

that the scheme has been put through fully with the equity
shareholders bringing in necessary cash to pay off the parties
U
and to leave a working capital of ` 20,000.

Also draw the Balance Sheet after reconstruction.
(c)
Business Accounting
ale
240
4. ` 1,20,000, 7% debentures. An issue of ` 1,00,000, 6%
Notes
debentures was made and allotted, payment for the same
___________________
having been received in cash. The goodwill, which stood at
n/S
___________________ ` 6,00,000, was written down to ` 3,00,000. The plant and
___________________ machinery, which stood at ` 2,00,000, was written down to
` 1,50,000. The freehold and leasehold premises, which stood
___________________
at ` 3,00,000, were written down to ` 2,50,000. Make necessary
tio
___________________ journal entries in the books of the company on the basis of
___________________ above transactions.
uc
___________________
___________________
Further Readings
___________________
Books
rod
___________________ T.S. Grewal, M.C. Shukla. “Advanced Accounts”. S. Chand, New
Delhi.
ep
Chand, New Delhi.
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New Delhi.
t fo
Web Readings
220.227.161.86/19670ipcc_acc_vol1_chapter-5.pdf
www.caclubindia.com › Discussion › Accounts › A/c entries
No
www.caclubindia.com › Discussion › Students › IPCC

articles.pubarticles.com › Articles & Tutorials
www.myicwai.com/StudyMaterialFinal/P-16.pdf
S,
http://www.cabible.com/forum/showthread.php/8948-IPCC-Good-
Accounts-Notes
U PE
(c)
UNIT 15: Case Study
ale
Unit 15
241
Notes
Case Study
___________________
n/S
___________________
___________________
Objectives
___________________
tio
___________________
uc
___________________
Case Study: Out to Lunch Cuisine Inc.
___________________
Out to Lunch was established in Vancouver, Canada, in 1985. It
is a rapidly growing fast-food restaurant chain. Their business
rod
___________________
model revolves around a uniquely flavoured hamburger, and a
___________________
very simple menu consisting of a hamburger, fries, and drinks.
They provide simple "round number" pricing, few products, and
rapid service. Out to Lunch also has a catering service for
ep
sporting events, corporate outings, and similar occasions.
Refer to the chart below to understand the working of OTL

Cuisine Inc. The blocks in the organization chart indicate the
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character of performance/responsibility evaluation that is

germane to each position. The Chief Executive Officer reports to
the owners, and the owners are primarily interested in their
return on investment. Three vice presidents report to the CEO:
t fo
1. The VP of operations is responsible for the overall investment

in operations, which is driven heavily by the combined profits
of each store. The VP of Operations oversees procurement,
No
store management, and catering management.
(i) The Procurement Manager oversees purchasing of food

and dishware.
(a) The Procurement activities are evaluated as cost

S,
centres, relying on budgets and standard costs to

control activities.
PE
(ii) The Store and Catering managers oversee supervisors

from each location.
(a) The Store and Catering Managers are responsible for

producing profits, and are evaluated accordingly.
U
2. The VP of Finance is viewed and evaluated as a cost centre.

(c)
3. The VP of Real Estate is responsible for site acquisition and

construction. Although the activities are largely viewed in the
Contd…
Business Accounting
ale
242 context of a cost centre, there is an expected rate of return for
Notes each new real estate investment. Therefore, the VP of Real
Estate is evaluated for cost control and return on investments.
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
The accounting system of the company supports preparation of an

accounting report for each responsibility centre. This information
ep
is essential to monitor, control, and direct each business unit.
Each individual store has a customized performance report.
Often, the reports provide a comparison between budgeted and
rR
actual data, with the difference being reported as a variance from

budget. These performance reports are consistent with the
organizational structure of the firm. At successively higher levels
within the organization, the reports tend to include less
t fo
transaction specific detail and more combinations of business

units.
No
S,
PE
Notice that Location A's performance report is very detailed, and

U
provides a basis for analysis of numerous facets of the business.

Graphics are frequently used to facilitate understanding by those
(c)
not accustomed to accounting reports. For example, each store

supervisor knows that fries and drinks have the highest profit
Contd…
UNIT 15: Case Study
ale
margins and they are encouraged to train employees to soft-sell 243
these items by asking customers "what type of drink did you Notes
prefer?" rather than "did you want a drink with this order?"
___________________
As a result, the report is "specialized" to show the product mix
n/S
___________________
proportions. In addition, each manager gets a bonus if food costs
are below 20% of sales; this incentive is designed to reduce food ___________________
waste and encourage sales of high margin products. The report
___________________
provides sufficient detail to show if the objectives are being met.
tio
Notice that unfavourable variances are highlighted in red. ___________________
Summarizing the results for Location A, note that the budgeted
___________________
goal for hamburger sales was not met. But, the profit objectives
uc
were nevertheless exceeded because the product mix of fries and ___________________
drinks produced offsetting higher margins. In addition Location A ___________________
managed to contain other variable costs.
rod
___________________
The next step up in the organizational chart is the Senior
Manager of Store Operations. This person is concerned with ___________________
making sure that each unit is profitable. Underperforming stores
are identified, problems are studied, and corrective measures are
ep
taken. Very little time is spent on locations that are meeting or
exceeding corporate profit goals. Although this manager has
access to the detailed reports for each store, the performance
rR
report of interest is a compilation of summary data for each

location that quickly highlights the areas of needed improvement.
Review the following performance report, noting the carry
forward of Location A's data into the report. Obviously, some
stores are performing much better than others; the senior
t fo
manager will certainly want to focus on store E immediately! Also

notice that there is $1,500,000 of fixed costs associated with store
operations that are not traceable to any specific location;
nevertheless, the senior manager of store operations must control
No
this cost and it is subtracted in calculating the overall margin.

Thus, the total fixed cost for all store operations is $9,500,000
($8,000,000 + $1,500,000).
S,
U PE
(c)
Contd…
Business Accounting
ale
244
Continuing up the organizational chart, the VP of Operations will
Notes
focus on summary data from store management, catering
___________________ management, and procurement. Notice that the "stores" column
(below) is derived from information found in the "combined"
n/S
___________________
column (above). Again, note the presence of fixed costs that are
___________________ not traceable to any specific operating segment ($1,300,000). Even
___________________ though this cost is not assigned to a specific segment, it remains a
cost for which the VP of Operations is responsible.
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
The next step in the corporate ladder is the CEO. This individual
is evaluated on the overall financial statement outcomes.
Although the CEO would have access to any and all of the reports
rR
from within the organization, they would mostly focus on the

reports emanating from each vice president's unit.
Questions
t fo
1. After analysing the case above, do you think all the

organizations, especially those in catering/hoteliering
business, should run on the same model of responsibility
accounting? Support your argument with reasons.
No
2. What problems do you see in responsibility accounting at OTL

Cuisines Inc.?
Source: www.otlcatering.com
S,
U PE
(c)
UNIT 16: Holding Company Accounts
ale
z 245
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
rod
___________________
ep ___________________
BLOCK-IV
rR
t fo
No
S,
U PE
(c)
ale
246
Notes
UNIT 16: HOLDING COMPANY ACCOUNTS
___________________ UNIT 18: ACCOUNTS OF BANKING COMPANIES
n/S
z z
___________________
z Meaning of Holding Company z Definition of Banking Company
___________________
z Consolidated Financial Statements z Preparation of Final Account
___________________
z Consolidated Balance Sheet (CBS)
tio
UNIT 19: ACCOUNTS OF INSURANCE
___________________
z Treatment of Balance Sheet Items on Consolidation COMPANIES
___________________ z Introduction
UNIT 17: LIQUIDATION OF COMPANIES
z Preparation of Final Accounts
uc
___________________
z Introduction
___________________
z Meaning of Liquidation UNIT 20: CASE STUDY
___________________
rod
z Liquidator's Final Statement of Account
___________________
z Liquidator's Remuneration ep
rR
t fo
No
S,
U PE
(c)
ale
Unit 16
247
Notes
Activity
Collect recent data on legal
Holding Company Accounts
___________________
requirements for a holding
n/S
company relating accounts.
___________________
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning of Holding Company ___________________

\ Consolidated Financial Statements
uc
___________________
\ Consolidated Balance Sheet (CBS)
___________________
\ Treatment of Balance Sheet Items on Consolidation
rod
___________________
\ Consolidated Profit & Loss Account
___________________
Introduction
ep
In order to enjoy the advantages of monopoly, to reduce the
competition, holding companies acquire the controlling interest in
other company. This company becomes holding company of other
rR
company. In the present unit the accounting treatment regarding

the consolidation of the financial statements of both the subsidiary
and holding companies is discussed.
t fo
Meaning of Holding Company

Business combination movement was promoted to eliminate
competition, to derive the advantage of monopoly or near monopoly
No
and economies in the production and management. These

advantages can be enjoyed by amalgamation or absorption of two
or more companies. But in such a case the amalgamated or
absorbed companies have to liquidate themselves and lose their
S,
identity. And in the case of holding companies, the subsidiary

companies need not liquidate themselves. They retain their
PE
identities and carry on their businesses in their own names. Thus

they continue to derive the advantage of their existing goodwill.
Holding companies are those that acquire majority (more than
U
50%) of paid up equity shares so as to have a controlling interest in

some other companies. Such other companies are known as
(c)
subsidiary companies. This controlling interest can be had by the

Business Accounting
ale
248 holding company in the subsidiary company by any of the following
Notes three ways:
___________________
1. By acquiring more than 50% of voting right shares of some
n/S
___________________ other companies.
___________________ 2. By controlling the composition of the Board of Directors of
___________________ some other companies.
tio
___________________ 3. By controlling any other company which is the holding
___________________ company of some other company.
The above position of a holding company and subsidiary can be
uc
___________________
___________________ illustrated as below:
___________________ (a) If Company A holds more than 50% voting right equity shares
rod
___________________
of Company B or C to control their Boards of Directors, B or C
will be the subsidiary company of Company A.
Company A Holding company of B or C.
ep
Company B or Company C Subsidiary company of Company A.
(b) If Company A acquires the controlling power of Company B

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which is already holding more than 50% voting right shares of

Company C; Company C will be automatically the subsidiary
of Company A.
Company A Holding of Company B.
t fo
Company B Subsidiary of Company B and holding of Company C.
Company C Subsidiary company of Company B and Company C.
Legal Definition of a Holding Company

No
Section 4 of the Companies Act 1956 defines a subsidiary company.

According to this section, a company is a subsidiary of another if:
(a) other company controls the composition of its Boards of
S,
Directors, or
(b) the other:
PE
(i) Where the first-mentioned company is an existing

company in respect of which the holders of preference
shares have the same voting rights in all respects as
U
the holders of equity shares, exercise or control more

than half of the total voting power of such company.
(c)
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249
(ii) The first-mentioned company is a subsidiary of any
Notes
other company, holds more than half in nominal value
of its equity share capital, ___________________
n/S
(c) the first-mentioned company is a subsidiary of any company ___________________
which is that other's subsidiary. ___________________
Thus the parent company which acquires the controlling interest ___________________
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in some other company is called holding company. The company ___________________
which is controlled by the holding company is known as the
___________________
subsidiary company of the holding company. Both the holding
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company and subsidiary company is called the group. The legal ___________________
separate entity of the subsidiary company will continue, it will not ___________________
be affected by the acquisition of controlling interest by holding
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___________________
company.
___________________
Wholly Owned and Partly Owned Subsidiary Companies
If a holding company acquires all the shares (100%) having voting
ep
rights of a company, such a company is called wholly-owned
subsidiary company. In the other case, if the holding company
owns the majority of shares having voting rights (i.e., more than
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50% of voting right shares) of a company, such a company is known

as partly owned subsidiary company. In such partly owned
subsidiary companies the remaining shares which the holding
t fo
company could not acquire, are called the minority shareholders or

outsiders and the interest of the minority shareholders in the
assets of the subsidiary company is called the minority interest.
According to the Section 42 of the Companies Act 1956, a
No
subsidiary company cannot acquire the voting right shares in its

holding company after being the subsidiary company. But if it
holds the share of its holding company before becoming the
subsidiary company, it may continue to hold such shares. But such
a subsidiary company will not have the voting right on these
S,
shares.
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Legal Requirements for a Holding Company Relating Accounts

As the holding company and the subsidiary company have their
separate legal entity, they prepare their own final accounts.
U
Procedure of preparing the final accounts is same as of the other

companies. Section 212 of the Companies Act 1956 governs the
(c)
presentation of final accounts of the subsidiary company by the

holding company.
Business Accounting
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250
The Section 212 is reproduced as below:
Notes
___________________
1. There shall be attached to the Balance Sheet of a holding
company having a subsidiary or subsidiaries at the end of
n/S
___________________
financial year as at which the holding company's Balance
___________________ Sheet is made out, the following documents in respect of such
___________________ subsidiary or of such subsidiaries, as the case may be:
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___________________ (a) a copy of the Balance Sheet of the subsidiary,
___________________ (b) a copy of its Profit and Loss Account,
(c) a copy of the report of its Board of Directors,
uc
___________________
___________________ (d) a copy of the report of its auditors,

___________________
(e) a statement of the holding company's interest in the
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___________________ subsidiary as specified in sub-section (3),
(f) the statement referred to in sub-section (5) if any, and
(g) the report referred to in sub-section (6), if any.
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2. (a) The Balance Sheet referred to in clause (a) of sub-section
(1) shall be made out in accordance with the requirements
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of this Act:
(i) as at the end of the financial year of the subsidiary,
where such financial year coincides with the financial
t fo
year of the holding company;

(ii) as at the end of the financial year of the subsidiary
last before that of the holding company, where the
financial year of the subsidiary does not coincide with
No
that of the holding company.

(b) The Profit and Loss Account and the reports of the board
of directors and of the auditors, referred to in clauses (b),
(c) and (d) of sub-section (1), shall be made out, in
S,
accordance with requirements of this Act, for the financial

year of the subsidiary referred to in clause (a).
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(c) Where the financial year of the subsidiary does not

coincide with that of holding company, the financial year
aforesaid of the subsidiary shall not end on a day which
U
proceeds the day on which the holding company's financial

year ends by more than six months.
(c)
(d) Where the financial year of a subsidiary is shorter in

duration than that of its holding company, references to
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the financial year of the subsidiary in clauses (a), (b) and 251
(c) shall be constructed as references to two or more Notes
financial years of the subsidiary the duration of which in ___________________
n/S
the aggregate is not less than the duration of the holding
___________________
company's year.
___________________
3. The statement referred to in clause (e) of sub-section (1) shall
___________________
specify:
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___________________
(a) the extent of the holding company's interest in the
___________________
subsidiary at the end of the financial years or of the last of
uc
___________________
the financial years of the subsidiary referred to in sub-
section (2). ___________________
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(b) the net aggregate amount, so far as it concerns members ___________________
of the holding company and is not dealt with in the ___________________

company's accounts of the subsidiary's profit after
deducting its losses or vice versa:
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(i) for the financial year or years of the subsidiary
aforesaid, and
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(ii) for the previous financial years of the subsidiary since

it became the holding company's subsidiary.
(c) the net aggregate amount of the profits of the subsidiary

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after deducting the losses or vice versa:
(i) for the financial year or years of the subsidiary

aforesaid, and
No
(ii) for the previous financial years of the subsidiary since

it became the holding company's subsidiary.
So far as those profits are dealt with, the provision is made for
those losses in the Company accounts.
S,
4. Clauses (b) and (c) of sub-section (3) shall apply only to profits
and losses of the subsidiary which may properly be treated in
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the holding company's accounts as revenue profits or losses,

and the profits or losses attributable to shares in subsidiary
for the time being held by the holding company or any other of
U
its subsidiaries shall not (for that or any other purpose) be

treated as aforesaid so far as they are profits or losses for the
(c)
period before the date on, or as from which the shares were
Business Accounting
ale
252 acquired by the company or any of its subsidiaries, except that
Notes they may be in a proper case, be so treated where:
___________________
(a) the company is itself the subsidiary of another body
n/S
___________________ corporate, and;
___________________
(b) the shares were acquired from that body corporate or a
___________________ subsidiary of it, and for the purpose of determining
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___________________ whether any profits or losses are to be treated as profits or
___________________
losses for the said period, the profit or losses for any
financial year of the subsidiary may, if it is not practicable
uc
___________________
to apportion it with reasonable accuracy by reference to
___________________
the facts, be treated as accruing from day to day during
___________________ that year and be apportioned accordingly.
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___________________ 5. Where the financial year or years of a subsidiary referred to
sub-section (2) do not coincide with the financial year of the
holding company, a statement containing information on the
ep
following matters shall also be attached to the Balance Sheet
of the holding company:
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(a) whether there has been any, and if so, what change in
holding company's interest in the subsidiary between the
end of the financial year or of the last of the financial
years of the subsidiary and the end of the holding
t fo
company's financial year.
(b) details of any material changes which have occurred

between the end of the financial year or of the last of the
No
financial years of the subsidiary and the end of the

holding company's financial year in respect of-
(i) the subsidiary's fixed assets,

S,
(ii) its investments,
(iii) the money lent by it,

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(iv) the moneys borrowed by it for any purpose other than

for meeting current liabilities.
6. If for any reason, the Board of Directors of the holding

U
company is unable to obtain information on any of the matters

required to be specified by sub-section (4) a report in writing to
(c)
that effect, shall be attached to the Balance Sheet of the

holding company.
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253
7. The documents referred to in clauses (e), (f), and (g) of sub-
section (1) shall be signed by the persons by whom the Balance Notes
Sheet of the holding company is required to be signed. ___________________
n/S
8. The Central Government may, on the application or with the ___________________
consent of the Board of Directors of the company, direct that in ___________________
relation to any subsidiary, the provisions of this section shall
___________________
not apply, or shall apply only to such extent as may be
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specified in the direction. ___________________
9. If any such person as is referred to in sub-section (6) of Section ___________________

209 fails to take all reasonable steps to comply with the
uc
___________________
provisions of this section, he shall in respect of each offence, be
___________________
punishable with imprisonment for a term which may extend to
six months, or with fine which may extend to one thousand
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___________________
rupees or with both. ___________________
Provided that in any proceeding against a person in respect of

an offence under this section, it shall be a defence to prove that
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a competent and reliable person was charged with the duty of
seeing that the provisions of this section were complied with
and was in a position to discharge that duty.
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Provided further that no person shall be sentenced to

imprisonment for any such offence unless it was committed
wilfully.
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10. If any person, not being a person referred to in sub-section (6)

of Section 209 having been charged Board of Directors as the
case may be, with the duty of seeing that the provisions of this
section are complied with, makes default in doing so, he shall,
No
in respect of each offence be punishable with imprisonment for

a term which may extend to six months, or with fine which
may extend to one thousand rupees, or with both.
Provided that no person shall be sentenced to imprisonment
S,
for any such offence unless it was committed wilfully.
Check Your Progress

PE
Fill in the blanks:

1 If a holding company acquires all the shares (100%)
U
having voting rights of a company, such a company is

called ………………….. .
(c)
2. Section 212 of the Companies Act 1956 governs the

presentation of ………………….. .
Business Accounting
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254
Consolidated Financial Statements
Notes
Activity
Under the Companies Act 1956, there is no need to prepare the
List ___________________
down the main
advantages of the consolidated accounts of the subsidiary company with the holding
n/S
___________________
consolidated financial company in India, though it is a legal obligation under the
statements.
___________________ Companies Act of England. However, it is appropriate to
___________________
consolidate the accounts so that the users of the financial
statements of the holding company obtain the information about
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___________________
the financial position, profit from operation and the changes in the
___________________ financial position of the group as a whole. This need of the
shareholders of the holding company is served by the consolidated
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___________________
accounts. AS-27 makes it obligatory for a holding company to
___________________
prepare the consolidated accounts. In the era of globalization of
___________________
business, it is necessary to prepare and present the consolidated
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___________________ financial accounts of the group. Some companies make the
consolidated accounts of the group treating it as a single economic
unit. The main object of preparation of the consolidated accounts of
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the holding company and subsidiary company is to acquaint the
shareholders of the holding company about the financial position
and the profit and loss of the holding company as a whole group.
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The main advantages of the consolidated financial accounts of the

holding company and its subsidiary company may be summed up
as under:
t fo
(i) From the consolidated financial statements, the shareholders

can obtain an overall picture of the financial position and
performance of the holding company and its subsidiary
company quite easily.
No
(ii) There is only the basis of consolidated financial statement to

compute the intrinsic value of the shares of the holding
company.
(iii) The manner in which the shareholder's fund is being utilised
S,
to acquire the control of the subsidiary company is significant.

The directors of the holding company show accounts and
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reports in the annual general meeting of the shareholders of

the holding company. For this purpose, the consolidated
accounts are a must.
U
(iv) To judge the overall financial position and the performance of

the group by the prospective investors, the consolidated
(c)
financial statements are prepared by the holding company.

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255
For the purpose of preparing of consolidated financial accounts, it
Notes
is necessary that the accounts of both the companies should be Activity
closed on the same date; otherwise there can be fraudulent Prepare a Performa of the
___________________
n/S
consolidated balance sheet of
manipulation of accounts. It is also necessary that the same ___________________
holding company and its
method of accounting should be used by the companies; otherwise a subsidiary.
___________________
number of difficulties will be faced at the time of consolidation of
accounts. ___________________
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___________________
Consolidated accounts of the holding company include:
___________________
(a) Consolidated Balance Sheet and
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___________________
(b) Consolidated Profit and Loss Account.
___________________
Consolidated Balance Sheet (CBS)
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___________________
___________________
According to the provisions of the Companies Act, there is no
requirement to prepare the Consolidated Balance Sheet therefore
there is no legal format of the same. However, CBS should be
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drafted in conformity with the Schedule VI of the Companies Act.
The Performa of the Consolidated Balance Sheet is as given below:
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Consolidated Balance Sheet of Holding Company and its

Subsidiary [as on ……….. date]
Share Capital of Holding Company: ……… Fixed Assets:
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Reserve and Surplus: ………. Cost of Control or Goodwill……….

(i) Revenue Reserve of Holding Co……… Goodwill of Holding Co……. .............
Add : Share in Revenue Add: Goodwill of
Reserve of subsidiary ………. ………. Subsidiary Co……… .............
(ii) Capital Reserve of Holding Company………. Less: Capital Reserve as per contra…
No
Other Fixed Assets of Holding

Add: Share in Pre-acquisition reserve Company…
and Profit of subsidiary………. Add: other fixed
Less: Goodwill as per contra ………… ……… Assets of subsidiary………… ………
(iii) Surplus or Profit of Holding Company… ……… Investments:
Add: Share in Revenue Profit of Subsidiary… Investments of Holding Company except
S,
Less: Share in Unrealized Profit of Subsidiary Shares in Subsidiary Co. ……..

Secured Loans: Add: Investments of Subsidiary Co. …… ……..
Secured Loans of Holding Co.......... .......... Current Assets, Loans and Advances:
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Add: Secured Loans of Subsidiary............ .......... Current Assets, Loans and Advances of
Unsecured Loans: Holding Company
Unsecured Loans of Holding Co………. Add: Secured Loans of Subsidiary ………..
Unsecured Loans of Subsidiary ……….. Subsidiary ……….
Current Liabilities: Less: Mutual Indebtedness ……… ............
U
Current Liabilities of Holding Company….. Less: Share of Unrealized Profits ………. ............
Add: Current Liabilities of Subsidiary…… Miscellaneous Expenditure:
Less: Inter-company Debit Balance of P. & L Account of
(c)
Indebtedness ............... ………...... Holding Company .............

Minority Interest .................. ..................
.................. ..............
Business Accounting
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256
Preparation of Consolidated Balance Sheet
Notes
The Consolidated Balance Sheet can be prepared by simply adding
___________________ items in the Balance Sheet of the holding company to the same
n/S
___________________ items in the Balance Sheet of the subsidiary company. However, at
the time of preparation of Consolidated Balance Sheet, the
___________________
students should keep in mind the following points:
___________________
(a) First of all, the students should see which company is the
tio
___________________
holding company and which company is the subsidiary
___________________ company. The company which invests in the shares of the
other company is called holding company and the other
uc
___________________
company is called subsidiary company.
___________________
___________________
(b) The second important point for the students is, the number of
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equity shares of the subsidiary company which are acquired by
___________________
the holding company. This number of shares will be more than
one half of the entire shares of the subsidiary company.
(c) The next point which has to be kept in mind by the students is
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the date of acquisition of shares by the holding company. If the
date of purchase of shares is not mentioned in the question, it
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is presumed, that the holding company has purchased the

shares of the subsidiary company in the beginning of the year
and the Balance Sheet of the subsidiary company is prepared
after the acquisition of shares.
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Some Fundamental Calculation

Before the preparation of the Consolidated Balance Sheet, the
students should learn some fundamental calculations. These are as
No
follows:
1. Calculation of Ratio of Interest.
2. Calculation of Current Year's Profit of Subsidiary Company.
S,
3. Calculation of Pre-acquisition Profits.

4. Calculation of Goodwill or Capital Reserve.
PE
5. Calculation of Minority Interest.

6. Calculation of Consolidated Profits.
U
1. Calculation of Ratio of Interest: This calculation is based on

the number of equity shares acquired by the holding company
(c)
and the total number of equity shares issued by the subsidiary

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company. This ratio is generally calculated in the percentage. 257
These are of two types: Notes
(a) Ratio of Holding Company's Interest ___________________
n/S
(b) Ratio of Minority (balance) Shareholders Interest ___________________
___________________
Here, number of balance equity shares means those shares,
which are not purchased by the holding company and are with ___________________
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the subsidiary company. ___________________
2. Calculation for current year's profit of subsidiary Co.: Before ___________________
the construction of consolidated balance sheet, the students
uc
___________________
should compute the current year's profit/loss of the subsidiary
company. To compute the current year's profit/loss, the ___________________
previous year's profits are subtracted and the transfer made
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___________________
general reserve during the current year and proposed dividend ___________________
are added to the aggregated profits shares in the balance
sheet. The current year's profit will be computed as follows:
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Aggregated Profit as per Balance Sheet .………….
Less: Last Year's Profit ……………
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Add: Transfer to General Reserve ……………

Proposed Dividends ……………
Current Year's Profit ……………
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3. Calculation of Pre-acquisition and Post-acquisition Profit/Loss:

When the date of acquisition of shares and the date of
consolidation are not the same and there exist some reserves
and profits of the subsidiary company on the date of
No
acquisition of shares of subsidiary company, the holding

company's share in profits and reserves are divided into two
parts i.e., pre-acquisition profits (capital profits) and post-
acquisition profits (revenue profits). For the division of profit,
S,
it is assumed that profits are earned evenly throughout the

year by the subsidiary company. For example, if the financial
year of the subsidiary company is the calendar year i.e., from
PE
1st January to 31st December and date of acquisition of shares

by the holding company is 31st March, pre-acquisition period
for the distribution of profit will be three months and the post-
U
acquisition period will be nine months. The ratio will be 3:9 or

1:3 for pre-acquisition and post-acquisition period. If we
(c)
further assume that holding company's share in profit is

` 24,000, pre-acquisition profit (capital profit) will be ` 6,000
Business Accounting
ale
258 (24,000 × 1/4) and post-acquisition profit will be ` 18,000
Notes (24,000 × 3/4). Pre-acquisition or capital profits cannot be
___________________ utilized by the holding company for the distribution of
dividend to the shareholders. These profits are considered for
n/S
___________________
calculating goodwill (cost of control) or capital reserve. Profits
___________________ or reserves concerning the post-acquisition period are termed
___________________ revenue profits of the subsidiary company.
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___________________ These profits are shown in the Consolidated Balance Sheet
along with the profits of holding company. The revenue profits
___________________
can be utilized by the holding company for the distribution of
dividends to its shareholders. Further, the profits due to the
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___________________
___________________ revaluation of assets and liabilities of the subsidiary company

are termed capital profits, even if such profits pertain to the
___________________
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post-acquisition period. The distinction between pre-
___________________
acquisition profit and post-acquisition profit is not required for
the purpose of calculating the minority (outsider) shares in
profit. Its reason is clear that minority shareholders were the
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members of the subsidiary company when the holding
company acquires the shares in the subsidiary company.
The concept of pre-acquisition profits, post-acquisition profits
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and profits for minority (outsiders) can be understood by the

following example very easily:
Suppose the financial year of a subsidiary company is from 1st
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January, 2012 to 31st December, 2012. The holding company

acquires its 80% shares on 1st April, 2012. Now, pre-
acquisition profits, post-acquisition profits and profits for
minority will be as:
No
1st April Holding Company's Shares

Pre-acquisition Profits 3/12 of Holding Company's share
Post-acquisition Profits 9/12 of Holding Company's Shares
Minority share 20% of Entire Profit for Minority
Entire Profit of Subsidiary Company

S,
Pre-acquisition profits can be computed by the following

formula:
PE
` `
Last Year's Profits ...............
Add: Current Year's Profit before
U
the date of purchase ...............

Last Year's Balance of Reserve ...............
(c)
Contd…
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Less: Last year's balance of loss ............... 259
Current Year's Loss before Purchase ............... Notes
Loss on Revaluation of Assets
___________________
and Liabilities ............... ...............
n/S
Pre-acquisition profits. ___________________
If there is no information regarding the General Reserves, it is ___________________

assumed that the same is built from the current year's profits. ___________________
tio
4. Calculation of Goodwill or Capital Reserve: In the real ___________________
world, it rarely happens that the holding company acquires the ___________________
shares in the subsidiary company at par or face value.
uc
___________________
Generally, the holding company purchases the shares either at
___________________
a premium or at a discount. The price at which the holding
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___________________
company acquires the shares in the subsidiary company is
known as investment or cost of shares or cost of acquisition ___________________
and it is shown in assets side of the Balance Sheet of holding

company. At the time of Consolidation of Balance Sheets of the
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holding company and the subsidiary company, this investment
account is cancelled against the share capital of the subsidiary
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company held by holding company.
There can be a difference between these two amounts. If the

amount of investment is more than the face value of shares of
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subsidiary company held by holding company, excess of the

investment will represent cost of capital or goodwill at the
time of consolidation. For example, if 8,000 shares of ` 10 each
are acquired at ` 1,20,000, the excess amount of ` 40,000 (i.e., `
No
1,20,000 - ` 80,000) is goodwill and will be shown in assets side

of the Consolidated Balance Sheet as goodwill.
On the other side, if the holding company acquires the shares

S,
of the subsidiary company at a discount, the difference

between the cost of investment and the face value of the shares
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will represent the Capital Reserve on Consolidation. For

example if 8,000 shares of ` 10 each were acquired at ` 70,000,
the less amount of ` 10,000 (i.e., ` 80,000 - ` 70,000) would be
U
Capital Reserve and will be shown in the liabilities side of the

Consolidated Balance Sheet as Capital Reserve. If, at the time
(c)
of acquisition of shares by holding company there are some

accumulated profits or loss or reserves with the subsidiary
Business Accounting
ale
260 company, Goodwill or Cost of Control or Capital Reserve will
Notes
be computed as follows:
___________________
Calculation of Goodwill:
n/S
___________________
` `
___________________
Price Paid for Acquisition of Shares
in the Subsidiary Company. ...............
___________________
Less: Face Value of the Shares of
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___________________
Subsidiary Company acquired by Holding Co. ...............
___________________
Proportionate Share of Holding Company in the
pre-acquisition or Capital Reserved of the Subsidiary Co. ...............
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___________________
Proportionate Share of Holding Company in Pre-acquisition
___________________ profits of Subsidiary Company. ...............
___________________ Proportionate Share in the Profit arising due to Revaluation
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of Assets and Liabilities of Subsidiary Company. ...............
___________________
Proportionate Share of Holding Company in
pre-acquisition Losses of Subsidiary Co. ...............
Proportionate Share of Holding Company in the

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loss arising due to Revaluation of Assets and
Liabilities of Subsidiary Co. ............... ...............
Cost of Control or Goodwill ...............

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Note: If the total amount of the above deductible items is more

than the amount of the price paid for the acquisition of shares,
difference will be called Capital Reserve.
If Goodwill A/c is given in the Balance Sheet of the subsidiary
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company and Capital Reserve is also present, existing

Goodwill will be adjusted in the Capital Reserve on
Consolidation. And if Capital Reserve is not present, it will be
No
shown along with the Goodwill of holding company.

5. Calculation of Minority Interest: When more than 50% but
less than 100% of shares of the subsidiary company are
acquired by the holding company, calculation of the minority
S,
interest is done. Herewith the holders (outsiders) of the rest of

the shares of the subsidiary company (which are not taken by
the holding company) are collectively called minority and
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collective interest of these outsiders is called minority interest.

For example, if 80% shares of A Ltd. are acquired by B Ltd., B.
Ltd. is the senior partner meaning the holding company and
U
20% (i.e., 100% - 80%) of shareholders are with outsiders

meaning junior partner and will be called minority. In such a
(c)
case, minority shareholder's claim is assessed and shown in

the liability side of the Consolidated Balance Sheet as
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'Minority Interest. Minority Interest represents the claims 261
payable to outsiders. Senior partner's interest is shown in the Notes
Consolidated Balance Sheet by including all assets and ___________________
liabilities of the subsidiary company along-with those of the
n/S
___________________
holding company. The minority interest is calculated as
follows: ___________________
Calculation of Minority Interest: ___________________
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` ` ___________________
Paid up Value of Shares Held by Minority ………….. ___________________

Add: Proportionate Share of Minority in
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___________________
Reserve and Profits of the Subsidiary Company …………..
___________________
Proportionate Share of Minority in the Profit
on Revaluation of Assets and Liabilities of
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___________________
Subsidiary Company. …………..
___________________
Less: Proportionate Shares of Minority in the
Loss of Subsidiary Company. ………….. …………..
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Proportionate Share of Minority in the Loss
on the Loss on Revaluation of Assets and
Liabilities of the Subsidiary Company ………….. …………..
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Minority Interest …………..
If some preference shares of the subsidiary company are also held

by the outsiders (minority shares-holders), paid up value of these
shares along with the dividends payable thereon (if there is
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sufficient amount of profit for the distribution of dividends) will

be added to the minority interest calculated above.
Reserves include Revenue Reserves, Capital Reserves, Share
Premium and Capital Redemption Reserves.
No
6. Calculation of Consolidated Profits: Consolidated profits

are those profits of the holding company which are the total of
the revenue profits of holding company and the share of
S,
holding company in the post-acquisition profits of subsidiary

company. The Consolidated profits are shown in the liability
side of the Consolidated Balance Sheet. This is calculated as
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follows:
`
Revenue Profits of Holding Company …………..
U
Add: Holding Company's Shares in the

Post-acquisition Profit of the Subsidiary
(c)
Company …………..
Consolidated Profits …………..
Business Accounting
ale
262
Treatment of Balance Sheet Items on Consolidation
Notes
Activity
A Ltd holds 80% of Equity
At the time of preparation of the consolidated balance sheet,
___________________
Shares of B Ltd. Calculate the students have to consolidate the various assets and liabilities of
n/S
___________________
unrealized profit if closing the subsidiary company along with those of holding company for
stock of A Ltd. includes `
___________________ the consolidation of these items. The students should keep in mind
80,000 of goods purchased
from___________________
B Ltd. and that of B Ltd. the following points:
includes ` 50,000 supplied by
tio
___________________ (1) Investments in the Equity Shares of Subsidiary
A Ltd. Goods are sold at a
profit___________________
of 10% on Cost by the Company: This account appears in the assets side of the
subsidiary company to the holding company as investments in the equity shares of the
subsidiary company. It represents the amount paid by the
uc
___________________
holding company and at a
profit of 20% on sales by the
___________________ holding company to acquire the shares of subsidiary company.
holding company to the
subsidiary company.
___________________
On the other side, this is shown in the liabilities side of the
rod
Balance Sheet of the subsidiary company as share capital. This
___________________
item becomes an internal item of the group i.e., assets for the
holding company and liability for the subsidiary company. On
the consolidation of the two Balance Sheets the internal items
ep
do not appear. Therefore, this item is eliminated or cancelled
Upon its elimination, the following situations are likely to
arise:
rR
(a) When all the equity shares of the subsidiary are held by the
holding company: The holding company may acquire the
shares of the subsidiary company at par, discount or
t fo
premium. When the holding company purchases all the

shares of the subsidiary company at par, at the time of
consolidation, investment account in the assets side of the
holding company and shares capital account in the
No
liability side of the subsidiary company are eliminated

and all the assets and liabilities of the subsidiary company
are consolidated respectively in the assets and liabilities
of the holding company. And if there is no accumulated
S,
profit or loss and no inter-company transaction between

the holding company and subsidiary company on the date
of acquisition of share of the subsidiary company, there
PE
will be neither Goodwill nor Capital Reserve and the

preparation of the consolidated balance sheet will be very
simple.
U
If the holding company acquires the shares of the

subsidiary company at premium (meaning higher-price
(c)
than nominal price), this premium will be the Goodwill

which will be shown in the assets side of the consolidated
ale
Balance Sheet. The amount of premium will be equal to 263
the difference of the paid up amount to acquire of shares Notes
by the holding company and owner's equity (equity capital ___________________
plus capital profits).
n/S
___________________
If the holding company acquires the shares of the
___________________
subsidiary company at discount (meaning price less than
the nominal price), this discount will be treated as Capital ___________________
tio
Reserve which will be shown in the liability side of the ___________________
Consolidated Balance Sheet. ___________________
(b) When more than 50% but less than 100% equity shares of
uc
___________________
subsidiary company are acquired by holding company: In
___________________
this case, those shares of the subsidiary company which
are not acquired by the holding company are held by the
rod
___________________
outsiders. They are known as 'Minority'. These minority ___________________

shareholders also have the right over assets, liabilities
and profits of the subsidiary company in the proportion of
ep
their holdings. Their share in the net assets of the
subsidiary company is called 'Minority Interest' which is
shown in the liability side of the consolidated balance
rR
sheet. In this case too, investment in the equity shares of

the subsidiary company's account of the holding company
is replaced by the net assets of the subsidiary company.
All assets and liabilities of the subsidiary company are
t fo
shown in the consolidated Balance Sheet along with that

of the holding company.
Illustration
No
On 1st July, 2012 the Indian Company Ltd. bought 3,500 shares of
` 10 each fully paid in the Bharat Company Ltd. for ` 20 each. The
following are the Balance Sheets of the two companies on 31st
December, 2012 as under:
S,
Indian Bharat Indian Bharat

Liabilities Company Company Assets Company Company
` ` ` `
PE
Share capital 1,50,000 40,000 Buildings 1,37,500 25,000

General Reserve Sundry Assets 45,000 60,000
on 1.1.2004 30,000 12,500 Debtors 40,000 15,000
P. & L. A/c on 1.1.2004 22,500 5,000 Shares in the
U
Profits for the year 47,500 17,000 Subsidiary 70,000 -

Co.
Creditors 42,500 25,500
(c)
2,92,500 1,00,000 2,92,500 1,00,000

Business Accounting
ale
264
Solution:
Notes
___________________
The Indian Company acquires 87.5% shares of Bharat Company on
1st July 2012. It means the post-acquisition period will be six
n/S
___________________
months (from 1st July 2012 to 31st December, 2012).
___________________
(a) Post-acquisition Profits: `
___________________
Profit for the year 17,000
tio
___________________
- 6/12 of Profit for Pre-acquisition Period 8,500
___________________
Post-acquisition (Revenue) Profits 8,500
uc
___________________
(b) Pre-acquisition (Capital) Profits:
___________________
P. & L. A/c on 1.1.2012 5,000
___________________
rod
+ Pre-acquisition Profits (calculated above) 8.500
___________________
Pre-acquisition Profits 13,500
(c) Calculation of Goodwill:
ep
Cost of Investments 70,000
Less: of Share Capital 35,000
rR
of General Reserve
of Pre-acquisition Profits 11,812.50 57,750
Goodwill 12,250
t fo
(d) Calculation of Minority Interest:

Minority Interest = 100 - 87.5 = 12.5% or
or 12.5% of Share Capital 5,000
No
12.5% of General Reserve 1,562.5

12.5% of P. & L. A/c (1.1.2012) 625
12.5% of profit for the year 2,125
S,
Minority Interest 9,312.5

(e) Consolidated Profits:
PE
P. & L. A/c of Indian Co. on 1.1.2012 22,500

+ Profits for the year of Indian Company 47,500
U
Total Profits of Indian Company 70,000

+ 7/8 of Post-acquisition Profits of
(c)
Bharat Company 7,437.5

Consolidated Profits 77,437.5
ale
265
+ 7/8 of Post-acquisition Profits of
Notes
Bharat Company 7,437.5
___________________
Consolidated Profits 77,437.5
n/S
___________________
Consolidated Balance Sheet of the Indian Company Ltd. and its
subsidiary Bharat Company Ltd. as on 31st December 2012. ___________________
___________________
tio
Share Capital 1,50,000 Goodwill 12,250 ___________________
General Reserve 30,000 Buildings (1,37,500 + 25,000) 1,62,500 ___________________
Consolidated Profits 77,437.5 Sundry Assets (45,000 + 60,000) 1,05,000
uc
___________________
Minority Interest 9,312.5 Debtors (40,000 + 15,000) 55,000
___________________
Creditors (42,500 + 25,500) 68,000
rod
3,34,750 3,34,750 ___________________
___________________
Illustration
Following are the Balance Sheets of X Ltd. and Y Ltd. as on 31st
December, 2012 on which date X Ltd. acquires 75% shares of Y
ep
Ltd. on the:
X Ltd. Y. Ltd. X. Ltd. Y. Ltd.
rR
Liabilities Assets
` ` ` `
Share Capital: Fixed Assets 4,00,000 95,000

(Equity Shares of ` 2,50,000 50,000 Investment in
10 each) Shares of Y. Ltd. 75,000
t fo
General Reserve 20,000 12,500

Profits 30,000 7,500
Sundry Creditors 1,75,000 25,000
4,75,000 95,000 4,75,000 95,000
Prepare the consolidated Balance Sheet:

No
Solution:
(a) There will be no post-acquisition profits of Y Ltd. and the

entire profit will be in the pre-acquisition period as the shares
S,
were acquired by the X Ltd. on the date of Balance Sheet.
(b) Calculation of Goodwill `

PE
Cost of Investments 75,000

– 75% of Share Capital of Y Ltd. 37,500
75% of General Reserve of Y Ltd. 9,375
U
75% of Profits of Y Ltd. 5,625 52,500

Goodwill 22,500
(c)
(c) Calculation of Minority Interest-

25% of Share Capital 12,500
Business Accounting
ale
266 Consolidated Balance Sheet of X Ltd.
Notes and 1st Subsidiary Y Ltd. as on 31st Dec., 2012
___________________ Liabilities ` Assets `
n/S
Equity Share Capital 2,50,000 Goodwill 22,500
___________________
General Reserve 20,000 Fixed Assets
___________________
Profits 30,000 (4,00,000 + 95,000) 4,95,000
___________________ Sundry Creditors
(` 1,75,000 + ` 25,000) 2,00,000
tio
___________________
Minority Interest 17,500
___________________ 5,17,500 5,17,500
uc
___________________ 2. Treatment of Preference Shares in Subsidiary Company:
___________________ If the subsidiary company has issued some preference shares
___________________ too, these will be treated as follows at the time of preparation
rod
of the Consolidated Balance Sheet:
___________________
(a) When the holding company does not acquire the
preference shares of the subsidiary company- In such a
case, the paid up value of all the preference shares and
ep
the amount of dividends accrued thereon to the date of
consolidation will be included in the minority interest and
rR
that will be shown in the liability side of the Consolidated

Balance Sheet.
(b) When the holding company acquires some preference
shares of the subsidiary company- If some preference
t fo
shares of the subsidiary company are held by the holding

company itself, to prepare the Consolidated Balance
Sheet, excess of amount paid by the holding company to
acquire the preference shares in the subsidiary company
No
over their paid up value and dividend there will be

calculated. That will be treated as Cost of Control or
Goodwill. Such Goodwill will be added to that Goodwill
that is derived from the equity shares held in the
S,
subsidiary company. If some dividend on preference

shares accrues to the date of acquisition, that will be
PE
treated as pre-acquisition profits and will be utilized to

calculate Goodwill.
If some dividend on preference shares accrued from the
U
date of acquisition to the date of Consolidation of

accounts, that will be treated as post-acquisition profits or
(c)
revenue profit (if it is declared out of post-acquisition

profits) and it will be added to the holding company's
ale
share in the revenue profits of the holding company. If the 267
profits of the subsidiary company are not sufficient (or Notes
there is debit balance in the P. & L. ___________________
n/S
Account of the subsidiary company) to pay the arrears of ___________________
dividends of preference shares, no provision will be made
___________________
for the arrears of preference dividend out of the
Consolidated profits, except to the extent of the existing ___________________
tio
surpluses of the subsidiary company. The preference ___________________
shareholders will not bear any part of the loss. The entire ___________________
loss of the P. & L. A/c will be borne by the equity
uc
___________________
shareholders into the ratio of their holdings. It means that
the debit balance of P. & L. A/c will be apportioned ___________________
between the holding company and minority interest into
rod
___________________
the ratio of their number of equity shares holdings.
___________________
3. Treatment of Inter-Company Transactions: If there are
some common/mutual transactions between the holding
ep
company and its subsidiary company, at the time of
Consolidation of Balance Sheet these transactions are
eliminated. In other words, these transactions are not recorded
rR
in the Consolidated Balance Sheet. These transactions are as:

(a) Debtors and Creditors: When goods are sold on credit by
the holding company to its subsidiary company or vice
t fo
versa, it is mutual indebtedness which appears as debtors

in the Balance Sheet of the selling company and as
creditors in the Balance Sheet of the purchasing company.
All such transactions (mutual debtors/creditors) are
No
eliminated on the Consolidation of Balance Sheet.

(b) Bills Receivable and Bills Payable: If there are some bills of
exchange drawn by the holding company and accepted by
subsidiary company and vice-versa, these bills will appear
S,
in the Balance Sheet of the drawer company as bills

receivable and in the Balance Sheet of accepting company
as bills payable. These are eliminated at the time of
PE
Consolidation of Balance Sheet. However, if bills receivable

have been discounted from the bank or endorsed to
outsiders, such bills will not be eliminated because the
U
accepting company will have to make the payment to an

outsider (i.e., bank) on the maturity of the bill.
(c)
(c) Mutual Loans: If some loans are advanced by the holding

company to its subsidiary company or vice-versa, these
Business Accounting
ale
268 appear as assets in the balance sheet of the company
Notes which gives the loan and as a liability in the balance sheet
___________________ of that company which takes the loan. On the
Consolidation of accounts such loans are eliminated. If
n/S
___________________
some amount of interest on loan is outstanding, P. & L.
___________________
A/c of the lender company will be credited with the
___________________ amount of outstanding interest and loan account of lender
tio
___________________ company will be debited or vice-versa. However, upon
Consolidation, loan account and interest thereon are
___________________
eliminated with the same amount.
uc
___________________
4. Treatment of Debentures of Subsidiary Company: If all
___________________
the debentures of the subsidiary company are with outsiders
___________________ only, the amount of the debentures will be shown in the
rod
___________________ Consolidated Balance Sheet like other liabilities. And if some
of the debentures are held by the holding company as
investment and some by outsiders, debentures with the
holding company will be treated as inter-company
ep
transactions. Investment in the debentures of subsidiary
company will be eliminated on the Consolidation of Balance
rR
Sheets and in the Consolidated Balance Sheet, only the paid

up value of those debentures which are with outsiders will be
shown as liability. Excess or less amount paid by the holding
company to acquire the debentures in the subsidiary company
t fo
are the paid up value of debentures held by holding company.

This will be adjusted in the Cost of Capital or Capital Reserve.
If some amount of interest on debentures held by the holding
company is due, it will also be treated as inter-company
No
transaction and will be eliminated on the Consolidation of

Balance Sheets. If some debentures of the holding company
are held by the subsidiary company, there will also adopt the
similar treatment as mentioned above.
S,
5. Treatment of Unrealised Profits on Stock: When goods are

sold by the holding company to its subsidiary company at a
PE
price (cost plus certain percentage of the profit on cost or sales)

or vice-versa and these goods remain unsold on the closing
date at the end of the financial year, there will be a problem of
unrealized profit on unsold stock. On the selling of the goods,
U
profit on sale is credited in the P & L A/c of the selling

company and included in the stock of the purchasing company.
(c)
And now when goods are unsold, it is not proper to credit the
profit on such goods which are unsold. Therefore, such profit
ale
on unsold goods (also called unrealized profits) is eliminated 269
from the closing stock and profit and loss account. There are Notes
two approaches to record the unrealized profits. ___________________
n/S
According to the first approach, the entire profit on the unsold ___________________
goods is eliminated from the closing stock of the purchasing
___________________
company and from the Profit and Loss A/c of the selling
company. This is the view given by AICPA. According to this ___________________
tio
view, the Consolidated Balance Sheet represents the financial ___________________
position of a single business enterprise. ___________________
According to the second approach, the amount of unrealized
uc
___________________
profit to the extent of interest of holding company only, is
___________________
eliminated from the closing stock of purchasing company and
from the profits of the selling company. Thus, the entire
rod
___________________
unrealized profit is divided into two parts, share belonging to ___________________

the holding company and share belonging to the minority
(outsiders). The profit belonging to minority shareholders is
ep
considered as realized because these shareholders are
outsiders and they will not affect in any way. Therefore, that
portion of unrealized profit which belongs to holding company
rR
is eliminated on the Consolidation of the Balance Sheets.

For elimination, first the unrealised profit will be calculated as
following:
t fo
(a) When Rate of Profit on Sales is given:
Unsold Goods × Rate of Profit

Unrealised Profit = × Holding
100
Co.’s share
No
(b) When Rate of Profit on Cost is given:

Unsold Goods × Rate of Profit on Cost
Unrealised Profit = ×
100 + Rate of Profit on Cost
S,
Holding Co.’s share

Then, the above calculated unrealized profit is eliminated
PE
from the stock and profits. Here, the students are advised
to adopt the second approach to solve the examination
problem. This approach is adopted in this book to solve
U
the problems.
6. Treatment of Contingent Liabilities: Contingent liability
(c)
means that liability which may or may not involve the

payment. Its payment depends upon the occurrence of future
Business Accounting
ale
270 events which are uncertain. This may or may not convert into
Notes actual liability. These liabilities can be due to the following:
___________________
(a) Discounting of bill receivable with bank.
n/S
___________________
(b) Guarantee of a loan.
___________________
(c) Arrears of dividend on preference shares.
___________________
(d) Calls on partly paid or unpaid calls.
tio
___________________
Contingent liability is of two types namely (a) Internal (b)
___________________
External. If the contingent liability is related to the
transaction between holding company and subsidiary
uc
___________________
___________________ company, it is called internal contingent liability. It is

eliminated from the footnote of the concerned Balance Sheet
___________________
rod
and in the Consolidated Balance Sheet it appears as a real
___________________ liability and not as a footnote. If a contingent liability is
related to the transaction between the holding company or
subsidiary company and the third part (outsiders), it is called
ep
external contingent liability. This liability appears as a
footnote to the Consolidated Balance Sheet.
7. Treatment of Revaluation of Assets & Liabilities: At the
rR
time of acquisition of shares of the subsidiary company, the

holding company revalues the assets and liabilities of the
subsidiary company to calculate the value of shares. On
t fo
account of such a revaluation of assets and liabilities there

may be profit or loss. This profit or loss due to revaluation is
adjusted in the Consolidated Balance Sheet as follows:
(i) Profit on revaluation of assets and liabilities of the
No
subsidiary company: If there is appreciation in the value

of fixed assets of the subsidiary company or reduction in
the liabilities of the subsidiary company, there will be
profit. This profit is always treated as capital profits in
S,
the view of the holding company. Therefore, it is not

available for the distribution of dividend. This profit is
PE
divided between minority shareholders and holding

company in their ratio of interest. The holding company's
share in this profit is treated as capital (pre-acquisition)
profit which is transferred to capital reserve or deducted
U
from Goodwill. Minority's share in this profit is added to

the minority interest.
(c)
ale
271
(ii) Loss on revaluation of assets and liabilities of the
Notes
Subsidiary Company: If there is reduction in the value of
fixed assets or an increase in the liabilities of the ___________________
n/S
subsidiary company, there will be a loss on revaluation. ___________________
This loss is also divided between minority and holding
___________________
company in their ratio of interest. Minority's share in loss
is deducted from minority interest and the holding ___________________
tio
company's share in this loss is treated as capital (pre- ___________________
acquisition) loss. If loss as revaluation takes place after ___________________
the acquisition of equity shares by the holding company,
uc
___________________
its share in this loss will be treated as revenue (post-
acquisition) loss. ___________________
8. Treatment of Depreciation on Appreciated Assets of
rod
___________________
Subsidiary Company: As the revalued assets of the ___________________

subsidiary company are shown in the Consolidated Balance
Sheet, it is necessary that proper adjustment should be made
ep
on the difference between the old value of assets and the
revalued assets for depreciation. This adjustment is made as
follows:
rR
(a) If the value of fixed assets is appreciated, additional

depreciation will be charged on the appreciated value of
assets from the date of revaluation of assets to the date of
t fo
Balance Sheet. This additional depreciation will be

subtracted from the revenue profits of the subsidiary
company. On the other side, this additional depreciation
will be deducted from the appreciated value of the assets.
No
(b) In the case of devaluation of assets, excess depreciation

provision made will be written back. In other words,
depreciation will be calculated on the difference between
the old value of assets and the reduced value of assets
S,
from the date of revaluation of assets to the date of

Balance Sheet. This depreciation will be added to the
revenue profit of the subsidiary company. On the other
PE
side, it will be added to revalued assets in the

Consolidated Balance Sheet.
9. Treatment of Goods and Cash in Transit: When the
U
holding company dispatches some goods or cash to the

subsidiary company or vice-versa, which does not reach the
(c)
receiving company up to the closing date of the accounts, that

is called Goods or Cash in Transit. When a company
Business Accounting
ale
272 despatches goods to another company in a group, the company
Notes that sends goods increases its debtors. But goods that are not
___________________ received by the other company are in transit. Therefore, on the
Consolidation of Balance Sheet, amount of goods in transit is
n/S
___________________
subtracted from the debtors and goods-in-transit is separately
___________________
shown in the assets side of Consolidated Balance Sheet.
___________________ Similarly when some cash is remitted by a company to the
tio
___________________ other company in the group, the company which remits the
cash deducts its creditors. But if on the date of Balance Sheet,
___________________
cash is in transit, an adjustment is made for the same. On the
Consolidation of Balance Sheet cash-in-transit is subtracted
uc
___________________
___________________ from the debtors and is shown separately in the assets side of
___________________
the Consolidated Balance Sheet. This is explained in the next
rod
illustration.
___________________
10. Treatment of Dividend Received from Subsidiary
Company: On receiving the dividend on equity shares in
subsidiary company, the holding company increases its cash
ep
balance in the assets side and profits in the liability side of the
balance sheet. But at the time of Consolidation of balance
rR
sheets, the dividend received from the subsidiary company is

dealt in the following ways:
(i) If the subsidiary company pays the dividend from pre-
acquisition profit: Such a dividend will be treated as
t fo
Capital Profit. Therefore it will be adjusted with goodwill

or capital reserve. Such a dividend received by holding
company will not be available for the payment of dividend
of the holding company. If this dividend is already
No
credited by the holding company in its P & L A/c, the

following entry will be passed by the holding company for
rectification:
Profit & Loss A/c Dr.
S,
To Cost of Capital (Goodwill) A/c

PE
(ii) If the subsidiary company pays the dividend completely

from post-acquisition profit: This will be treated as
revenue profit for the holding company and will be
credited to the P & L A/c of the holding company. This
U
dividend will be available for the payment of dividends to

the shareholders of the holding company.
(c)
ale
273
(iii) If the subsidiary company pays the dividend partly out of
Notes
pre-acquisition profits and partly out of post-acquisition
profits: Dividend received by the holding company from ___________________
n/S
pre-acquisition profits would be treated by the holding ___________________
company as capital profits (as mentioned in the first
___________________
situation above) and the dividend received by the holding
company from the post-acquisition profits would be ___________________
tio
treated as revenue profit (as given in the second situation ___________________
above). Thus, this situation is a combined situation of the ___________________
above two.
uc
___________________
If there is no information whether dividend is paid out of post-
___________________
acquisition or pre-acquisition profits, it is presumed that
dividend is paid from the profits of the year for which the
rod
___________________
dividend is declared. ___________________
11. Interim Dividend Received from Subsidiary Company:

The subsidiary company pays the interim dividend from the
ep
current year's profit. Interim dividend is an appropriation
against the current year's profit (revenue profit) which is
shown in the Profit and Loss Appropriation Account of the
rR
subsidiary company. Interim dividend received from the

subsidiary company by the holding company is divided
between pre-acquisition period and post-acquisition period.
t fo
For the division of interim dividend, it is assumed that

dividend is earned evenly throughout the year. Interim
dividend of post-acquisition period is added to revenue profit
and interim dividend of pre-acquisition profit is adjusted with
No
the Goodwill or Capital Reserve.

12. Proposed Dividend of Subsidiary Company: If the
subsidiary company has proposed the dividend on equity
shares, it is debited in the Profit and Loss Account and
S,
credited in the proposed dividend account. This is shown as

liability in the balance sheet. In the absence of information, it
is assumed that proposed dividends are intended to be paid out
PE
of the post-acquisition profit. The amount of proposed dividend

for the holding company is added to the share of other profits
of holding company while the amount of proposed dividend
U
for minority shareholders is added to the minority interest.

If the proposed dividend is not given in the Balance Sheet of
(c)
the subsidiary company, but is given as additional information

with the Balance Sheet, it will not have any effect on the
Business Accounting
ale
274 Consolidated Balance Sheet and that should be omitted.
Notes Alternatively, the part of proposed dividend belongs to
___________________ minority shareholders may be deducted from the proposed
dividend of the subsidiary company and shown in the
n/S
___________________
liabilities side of the Consolidated Balance Sheet. But for this,
___________________
it should first be subtracted from minority interest.
___________________
13. Treatment of Unclaimed Dividend: Unclaimed dividend is
tio
___________________ that part of declared dividend which has not been claimed by
___________________ the shareholders until the date of Balance Sheet. Unclaimed
dividend is shown in the liability side of the balance sheet of
uc
___________________
the subsidiary company. At the time of preparation of the
___________________
Consolidated Balance Sheet, unclaimed dividend is divided
___________________ into two: (i) Unclaimed dividend belonging to the holding
rod
___________________ company and (ii) Unclaimed dividend belonging to minority
shareholders. Unclaimed dividend belonging to holding
company is treated as inter-company transaction and is
eliminated by the corresponding unclaimed dividend
ep
appearing in the assets side of Balance Sheet of the holding
company. The second part of the unclaimed dividend belonging
rR
to minority shareholders is added to the minority interest in

the Consolidated Balance Sheet.
14. Treatment of Bonus Shares Issued by Subsidiary
Company: When bonus shares are issued by the subsidiary
t fo
company, we have to see the source from which these are

issued. The source may be pre-acquisition profits or post-
acquisition profits of the subsidiary company.
No
Upon the issue of bonus shares, the number of shares held by

the holding company as well as the subsidiary company
increases. Bonus shares are always treated as capital profit in
the view of holding company. For the treatment of bonus
shares, the following situations are likely to arise:
S,
(a) Treatment of Bonus Shares issued out of Pre-acquisitions

Profits: When bonus shares are issued by the subsidiary
PE
company out of pre-acquisition profits, there will be no

effect on accounting treatment and Cost of Control or
Goodwill will remain the same as it was before the issue of
U
bonus shares. Its reason is that in such a case the amount

of bonus shares for the holding company is reduced from
(c)
the holding company's share in the pre-acquisition profits

ale
and the paid up value of shares held in the subsidiary 275
company is increased. Notes
(b) Treatment of Bonus Shares Issued out of Post-acquisition ___________________
n/S
Profits: In such a situation, first of all the amount of ___________________
bonus shares is subtracted from the post-acquisition
___________________
profits. By doing so, the share of the holding company in
the post-acquisition profit is reduced and the paid up ___________________
tio
value of the share held by the holding company is ___________________
increased without changing the cost of investment. Thus,
___________________
Goodwill is reduced or Capital Reserve is increased by
uc
the amount of bonus shares for the holding company. On ___________________
the other hand, the amount of minority interest is not ___________________
changed by the issue of bonus 1 shares out of the post-
rod
___________________
acquisition profits. This situation will be clear by the
following illustration: ___________________
15. Treatment of Goodwill of Subsidiary Company: If

Goodwill is given in the Balance Sheet of the subsidiary
ep
company, it is aggregated along with the Goodwill arrived at
by elimination and Goodwill (if any) of the holding company in
the Consolidated Balance Sheet. If there is Capital Reserve, it
rR
is adjusted with Capital Reserve. Thus, the value of Goodwill

which will be shown in the Consolidated Balance Sheet, will
be calculated as follows:
t fo
Goodwill for CBS = Goodwill of Subsidiary Company.
+ Goodwill of Holding Company
+ Goodwill/Capital Reserve
calculated by elimination.
No
Goodwill/Capital Reserve calculated by elimination means

that value which is calculated by the method mentioned under
the forthcoming points in the fundamental calculations of this
chapter.
S,
16. Treatment of Preliminary Expenses, Underwriting

Commission etc.: If there are given preliminary expenses,
PE
underwriting commission, and discount on issue of shares and

debentures in the assets side of the subsidiary company, at
the time of preparation of Consolidated Balance Sheet, these
items will be treated as capital losses (pre-acquisition losses)
U
and are apportioned between the holding company and

minority interest. Share of the holding company in these
(c)
losses is adjusted with goodwill or capital reserve. On the

Business Accounting
ale
276
other hand, the minority share in these losses is subtracted
Notes from minority interest.
___________________ 17. Treatment of Provision for Taxation of Subsidiary
n/S
___________________ Company: If there is given provision/reserve for future
taxation in the Balance Sheet of the subsidiary company that
___________________
is neither treated as pre-acquisition (capital) profit nor post-
___________________ acquisition (revenue) profit. But it is treated as liability of
tio
___________________ subsidiary company and is shown in the liability side of the
Consolidated Balance Sheet as others.
___________________
18. Treatment of Changes in the Equity of Holding
uc
___________________
Company: Due to the following reasons the equity of holding
___________________
company may change:
___________________ (a) Successive Purchases of shares
rod
___________________ (b) Sale or Disposal of shares.
(a) Successive Purchases of Shares: It is not necessary that
the holding company should purchase more than 50% of
ep
equity shares in the subsidiary company at one time. The
holding company may acquire the controlling interest in
the subsidiary company through several purchases of
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shares. It is also known as gradual control of the holding

company on subsidiary company. The date on which the
holding company acquires more than 50% of shares in the
subsidiary company is called the date of control.
t fo
According to the date of acquisition of control the profits

of the subsidiary company are divided into capital (pre-
acquisition) profits and revenue (post-acquisition) profits.
This is explained in the following illustration:
No
(b) Disposal or Sale of Shares: Sometimes the holding

company disposes of some of the shares acquired by it in
the subsidiary company. If there are any profits on such a
sale of shares of the subsidiary company, it is either used
S,
to reduce the cost of control or transferred to 'Investment

Fluctuation Reserve'. On the other side, if there is a loss
on the sale of shares, it is debited to Cost of Control of
PE
Goodwill A/c Minority Interest and Goodwill/Cost of

Control is calculated on the basis of shares left with the
holding company for the Consolidation of Balance Sheets.
U
Double Entry Method for Consolidation of Balance Sheets

(c)
For the Consolidation of Balance Sheets of the holding company

and the subsidiary, company the double entry method may also be
ale
used. This method is easier than the method adopted so far in the 277
previous illustrations. Under this method, the holding company Notes
and its subsidiary company are treated as a single unit and for all ___________________
the adjustments journal entries are passed. For each item
n/S
___________________
appearing in the balance sheets of the holding company and its
subsidiary company are account is opened. In addition two new ___________________
accounts are also opened i.e.: (i) Minority Interest Account and (ii) ___________________
Cost of Control (Goodwill) A/c. There are two situations at which
tio
the Consolidation of Balance Sheets is done. ___________________
___________________
(a) Consolidation of Balance Sheet at the time of acquisition of
uc
shares. ___________________
___________________
(b) Consolidation of Balance Sheet some time after of acquisition
of shares.
rod
___________________
(a) Journal entries for Consolidation at the time of ___________________

acquisition of shares:
1. When investment account is transferred to cost of control

ep
account:
Cost of Control Account Dr.

rR
To Investment A/c
(Being the transfer of investment A/c to Cost of Control

A/c)
t fo
2. When share capital of the subsidiary company is

eliminated:
Shares Capital A/c Dr.
No
To Cost of Control A/c
To Minority Interest A/c
(Being transfer of Share Capital A/c of the subsidiary to

S,
Cost of Control A/c and Minority Interest A/c).
3. When credit balance of P. & L. A/c and General Reserve

PE
of the subsidiary company are transferred to cost of

capital a/c and minority interest A/c:
Profit and Loss A/c Dr.
U
General Reserve A/c Dr.
To Cost of Control A/c

(c)
To Minority Interest A/c

Business Accounting
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278
Notes (Being transfer of P. & L. A/c and General Reserve to
Cost of Control A/c, and Minority Interest A/c)
___________________
4. At this stage the above three journal entries will be
n/S
___________________
posted in the Cost of Control A/c. If the debit side of this
___________________ account is more than the credit side, differences will be
___________________ transferred to goodwill account. And if the credit side of
this account is more than the debit side of it, the
tio
___________________
difference will be transferred to capital reserve account.
___________________ Cost of Control A/c will appear as follows:
Cost of Control A/c
uc
___________________
___________________ ` `
To Investment A/c ------------ By Share Capital A/c ------------
___________________
rod
To Capital Reserve (difference) ------------ By General Reserve ------------
___________________ By P. & L. A/c ------------
By Goodwill (balance) ------------
5. When inter-company transactions are eliminated, the

ep
following entries will be passed:
(a) For the dues of money from one company to another

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company on account of trading transactions:

Sundry Creditors (of Debtor Company) Dr.
To Sundry Debtors (of Creditor Company) A/c
(b) For the outstanding of Bills of Exchange between the
t fo
holding company and the subsidiary company.

Bills Payable A/c Dr.(Acceptor Company)
To Bills Receivable A/c (Drawer Company)
No
(c) For holding the debentures of one company by another

company:
Debentures A/c Dr.(Issuing Company)
To Investment A/c (Investing Company)
S,
(d) For the outstanding of debentures-interest:

Debentures Interest Receivable A/c Dr.
PE
(Investing Co.)
To Debentures-interest Payable A/c
(Issuing Co.)
(e) For the elimination of unrealized profits on unsold stock
U
P & L A/c Dr.(Selling Company)

To Stock A/c (Purchasing Company)
(c)
ale
279
6. When the value of assets of subsidiary company is
Notes
Activity
increased (overvalued) at the time of acquisition of
On ___________________
1st September, 2012 X
shares:
n/S
Ltd., purchased 25,000 equity
___________________
shares (` 10 each fully paid)
Assets A/c Dr. (Amount of overvaluation)
at `12 in Y Ltd. The Balance
___________________
To Cost of Control A/c (Holding company's share)
Sheet of Y Ltd. 31st
To Minority Interest A/c (Minority share) ___________________
December, 2012 showed
tio
profit and loss account in
7. When the value of assets of the subsidiary company is ___________________
credit as follows:
decreased (undervalued) at the time of acquisition of ___________________
Profit brought forward `
shares: 30,000
uc
___________________
Cost of Control A/c Dr. (Holding company's share) Profit for the year ` 80,000
___________________
The issued share capital
Minority Interest A/c Dr. (Minority's share)
of Y___________________
Ltd., was 30,000 equity
rod
To Assets A/c (Amount of devaluation) shares.
___________________
(b) Journal entries for Consolidation after sometime of At the annual general
acquisition of shares: If Consolidation of Balance Sheets meeting, the members
approved the following
take place after sometime of acquisition of shares, the profit of
ep
recommendations of the
the subsidiary company is divided between pre- and post- directo`
acquisition profits. General reserves and balance of Profit and – Payment of equity dividend
Loss account is transferred to Minority Interest and Cost of
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of 25%. Draft journal entries to

Control account. For transferring these items the same entries record the receipt of this
dividend in the books of X Ltd.
will be passed which were previous. The post-acquisition profit
is transferred to Minority Interest account and the Profit and
t fo
Loss account of the holding company. For this purpose, no new

entry is passed.
Check Your Progress

No

1. According to the provisions of the Companies Act, there
is no requirement to prepare the Consolidated Balance
Sheet therefore there is no legal format of the same.
S,
2. To compute the current year's profit/loss, the previous

year's profits are added.
PE
Consolidated Profit & Loss Account

For the knowledge of the shareholders of the holding company
U
regarding the profits of the group, the consolidated profits and loss
A/c, is prepared. It is prepared in columnar form. Apart from the
(c)
usual items of incomes, gains, losses and expenses which are

shown in the individual Profit and Loss A/c of the holding and
Business Accounting
ale
280 subsidiary companies. Then these are aggregated for the
Notes Consolidation of Profits and Loss A/c Besides the aggregation of
___________________ items of P & L A/c, some adjustments are made. Some of these
adjustments are as follows:
n/S
___________________
___________________ 1. The holding company's share in pre-acquisition profits of the

subsidiary company is debited to the Consolidated Profit and
___________________
Loss A/c, and credited to the Goodwill/Cost of Control/Capital
tio
___________________ Reserve A/c (as may be). And if there is a loss, that is credited
___________________ and Goodwill/Cost of Control/Capital Reserve A/c is debited.
2. Minority shareholder's share in the total profits of the
uc
___________________
___________________
subsidiary company should be debited to the Consolidated
Profits and Loss A/c and to credited Minority Interest A/c In
___________________
case of loss, Consolidated P & L A/c, is credited and Minority
rod
___________________ Interest A/c is debited.
3. All the inter-company transactions (incomes, losses and
expenses) are eliminated in the total column of Consolidated
ep
Profit and Loss A/c. These items may be as follows:
(a) Inter-company Sales and Purchases of Goods: If there is
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any inter-company sales and purchase between the

holding company and subsidiary company, at the time of
preparation of Consolidated P. & L. A/c that is eliminated
from the purchases of the purchasing company and from
t fo
the sales of the selling company.

(b) Unrealised Profits on Unsold Stock: If some goods are sold
on profits within the group and which is still unsold, profit
on such unsold goods is called unrealized profits. Holding
No
company's shares in the unrealized profit is debited to the

Consolidated Profit and Loss A/c, and credited to the
reserve for unrealized profits.
S,
(c) Inter-company Interest on Debentures and Dividend: If

there is some interest on debentures and dividends
received by one company from another company of the
PE
group that will have to be eliminated from both sides of

the Consolidated P. & L. A/c.
(d) Common Expenses and Incomes: Similarly, if there are
U
some common incomes and expenses, those will also be

eliminated from the Consolidated Profit and Loss A/c.
(c)
ale
281
(e) Proposed Dividends Relating to Holding Company and
Notes
Subsidiary Company: If one company has proposed the
dividend in favour of another company of the group and ___________________
n/S
both the companies have passed the entries for the ___________________
dividend, shares of holding company in the proposed
___________________
dividend will be eliminated from both sides of the
Consolidated Profit and Loss A/c If the holding company ___________________
tio
has not passed any entry regarding the proposed ___________________
dividend, its share in the proposed dividend of the ___________________
subsidiary company will be reduced from the total of
uc
___________________
proposed dividends of subsidiary company in the debit
side of Consolidated Profit and loss A/c. ___________________
4. If the fixed assets of the subsidiary company are revalued at
rod
___________________
the time of acquisition of shares, necessary adjustment is ___________________

made in the depreciation of fixed assets in the debit side of the
Consolidated Profits and Loss A/c.
ep
5. If there is any profit on the redemption of preference shares of
the subsidiary company, the holding company's share in such a
profit should be debited to the Consolidated Profit and Loss
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A/c, credited to the Capital Redemption Reserve A/c.

6. If there are some arrears of cumulative preference dividends,
such arrears of dividends are divided into two:
t fo
(a) amount relating to minority shareholder, and

(b) amount relating to the holding company. Amount relating
to minority shareholders is debited to the Consolidated
No
Profit and Loss A/c and credited to Minority Interest A/c.

Amount of arrears of dividend relating to holding company
is cancelled.
Check Your Progress

S,
Fill in the blanks:

PE
1. The holding company's share in pre-acquisition profits of

the subsidiary company is debited to the ………………..
and credited ………………..
U
2. If some goods are sold on profits within the group and

which is still unsold, profit on such unsold goods is
(c)
called ……………….. .
Business Accounting
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282
Summary
Notes
A holding company is that which acquires the controlling interest
___________________
in other company. The other company is called subsidiary company
n/S
___________________ of the holding company. On acquiring the interest in other
___________________ company, the holding company prepares the consolidated financial
___________________
statements. Among consolidated financial statements,
Consolidated Balance Sheet and Consolidated P&L. Account are
tio
___________________
prepared. Before the preparation of consolidated Balance Sheet,
___________________ some fundamental calculations are done. Treatment of different
items of Balance Sheet of the subsidiary Company and holding
uc
___________________
Company on Consolidation. Methodology to prepare the
___________________
consolidated Balance Sheet and P. & L. A/c.
___________________
rod
___________________
Lesson End Activity
What do you mean by Consolidated Balance Sheet? How is it
prepared? What points are kept in mind while preparing a
ep
Consolidated Balance Sheet?
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Keywords
Holding Company: Holding companies are those that acquire
majority (more than 50%) of paid up equity shares so as to have a
t fo
controlling interest in some other companies.

Debtors and Creditors: When goods are sold on credit by the
holding company to its subsidiary company or vice versa, it is
mutual indebtedness which appears as debtors in the Balance
No
Sheet of the selling company and as creditors in the Balance Sheet

of the purchasing company.
Consolidated Balance Sheet (CBS): It is the balance sheet in
which the financial information of parent as well as subsidiary
S,
company is merged(consolidated) for the financial reporting

purpose.
PE
Calculation of Ratio of Interest: This calculation is based on the

number of equity shares acquired by the holding company and the
total number of equity shares issued by the subsidiary company.
U
Consolidated profits: Consolidated profits are those profits of the

holding company which are the total of the revenue profits of
(c)
holding company and the share of holding company in the post-

acquisition profits of subsidiary company.
ale
283
Wholly-owned subsidiary company: If a holding company
Notes
acquires all the shares (100%) having voting rights of a company,
such a company is called wholly-owned subsidiary company. ___________________
n/S
Unrealized profits: If some goods are sold on profits within the ___________________
group and which is still unsold, profit on such unsold goods is ___________________
called unrealized profit.
___________________
tio
___________________
___________________
1. What do you mean by a holding company?
uc
___________________
2. Explain the circumstances under which one company controls ___________________
the other.
rod
___________________
3. What is the legal definition of a holding company?
___________________
4. Write short note on wholly owned and partly owned subsidiary
companies.
ep
5. What are the legal requirements for a holding company
relating accounts?
rR
6. What is minority interest? And explain the method to

calculate it.
7. Write down the formulae to find out the cost of control.
t fo
8. The Balance Sheets of X Ltd. and its subsidiary Y Ltd. as on

31st March, 2012 are as follows:
Balance Sheets of X Ltd. & Y Ltd.

as on 31st March, 2012
No
X Ltd. Y Ltd. X Ltd. Y Ltd.

Liabilities Assets
` ` ` `
Share Capital: Plant & Machinery 2,40,000 45,000
Equity Shares of ` 10 Furniture 7,500 13,500

S,
each fully paid 2,00,000 50,000
General Reserve (on 1.4.2004) 1,40,000 17,000 Investment 1,00,000 -
P. & L. A/c 85,000 21,000 Stock 47,500 21,000

PE
Creditors 35,000 17,500 Debtors 30,000 16,000
Cash 35,000 10,000
4,60,000 1,05,500 4,60,000 1,05,500

U
The following information is also given to you:

(i) X Ltd. acquired 4,000 equity shares in Y Ltd., as on 1st
(c)
July 2011, at a cost of ` 1,00,000.

Business Accounting
ale
284
(ii) Stock of X Ltd., includes ` 3,000 relating to stock
Notes
purchased from Y Ltd., which follows the practice of
___________________
charging 25% extra on the cost for determining the sale
n/S
___________________ price.
___________________ (iii) Creditors of X Ltd., include ` 5,000 on account of purchase
___________________ from Y Ltd.
tio
___________________ (iv) Profit and Loss A/c of X Ltd includes dividend @ 10% for
the year 2011-12 received from Y Ltd., which declared and
___________________
paid after 1st July, 2011.
uc
___________________
(v) Balance of Y Ltd.'s Profit and Loss Account on 1st April,
___________________
2011 was ` 13,000. Dividend @ 10% for the year 2010-11
___________________ was declared out of this balance after 1st July, 2011.
rod
___________________ (vi) Profits during the year 2012-13 have been entered on a
uniform basis throughout the year.
Prepare a Consolidated Balance Sheet of X Ltd., and its
ep
subsidiary Y Ltd., as on 31st March 2012.
rR
Further Readings
Books
Dr. K.K. Verma, Corporate Accounting, Excel Books
t fo
M.C. Shukla & T.S. Grewal, Advanced Accounting

R.L. Gupta, Advanced Accounting
Jain & Narang, Advanced Accounting
No
Web Readings
http://www.slideshare.net/divinvarghese/holding-company-
accounts-and-consolidated-balance-sheet-presentation
S,
http://www.theglobaltuto`com/financial-accounting/holding-
subsidiary-companies-accounting.aspx
PE
www.ruf.rice.edu/~sazeff/PDF/Unilever%20article.pdf
reports.investis.com/...ar.../trm_ar_2005_en_extract_110-117.pdf
U
(c)
UNIT 17: Liquidation of Companies
ale
Unit 17
285
Notes
Activity
Explain the conditions under
Liquidation of Companies
___________________
which a Company goes into
n/S
winding up compulsorily.
___________________
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning of Liquidation ___________________

\ Types of Liquidation
uc
___________________
\ Liquidator's Final Statement of Account
___________________
\ Liquidator's Remuneration
rod
___________________
___________________
Introduction
The legal procedure to wind up of a limited company is called the
ep
liquidation of a company. In the case of the liquidation all the
assets are sold and from the amount of so realized all the external
liabilities are paid off. For this work, a person is appointed by the
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court, who is called liquidator. He prepares a statement, which is

called Liquidator's Final Statement of Account. The procedure to
prepare this statement is given in the present unit.
t fo
Meaning of Liquidation
A company comes into existence by law and can come to an end
only through a legal process. The legal procedure to wind up a
No
company is called liquidation. Therefore, when the process of

winding up begins, the company is said to be in liquidation. The
procedure of winding up of a company is laid down in the
Companies Act, 1956. A company can be liquidated at any time. It
S,
is not compulsory that only insolvent companies should be

liquidated. Sometimes, even solvent companies maybe liquidated.
PE
Liquidation of a company is different from insolvency. The word

insolvency is used in the case of individual, partnership firms and
Hindu Undivided Families, while the word liquidation is applicable
to the companies. Secondly, insolvency of firm, individual or H.U.F.
U
is governed by the Insolvency Act, while liquidation of companies is

governed by the Companies Act.
(c)
Business Accounting
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286
In the case of liquidation of a company, all the assets of the
Notes
company are realized and amount is collected from unpaid calls on
___________________
the shares. Then out of the proceeds claims of the external
n/S
___________________ liabilities are settled. After the settlement of the claims of the
___________________ liabilities and creditors, if any amount is left, it is given to the
preferential and equity shareholders according to their rights. A
___________________
person is appointed to realize the various assets and to make the
tio
___________________ payments of various liabilities, who is called liquidator.
___________________
Types of Liquidation
uc
___________________
Under Section 425(1) of the Companies Act, a company can be
___________________
liquidated in any of the following three ways:
___________________
rod
1. Compulsory Winding Up (by court)
___________________
2. Voluntary Winding Up (by the members or creditors)
3. Winding Up Subject to Supervision of Court.
ep
1. Compulsory Winding up: In the following circumstances, a
company will be compulsorily wound up by the court:
(a) If the company has passed a special resolution to be
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wound up by court.
(b) If the company is in default to deliver the statutory report
to the Registrar of Companies for holding the statutory
t fo
meeting.
(c) If the company does not commence its business within a
year from the date of its incorporation or suspends its
No
business for a whole year.

(d) If the number of its member comes below seven and in
case of a private company, below two.
(e) If the company is not in a position to pay its debts.
S,
(f) If the court is of the opinion that it is just and equitable

that the company should be wound up.
PE
In compulsory winding up, any one of the following may file a

petition: (1) the company, (2) any creditor, (3) any
contributory, (4) all or any of the above mentioned parties (5)
U
the Registrar (6) any person authorised by the Central

Government. The Central Government authorizes a person to
(c)
file the petition when it asks for the winding up of a company.

ale
287
2. Voluntary Winding up: Voluntary winding up may be two
Notes
types: (a) Voluntary winding up by members (b) Voluntary
winding up by the creditors. In members' voluntary winding ___________________
n/S
up, the directors, or if there are more than two directors, of ___________________
them, at the meeting of Board of Directors, have to give a
___________________
declaration of the solvency of the company, verified by an
affidavit. The declaration indicates that the company has no ___________________
tio
debts or will be able to pay its debts in full within three years ___________________
from the commencement of winding up, as may be specified in ___________________
the declaration.
uc
___________________
At the time of passing of resolution for winding up in the
___________________
general meeting, the company appoints one or more
liquidators and also fixes their remuneration. If the liquidator
rod
___________________
is of the opinion that the company is not in a position to pay its ___________________
debts in full within the period stated in the declaration, or the
period will be over without the payment of debts, he must call
ep
a meeting of the company at the end of first year of the
commencement of winding up and of each coming years, and
should clear the position of his acts and conduct regarding the
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winding up.
Upon the completion of the affairs of the company the
liquidator must call a final meeting and lay down these
t fo
accounts before the meeting. Within one week from this

meeting, a copy of these accounts must be dispatched to the
Registrar of Companies. After registering these accounts in the
register by the Registrar, these accounts are returned to the
No
official liquidator. Then the official liquidator scrutinises these

accounts and reports to the court. Then the company is
deemed to be dissolved from the date of submission of this
report.
S,
If the declaration of solvency is not made by the directors at

the meeting of Board and delivered to the Registrar, it is
presumed that the company is insolvent. In such a case, it is
PE
called creditors' voluntary winding up. In this case, the

company must call a meeting of its creditors for passing the
resolution for winding up. After passing the resolution of
U
winding up in this meeting, a copy of the resolution is

dispatched to the Registrar within 10 days of the date on
(c)
which the resolution is passed. Members and creditors both

appoint their liquidators in their meetings.
Business Accounting
ale
288
3. Winding up Subject to Supervision of Court: It is a
Notes
Activity voluntary winding up of the company subject to the
Explain the order of priority in
___________________
supervision of the court on any terms or conditions and with
the payment of debts in the
n/S
case___________________
of liquidation of a all liberty for creditors, members or others to apply to the
Company.
___________________ court. The liquidator will continue to exercise all powers, but
power will be exercisable subject to any restriction or
___________________
conditions laid down by the court. Such type of winding up is
tio
___________________ comparatively rare.
___________________
Check Your Progress
uc
___________________
Fill in the blanks:
___________________
1. In the case of …………….., all the assets of the company
___________________
rod
are realized and amount is collected from unpaid calls
___________________ on the shares.
2. Voluntary winding up may be two types: ……………..
and …………….. .
ep
Liquidator's Final Statement of Account
rR
The liquidator's main job is to collect the assets of the company

and realise them, surplus, if any, from the securities held by the
fully secured creditors and proceeds from the partly paid up
contributories and distribute the amounts among the various right
t fo
claimants. This amount is distributed by the liquidator strictly in

the prescribed order of payment. For this purpose, he prepares a
cash book for recording the receipts and payments. In the case of
No
compulsory winding up, he is required to submit an abstract of

cash book to the court and in the case of voluntary winding up to
the company. On the completion of winding up, he prepares a
statement known as Liquidator's Final Statement of Account
which he has to submit. This account must be prepared according
S,
to the prescribed Form No. 156 of the Companies Act, 1956. This
prescribed form is given below:
PE
Form No. 156

(See Rule 329)
Companies Act, 1956
U
* Here, state whether the winding up is a Members' or Creditors'

voluntary winding up or a winding up under the Supervision of
(c)
Court. If under the Supervision of Court, mention the number of

the petition in which the order was made and the date of the order.
ale
Liquidator's Statement of Account of the Winding 289
up (Members'/Creditors' Voluntary Winding up) Notes
(Pursuant to Section 497/509) ___________________
n/S
1. Name of the Company -------------Ltd.
___________________
2. Nature of proceeding -------. ___________________
3. Date and commencement of the winding up----- ___________________
tio
4. Name and address of the Liquidator: ___________________
Statement showing how the winding up has been conducted ___________________

and the property of the company has been disposed of from-----------
uc
___________________
-19-------- (commencement of winding up) to------19--- (close of
___________________
winding up).
rod
___________________
Estimated Value
Receipts Payment Payment
Value realised
___________________
` ` ` `
Assets: Legal Charges:
Cash at Bank Liquidator's Remuneration:
Cash-in-Hand Where applicable–
ep
Marketable Securities % on ` ……realised
Bills Receivable % on ` ……distributedz
Trade Debtors Total
Loans and Advances (By whom fixed----)
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Stock-in-Trade Auctioneers' and Valuers'

Charges
Work-in-Progress Costs of procession and
maintenance of estate
Freehold Property Cost of notice of Gazette on
News Papers
t fo
Leasehold Property Incidental outlay

(establishment charges and
other expenses of
liquidation)
Plant & Machinery Total Cost and Charges
Furniture & Fittings (i) Debenture-holders
Utensils etc.
No
Patents Trade Marks, etc. Payment of `……per

`……debenture
Investments other than Payment of `……per
Marketable Securities `……debentures
Payment of `……per
`……debentures
Surplus from Securities (ii) Creditors:
S,
Unpaid calls at the #Preferential

commencement of winding
up
PE
#Unsecured
Amount receivable from Dividend(s) …….P. in the
calls on contributories rupee on `
made in winding up
Receipts from trading (The estimate of the amount
account
U
Other Property, viz., expected to rank for

dividend was `……)
…………… (iii) Return to
Contributories:
(c)
…………… ……P. per `

……**Share……
Contd…
Business Accounting
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290 ……P. per `……**Share
……
Notes Total ……P. per `……**Share
……
___________________ Less:
Payment to redeem
n/S
Securities
___________________ Cost of Execution.
Payments per Trading
___________________ account
Net Realizations Add balance
___________________ # State the number. Preferential creditors need not be separately shown if all creditors have been paid in
full.
tio
___________________ * State nominal value and class of share.
___________________
Realisation of Amount by a Liquidator
uc
___________________
At the time of winding up, the Liquidator of the company realises
___________________ the amount due from the debtors, the sale of the assets of the
___________________ company, surplus from fully secured creditors, and makes calls on
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___________________ the contributories and realise the amount from them.
Disbursement of the Amount realised among Various

Claimants
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The Liquidator has to disburse the amount in a prescribed order of
payment. This is as follows:
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1. Payment to fully secured creditors.

2. Payment of legal expenses cost of winding up.
3. Remuneration of the Liquidator.
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4. Expenses of Liquidator.
5. Payment to debenture-holders or creditors secured by the
floating charge as the assets of the company.
6. Payment to unsecured creditors including the preferential
No
creditors.
7. Payment of preferential shareholders including arrears of
dividend.
S,
8. Payment of equity shareholders (the remaining amount).
Check Your Progress

PE
Fill in the blanks:

1. ………………………. amount is distributed by the liquidator
strictly in the prescribed order of payment.
U
2. At the time of winding up, the Liquidator of the

company realises the amount due from the ………………,
(c)
the sale of the assets of the company, surplus from fully

secured creditors, and makes calls ……………………. .
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Liquidator's Remuneration 291
Notes
Activity
The Liquidator receives his remuneration in the form of
Explain the formulae to
___________________
commission which is usually based as a percentage on assets
n/S
compute the remuneration of
realised and payment made to unsecured creditors. At the time of ___________________
liquidator.
calculating the remuneration of the liquidator, students should ___________________
keep in mind the following points:
___________________
tio
1. Remuneration on Assets Realised: At the time of
___________________
calculation of Liquidator's remuneration on assets realised,
___________________
generally cash-in-hand and cash at bank are not considered,
unless the examination problem provides for it directly or
uc
___________________
indirectly. Only surplus from fully secured creditors is mostly ___________________
included in the amount of assets realised for the calculation of
rod
___________________
Liquidator's remuneration. Regarding this, it is assumed that
secured creditors themselves realise the assets held by them ___________________
as security. The Liquidator has only made an effort at

realizing the surplus from secured creditors. Therefore, it is
ep
suggested that the only surplus should be included in the
amount of assets realised.
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2. Remuneration on the Amount Distributed to Unsecured

Creditors: Sometimes the liquidator is also entitled to receive
the commission on the amount paid or distributed to
unsecured creditors. In this condition, the preferential
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creditors are also considered because they are basically

unsecured creditors. Any one of the following situations can
arise in this connection-
(i) If the amount available for the payment of unsecured
No
creditors is sufficient, remuneration will be calculated as

follows–
Liquidator's Remuneration =
S,
Amount of Unsecured Creditors × % of Commission

100
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(ii) If the amount available for the payment of unsecured

creditors is insufficient, remuneration will be calculated
as follows–
U
Amount available for Unsecured Creditors × % of Commission
(c)
100 + % of Commission
Business Accounting
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292
(In this situation, the amount available for unsecured
Notes
creditors means that total of the amount appearing in the
___________________
left side of the Final Statement of the Liquidator minus
n/S
___________________ legal charges, remuneration of the liquidator on the assets
___________________ realised, cost of liquidation and amount paid to debenture-
holders having charge.)
___________________
Suppose the amount to be paid to unsecured creditors is `
tio
___________________
2,50,000 and the amount available for the payment of
___________________ unsecured creditors is ` 1,06,000 and a commission of 5%,
is to be given on the amount paid to unsecured creditors.
uc
___________________
___________________
The commission will be calculated as below–
1,05,000 5 1,05,000 5
___________________ = = ` 5,000
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100 5 105
___________________
This is done so because the amount of ` 1, 05,000 includes
the amount of commission of the liquidator of ` 5,000. If
the whole amount of ` 1, 05,000 is paid to unsecured
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creditors, nothing will be left for the commission of
liquidator. Actually, the amount of ` 105,000 are for
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unsecured creditors and liquidator's remuneration.

(iii) Remuneration on the Amount Distributed to the
Contributories: If the liquidator is also entitled to receive
commission on the amount distributed to the member of
t fo
the company, it is calculated under the following manner:

Balance of Amount × % of Commission
No
100 + % of Commission
In this case, balance of amount means that total of amount
appearing in the left side of the Final Statement of the
Liquidator minus legal charges, cost of liquidation, liquidator's
S,
remuneration on assets realised and amount paid to unsecured

creditors, payment to debenture-holders and payment to
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unsecured creditors including preferential creditors.

3. Distribution of Surplus: After the payment of all liabilities,
if any balance of assets remains, this balance is called the
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surplus which is distributed among the shareholders of the

company as per provisions of the Memorandum of Association
(c)
and Articles of Association. If the preferential shareholders

have the priority over equity shareholders, preference
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shareholders must be paid off first, before equity shareholders. 293
If there are various types of paid up value of equity shares and Notes
there is no provision, excess amount paid on any share must ___________________
n/S
be paid first and the remaining amount must be distributed
___________________
among the all types of equity shareholders proportionately.
___________________
4. Interest on Debentures and Loans: If the company is
___________________
solvent, interest on loans and debentures should be paid up to
tio
___________________
the date of payment. On the other hand, if the company is
insolvent, interest on debentures and loans should be paid up ___________________
to the date of commencement of winding up. If the instructions
uc
___________________
in the examination problem are against this rule, the students ___________________
must do according to the instructions of the question.
rod
___________________
5. Dividend on Preference Shares: For non-cumulative
___________________
preference shares there will be no arrears of dividend. In the
absence of specific wording as non cumulative, the preference
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shares must be treated as cumulative. And the dividend on
cumulative preference shares should be paid up to the date of
winding up. Regarding the payment of dividend the provisions
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of Articles of Association must be followed. As a rule, when the

dividend is declared, that must be treated as debt not as
arrear of dividend.
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But if the dividend is not declared and that is in arrear, such

arrears of dividend will be paid only after the payment of
preferential capital and equity shares capital in full and any
surplus is left. The reason behind this is that the preference
No
shareholders have priority regarding the return of capital over

the return of equity capital. They also have priority regarding
the payment of preference dividend over the payment of
dividend of equity shareholders. Thus, arrears of dividends of
S,
preference shares must be paid after the payment of equity

capital, in full. After the payment of equity capital, if any
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surplus remains, that must be treated as profit. From this

profit, first arrears of preferential dividend must be paid
before the payment of the dividend of equity shareholders.
U
6. Calls-in-Arrear and Calls-in-Advance on Equity Shares:

If the funds are available after the settlement of all claims of
(c)
all outsiders and preference shareholders, equity shareholders

are paid off. And in case a company has partly paid up equity
Business Accounting
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294 shares and preference shares and the available amount is not
Notes sufficient to meet the claims of preference in full, the company
___________________ should make the necessary calls on the equity shares to collect
n/S
___________________ a suitable amount to the claims of preference shareholders.
___________________ There are chances that some shareholders may fail to pay such
___________________ calls. In such cases, if the surplus after the settlement of the
claims of the preference shareholders in full, is not enough to
tio
___________________
refund of equity shareholders, such surplus will be first used to
___________________
refund the share capital of those shareholders who have paid the
calls which were recently made, till the paid up capital equals the
uc
___________________
___________________ amount paid up by the defaulting equity shareholders. After such

___________________
refund, if there is still surplus, it will be distributed equally among
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the all equity shareholders, including the defaulters. On the other
___________________
hand, if some equity shareholders have paid some calls in advance,
such calls-in-advance will be given priority in the refund over the
paid up share capital of those calls. In case the equity shareholders
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have paid the different amount on their holdings, at the time of
distribution of surplus, an effort should be made that each equity
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shareholder may undergo equal loss.
Illustration
Vanijya Ltd. which has a paid up capital of ` 1, 00,000 and a loss of

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` 1, 11,500 standing on its Balance Sheet went into voluntary

liquidation on 31st March, 2012. The following are the particulars
with regard to its assets and liabilities as on that date:
No
Machinery, Stock and Debtors (which realise their book value) `

79,000; Cash ` 1,000, Creditors ` 40,000, 6% Debentures (which
were carrying the floating charge) and interest accrued thereon for
6 months ` 1,500.
S,
The above debentures were paid off with interest on 30th

September, 2012. On this date, a first and final dividend was also
PE
paid to the creditors. ` 5,000 of the creditors are preferential and

rest are unsecured. The cost of liquidator amounted to ` 500. The
liquidator is entitled to 3% of the total amount realised from the
sale of assets including cash and 2% of the amount distributed to
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the unsecured creditors by way of his own remuneration. Prepare

the Liquidator's Final Statement of Account.
(c)
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Solution: 295
Notes
Vanijya Limited
___________________
Liquidator's Final Statement of Account.
n/S
___________________
Amount Amount
Receipts Payments ___________________
` `
___________________
Assets Realised: Cost of Liquidation 5, 00
tio
___________________
Machinery, Stock and Liquidator's Remuneration:
___________________
Debtors 79,000 3%on ` 80,000 2,400
uc
___________________
Cash 1,000 2% on ` 5,000 100
___________________
2% on ` 20,098.04 401.96 2,901.96
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6% Debentures 50,000 ___________________
+ Interest Accrued 1,500 51,500 ___________________
Preferential Creditors 5,000
Unsecured Creditors 20,098.04

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80,000 80,000
Working Note:
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1. Amount available for unsecured creditors and liquidator's

remuneration thereon:
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Total Amount available 80,000
Less: Cost of Liquidation 500

No
Liquidator's remuneration on assets realised and
Preferential Creditors (2,400 +100) 2,500
6% Debentures + Interest Accrued 51,500

S,
Preferential Creditors 5,000 59,500

PE
Amount available for unsecured
creditors and Liquidator's remuneration 20,500
Less: Liquidator's Remuneration 401.96

U
Amount for Unsecured Creditors 20,098.04

(c)
2. In the case of solvency of the company, interest on debentures

is paid up to the date of payment.
Business Accounting
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296
Check Your Progress
Notes
Fill in the blanks:
___________________
1. At the time of calculation of Liquidator's remuneration
n/S
___________________
on assets realised, generally ………………… are not
___________________
considered, unless the examination problem provides for
___________________ it directly or indirectly.
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___________________ 2. Sometimes the liquidator is also entitled to receive the
___________________ commission on the amount ………………… to unsecured
creditors.
uc
___________________
___________________ 3. After the payment of all liabilities, if any balance of

assets remains, this balance is called the …………………
___________________
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which is distributed among the shareholders of the
___________________ company.
4. For ………………… shares there will be no arrears of
dividend. In the absence of specific wording as non
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cumulative, the preference shares must be treated as
cumulative.
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Summary
In this unit we have discussed the meaning and types of
liquidation and priority of payment adopted by the liquidator, he
t fo
procedure which is adopted to prepare the Statement of Affairs and

Deficiency / Surplus Account in the case of liquidation Liquidator's
Final Statement of Account prepared by the liquidator,
No
methodology to prepare the Final Statement of Account of the

Liquidator, Receiver's Receipts and Payments Accounts and
Liabilities of "B" List contributories.
Lesson End Activity

S,
What are the different modes of winding up of a company? Explain

PE
the consequences of the winding up.
Keywords
U
Liquidation: The legal procedure to wind up of a limited company

is called the liquidation of a company.
(c)
Liquidator: In the case of voluntary liquidation by members, a

liquidator is appointed by passing a resolution in the general
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meeting of the company, and in the case of winding up by creditors 297
he is appointed in the meeting of creditors and his remuneration is Notes
also fixed in the meeting. ___________________
n/S
Contributories: When the winding up process of a company ___________________
begins, shareholders of that company are known as contributories.
___________________
Calls in Arrears: If any amount has been called by the company
___________________
either as allotment or call money and a shareholder has not paid
tio
___________________
that money, this is known as callas in arrears.
___________________
Calls in Advance: If any call has been made but while paying
uc
that call, some shareholders paid the amount of the rest of calls ___________________
also, then such amount will be called as calls in advantage. ___________________
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___________________
Questions for Discussion ___________________
1. What do you mean by Liquidation?
2. Explain the Preferential Creditors as per Companies Act 1956
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at the time of liquidation.
3. Give the various lists to be attached to the Statement of
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Affairs.
4. Give the various lists to be attached to the statement of
affairs.
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5. Following is the Balance Sheet of Swadeshi Company Limited

on 31st March, 2012:
No
24,000 Fully paid Buildings 2,00,000

Shares of ` 10 each 2,40,000 Machinery and Plant 80,000
Sundry Creditors 60,000 Stock 30,000
Bank Overdraft 56,000 Debtors 44,000
S,
P. & L. A/c. 2,000

3,56,000 3,56,000
PE
There was voluntary liquidation of Swadeshi Company

Limited and the assets were sold for ` 3, 00,000. Its payment is
made as under: (i) ` 1, 20,000 in cash (which is sufficient to
pay off Creditors, Bank Overdraft and Liquidation Expenses of
U
` 4,000), (ii) ` 1, and 80,000 by allotment of 24,000 shares of

` 10 each of Videshi Company Limited which will be treated as
(c)
` 7.50 per share paid up. Prepare Liquidator's Final Statement

Business Accounting
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298 of Account in the books of Swadeshi Co. Ltd. and pass the
Notes Journal Entries in the books of Videshi Co. Ltd.
___________________
n/S
___________________ Further Readings
___________________
Books
___________________
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___________________
___________________
uc
___________________
___________________
___________________ Web Readings
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___________________ 220.227.161.86/19018comp _sugans_pe2_accounting_cp9 _5.pdf
www.caclubindia.com › Discussion › Accounts
www.companyliquidator.gov.in/12/Liquidation.htm
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http://www.publishyourarticles.net/knowledge-hub/company-
accounts/complete-information-about-liquidation-of-companies-its-
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modes-and-consequences-of-winding-up.html
www.insolvencyjournal.ie/
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No
S,
U PE
(c)
UNIT 18: Accounts of Banking Companies
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Unit 18
299
Notes
Activity
Make a presentation on Slip
Accounts of Banking Companies
___________________
System of Banks, its
n/S
advantages
___________________and
disadvantages.
___________________
Objectives
___________________
tio
topics: ___________________
\ Definition of Banking Company ___________________

\ Preparation of Final Account
uc
___________________
\ Specimen Form Of Accounting Policies-Schedule 18 Principal
Accounting Policies ___________________
rod
___________________
Introduction ___________________
Banking business is a specialized business which is controlled by

RBI in India. A lot of legal requirements are to be fulfilled to
ep
prepare the final accounts of it. RBI has issued the legal guidelines
to prepare the final accounts. In the present unit the procedure to
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prepare the final accounts of a banking company is given.
Definition of Banking Company

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As per Section 5 of the Banking Regulation Act, Banking Company

may be defined as, "Banking Company means any company which
transacts the business of banking in India." It further explains the
word banking in its sub-section 5(b) as "banking means the
No
accepting, for the purpose of lending or investment, of deposits of

money from the public, repayment on demand or otherwise and
withdraw able by cheque, draft, order form otherwise."
As per the Banking Regulation Act, 1949 it is compulsory to use
S,
the bank, banker and banking with the name of the company
which is engaged in the business of banking. In the business of
PE
banking the following functions are included:

(A) Accepting of Deposits:
Fixed Deposits
U
Saving Deposits
(c)
Current Deposits
Other Deposits
Business Accounting
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300
(B) Advancing of Loans:
Notes
___________________
Loans
n/S
___________________ Overdrafts
___________________ Discounting of Bills
___________________ Cash Credits
tio
___________________ (C) Agency Functions
___________________ (D) Issue of Notes
(E) Contingent Functions
uc
___________________
___________________
(F) Other useful Functions
___________________
rod
Books of Accounts of a Bank
___________________
Slip System is adopted in the banks. As per Bankers Book
Evidence Act, bank uses the cash books, ledger and registers and
these can be classified into followings:
ep
(A) Books Section: This includes the following books–
i. General Cash Book,
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ii. Sectional Cash Book,

iii. Counter Receipts Book,
t fo
iv. Counter Payment Book,

v. Cash Balance Book,
vi. Cash Reserve Book,
No
vii. Day Book.

(B) Ledger Section: Like a business house, in banks the
transactions are first recorded in the books and then posted in
the ledger. These ledgers include–
S,
i. General Ledger,
PE
ii. Current Account Ledger,

iii. Saving Bank Account Ledger,
iv. Fixed Deposit Ledger,
U
v. Investment Ledger,
(c)
vi. Recurring Deposit Ledger,

vii. Loans Ledger,
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301
viii. Bills Receivable Ledger,
Notes
ix. Bills Payable Ledger,
___________________
n/S
x. Branch and Agency Ledger,
___________________
xi. Foreign Bill Ledger. ___________________
(C) Registers Section: Some registers are also maintained by the ___________________
banks which are as follows–
tio
___________________
i. Bills for collection register,
___________________
ii. Clearing register,
uc
___________________
iii. Security register, ___________________
iv. Demand Draft register,
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___________________
v. Document register, ___________________
vi. Standing Order register,

vii. Jewellers register,
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viii. Dishonoured Cheques register,
ix. Letters of credit register,
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x. Drafts Issue register,

xi. Draft Payable register.
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Slip System of Posting

This system is used for the rapid posting in the books. In banks the
transactions are posted on the basis of double entry system. Under
No
this system slips are used for the posting. Slips are nothing but
loose leaves which are used to record the transaction in the books.
When a customer comes in the bank to deposit the money, he has
to fill up a slip which is called "Pay-in-slip". After filling up this
slip, the customer hands over to the cashier. After receiving the
S,
amount from the customer, the cashier puts his signature on the
slip and its counter foil is given to the customer. This slip is used
PE
for the immediate posting in the different ledger. Similarly when a

customer presents a cheque for payment before the cashier, the
cashier credits the cash account and then passes this cheque to the
U
ledger-keeper for debiting the account of the customer. In this case,

cheques play the role of slip. In this system cheques/slips are the
(c)
base to record the transactions. This system is also known as 'Unit

Media of Posting'.
Business Accounting
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302 Advantages of Slip System
Notes
On the adoption of this system, bank gets the following
___________________
advantages:
n/S
___________________
1. As a transaction is recorded in a number of books in the books,
___________________ this system is convenient in use.
___________________
2. The Bank customers fill up the different slips for depositing,
tio
___________________ withdrawing and; ending of money themselves. Thus it saves
___________________ the time of the employees.
3. The slips filled by the customers are the basis of recording the
uc
___________________
transactions. These provide an objective evidence and more
___________________
reliable.
___________________
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4. It makes the work of auditing easy. Auditing is done on the
___________________
basis of vouchers. These slips are used as vouchers at the time
of auditing.
5. There is no need to record the transactions in the preliminary
ep
books because the transactions are directly posted in the
ledger on the basis of these slips.
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Disadvantages of Slip System

This system suffers a number of disadvantages:
1. There is always a risk of lost, misappropriation and
t fo
destruction of these slips.

2. There is wastage of money and manpower to keep these slips
safe.
No
3. There can be the misuse of these slips.
Check Your Progress

Fill in the blanks:
S,
1. As per the Banking Regulation Act, 1949 it is

compulsory to use the ………………….. with the name of
PE
the company which is engaged in the business of

banking.
2. ………………….. system is used for the rapid posting in
U
the books.
3. As a transaction is recorded in a number of books in the
(c)
books, ………………….. system is convenient in use.

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Preparation of Final Account 303
Notes
Activity
As per Section 29 of the Banking Regulation Act, 1949, a banking
Prepare a specimen of revised
___________________
company is required to prepare its final account (Balance Sheet
n/S
form of Balance Sheet and P.
and P. & L A/c) at the end of each year. These final accounts will & L.___________________
A/c.
be prepared as per the Form given in III Schedule of the Act. On ___________________
10th December, 1991, the Central Government issued a
___________________
notification. As per this notification, a banking company under RBI
tio
is required to prepare its Balance Sheet and P. & L. A/c as per the ___________________
revised formats of Balance Sheet and P. & L. A/c every year from ___________________
31.3.1992. Revised formats of Balance Sheet and P. & L. A/c are
uc
___________________
given in the Form A and Form B.
___________________
New Form of Balance Sheet
rod
___________________
FORM 'A' ___________________

Balance Sheet of -----------------------
(here enter name of the banking company)
As on 31st March (year)
ep
Capital and Liabilities Schedule as on 31.3--- as on 31.3-
(Current year) (Previous year)
Capital 1
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Reserve & Surplus 2
Deposits 3
Borrowings 4
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Other liabilities and provisions 5
--------------- ---------------
Total ---------------- ---------------
Assets
No
Cash and balances with Reserve
Bank of India 6
Balance with bank and money at
call and short notice 7

S,
Investments 8
Advances 9
PE
Fixed Assets 10
Other Assets 11
--------------- -------------
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Total --------------- --------------
Contingent Liabilities
(c)
Bills for collection 12

Business Accounting
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304
Schedule 1 – Capital
Notes
As on 31.3--- As on 31.3---
___________________ (Current Year) (Previous Year)
n/S
___________________ I. For Nationals Banks
Capital(Fully owned by Central Government)
___________________ II. For bank Incorporated outside India Capital
___________________ (i) (The amount brought in by banks by way

of start-up capital as prescribed by RBI
tio
should be shown under this head)
___________________
(ii) Amount of deposit kept with the RBI
___________________ under Section 11(2) of the banking
regulation Act. 1949 ---------- ----------
Total: ---------- ----------
uc
___________________
(iii) For other banks
___________________ Authorized capital
(….Share of `….. Each)
___________________
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Issued Capital
___________________ (….Share of `….. Each)
Subscribed Capital
Called up Capital
ep
Less: Calls unpaid
Add: Forfeited shares --------------- ---------------
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Schedule 2 – Reserves & Surplus
As on 31.3--- As on 31.3---
(Current Year) (Previous Year)
I. Statutory Reserves
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Opening Balance
Addition during the year
Deductions during the year
II. Capital Reserves
No
Opening Balance
III. Securities premium
S,
Opening balance
PE
IV. Revenue and Other Reserves

Opening balance
U

V. Balance in Profit and Loss A/c
(c)
Total (I, II, III, IV, V) …………….. ……………..

…………….. ……………..
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Schedule 3 - Deposits 305
As on 31.3--- As on 31.3--- Notes

___________________
A. I. Demand deposits
n/S
(i) From Banks ___________________
(ii) From other ___________________

II. Saving bank deposits
___________________
III. Term deposits
tio
___________________
(i) From Banks
(ii) From other ___________________
Total (I, II, III) …………….. ……………..
uc
___________________
B. (i) Deposits of branches in India
___________________
(ii) Deposits of branches outside India
rod
Total …………….. …………….. ___________________
…………….. …………….. ___________________
Schedule 4 – Borrowings
As on 31.3--- As on 31.3---
ep
I. Borrowings in India
(i) Reserve Bank of India
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(ii) Other bank

(iii) Other institutions and agencies
II. Borrowings outside India
Total (I and II) …………….. ……………..
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Secured Borrowings included in I & II above - `
Schedule 5 – Other Liabilities and Provisions
As on 31.3--- As on 31.3---
No
I. Bills Payable
II. Inter-office adjustments(net)
III. Interest accrued
IV. Others(including provisions)
S,
Total (I, II, III and IV) …………….. ……………..
Schedule 6 – Cash and Balances with Reserve Bank of India

PE
As on 31.3--- As on 31.3---
I. Cash in hand
(including foreign currency notes)
U
II. Balance of Reserve Bank of India

(i) In current A/c
(c)
(ii) In other A/c

Total (I and II) …………….. ……………..
Business Accounting
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306 Schedule 7 – Balances with Bank & Money at
Notes Call & Short Notice
As on 31.3--- As on 31.3---
___________________
n/S
___________________ I. In India
___________________ (i) Balance with banks

(a) In current A/c
___________________
(b) In other deposit A/c
tio
___________________ (ii) Money at call and short notice
___________________ (a) With bank

(b) With other institutions
uc
___________________
Total (i) and (ii) …………….. ……………..
___________________ II. Outside India
___________________ (i) In current A/c
rod
(ii) In Other Deposit A/c
___________________
(iii) Money at call and short notice
Total (i), (ii), and (iii) …………….. ……………..
Grand Total (I and II) …………….. ……………..
ep
Schedule 8 – Investments
As on 31.3--- As on 31.3---
rR

I. Investment in India in
(i) Government security
(ii) Other approved securities
t fo
(iii) Shares
(iv) Debentures and Bonds
(v) Subsidiaries and/or Joint Ventures
(vi)Others (to be specified)
No
Total …………….. ……………..

II. Investments outside India in
(i)Government securities
(including local authorities)
(ii) Subsidiaries and/or Joint Ventures abroad
S,
(iii)Other investments (to be specified) …………….. ……………..

Total …………….. ……………..
PE
Grand Total (I and II) …………….. ……………..
Schedule 9 – Advances
As on 31.3--- As on 31.3---
U

A (i) Bill purchased and discounted
(c)
(ii) Cash credits, overdrafts and loans

repayable on demand
Contd…
ale
(iii) Term loans …………….. ……………..
307
Total …………….. …………….. Notes
B. (i) Secured by tangible, assets ___________________
n/S
(ii) Covered by bank/Government guarantees
___________________
(iii) Unsecured …………….. ……………..
Total …………….. ……………..
___________________
C. I Advances of India ___________________
tio
(i) Priority sectors
___________________
(ii) Public sectors
___________________
(iii) Banks
uc
(iv) Others …………….. …………….. ___________________
Total …………….. …………….. ___________________
II. Advances outside India
rod
___________________
(i)Due from banks
(ii) Due from others ___________________
a. Bill purchased and discounted

b. Syndicated loans
ep
c. Others …………….. ……………..
Total …………….. ……………..
Grand Total (C I and II) …………….. ……………..
rR
Schedule 10 – Fixed Assets

As on 31.3--- As on 31.3---
t fo
I. Premises
At cost as on 31st March of the preceding year
No
Depreciation to date
Other Fixed Assets (including furniture and fixture)
At cost as on 31st March of the preceding year
S,
Depreciation to date
Total ( I and II) …………….. ……………..
PE
Schedule 11 – Other Assets

As on 31.3--- As on 31.3---
U
Inter-office adjustments (Net)

Interest accrued
(c)
Tax paid in advance / tax deducted at source

Stationary and stamps
Non banking assets acquired in satisfaction of claim Contd…
Business Accounting
ale
308
Other @
Notes
Total @ …………….. ……………..
___________________ There is any unadjusted balance of loss the same may be shown under this item with
appropriate footnote.
n/S
___________________
Schedule 12 - Contingent Liabilities
___________________
As on 31.3--- As on 31.3---
___________________ (Current Year) (Previous Year)
tio
I. Claims against the bank not acknowledged as debts
___________________
II. Liabilities for partly paid investments
___________________
III. Liabilities on account of outstanding forward
Exchange contracts
uc
___________________
IV. Guarantees given on behalf of constituents
___________________
(a) In India
___________________ (b) Outside India
rod
___________________ V. Acceptances. Endorsements and other obligations
VI. Other items for which the bank is contingently liable
Total …………….. ……………..
ep
Form of Profit and Loss Accounts
Form 'B'
rR
Profit &Loss Account for the year ended 31st March (Year)
Schedule No. Year ended Year ended
on 31.3--- on 31.3---
I. Income 13
t fo
Interest earned 14
Other incomes
Total …………….. ……………..
…………….. ……………..
II. Expenditure
No
Earnest expended 15
Operating expenses 16
Previous and contingencies …………….. ……………..
Total …………….. ……………..
III.Profit/Loss
S,
Net profit/loss (-) for the year

Profit/loss (-) brought forward
Total …………….. ……………..
PE
…………….. ……………..
IV. Appropriations
Transfer to statutory reserves
Transfer to other reserves
U
Transfer to Government/proposed dividend

Balance carried over to balance sheet
Total …………….. ……………..
(c)
…………….. ……………..
ale
Schedule 13 - Interest Earned 309
Year ended Year ended Notes
on 31.3--- on 31.3---
(Current year) (Previous year) ___________________
n/S
I. Interest/discount on advances/bills
___________________
II. Income on investment
___________________
III. Interest on balances with Reserves Bank
of India and other inter-bank funds
___________________
IV. Other
tio
___________________
Total …………….. ……………..
…………….. …………….. ___________________
uc
Schedule 14 - Other Income ___________________
Year ended Year ended ___________________

on 31.3--- on 31.3---
rod
___________________
I. Commission, exchange and brokerage
___________________
II. Profit on sale of investments
Less: Loss on sale of investments
III. Profit on revaluation of investments
ep
Less: Loss on revaluation of investments
IV. Profit on sale of land, building and other assets
rR
Less: Loss on sale of land, building and other assets

V. Profit on exchange transactions
Less: Loss on exchange transactions
VI. Income earned by way of dividends etc. from
t fo
Subsidiaries/ companies and/or joint ventures

abroad/in India
VII. Miscellaneous Income …………….. ……………..
Total …………….. ……………..
Note: Under items II to V, loss figures may be shown in brackets
No
Schedule 15 - Interest Expended

Year ended Year ended
on 31.3--- on 31.3---
S,
I. Interest on deposit
II. Interest on Reserve Bank of India/Inter bank
Borrowings
PE
III. Others
Total …………….. ……………..
…………….. ……………..
U
(c)
Business Accounting
ale
310 Schedule 16 - Operating Expenses
Notes Year ended Year ended
on 31.3--- on 31.3---
___________________ (Current year) (Previous year)
n/S
___________________ I. Payments to and provisions for employees
II. Rent, taxes and lighting
___________________
III. Printing and stationary
___________________ IV. Advertisement and Publicity
tio
___________________ V. Depreciation on banks property
VI. Directors' fee allowances and expenses
___________________
VII. Auditors' fee allowances and expenses
(Including branch auditors' fees & expenses)
uc
___________________
VIII. Law charges
___________________
IX. Postage, Telegrams, Telephones, etc.
___________________
rod
X. Repairs and Maintenance
___________________ XI. Insurance
XII. Other expenditure
Total …………….. ……………..
ep
…………….. ……………..
II. Expenditure
Earnest expended 15
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Operating expenses 16
Previous and contingencies …………….. ……………..
Total …………….. ……………..
III. Profit/Loss
t fo
Net profit/loss (-) for the year

Profit/loss (-) brought forward
Total …………….. ……………..
…………….. ……………..
No
IV. Appropriations
Transfer to statutory reserves
Transfer to other reserves
Transfer to Government/proposed dividend
S,
Balance carried over to balance sheet

Total …………….. ……………..
PE
…………….. ……………..
Schedule 13 - Interest Earned

on 31.3--- on 31.3---
U

I. Interest/discount on advances/bills
(c)
II. Income on investment
Contd…
ale
III. Interest on balances with Reserves Bank
311
of India and other inter-bank funds Notes
IV. Other
___________________
Total …………….. ……………..
n/S
…………….. …………….. ___________________
___________________
Schedule 14 - Other Income
Year ended Year ended ___________________
tio
on 31.3--- on 31.3---
(Current year) (Previous year) ___________________
I. Commission, exchange and brokerage ___________________
II. Profit on sale of investments
uc
___________________
Less: Loss on sale of investments
III. Profit on revaluation of investments ___________________
Less: Loss on revaluation of investments
rod
___________________
IV. Profit on sale of land, building and other assets
___________________
Less: Loss on sale of land, building and other assets
V. Profit on exchange transactions
Less: Loss on exchange transactions
ep
VI. Income earned by way of dividends etc. from
Subsidiaries/ companies and/or joint ventures
abroad/in India
rR
VII. Miscellaneous Income …………….. ……………..

Total …………….. ……………..
Note: Under items II to V, loss figures may be shown in brackets
t fo
Schedule 15 - Interest Expended

on 31.3--- on 31.3---
I. Interest on deposit
No
II. Interest on Reserve Bank of India/Inter bank

Borrowings
III. Others
Total …………….. ……………..
…………….. ……………..
S,
Schedule 16 - Operating Expenses

PE

on 31.3--- on 31.3---
I. Payments to and provisions for employees
II. Rent, taxes and lighting
U
III. Printing and stationary

IV. Advertisement and Publicity
(c)
V. Depreciation on banks property
Contd…
Business Accounting
ale
312
VI. Directors' fee allowances and expenses
Notes
VII. Auditors' fee allowances and expenses
(Including branch auditors' fees & expenses)
___________________
VIII. Law charges
n/S
___________________
IX. Postage, Telegrams, Telephones, etc.
___________________ X. Repairs and Maintenance
___________________ XI. Insurance

XII. Other expenditure
tio
___________________
Total …………….. ……………..
___________________
…………….. ……………..
uc
___________________
Specimen Form of Accounting Policies-Schedule 18 Principal
___________________
Accounting Policies
___________________
rod
Following are the specimen form of accounting policies-schedule 18
___________________ principal accounting policies:
1. General: The accompanying financial statements have been
prepared on the historical cost basis and from to the statutory
ep
provision and practices prevailing in the country.
2. Transaction involving foreign exchange:
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(a) Monetary assets and liabilities have been translated at

the exchange rate prevailing at the close of the year. Non-
monetary assets have been carried in the books at the
historical cost.
t fo
(b) Income and expenditure items in respect of the Indian

branches have been translated at the change rates ruling
on the date of the transaction and in respect of overseas
No
branches at the change rates prevailing at the close of the

year.
(c) Profit or loss on pending forward contracts has been
accounts for.
S,
3. Investment:
(a) Investments in Government and other approved securities
PE
in India are valued at the lower of; cost or market value.

(b) Investment in subsidiary companies and in some
companies (i.e. companies in which at least 25% of the
U
share capital) have been accounted for on the historical

cost basis.
(c)
ale
313
(c) All other investment is valued at the lower of cost or
Notes
market value.
___________________
4. Advances:
n/S
___________________
(a) Provisions for doubtful advances have been made to the
___________________
satisfaction of the auditors:
___________________
(i) In respect of the identified advance, based on a
tio
___________________
periodical review of advances and after taking into
account the portion of advance guaranteed by the ___________________
Deposit Insurance and Credit Guarantee Corporation
uc
___________________
and similar statutory bodies.
___________________
(ii) In respect of general advances as a percentage of total
rod
___________________
advances taking into account guidelines used by the
___________________
Government of India and the Reserve Bank of India.
(b) Provisions in respect of doubtful advances have been

ep
deducted from advances to the extent necessary and the
excess has been includes under "other liabilities and
provisions."
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(c) Provisions have been made on a gross basis. Tax relief

which will be available when the advance is written off
will be accounted for in the year of write off.
t fo
5. Fixed Assets:
(a) Premises and other fixed assets have been accounted for
at their historical cost. Premises which have been
No
revalued are accounted for at the values determined on

the bass of such revolution made by professional values.
Profit arising on revolutions has been credited to capital
reserve.
S,
(b) Depreciation has been provided for on the straight

line/diminishing balance method.
PE
(c) In respect of revalued assets, depreciation is provided for

on the revalued figure and on the capital reserve to the
general reserve/ profit and loss account.
U
6. Staff Benefits: Provisions for gratuity/pension benefits to

staff has been made on an accrual/cash basis. Separate funds
(c)
for gratuity/pension have been created.

Business Accounting
ale
314
7. Net profit:
Notes
___________________
(a) The net profit disclosed in the profit and loss account is
after:
n/S
___________________
(i) Provisions for taxes on income in accordance with
___________________
statutory requirements,
___________________
(ii) Provisions for doubtful advances,
tio
___________________
(iii) Adjustment to the value of “current investment". In
___________________
Government and other approved securities in India
valued at lower of cost or market value.
uc
___________________
___________________ (iv) Transfers to contingency funds,

___________________
(v) Other usual or necessary provisions.
rod
___________________
(b) Contingency funds have been grouped in the balance sheet
under the head. “Other Liabilities and Provisions”.
Illustration
ep
Prepare Profit and Loss Account for the Year ended 31 March 2012
for Vijay Bank Ltd. from the following particulars:
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Interest on Loan 10, 36,000

Interest on Cash credit 8, 92,000
Interest on Current accounts 1, 68,000
t fo
Discounts on Bills discounted 7, 80,000

Interest on Overdraft 2, 16,000
Interest on Saving Bank a/c 2, 72,000
Interest on Fixed Deposits 11, 00,000
No
Commission and Exchange 32,800

Directors and Auditors fees 16,800
Rent and Taxes 72,000
Postage & Telegram 5,600
S,
Sundry charges 4,000

Printing 8,000
PE
Law charges 3,600

Establishment 2, 16,000
Lockers Rent 1,400
U
Transfer Fees 2,800

Depreciation on Bank’s property 20,000
(c)
Provident Fund Contribution 2,800

ale
Other information’s: 315
Notes
(i) Rebate on Bills discounted ` 1, 96,000;
___________________
(ii) Bad Debts ` 1, 16,000;
n/S
___________________
(iii) Transfer to Statutory reserve 20% of net profit. ___________________
Solution:
___________________
tio
Profit & Loss account of Vijay Bank Ltd. ___________________
For the year ended 31 March, 2012
___________________
(000’s omitted)
uc
___________________
Schedule Year ended Year ended
No. 31-03-2012 31-03-2011 ___________________
I. INCOME
rod
___________________
Interest earned 13 2,728
Other Income 14 37 ___________________
Total-1 2,765
II. EXPENDITURE
ep
Interest expended 15 1,540
Opening expenses 16 348.8
Provision and Contingencies 116
rR
Total-II 2, 004, 8
III PROFIT/LOSS
Net Profit for the year (I-II) 760.2
Profit/loss (-) brought forward _
IV APPROPRIATIONS
t fo
Transfer to Statutory reserve Balance

152.04
carried over the Balance sheet 608.16
760.20
No
Working Notes:
(` In Thousands)
Schedule -13 Interest earned Schedule – 14 Other
Income
S,
Int. on Loan 1, 036 Commission & Exchange 32.8

Int. on Cash credit 892 Lockers rent 1.4
PE
Int. on Overdraft 216 Transfer fees 2.8

Discount on bills discounted 780 37.0
2,924 Schedule -16 Operating
Expenses
U
Directors & Auditors fees 16.8

Less: Rebate 196 Rent and Taxes 72.0
(c)
2,728 Postage & Telegram 5.6

Schedule – 15 Interest Expended Sundry charges Contd…
4.0
Business Accounting
ale
316
Int. on Current a/c 168 Printing 8.0
Notes
Int. on Saving Bank a/c 272 Law charges 3.6
___________________
Int. on Fixed Deposit 1,100 Establishment 216.0
n/S
___________________ 1,540 Depreciation 20.0
___________________ Provident Fund
Contribution 2.8
___________________
348.8
tio
___________________ Prov. Bad Debts 116.0
___________________ Statutory Reserve = 760.2 ×20/100=152.04
Illustration
uc
___________________
___________________ Prepare the Balance sheet of Gagan Commercial Bank Ltd. in

___________________ proper as on 31 March, 2012 from the following particulars:
rod
___________________ Authorized capital : 40,000 Shares of ` 100 each ` 40,00,000;Paid
up capital ` 32,00,000; Bills discounted and Purchased ` 65,60,000;
Statutory Reserve ` 48,80,000; Cash credit and Overdraft
Rs.46,00,000; Cash in hand and with Reserve Bank of India `
ep
21,60,000; Current Account ` 71,20,000; Furniture after
depreciation ` 80,000; ` 3,20,000; Loans ` 24,40,000; Unclaimed
Dividend Rs.80,000; Fixed Deposits ` 25,60,000; Balance with
rR
other banks ` 5,36,000; Investment at cost ` 30,00,000; Stamps and

Stationery ` 24,000; Savings Deposit ` 24,80,000; Profit & Loss a/c
(Cr.) ` 7,20,000; Premises after depreciation ` 3,20,000; `
t fo
12,80,000; Unexpired Discount ` 1,20,000; Money at call and short

notice ` 4,00,000; Bills Payable ` 1,60,000;
Bills of ` 5, 60,000 received from customers for collection have not
yet been collected and liability of the bank for acceptances,
No
endorsement etc.; on behalf of customers is ` 8, 00,000. The

directors of the bank require to show the investment in the B/S at
market value which is ` 32, 80,000 and the profit be transferred to
Investment reserve.
S,
Solution:
Balance Sheet of Gagan Commercial Bank Ltd.

PE
as on 31 March, 2012
As on As on
Capital & Liabilities Schedule 31-03- 2012 31-03-2011
U
` (‘000) ` (‘000)
CAPITAL: 1
Authorised 40,000 shares of ` 100 each 4,000
(c)
issued & Subscribed, 32,000 shares of ` 100

each, Fully paid 3,200
Contd…
ale
RESERVES AND SURPLUS: 2 317
Statutory Reserve 4,880 Notes
Investment Reserve 280 ___________________
n/S
Balance in P & L a/c 720
___________________
DEPOSITS: 3
Current Account 7,120 ___________________
Fixed Deposit 2,560 ___________________
tio
Savings Deposit 2,480
___________________
BORROWINGS: 4
OTHER LIABILITIES ___________________
uc
AND PROVISIONS: 5 ___________________
Bills Payable 160
___________________
Unexpired discount 120
rod
Unclaimed dividend 80 ___________________
TOTAL 21,600 ___________________

Assets
CASH AND BALANCE WITH
ep
RESERVE BANK OF INDIA : 6 2,160
BALANCE WITH BANKS
AND MONEY 7
AT CALL AND SHORT NOTICE:
rR
Balance with other banks 536

Money at call and short notice 400
INVESTMENTS 8
Investment at market value 3,280
t fo
ADVANCES: 9
Bills discounted and purchased 6,560
Cash credit and overdraft 4,600
Loans
No
2,440
FIXED ASSETS: 10
Premises at cost 1,600
Less : Depreciation 160 1,280
S,
Furniture at cost 200

Less : Depreciation 40 320
OTHER ASSETS: 11
PE
Stamps and Stationery 24

TOTAL 21,600
CONTINGENT LIABILITIES: 12
U
Acceptances, endorsements and 800

other obligation
Bills for collection 560
(c)
Business Accounting
ale
318
Check Your Progress
Notes
Fill in the blanks
___________________
1. As per …………………….. of the Banking Regulation
n/S
___________________
Act, 1949, a banking company is required to prepare its
___________________
final account (Balance Sheet and P. & L A/c) at the end
___________________ of each year.
tio
___________________ 2. …………………….. have been prepared on the historical
___________________ cost basis and from to the statutory provision and
practices prevailing in the country.
uc
___________________
___________________ 3. Investments in Government and other approved

securities in India are valued at the lower of
___________________
rod
…………………….. value.
___________________
4. Depreciation has been provided for on the ………………
balance method.
ep
Summary
In this unit we have touched the following points the main
rR
functions of a banking company are accepting the deposits from

public and lending the money to the public, principal books which
are maintained by a banking company, advantages and
t fo
disadvantages of the slip system of book keeping in banks, and new

forms for the Balance Sheet and P. & L. Account.
Lesson End Activity

No
Explain the guidelines issued by RBI for the preparation of the

final accounts of banking companies. Give explanation of
important items of final accounts.
S,
Keywords
Banking Company: As per Section 5 of the Banking Regulation
PE
Act, Banking Company may be defined as, "Banking Company

means any company which transacts the business of banking in
India."
U
Slip System of Posting: This system is used for the rapid posting
in the books. Under this system slips are used for the posting.
(c)
ale
319
Fixed assets: Fixed assets, also known as a non-current asset or
Notes
as property, plant, and equipment (PP&E), is a term used
in accounting for assets and property which cannot easily be ___________________
n/S
converted into cash. ___________________
Investment: Investment is putting money into something with the ___________________

expectation of gain, usually over a longer term. This may or may
___________________
not be backed by research and analysis.
tio
___________________
Questions for Discussion ___________________
uc
___________________
1. What is slip system of book keeping in banks?
___________________
2. Explain the merits and demerits of slip system of book keeping
rod
___________________
in banks.
___________________
3. Prepare a balance sheet of a banking company with imaginary
figures.
ep
4. Explain the main books that are generally required to be
maintained by a bank.
rR
Further Readings
Books
t fo

No
Web Readings
220.227.161.86/19019comp_sugans _pe2 _accounting_cp10. pdf
S,
www.scribd.com › Research › Business & Economics

www.caclubindia.com › Discussion › Accounts
PE
www.iibf.org.in/documents/jaiib_accfinance_d.ppt
U
(c)
Business Accounting
ale
320
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 19: Accounts of Insurance Companies
ale
Unit 19
321
Notes
Activity
Accounts of Insurance Companies

Prepare a specimen of revised
___________________
n/S
form of Balance Sheet and P.
& L.___________________
A/c.
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning and Definition of Insurance ___________________

\ Types of Insurance
uc
___________________
\ Preparation of Final Accounts
___________________
rod
___________________
Introduction
___________________
Various risks occur during the operation of business. To minimize
these risks insurance contracts are done between the owner of
ep
business and insurance company. Business of insurance company
is a specialized type of business in which premium is paid in
advance and the risk is covered for future. There is IRDA to
rR
regulate the business of insurance. Under the regulations of IRDA

the final accounts of the insurance companies are maintained. This
is discussed in the unit.
t fo
There are numerous risks in the life of business. Insurance is a

tool to reduce the risk of business. Insurance is such type of
contract in which one part, known as the insurer is indemnified for
No
a loss on happening a particular event by the other party (insured).

The document on which the terms and conditions of the contract
are mentioned is called policy. The amount for which this contract
is being done is called the amount of policy. For this service the
S,
insured (Insurance Company) charges a consideration which is

called premium.
PE
Meaning and Definition of Insurance

Insurance is a contract between two parties. In which one party
insured undertakes the responsibility to pay the insured amount to
U
the insurer or any other person nominated by the insurer, on the

(c)
death of the insurer or happening a particular event within a

stipulated time for a fixed consideration (premium).
Business Accounting
ale
322
Types of Insurance
Notes
The main types of insurance are as follows-
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
Statutory Books of Insurance Companies
___________________
Under Insurance Act, an Insurance company has to maintain the
___________________
following books:
rod
___________________
1. Register of Policies.
2. Register of Claims.
ep
3. Register of Licensed Insurance Agents.
Subsidiary Books of Insurance Companies

rR
Following subsidiary books are also maintained by an Insurance

company:
1. Register of Proposals
t fo
2. Register of Commission
3. New Premium Cash Book
4. Renewal Premium Cash Book
No
5. Petty Cash Book

6. General Cash Book
7. Claims Cash Book
S,
8. Agency and Branch Cash Book

9. Bank Cash Book
PE
10. Lapsed and Surrendered Policies Book

11. Policy Loan Ledger
U
12. General Loan Ledger

13. Investment Ledger
(c)
14. Journal etc.

ale
Explanation of Various Terms Relating to 323
Insurance Business Notes
(1) Premium: Premium is that amount which is paid by the ___________________
n/S
insurer to the insurance company in the form of consideration.
___________________
As General Insurance contract is for one year, premium is paid
___________________
for one year. In the case of Life Insurance, contract is for long
time. Premium is paid annually up to the date of maturity. ___________________
tio
(2) Claims: Claim means the insured amount payable by the ___________________
insurance company to the insurer on the happening a ___________________

particular event. This is the first item which is shown in the
uc
___________________
debit side of the revenue account. In order to calculate the
___________________
actual loss due to claims, the previous year's outstanding
claims, claims intimated but not paid should be kept in mind.
rod
___________________
The following statement may be prepared to find the actual ___________________
amount of claims of the current year which is shown in the
revenue account.
ep
Statement of Claims
`
Claim paid during the year ………………………..

rR
- Outstanding claims in the beginning of the year ……………………….
+ Outstanding claims at the end ………………………..

of the year ……………………….
t fo
+ Legal and other expenses ………………………..

regarding claims ……………………….
Less: Closing Reinsurance Recoveries (A) ………………………..

- Opening Reinsurance Recoveries (B) ( A- B )
No
Total Claims -
(3) Reinsurance: Sometimes the insurance company considers

that a particular risk accepted is out of its capacity. In such a
situation it gets a part of risk insured with other insurance
S,
company, which is called reinsurance or insurance of

insurance.
PE
(4) Commission on Reinsurance ceded/accepted: When an

insurance company accepts the insurance of other insurance
U
company, commission payable on this reinsurance business is

called commission on reinsurance accepted and is shown in the
(c)
debit side of revenue account. Similarly when an insurance

company gives its business to other company, this company
Business Accounting
ale
324 (which gives business) gets a commission from other company
Notes (which gets business). Such a commission is called commission
___________________ on reinsurance ceded. It is the gain; therefore it is shown in
n/S
___________________ the credit side of revenue account.
___________________ (5) Revenue for unexpired risk: Here unexpired risk means the
___________________ risk, which has been expired up to the date of preparation of
final account of the insurance company. The business of the
tio
___________________
insurance is of a peculiar in nature that premium is received
___________________
in advance while risk can take place any of days. Risk is
uc
___________________
covered for the whole year. For example if an insurance
___________________ company takes the business on 1st March and accounts are
___________________ closed on 31st March. Thus on the date of accounts only one
rod
___________________ month is expired and eleven months are not expired. In this
case risk is due for eleven months. Thus a large portion of
premium collected is kept in reserve for unexpired risk. II B of
the Insurance Regulatory and Development Authority 2000
ep
lays down the following rates to make the reserve for
unexpired risk:
rR
(i) For Marine Hull business- 100% of net premium
(ii) For Fire business- 50% of net premium

t fo
(iii) For Miscellaneous business- 50% of net premium.
This reserve is showed in the debit side of the revenue account

and in the liability side of the balance sheet under the heading
of 'Balance of Funds and Accounts'.
No
(6) Additional Reserve for Unexpired risk: Some times some

insurance companies consider that the rate recommended by
the General Insurance Council for the reserve for unexpired
S,
risk is not sufficient to meet the unexpired risk. In such a

condition they make an additional reserve to protect their
PE
business. Efforts are made to increase the amount of

additional reserve. At the end of year it is shown in the
liabilities side of the balance sheet and in the next year, it is,
U
shown in the credit side of the revenue account.

(c)
ale
325
Check Your Progress
Notes
Activity
Fill in the blanks:
Prepare with imaginary figures
___________________
1. ………………… is a contract between two parties in
n/S
the Revenue Account of
___________________
General Insurance Company.
which one party insured undertakes the responsibility
___________________
to pay the insured amount to the insurer or any other
person nominated by the insurer. ___________________
tio
___________________
2. ………………… means the insured amount payable by
the insurance company to the insurer on the happening ___________________
a particular event.
uc
___________________
3. ………………… means the risk, which has been expired ___________________
up to the date of preparation of final account of the
rod
___________________
insurance company. ___________________
4. Sometimes the insurance company considers that a

particular risk accepted is out of its capacity. In such a
ep
situation it gets a part of risk insured with other
insurance company, which is called …………………
rR
Preparation of Final Accounts

Business of Insurance is regulated by the Insurance Regulatory
t fo
and Development Authority Act (IRDA), 1999. IRDA published the

Insurance Regulatory and Development Authority Regulation,
2000 in the official Gazette of India, Extra Ordinary, Part-III,
Section-4, Notification dated 14th August, 2000 followed by IRDA,
No
2002.
As per this notification, the Insurance Companies are required to

prepare their Financial Statements- Revenue Account, Profit and
Loss A/c and Balance Sheet according to the Insurance Regulatory
S,
and Development Authority (Preparation of Financial Statement

and Auditors Report of Insurance Companies) Regulations-2002.
PE
The Life Insurance business shall comply with the requirements of

Schedule which gives the following forms-
(i) Revenue Account - Form A-RA

U
(ii) Profit Loss Account - Form A-PL

(c)
(iii) Balance Sheet - Form A-BS

Business Accounting
ale
326
General insurance business shall comply with the requirements of
Notes
Schedule B which includes the following forms:
___________________
(i) Revenue Accounts - Form B-RA
n/S
___________________
(ii) Profit and Loss Accounts - Form B-PL
___________________
(iii) Balance Sheet - Form B-BS
___________________
Life Insurance Business
tio
___________________
___________________ In the case of life insurance business the final accounts will be
prepared in the prescribed forms. These forms are given below:
uc
___________________
___________________ Life assurance co. Ltd.

Revenue account
___________________
(for the year ended 31st March 200…)
rod
___________________ Policy holders' Account (Technical Account)
Particulars Schedule Current Previous
Year Year
(` )
ep
(` )
Premiums earned net : 1
a) Premium
b) Reinsurance ceded
rR
c) Reinsurance accepted
Income from Investments :
(a) Interest, Dividends & Rent-Gross
(b) Profit on sale/redemption of
t fo
investments
(c) Loss on sale/redemption of
investments
Other Income (to be specified)
No
Total (A)
Commission 2
Operating Expenses related to Insurance 3
Business
Other Expenses (to be specified)
S,
Provisions (other than taxation)

(a) For diminution in the value of
investment (Net)
PE
(b) Others (to be specified)

4
Total (B)
Benefits Paid (Net)
U
Interim Bonuses Paid

Change in valuation of liability against life
policies in force
(c)
(a) Gross**
(b) Amount ceded in Reinsurance
(c) Amount accepted in Reinsurance
Contd…
ale
327
Total (C)
Notes
Surplus [(A) – (B) – (C)]
___________________
Appropriations
n/S
Transfer of Shareholders’ Account ___________________
Transfer to Other Reserves (to be specified)
___________________
Transfer to Funds for Future Appropriations
___________________
Total (D)
tio
___________________
Form A-PL
___________________
Profit & Loss Account
(for the year ended 31st March 2007)
uc
___________________
Policy holders' Account (Non-Technical Account)
___________________
Year Year
rod
___________________
(`) (`)
___________________
Balance brought forward from/transferred to
the Policy holders Account (Technical
Account)
ep
Income from Investments:
(b) Interest, Dividends & Rent-Gross
(c) Profit on sale/redemption of
investments
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(d) Loss on sale/redemption on

investments
Other Income (to be specified)
Total (A)
t fo
Expenses other than those directly related to

the insurance business
Provisions (Other than taxation)
(a) For diminution in the value of
investments (Net)
No
(b) Others (to be specified)

Total (B)
Profit/Loss) before tax
Provision for Taxation
Profit/(Loss) after tax
S,
Appropriations
(a) Brought forward Reserve Surplus
PE
from the Balance sheet

(b) Interim dividends paid during the
year
(c) Proposed final dividend
(d) Dividend distribution on tax
U
(e) Transfer to reserves/other accounts

(to be specified)
(c)
Profit carried forward to the Balance

Sheet
Business Accounting
ale
328 Balance Sheet
Notes (at 31st March 200….)
Shareholders' Account (Non-Technical Account)
___________________
n/S
___________________ Year Year
(` ) (` )
___________________
Source of Funds:
___________________ Shareholders’ Funds 5
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___________________ Share Capital 6
Reserves and Surplus
___________________ Credit/Debit Fair value change 7
account
uc
___________________
___________________ Sub Total (A)

Borrowings
___________________
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Policy holders’ Funds
___________________ Credit [Debit] Fair value change
account
8
Policy Liabilities
Insurance Reserves
ep
9
Provisions for linked liabilities
10
Sub-Total 11
12
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Funds for future appropriations
Total 13
Application of Funds 14
Investments:
t fo
Shareholders’
Policyholders’
Assets held to cover linked liabilities
Loans
No
Fixed Assets
Current Assets
Cash and Bank Balances
Advance and Other Assets
Sub-Total (A)
S,
Current Liabilities
Provisions
PE
Sub-Total (B)
Net Current Assets (C) = (A – B )
Miscellaneous expenditure
(to the extent not written off or
U
adjusted)
Debit Balance in Profit & Loss
Account
(c)
(Shareholders’ Account)
Total
ale
General Insurance Business 329
Notes
General Insurance Companies shall comply the requirement of
Form 'B' under which they shall prepare the revenue account ___________________
n/S
separately for life, marine and miscellaneous business, P& L A/c ___________________
and Balance sheet. These are as follows:
___________________
Form B-RA ___________________
tio
Revenue Account (for the year ended 31st March, 2007) ___________________
Fire Insurance Business
___________________
Particulars Schedule Current Year
uc
` ___________________
Premium (net) 1 ___________________

Change in provision for unexpired risk
rod
___________________
[` (17,26,004 + 4,40,000) – (12,40,000 +
14,400.000)] ___________________
Interest, Dividend & Rent- Gross
Share transfer fees
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Total (A)
Claims incurred 2
Commission 3
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Operating Expenses related to Insurance 4

business
Total (B)
t fo
Profit from Fire Insurance business (A-B)
Form B-PL
Profit & Loss Account (for the year ended 31st March, 2007
No
Particulars Current Year

`
1. Opening Profit/Loss
2. Income from Investments

S,
3. Other Income
Total (A)
PE
4. Provisions (other than taxation)
5. Other Expenses
U
Total (B)
Profit before Tax

(c)
Provision for Taxation
Contd…
Business Accounting
ale
330
Appropriations
Notes
(a) Transfer to General Reserve
___________________
(b) Transfer to Proposed Dividend 12%
n/S
___________________
___________________
Balance of Profit/Loss brought forward from last year
___________________
Balance carried forward to Balance Sheet
tio
___________________
Form B-BL
___________________ Balance Sheet (As at 31st March, 2007)
Current
uc
___________________
Particulars Schedule
Year (`)
___________________
Source of Funds
___________________
rod
Shareholders Fund
___________________
Share Capital 5
Reserves & Surplus 6
Credit/Debit Fair Value Change A/c

ep
Borrowings
Policy holders Funds

rR
Credit/Debit Fair value Change A/c
Policy-liabilities
Provisions for Linked-Liabilities

t fo
Sub-Total
Funds for future Appropriation
Total
Application of Funds
No
Investments
Shareholders 8
Policyholders 8A
S,
Assets held to cover linked Liabilities 8B
Loans 9
PE
Fixed Assets 10
Current Assets
Cash & Bank Balance 11

U
Advance & other Assets 12
Sub-Total (A)
(c)
Current Liabilities 13
Contd…
ale
Provision for tax 331
Sub-Total (B) Notes
Net Current Assets (A – B) ___________________
n/S
Misc. Exp. ___________________
Debit Balance of P&L Account 15 ___________________

Total ___________________
tio
Illustration ___________________
From the following particulars, you are required to prepare Fire ___________________
Revenue Account for the year ending 31st March, 2012:
uc
___________________
Claims paid: 9.60,000 ___________________
Claims outstanding on 1st April, 2011:80,000
rod
___________________
Claims intimated but not accepted on 31st March, 2012: 20,000
___________________
Claims intimated and accepted but not paid on 31st March,
2012:1, 20,000
ep
Premium received: 24, 00,000
Re- insurance Premium: 2, 40,000
Commission: 4, 00,000
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Commission on re-insurance ceded: 20,000

Commission on re-insurance accepted: 10,000
Expenses of Management: 6, 10,000
t fo
Reserve for unexpired risks on 1st April, 2011: 8, 00,000

Additional Reserve for unexpired risks on 1st April, 2011: 40,000
Bonus in reduction of premium: 24,000
No
You are required to provide for additional reserve for unexpired

risks at 1% of the net premium in addition to the opening balance.
Solution:
Fire Revenue Account
S,
the year ended 31st March, 2012

` ` ` `
PE
Claims paid 9,60,000 Balance of account at

the beginning of the
year:
Add: Claims
Outstanding
U
at the end of the year Reserve for unexpired 8, 00,000

(Rs.20, 000+Rs.1, 20,000) 1,40,000 Additional reserve 40,000
11,00,000 Premiums 24,00,000
(c)
Less: Reinsurance 2,40,000

Contd…
Business Accounting
ale
332 Premium 21,60,000
Notes Less: Outstanding in the Add: Bonus in reduction

beginning of the year 80,000 10,20,000 of premium 24,000
___________________ 21,84,000
n/S
Commission 4,00,000
___________________
Commission of reinsurance 10,000 Interest, Dividend & -
accepted Rent
___________________
Bonus 24,000 Commission reinsurance 20,000
ceded
___________________
Expenses of Management 6,10,000 Loss transferred to P&L 1,73,840
tio
a/c
___________________
Bad Debts -
___________________ Taxes -
Other Exp. -
uc
___________________
Provision for unexpired -
risks:
___________________
50% of net premiums 10,92,000
___________________ Additional reserve:
rod
on 1st April 40,000
___________________ Add: 1% of net premium 21,840 61,840
(1% ` 21, 84,000)
32,17,840 32,17,840
ep
Check Your Progress
Fill in the blanks:
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1. Business of Insurance is regulated by the ………………. .

2. ………………… business shall comply with the
requirements of Schedule B under which they shall
t fo
prepare the revenue account separately for life, marine

and miscellaneous business.
Summary
No
There are two main type of insurance i.e. Life Insurance and
General Insurance. In this unit we have touched the following
points -Meaning and definition and types of insurance business,
Explanation of reserve for unexpired risk, additional reserve,
S,
provision for bad debts, claims and premium, IRDA's regulations to

prepare the Revenue A/c, P. & L. Account and Balance Sheet of
PE
Insurance Company and New Forms to prepare the Final A/c of

Life Insurance Business and General Insurance Business.
U
Lesson End Activity

In the case of life insurance business the final accounts are
(c)
prepared in the prescribed forms. Discuss the various forms which

are required according to the Insurance Regulatory and
ale
Development Authority (Preparation of Financial Statement and 333
Auditors Report of Insurance Companies) Regulations 2010. Notes
___________________
n/S
Keywords ___________________
Insurance: Insurance is a contract between two parties. In which ___________________

one party insured undertakes the responsibility to pay the insured ___________________
amount to the insurer or any other person nominated by the
tio
___________________
insurer, on the death of the insurer or happening a particular
event within a stipulated time for a fixed consideration (premium). ___________________
uc
Premium: Premium is that amount which is paid by the insurer to ___________________
the insurance company in the form of consideration. ___________________
Claims: Claim means the insured amount payable by the
rod
___________________
insurance company to the insurer on the happening a particular ___________________
event.
Insurance Contract: Various risks occur during the operation of
ep
business, to minimize these risks insurance contracts are done
between the owner of business and insurance company.
rR

1. What is Insurance Contract? Explain the different types of it.
t fo
2. Explain the types of insurance business.

3. Prepare a revenue account of Insurance Company with
imaginary figures as per new Form of IRDA.
4. Clearly explain:
No
(i) Commission on Reinsurance Accepted/Ceded

(ii) Commission on Reinsurance
5. Prepare Revenue Account, Profit & Loss Account, P&L
S,
Appropriation Account and Balance Sheet of the New Bharat

and General Insurance Co. on 31st March,2012 from the
PE
following:
Reinsurance Premium 1, 38,000

Losses by Fire 9, 60,000
U
Expenses of Management 2, 40,000

(c)
Commission 2, 38,000
Taxes 22,000
Business Accounting
ale
334
Shareholders Dividend paid and payable 12,000
Notes
Mortgages within India 2, 00,000
___________________
Mortgages outside India 20,000
n/S
___________________
Foreign Securities 3, 10,000
___________________
Railway Debentures and Stock 3, 00,000
___________________
Railway Preference Shares 66,000
tio
___________________
Municipal Loans 34,000
___________________ Bank Deposits 40,000
Deposit with Foreign Companies 34,000
uc
___________________
___________________ Deposit with Trustees 22,000

___________________ Agents and Branch office Balances 2, 10,000
rod
___________________ Outstanding Premium at Head Office 3,000
Cash at Bank 21,000
Management expenses (Not applicable any
ep
particular a/c) 13,000
Premiums 15, 40,000
rR
Losses recoverable 1, 20,000

Profit and Loss Account 7,000
General Reserve Fund 5, 60,000
t fo
Interest and Dividend (of which ` 10,000 has not

Received) 27,000
Capital 5, 00,000
Outstanding Fire Losses 1, 26,000
No
Outstanding Dividend 13,000

No reserve for unexpired risk is created.
S,
Further Readings
Books
PE

U

(c)
ale
Web Readings 335
Notes
http://www.slideshare.net/divinvarghese/insurance-companies-
accounts-presentation ___________________
n/S
www.caclubindia.com › Share Files › Accounts ___________________
220.227.161.86/11199p1302-05.pdf ___________________
___________________
http://classof1.com/homework_answers/financial_accounting/accou
tio
nts_of_insurance_companies/ ___________________
http://www.amttraining.com/financial-training/financial- ___________________
institutions-fig/insurance-company-accounting.html
uc
___________________
___________________
rod
___________________
ep ___________________
rR
t fo
No
S,
U PE
(c)
Business Accounting
ale
336
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 20: Case Study
ale
Unit 20
337
Notes
Case Study
___________________
n/S
___________________
___________________
Objectives
___________________
tio
___________________
uc
___________________
Case Study: Creative Promotion Company
___________________
Mr. Bhatt is a young man of bright ideas. Although he is
employed as an engineer in one of the large engineering concerns
rod
___________________
in Lahore (Pakistan), he spends all his spare time developing new
___________________
products in his private laboratory at home. Currently, he has
commercially perfected a domestic appliance called Lavex, which
would be a great convenience kitchen not help to housewives. He
ep
is not interested in manufacturing and selling his new products;
his only interest in developing new products is to make money by
way of selling patent rights to some established concerns.
rR
However, he releases that till he succeeds in selling the patent

rights at price he expects, he has to manufacture and sell the new
products on ad hoc basis so as to demonstrate the commercial
superiority of his products and thereby to induce the parties to
t fo
buy the patents from him. With this objective, he is currently

thinking of manufacturing and selling 'Lavex'. He will not give up
his full-time job; he will supervise and guide 'Lavex' production
and sales during his spare time.
Bhatt has already spent ` 30,000 in developing the product. He
No
proposes to buy the component from other parties and keep the
production activity to a minimum. The minimum equipment
required would cost ` 11,000. He would need to rent a small place
for ` 1,200 per month for production. He proposes to use his
S,
residence as office for sales activity.

Bhatt proposes to introduce the product in Chennai city only. His
sales projections are as follows:
PE
January 60
February 40
March 110
U
April 140
May 220
(c)
June 180
Contd…
Business Accounting
ale
338
He is not interested in pushing sales beyond 220 units per month
Notes
as he cannot cope with the production. He has budgeted ` 20,000
___________________ for sales promotion, which will be spent mostly for demonstration
in leading department stores in the city. The promotion budget is
n/S
___________________
scheduled as follows:
___________________
January 7,000
___________________
February 7,000
tio
___________________
March 3,000
___________________
April 3,000
uc
___________________
This selling price per unit will be ` 280 and the dealers will be
___________________ given 15% trade discount. He calculates that about 50 units will
___________________ be needed for "demonstration and display" in the leading stores at
rod
his cost. Although the sales to dealers will be made on one
___________________
month's credit, he knows that the actual collections will be
realized in about 4 week’s time. He rules out cash sales.
Assembling is the activity in the production process. Components

ep
and materials which will be purchased from outside parties
strictly on 30 days credit will cost ` 160 per unit. Wages per
month will be ` 6000. The production capacity per month will be
rR
220 units. Wages will be paid weekly. Overhead expenses are

estimated at ` 2,800 per month. Materials and components need
to be ordered at least one month in advance. There will be
inventory of finished goods or goods in process as the production
t fo
will be strictly against firm orders. Bhatt proposes to employ a

full-time production, sales supervisor for ` 880 per month.
Mr Bhatt wants to know how much finance will be needed for his
first six months operation and when, so that he may plan
No
accordingly.
Questions
1. Discuss the nature of the financial problem involved.

S,
2. Prepare the monthly cash budget for the first six-month

period of the proposed venture.
PE
3. How can the above-mentioned problem be sorted out?

Source: Pandikumar M P (2010). “Management Accounting: Theory and Practice”. Excel Books.
U
(c)
UNIT 21: Inflation Accounting
ale
z 339
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
rod
___________________
ep ___________________
BLOCK-V
rR
t fo
No
S,
U PE
(c)
ale
340
Notes
UNIT 21: INFLATION ACCOUNTING
___________________ UNIT 23: GOVERNMENT SYSTEM ACCOUNTING
n/S
z z
___________________
z Meaning and Need of Inflation Accounting z Differences between Commercial Accounting and
___________________ Government Accounting
z Definition and Methods of Inflation Accounting
___________________ z Basic Principles of Government System Accounting
z Problems to Inflation Accounting
tio
___________________ z Structure of Financial Administration in India
UNIT 22: HUMAN RESOURCE ACCOUNTING
___________________
UNIT 24: RESPONSIBILITY ACCOUNTING
z Introduction
uc
___________________ z Introduction
z Meaning and Definition of Human Resource
Accounting (HRA)
___________________ z Meaning and Definition of Responsibility
Accounting
z Need and Objectives of HRA
___________________
rod
z Characteristics or process of Responsibility
z Methods of Human Resource Accounting
___________________ Accounting
z Importance of HRA
z Responsibility Centres
z HRA in Indian Corporate Sector
z Responsibility Report
ep
UNIT 25: CASE STUDIES
rR
t fo
No
S,
U PE
(c)
ale
Unit 21
341
Notes
Activity
Why should we adopt the
Inflation Accounting
___________________
Inflation Accounting? Give any
n/S
three reasons of it.
___________________
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning and Need of Inflation Accounting ___________________

\ Definition and Methods of Inflation Accounting
uc
___________________
\ Problems to Inflation Accounting
___________________
rod
___________________
Introduction
___________________
Inflation accounting is that accounting which reduces the effect of
changing in prices due to inflation. Under this accounting the
ep
supplementary financial statements are prepared along with the
historical financial statements. The present unit is written for the
purpose.
rR
Meaning and Need of Inflation Accounting

Inflation accounting means that accounting which is for changing
t fo
prices due to unprecedented pressure of inflationary price rise in

the country. Inflation in prices reflects on the purchasing power or
the value of currency of a country. Any increase in the price-level
will reduce the purchasing power of money of that country and vice
No
versa. Increasing the price level or devaluation of the currency is

called inflation and decrease in the price-level or increase in the
value of currency is called deflation. The change in the price-level
of commodities in a country affects adversely on the financial
S,
Statement because profit and loss and assets and liabilities are
shown in these Statements in money, which is automatically
PE
changing with the change of price level. Due to the change in the
value of money, financial Statement of an organization prepared
on the basis of historical cost, loses their relevance and misleads in
the measurement of economic value. In the case of inflation in a
U
country, to overcome the effect of the inflation on the financial

Statements an accounting method is used which is called inflation
(c)
accounting or price-level accounting.

Business Accounting
ale
342
Need of Inflation Accounting
Notes
Due to the following reasons, the financial Statement is being
___________________ distorted and a need for the inflation accounts arises:
n/S
___________________
1. The fixed assets are shown at the historical cost in the
___________________ balances sheet. Therefore these do not show the true current
___________________ value of the asset and are unrealistically low. As a result a
need for inflation accounting arises.
tio
___________________
___________________ 2. If the provision for depreciation is made on the historical cost,

that would not be sufficient to replace a particular asset. As a
uc
___________________
result the firm will be in a serious problem of paucity of fund.
___________________
So accounting should be made keeping in mind the pries level
___________________
changes.
rod
___________________
3. In the situation of inflation the net profit showed by the P. & L
A/c becomes more than the actual profit since the cost of goods
sold, and depreciation are computed on the historical cost
ep
basis. Even the stock is also valued at that price which is lower
between two (market price or cost of stock). And no allowance
is made for the reduction of the purchasing power of money. As
rR
a result heavy taxes and heavy dividend are paid by the firm,
which becomes a financial strain.
4. When the profits of the company are more than the actual
t fo
profits, the company has to pay the more dividends. This

dividend will be paid out of capital not form profits. As a result
there will be erosion of capital and capital will not be intact.
No
Therefore, financial Statements should be made as per price-

level.
5. In the period of inflation of prices, there will be a loss on

current assets and a profit on current liabilities. Therefore an
S,
adjustment should be made for these. As a result the need for

these changes arises.
PE
On the basis of above-mentioned reasons, we can observe that

profit and loss account of a compound does not depict the actual
profit or loss and the balance sheet does not show the true
U
economic value of the assets. Thus the effect of price level changes
should be adjusted in the financial Statements. For the purpose a
(c)
technique was developed which is called inflation accounting or

accounting for price level changes or revaluation accounting.
ale
343
Check Your Progress
Notes
Activity
Fill in the blanks:
Make an assignment on
___________________
1. ……………….. means that accounting which is for
n/S
features of Current Cost
___________________
Accounting (CCA) method.
changing prices due to unprecedented pressure of
inflationary price rise in the country. ___________________
___________________
2. ……………….. reflects on the purchasing power or the
tio
value of currency of a country. ___________________
3. In the case of inflation in a country, to overcome the ___________________

effect of the inflation on the financial Statements a
uc
___________________
……………….. is used.
___________________
rod
___________________
Definition and Methods of Inflation Accounting
___________________
Following are the definition and methods of inflation accounting:
As per J. Batty - "Complete revaluation accounting adjusts all
ep
fixed assets to current values and in addition, attempts to ensure
that capital is maintained in tact through consideration of the loss
(or gain) in purchasing power of current assets."
rR
Prof. H. Chakraborty says "The principle of replacement

accounting is that for determination of income, revenues are
matched not against actual cost but against what is expected cost
t fo
for replacement of stock sold and the portion of assets depleted in

this process of business operations."
Prof. J. Batty says "The term Revaluation accounting is used to
denote the methods used for overcoming the problems connected
No
with fixed assets replacements in a period of rising prices."
Methods of Inflation Accounting

There are various methods in the accounting to reflect the true
S,
changes in the purchasing power of money. But only two methods

are important and popular among entrepreneurs. These methods
PE
are as follows:
1. Current Purchasing Power Accounting Method
2. Current Cost Accounting Method
U
Current Purchasing Power Accounting Method

(c)
Under this method the adjustments are made in the various items
of P. & L. A/c and Balance Sheet. This method is developed on the
Business Accounting
ale
344 recommendations given by Accounting Policy Board and also the
Notes Financial Accounting Standards Board of USA. In this method the
___________________ adjustments are made in the historical cost for changes in the
general level of prices shows the changes in purchasing power of
n/S
___________________
money. In the period of inflation the purchasing power of money
___________________
reduces while in deflation the purchasing power of money
___________________ increases. Under CPP method the various historical costs/assets
tio
___________________ are transformed into current purchasing power at a particular
time.
___________________
Under this method following steps are taken to convert the
uc
___________________
historical cost basis financial Statements into current purchasing
___________________
power basis Statements.
___________________
(a) Profit and Loss account and Balance Sheets are prepared on
rod
___________________ the basis of historical cost.
(b) Besides the financial Statement, supplementary Statements
will also prepared by the organizations in which values of
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various items of the Statements are changed as per the
changes in price-level changes.
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(c) An appropriate price index is chosen to convey the values of

items.
(d) A report is given to the board of directors regarding the basis
of changing.
t fo
For the purpose of conversion the items of the balance sheet are
divided into monetary items and non-monetary items. Monetary
items are those which are not restated in the balance sheet. These
No
items represent a claim to receive or an obligation to pay a fixed

amount of foreign currency. These include cash, receivables,
payables, loans and advances and investments. If there is any
profit or loss due to the changing of monetary items by the current
S,
purchasing power of money that is adjusted in the profit and loss

account.
PE
Non-monetary items are those which are the result of past

transactions as plant and machinery, stock and depreciation in
profit and loss account. For the conversion of these items the
following formula is used
U
Historicalcost of theitem×C.Y.Index
Coverted value of theitem =
(c)
Index of the acquisition year

ale
345
All the items of expenses and incomes are brought at par with the
Notes
current purchasing power of money for which the price index is
used. The items of P. & L. A/c (except those expenses and incomes ___________________
n/S
which occurs on specific dated) is adjusted on the basis of average ___________________
rate of inflation. The average rate of inflation is determined by
___________________
dividing two to the sum of the opening rate and closing rate of
inflation of that year. The reason behind it is that these ___________________
tio
transactions occur through out the year. Some items may occur in ___________________
the earlier part of the year and some in the latter. As sales are
___________________
revalued at the average rate of inflation because it is effected
uc
through out the year. This method will clear in the following ___________________
illustrations. ___________________
Illustration
rod
___________________
The income Statement of XYZ Ltd. for the year ending 31st ___________________
December, 2012 prepared under conventional accounting is as
under:
ep
` ` `
Sales 24, 00,000

Cost of sales:
rR
Opening stock 2, 40,000

Purchases 16, 56,000 18, 96,000
Closing Stock
t fo
(from purchases) 2, 16,000 16, 80,000

Expenses:
Salaries & wages 3, 00,000
Other Expenses 1, 20,000
No
Depreciation on
Building 24,000
Interest 12,000 4, 56,000 21, 36,000
Net Income 2, 64,000
S,
Dividend 1, 60,000
Retained Earnings 1, 04,000
PE
Additional Information:
(i) Assume General price Index Nos. are

U
January 1, 2012 100
December 31, 2012 200

(c)
Average for 2012 150

Business Accounting
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346
Notes (ii) Interest and Dividend are paid on 31st December.
___________________ (iii) Building was purchased in 2000 when the General price index
was 50.
n/S
___________________
Prepare income Statement under C.P.P method.
___________________
___________________ Solution:
tio
___________________ Income Statement of XYZ Ltd.
(Under C.P.P Method)
___________________
Particulars Conversion ` `
uc
___________________
Sales 24,00,000×200/15 32,00,000
___________________ Cost of sales: 0
Opening stock 4,80,000
___________________ + Purchases 2,40,000×200/100 22,08,000
rod
1656,000×200/150 26,88,000
___________________
-Closing stock 2,88,000 24,00,000
Gross Margin 2,16,000×200/150
Expenses: 8,00,000
ep
Salary & Wages 4,00,000
Other Expenses 3,00,000×200/150 1,60,000
Depreciation 1,20,000×200/150 96,000
Interest (No change) 24,000×200/50 12,000 6,68,000
rR
Net profit
-Dividend 1,32,000
Erosion in Retained 1,60,000
Profit/Capital
t fo
28,000
Illustration
From the following particulars, of ABC Ltd., Prepare:

No
(i) Supplementary Comparative Balance Sheet as on 2012 rupee

value.
(ii) Supplementary Income Statement on 2012 rupee value.

S,
ABC Co. Ltd.

Balance Sheet
(as on 31st December, 2011 & 2012)
PE
Liabilities 2011 2012 Assets 2011 2012

Equity share Fixed Assets
Capital 2,50,000 2,50,000 (Acquired in 1995
U
P. & L A/C 34,000 40,000 at ` 4,00,000) 2,00,000 1,60,000

Creditors 38,000 40,000 Current Assets :
Debtors 40,000 60,000
(c)
Stock 60,000 80,000

Cash 22,000 30,000
3,22,000 3,30,000 3,22,000 3,30,000
ale
Other information: 347
Notes
(i) Assume price index numbers:
___________________
2000 100
n/S
___________________
2011 200 ___________________
2012 220 ___________________
tio
(ii) The fixed assets have been duly depreciated. ___________________
___________________
Solution:
uc
___________________
Supplementary Income Statement
(Based on the prices 2012) ___________________
rod
` By Profit ` ___________________
To Additional Dep. on fixed 48,000 (`40,000-34,000)
assets 6,000 ___________________
8,400 By balance transferred
To Loss on monetary items to Revaluation Resource
50,400
ep
56,400
56,400
Supplementary Comparative Balance Sheet

(Based on 2012 rupee value)
rR
Assets 2011 2012 Liabilities 2011 2012

` ` ` `
Fixed assets 4,40,000 3,52,000
Equity Share 2,50,000 2,50,000 Current
t fo
Capital assets: 44,000 60,000

2,82,400 2,32,000 Debtors 66,000 80,000
Revaluation 41,800 40,000 Stock 24,200 30,000
Reserve A/c Cash
Creditors
No
5,74,200 5,22,000 5,74,200 5,22,000
orking Note:
(1) Depreciation on fixed assets at historical cost
(2, 00,000-1, 60,000) 40,000
S,
Depreciation at C.P.P. (40,000×220/100) 88,000

Additional Depreciation 48,000
PE
(2) Calculation of Profit/Loss on Monetary items:

Debtors 40,000×220/200 44,000
Addition in Debtors 20,000
Stock 60,000×220/200 66,000
U
Addition in stock 20,000

Cash 11,000×220/200 24,200
(c)
Addition in cash 8,000

1, 82,200
Business Accounting
ale
348
Less: Historical Cost on 2005 (60,000+80,000+30,000) 1,
Notes
70,000
___________________
Monetary Loss 12,200
n/S
___________________
Creditors 38,000×220/200 41,800
___________________
Addition in creditors 2,000
___________________
43,800
tio
___________________
Less: Historical cost in 2005 40,000
___________________ 3,800
Net Monetary Loss: 8,400
uc
___________________
___________________ (3) Fixed assets in 2004 = 2, 00,000 × 220/200 = 4, 40,000

___________________ Fixed assets in 2005 = 4, 40,000 – 88,000 = 3, 52,000
rod
___________________
Current Cost Accounting Method
To overcome the shortcomings of CPP method, an Inflation
Accounting Committee was appointed Under the chairmanship of
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F. Standi Lands in 1975. This Committee recommended a method
for inflation accounting, which is known as Current Cost
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Accounting (CCA) Method. The Institute of chartered accountants

of England and Wales has also prescribed this method. After
extensive study and debate, now it has been finalized by the issue
of Statement of Standard Accounting Practice (SSAP)-16. The
t fo
salient features of this method are as below:

(a) Non-monetary items such as fixed assets will be shown at
their value of business mean net replacement value.
(b) The replacement value will be computed on the basis of
No
general price index.

(c) Depreciation will be calculated at the current value of assets.
(d) Stock consumed will be calculated at the date of consumption.
S,
(e) For gain or loss due to the changes in price-level will be shown
in the profitability Statement. For the ascertainment of
gain/loss the following adjustments are made:
PE
(i) Depreciation Adjustments which will be based on the

replacement value of assets.
(ii) Cost of Sales Adjustment (COSA).
U
(iii) Monetary Working Capital Adjustments (MWCA).

(iv) Gearing Adjustments (GA).
(c)
ale
349
After computing all the above adjustments CCA Income Statement
Notes
is prepared. Its format is given below:
___________________
XYZ Company Ltd.
n/S
CCA Income Statement ___________________
(For the year ended...)
___________________
` ` ___________________
tio
Sales .........
___________________
Historical cost trading profit
___________________
(before charging interest on loan) .........
uc
Less: Current Cost Adjustments: ___________________
COS Adjustments ......... ......... ___________________

MWC Adjustments ......... .........
rod
___________________
Depreciation Adjustments ......... ......... ___________________
Current cost operating profit ......... .........
Gearing adjustment ......... .........
ep
Less: Interest paid ......... .........
......... .........
Current cost operating profit before tax ......... .........
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Less: Tax ......... .........

......... .........
Profit to shareholders after tax ......... .........
t fo
Less: Proposed dividends

Retained Earnings ......... .........
Illustration (Based on COSA):

No
From the following data, find out the value of COSA:
Opening Stock ` 36,000
Closing Stock ` 48,000

S,
Index No. for the beginning of the year 160

PE
Average Index No. for the year 180
Index No. at the end of the year 200

⎛S S ⎞
Solution: COSA = (S2-S1) – Ia × ⎜ 2 – 1 ⎟
U
⎝ Ic Io ⎠
(c)
Where, S2 = Historical Cost of Opening Stock.
S1 = Historical Cost of Closing Stock.

Business Accounting
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350
Notes Ia = Average Index No.
___________________ Io = Index No. for Opening Stock.
n/S
___________________ Ic = Index No. for Closing Stock.
___________________
⎛ 48000 36000 ⎞
= (48,000 – 36,000) – 180 × ⎜ – ⎟
___________________ ⎝ 200 160 ⎠
tio
___________________
= 12,000 – 180 (240 – 225)
___________________
= 12,000 – 180 × 15
uc
___________________
= 12,000 – 2,700
___________________
___________________ = ` 9,300
rod
___________________ Illustration: (Based on M.W.C.A.)
On the basis of the following data, find the value of Monetary
Working Capital Adjustment (M.W.C.A.). Assume that monetary
ep
working capital consists of only debtors and creditors.
Opening Debtors ` 72,000

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Closing debtors ` 84,000
Opening creditors ` 40,000
Closing creditors ` 48,000

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Opening Index No. - 176
Average Index No. - 190

No
Closing Index No. - 201
⎛W W1 ⎞
Solution: MWCA = (W2 – W1) –Ia × ⎜ 2 –
⎝ Ie Io ⎠⎟
S,
Where W2 = Closing Monetary Working Capital

W1 = Opening Monetary Working Capital
PE
Ia = Average Index No. for the period.
Io = Index No. for opening MWE

U
Ic = Index No. for closing MWC

(c)
Here W2 = 84,000 – 48,000 = ` 36,000

ale
351
W1 = 72,000 – 40,000 = ` 32,000
Notes
Activity
Present drafts of written
___________________
⎛ 36,000 32,000 ⎞
MWCA = (36,000 – 32,000) –190 × ⎜ –
n/S
assignments for critique on
⎝ 201 ⎟
176 ⎠ ___________________
Inflation Accounting and then
revise the drafts which are
___________________
= 4,000 – 190 (179.1 – 181.8) based on other student
comments. Groups for this
___________________
= 4,000 – 190 (–2.7)
tio
activity should not be too
___________________
large.
= 4,000 – 513
___________________
= ` 3,487
uc
___________________
Fill in the blanks:
rod
___________________
1. Under …………………… method the adjustments are ___________________

made in the various items of P. & L. A/c and Balance
Sheet.
ep
2. …………………… are those which are the result of past
transactions as plant and machinery, stock and
depreciation in profit and loss account.
rR
Problems to Inflation Accounting

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Although there is an imperative need for the inflation adjusted

profit and loss account and balance sheet for the presentation to
shareholders and other interested outsiders, yet there are a
number of problems and obstacles in the way of inflation
No
accounting. These are as follows:

(1) If the financial Statements (Profit and loss account and
balance sheet) are prepared under CCA or CPP method only
(leaving conventional system), these will loose their credibility.
S,
Thus their objectivity concert will violate.

(2) If profit is determined by inflation adjusted technique after
PE
revaluing the depreciation and assets, it is not acceptable to

Income-Tax Authorities.
(3) If profits are computed on the basis of inflation accounting, the
U
amount of profit wills leas than the actual profit. This

decreased amount of profit is not acceptable to the worker as
(c)
they were getting fewer bonuses.

Business Accounting
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352
(4) Inflation accounting is move expensive and labour extensive.
Notes
Therefore it is not getting so much popularity as should be.
___________________
(5) The meaning of replacement cost is not clear therefore it can
n/S
___________________
not be computed correctly.
___________________
(6) If there is profit on converting the historical cost of an asset in
___________________
current price-level, it will mean these are arising a capital
tio
___________________ gain. Thus there should be capital gain tax not income tax.
___________________
From the above discussion it is clear that inflation accounting is
carrying so many problems in implementation but the main
uc
___________________
___________________ problem is that so far no method has been able to come up with an
___________________ accounting system that would satisfy all and remove the relating
rod
problems. We hope in future there will be a method that would
___________________
satisfy all by overcoming the effect of inflation.
Check Your Progress

ep
State true or False:
1. If the financial Statements are prepared under CCA or
rR
CPP method only (leaving conventional system), these

will loose their credibility.
2. If profits are computed on the basis of inflation
t fo
accounting, the amount of profit wills leas than the

actual profit.
Summary
No
Now- a -days the inflation accounting is being adopted by the

Companies to comply the Accounting Standards. In this unit we
have touched the following points-To reduce the effect of price-level
changes (inflation) on the financial statement of a company, the
S,
inflation accounting is being used. Inflation accounting, there are

two main methods to prepare supplementary Income Statement
PE
and Balance Sheet. These are Current Purchasing Power

Accounting Method and Current Cost Accounting Method. On the
adoption of inflation accounting some problems are faced by the
U
companies- as- inflation adjusted statements are not accepted by

the income to department and conventional accounts loose their
(c)
credibility etc.
ale
Lesson End Activity 353
Notes
What are the major differences between Current Purchasing
___________________
Power Accounting (CPPA) method and Current Cost Accounting
n/S
(CCA) method of inflation accounting? Discuss the advantages of ___________________
CCA method over CPPA method. ___________________
___________________
Keywords
tio
___________________
Inflation Accounting: Inflation accounting is that accounting ___________________
which reduces the effect of changing in prices due to inflation.
uc
___________________
Inflation: Inflation in prices reflects the any increase in the price-
___________________
level will reduce the purchasing power of money of that country
rod
and vice versa. ___________________
___________________
Current Purchasing Power Accounting Method: It involves
the restatement of some or all of the items in the historical
financial statement for changes in the general price level.
ep
Current Cost Accounting Method: Method of measuring assets
in terms of replacement cost.
rR
Non-monetary Items: Non-monetary items are those which are

the result of past transactions as plant and machinery, stock and
depreciation in profit and loss account.
t fo

1. Define Inflation Accounting. Explain its need in business.
No
2. Explain the different methods used in inflation accounting.

3. Explain the main problems in the way of Inflation accounting.
4. Do you agree with the statement “Any increase in the price-
level will reduce the purchasing power of money of that
S,
country and vice versa”. Explain.

PE
Further Readings
Books
U

(c)

Business Accounting
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354
Web Readings
Notes
www.caclubindia.com › Articles › Accounts
___________________
www.economywatch.com › Economics › Inflation
n/S
___________________
www.scribd.com/doc/22592497/Inflation-Accounting
___________________
www.tandfonline.com/doi/abs/10.1080/09638189400000018
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
rR
t fo
No
S,
U PE
(c)
UNIT 22: Human Resource Accounting
ale
Unit 22
355
Notes
Activity
Human Resource Accounting

Make student teams and work
___________________
n/S
on HRA and its objectives to
___________________
be posted to the class, etc.
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning and Definition of Human Resource Accounting (HRA) ___________________

\ Need and Objectives of HRA
uc
___________________
\ Methods of Human Resource Accounting
___________________
\ Importance of HRA
rod
___________________
\ HRA in Indian Corporate Sector
___________________
Introduction
ep
Human resource accounting is the most important source of an
organization. It provides quantitative and valuable information
regarding human capital, which helps the management to take
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decisions. HRA may be defined “as the process of identifying and

measuring the data about human resources and communicating
this information to the interested parties”, according to American
t fo
Accounting Association Committee.
Meaning and Definition of Human Resource

Accounting (HRA)
No
Human resource accounting means the accounting for human

beings, which is the most important source of an organization. Now
human beings of an organization are treated assets like other
S,
assets of the organization. It is recorded in the books like other

assets. It provides quantitative and valuable information regarding
PE
human capital, which helps the management to take decisions. In

other words we can say that HRA deals with the measurement of
costs on recruiting, selecting, hiring, training, placing and
U
development of employees in one side and on the other side it deals

with the present economic value of the employees. For the
(c)
determination of human value in the organization, various

techniques are used.
Business Accounting
ale
356
Definition of HRA
Notes
Activity As per the American Accounting Association Committee, HRA may
In ___________________
the conventional be defined "as the process of identifying and measuring the data
accounting, there was no
n/S
___________________
place to the human beings in
about human resources and communicating this information to the
the accounts. interested parties." In fact the HRA provides the information
___________________
which helps the management of the organization in the planning
___________________
and controlling of the people.
tio
___________________
Aspects of HRA
___________________
These are three important aspects of HRA. These are as follows:
uc
___________________
(a) Are Human Resources an asset?
___________________
___________________ (b) If yes, how should they be valued?
rod
___________________ (c) What type of principles should be used for the inventory and
obsolescence of human resources?
In the reply of first question, it is said that human resource should
ep
be treated as an assets as other assets. The reason behind is that
the organization spent a lot of amount on the human resources an
expenses on training and development and the organization will
rR
get the benefits on the increased efficiency and ability of the

personnel in future for a long period. Thus, amount spent on the
training and development of the employees should be treated as a
capital expenditure not revenue expenditure. As a result the
t fo
human resource should be treated as assets.
Check Your Progress

Fill in the blanks:
No
1. …………………. means the accounting for human

beings, which is the most important source of an
organization.
S,
2. Amount spent on the training and development of the

employees should be treated as a …………………. .
PE
Need and Objectives of HRA

In the conventional accounting, there was no place to the human
U
beings in the accounts. Now human resources have got a place in

the accounting due to its utility, quality and calibre. Previously the
(c)
management of the organization had no information regarding the

investment in human resources but now it is possible through
ale
HRA. The information regarding the amount spent on the 357
acquisition of human resources for planning and control can not be Notes
Activity
abstained in the conventional accounting, therefore to provide this Do ___________________
you agree with the
information HRA is needed. In order to minimize the rate of labour
n/S
statement “Write the names of
___________________
turn over and frustration and dependency among industrial work the different methods of HRA”.
What is your experience? Talk
force, HRA is needed which recognizes the talent, calibre and ___________________
to ten other colleagues of
potentiality of the works and accordingly the plans are prepared by yours from
___________________ various
tio
the management. organisations and, form an
___________________
opinion?
Objectives of HRA ___________________
uc
There are three main objectives of Human Resource Accounting: ___________________
(a) To provide the quantitative information of human resources ___________________
especially who are efficient, and loyal towards organization.
rod
___________________
(b) To estimate the costs and return on the investment on human ___________________
resources.
(c) To send the information regarding the worth of human
ep
resources to the organization.
Check Your Progress

rR
Fill in the blanks:

1. In order to minimize the rate of labour turn over and
frustration and dependency among industrial work force
t fo
……………….. is needed.
2. The objectives of Human Resource Accounting is to
provide the ……………….. of human resources especially
No
who are efficient, and loyal towards organization.
Methods of Human Resource Accounting

In the solution of second problem, the following methods are used
S,
for the valuation of human resource:

1. Historical Cost Method: It is also known as a traditional
PE
method. Under this method human resource is valued, as the

other physical assets are valued. Under this method the total
cost of human resource is determined. This cost includes-the
U
cost of selection, and placement, cost of formal training and

the cost of informal training and any other cost incurred to
(c)
increase the efficiency of the employees. This total cost is

capitalized. This cost is divided by the total expected period of
Business Accounting
ale
358 service of the employees. The dividend is written off every
Notes year. If there is any unwritten value of it, that is shown in the
___________________ balance sheet as an asset.
n/S
___________________ This method is criticized by saying that it is not easy to
___________________ forecast the service period of the employees-
___________________ 2. Replacement Cost Method: This is current value approach.

Under this method first of all the replacement cost of the
tio
___________________
existing employees is corrupted. This exercise may be
___________________ redundant unless the management desires to replace the
existing employees. Replacement cost is determined by two
uc
___________________
___________________
methods- first is positional replacement cost. It is the
combination of two costs one acquisition and learning cost, two
___________________
separation cost. It is typical to calculate. It can be understood
rod
___________________ by an example. What will be the replacement cost for the
position of an accountant? In the place of an old employee, if a
new employee is appointed, the cost of advertisement,
ep
selection, training and development. Second is personal
placement cost. It is relating to a particular person. How much
be one capable of the equivalent efficiency as the one needy to
rR
be cost will occurred to replace a particular employee. The

substitute must be Replacement cost is relating to the
economic value.
t fo
3. Opportunity Cost Method: It is also known as competitive

bidding method. This method was advocated by Hekimian and
Jones. This method is used only in those cases where the
resources are scarce. Value of human resource is ascertained
No
on the basis of the value of individual employees in alternative

use. Here the human assets are valued only when there is
alternative use of them i.e. only scarce employees represent
the value of human assets. Here the opportunity cost is
determined by a competitive bidding by the officers of the
S,
different departments. The amount of bidding is included in

the capital employed of the successful bidder for determining
PE
the rate on investment. Suppose a department's target ROI is

12% and a capital base of ` 2 crore but its profit is only
` 23, 00,000 i.e. ` 1,00,000 short of the target. It is felt that if it
U
can acquire the services of a specified executive, its profit can

improve by ` 24,000 i.e. the profit will be ` 24, 24,000.
(c)
` 24, 000 more than ` 24, 00,000. If ` 24, 000 is capitalized @ of

12%, it will be ` 2, 00,000. The department certainly may bid
ale
up to ` 2, 00,000 for the services of that executive. Actually the 359
maximum bid may even be the capitalized value of ` 1, 24,000. Notes
The extra profit is likely to be generated by the executive ___________________
availability.
n/S
___________________
4. Models Approach: For the valuation of the human resources,
___________________
there are several models. Some important models are being
given below: ___________________
tio
___________________
(a) Lev and Schwartz Model: This is based on the present
value of future earnings. It is vary popular in India. It is ___________________
also called capitalization of salary method. In this method
uc
___________________
the future earning of the employees are calculated up to
___________________
the age of his retirement. Then this earning is discounted
rod
at the present rate. The formula of this model is as below: ___________________
___________________
Vx = E(t) (1+r) t-x
V = Capitalized value of human being.

ep
X = Age at present (of the employee)
E (t) = estimated annual earning up to retirement.
rR
r = discounted rate
t = age of retirement.
This is an assumption of this model that in future the
t fo
level of the employee will not change. All the employees of

an organization will be divided equally among skill, semi-
skill and unskilled. This model is adopted in BHEL in
India. The main draw back of this model is that it is
No
difficult to compute the future earnings of the employees.

(b) Flamholtz Model: This model seeks to remove all the
defects of the Lev and Schwartz Model. Under this model
human resource is valued on the basis of the discounted
S,
earnings of the employee in the future taking into account

the changes in his service status and the possibility of
PE
early retirement. For the valuation of the employee the

following estimates are done:
1. For how much period, the employee will do work (it is
U
estimated)
2. On which position the employee will stay in future (it
(c)
is forecasted)
Business Accounting
ale
360
3. What will be the gain to the organization from the
Notes
employee (it is estimated)
___________________
4. In the last, the future earnings of the employee are
n/S
___________________
discounted at the present rate.
___________________
There is a drawback in this model i.e. if any employee
___________________ holds on the different posts and has more than one Salary,
tio
___________________ to calculate all is not easy.
___________________ (c) Harmanson's Model: Harmanson advocated two methods
for the valuation of human resources. Both of these are
uc
___________________
based on the economic concept. These methods are as
___________________
below:
___________________
rod
1. Unpurchased Goodwill Model:
___________________
2. Adjusted Discounted Future Wages Model.
5. Unpurchased Goodwill Model: Under this model he
ep
advocated that value of human resource is determined by
capitalizing the excess profit (super profit) over normal profits.
Normal profits are calculated on the basis of normal rate of
rR
earnings. Suppose if in any company there are super profit `

50,000 and normal rate of return 20%, capitalized value of the
super profit will be ` 2,50,000 (50,000 × 100/20). In this
method there are some demerits as (a) in the case of normal
t fo
profit it evaluates the human value zero and this method is

purely bond on the unknown assets.
6. Adjusted Discounted Future Wages Model: This model is
No
similar to the model of Lev Schwartz. In this model the value

of human resources is determined by multiplying the
discounted future wage of the employees by the efficiency
ratio. Efficiency ratio is determined by dividing the actual
average profits by the normal profits of all the firms. Efficiency
S,
ratio is calculated on the basis of weighted average. Current

year gets more weight than the origin year. There are also
PE
criticism on the efficiency ratio and weighing method in this

model.
7. Economic Value Method: This method measures the value of
U
an asset on the basis of present value of the future economic

benefits from that asset. Similarly there should be the
(c)
valuation of human resource on the basis of present value of

future profits generated by those persons. To find the value of
ale
human beings first of all the future economic benefits from the 361
human beings is determined then the rate of discount for the Notes
Activity
present value is determined. These methods can not be applied Prepare a presentation
___________________
only in the case of a large number of employees. In practical
n/S
showing the importance of
life to determine the exact discount factor is difficult. HRA___________________
___________________
tio
Fill in the blanks:
___________________
1. ………………… is also known as a traditional method. ___________________
2. ………………… is also known as competitive bidding
uc
___________________
method.
___________________
rod
___________________
Importance of HRA
___________________
HRA facilitates the management in its planning and control
function regarding low productivity, performance evaluation, and
labour turnover. It helps the management by providing qualitative
ep
information regarding the human capital in improving the quality
of managerial decisions. It also prides the valuable information to
rR
the investors and public. It assists the management of the

organization in the decision of further recruitment of personnel by
providing the requisite data and in the decision of investment on
human resource and human planning. Charges in the value of
t fo
employees may be used as an indicator of the cost of employee

turnover.
HRA in Indian Corporate Sector

No
As per Companies Act it is required to give the details of the

employees of the company. The Companies Act does not call for
any disclosure regarding the human resources. But, some
S,
companies like BHEL, SAIL, ONGC, MMTC, SPIC and NLC are
giving the information along with its published accounts. These are
adopting Lev and Schwartz Model for the valuation of human
PE
resources. Rate of discounts varies from company to company. The

present value of future earnings of the employees is given as per
the category of employees and age groups. Social Balance Sheet is
U
also shown. In the assets side of this SBS value of human capital to
the organization is shown while in its liabilities side social equity
(c)
representing the employee’s contribution is shown. In the last the

ratio of human to non-human resources, ratio of turnover,
Business Accounting
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362 production ratio to human resource and value added per employee
Notes
Activity are also given. If this trend is developed properly in providing the
You___________________
and your group members information at all level, it will lead to better decisions of
are required to develop an management for human resource.
n/S
___________________
assignment on recent
developments
___________________ in
on HRA
Indian Corporate Sector.
Check Your Progress
___________________ Fill in the blanks:
tio
___________________ 1. ……………….. helps the management by providing
___________________ qualitative information regarding the human capital in
improving the quality of managerial decisions.
uc
___________________
___________________ 2. The present value of future earnings of the employees is

given as per the category of employees and ___________.
___________________
rod
___________________
Summary
As per Companies Act it is required to give the details of the
employees along with the financial statement. For the purpose,
ep
HRA is adopted. In this unit we discuss the following points:
Meaning, definition, need and objectives of HRA in the business.
rR
The different methods are used to maintain the HRA in a

company. These are - (i) Historical Cost Method, (ii) Replacement
Cost Method, (iii) Opportunity Cost Method, (iv) Different Model
Approach and (v) Economic Value Method. Realizing the
t fo
importance of HRA, Many Indian Companies is using it.
Lesson End Activity

No
Critically examine the various methods of Human Resource

Accounting. Which method, do you think is better than others?
Keywords
S,
Human Resource Accounting (HRA): Human resource

accounting means the accounting for human beings, which is the
PE
most important source of an organization.

Lev and Schwartz Model: This is based on the present value of
future earnings.
U
Flamholtz Model: This model seeks to remove all the defects of

the Lev and Schwartz Model.
(c)
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363
Harmanson's Model: Harmanson advocated two methods for the
Notes
valuation of human resources. Both of these are based on the
economic concept. These methods are: Unpurchased Goodwill ___________________
n/S
Model and Adjusted Discounted Future Wages Model. ___________________
___________________
___________________
tio
1. Define HRA and explain its objectives. ___________________
2. What do you mean by HRA and explain its different methods. ___________________
3. Write short notes on the followings:
uc
___________________
(i) Lev and Schwartz Model ___________________
(ii) Replacement Cost Method
rod
___________________
(iii) Opportunity Cost Method ___________________
4. What is the importance of HRA?

ep
5. Briefly explain HRA in Indian Corporate Sector.
Further Readings
rR
Books
t fo

No
Web Readings
www.charteredclub.com/what-is-human-resource-accounting/
http://kalyan-city.blogspot.in/2011/05/human-resource-accounting-
S,
hra.html
vlex.in/vid/resource-accounting-indian-industries-227842623
PE
www.citehr.com
www.scribd.com/doc/8358363/Human-Resource-Accounting
U
www.lachoomemorial.org/lmj/vol2/lmj2.pdf
(c)
Business Accounting
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364
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
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t fo
No
S,
U PE
(c)
UNIT 23: Government System Accounting
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Unit 23
365
Notes
Activity
Government System Accounting

Give___________________
the classification of
n/S
accounts under Government
___________________
Accounting.
___________________
Objectives
___________________
tio
topics: ___________________
\ Differences between Commercial Accounting and Government ___________________

Accounting
uc
___________________
\ Basic Principles of Government System Accounting
\ Structure of Financial Administration in India ___________________
rod
___________________
Introduction ___________________
Government accounting is relating to the accounting of Central

and State Government. Financial administration of the activities
ep
of the Government, to promote the maximization of welfare in the
form of different services is the main objectives of this accounting.
rR
The principle of a government, are to govern a country and to

administer the various departments to promote welfare among the
people in the best possible way.
t fo
Differences between Commercial Accounting and

Government Accounting
These are as follows:
No
1. In commercial accounting, accounts are maintained on the

accrual basis and at the end of the year balance sheet and
profit and loss account are prepared while in Government
accounting accounts are maintained on the cash basis and at
S,
the end of the year Statements are prepared to ensure its

sources of fund and their uses, Government account to
PE
determine the net result and Statement of balancing accounts

(which shows the balance of debtors and editors).
2. Commercial accounting follows the rules of Double Entry
U
System while Government accounting follows Single Entry

System for accounting.
(c)
3. In Government accounting, Government budgets are prepared

in which an estimate of expenditure and sources of funds to be
Business Accounting
ale
366 raised, are shown while in the commercial accounting separate
Notes set of cost accounts is maintained to find the cost of the
___________________ product and selling price of the product.
n/S
___________________ 4. In the commercial accounting, the classification of accounts is -
___________________ (a) Personal Account, (b) Real Account and (c) Nominal
Account, while in the Government accounting the classification
___________________
of accounts is as under(see figure 23.1) :
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
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Figure 23.1: Government Accounts
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5. In commercial accounting, as dual aspect concept is follows,

every transaction of the business gets two aspects i. e. debit
and credit. In the manufacturing concerns a separate set of
t fo
accounts for costing is maintained. And at the end of the year

trading and P/L account and balance sheet are prepared. In
the Government accounting, most of the accounts are kept
under single entry system. Only a portion of accounts is
No
prepared under double entry system to determine the balance

of accounts with regard to which Government acts as a banker,
remitter, borrower or lender.
S,
Government accounts are prepared to decide what expenditure

will be necessary for a particular activity and how the sufficient
funds will be raised to meet the expenditure. This is done by
PE
the budgets, which are passed in the parliament and State

legislature. The main object of Government accounting is not to
compute the profit or loss on a particular activity of the
U
government as a whole. The transactions in the Government

accounting are determined on the basis of administrative
(c)
activities and on the nature of activities.

ale
367
Check Your Progress
Notes
Activity
How___________________
many types of accounts
1. Government accounting is relating to the accounting of
n/S
of ledgers are maintained in
___________________
Government Accounting?
Central and State Government.
Explain.
___________________
2. Commercial accounting follows the rules of Single Entry
___________________
System while Government accounting follows Double
tio
Entry System for accounting. ___________________
___________________
Basic Principles of Government System
uc
___________________
Accounting ___________________
Basic principles of Government System Accounting are as follows:
rod
___________________
1. As we know that Government accounts are maintained under ___________________

single entry system but only a few accounts are prepared
under double entry system. To ascertain the arithmetical
ep
accuracy trial balance is also prepared.
2. If there is a commercial enterprise under public sector, double
entry system is followed. And under this system at the end of
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the year P. & L. A/c and balance sheet are prepared. In some
cases the cash flow analysis, fund flow analysis and ratio
analysis is also conducted.
t fo
3. As per the requirements of the Government, the incomes and

expenditures are classified for example the central
Government classifies its revenue as follows:
No
S,
U PE
Figure 23.2: Revenues of Central Budget

(c)
Business Accounting
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368
Similarly the expenditure on the different services is classified
Notes
as follows:
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
Figure 23.3: Expenditure of Central Budget
___________________
4. First the transactions are recorded under various heads of
___________________
rod
accounts, and then these are consolidated on the basis of time
___________________ in Government accounting.
Technical Accounts
ep
Following are the detail of technical accounts:
General: Government accounts are maintained under single entry
system. To maintain the technical accounts as Journal and Ledger
rR
Double Entry System is followed. The balances of ledger accounts

ascertain the position of Government, as is it a borrower, remitter
lender etc. The balances of ledger accounts can be ascertained by
t fo
single entry system but their arithmetical accuracy can not be

attained. This can be obtained if ledger accounts are maintained by
double entry system and after balancing, the trial balance is also
prepared.
No
Journal
Journal is made to incorporate the previous balance (opening
balance) with the transactions of current year and at the end of the
year closing balance of the account is found out.
S,
Ledger
The accounts of the ledger are classified as below:
PE
(a) Opening and Closing heads.

(b) Revenue Receipts
(c) Service Expenditure
U
(d) Capital Expenditure

(c)
(e) Debt deposit and Remittance heads.

(f) Personal accounts
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Classification of Government System 369
Accounting in India Notes
As per Indian Constitution, the following three accounts are ___________________
n/S
prepared for:
___________________
Consolidate Funds ___________________
Consolidated funds accounts are maintained for Union ___________________
tio
Government and the State Governments. This fund account will ___________________
include- (a) all revenues received by the Government, (b) all loans
___________________
raised by the Government, (c) money received in the form of
uc
advances, (d) all money received in the repayment of loans. This ___________________
fund is divided into three parts and these are as follows: ___________________
rod
(i) Consolidated Fund ___________________
(a) Revenues & Expenditures
___________________
Taxes, Duties and other ` A. Collection of Taxes, Duties `
Principal Heads of revenue and other Principal
(iv) Taxes on Income revenues-
ep
other than (4) Taxes on Income other
corporation taxes than
and Estate Duty. Corporation Taxes and
(v) Estate Duty etc. State Duty.
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C. Irrigation (7) Land Revenue etc.

E. Debt Services C. Irrigation
F. Administrative Services E. Debt Services
etc. F. Administrative Services etc.
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Total-Revenue Receipts Total-Expenditure on Revenue

Account
(b) Capital Receipts and Disbursements

` Payment of `
No
Compensators etc.
Irrigation
Agricultural
(Public Improvements etc.
Debts)
Total-Capital
S,
expenditures
(c) Debts, Loans and Advances

PE
` `
Permanent Debt Permanent Debt
Loans from Central Govt. etc. Loans from Central Govt.
Total-Consolidated Fund etc.
U
Total-Consolidated Fund
(c)
Business Accounting
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370
Contingency Fund
Notes
Activity A separate contingency fund account is maintained for each
Present drafts of written
___________________ Government. The fund is disposed of by the resident and governor
assignments for critique on
n/S
___________________
Structure of Financial
to meet the unforeseen expenditures. The fund is financed by the
Administration Act of the Appropriate Legislature from time to time.
___________________and
in India
then revise the drafts which
are ___________________
based on other student Contingency Fund
tio
comments. ` `
___________________
___________________
Contingency Fund Contingency Fund
Total Total
uc
___________________
___________________ Public Accounts

___________________ This account is maintained by the Central as well as State
rod
Governments separately. Total public moneys received on the
___________________
behalf of the Government are credited to this account and the
disbursement of the fund is credited to this account.
ep
Public Account Debt (other than those mentioned in
consolidated fund) and Deposit
` `
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Unfounded Debts Unfounded Debts

Deposits and Advances etc. Deposit and Advances etc.
Remittance Remittance
Total-Public Accounts Total-Public Accounts
t fo
Total Receipts Total Disbursement

Opening Cash Balance Closing Cash Balance
Grand Total Grand Total
No
Check Your Progress

Sate true or false:
1. If there is a commercial enterprise under public sector,
double entry system is followed.
S,
2. Journal is made to incorporate the previous balance

(opening balance) with the transactions of current year
PE
and at the end of the year closing balance of the account

is found out.
U
Structure of Financial Administration in India

India became Sovereign Democratic Republic on 26th January
(c)
1950. It is the Union of 28 States and 7 Union Territories. The

ale
executive powers of the Union are in the hands of the President 371
and that of the States in the hands of Governor. The initial Notes
responsibility to administer a particular department of ___________________
Government lay down on the shoulders of the head of the
n/S
___________________
department. He is also responsible for the collection of revenue and
the control of expenditure of that department. ___________________
All the States are divided into different districts, which have ___________________
tio
Government treasury. State treasuries are controlled by the State ___________________
Government whereas Union treasuries are controlled by the Union ___________________
Government. Union territories are controlled by Central
uc
___________________
Governments. Collector of the district is in general charge of the
treasury with treasury officer. Treasury has two departments (a) ___________________
for cash, stamps, opium under the change of treasures and (b) for
rod
___________________
all other accounts under the charge of accountant. If any person
___________________
has to make any payment to the Government, he has to fill a
challan and along with the challan, he deposits the amount at the
treasury and then gets a receipt. If any one has to receive the
ep
payment from Government, he presents a receipted bill at the
treasury, or a cheque issued in his favour by a competent officer
rR
and gets the payment of it.

The Union and the State Governments have their own accounts
with RBI. Therefore, the RBI deals two groups of accounts, i.e. (a)
with the Union and (b) with the States. If there is any kind of
t fo
adjustment between Union and State Governments, that is done

by RBI.
Accounts with Bank

No
The Union and the State Governments have their separate

accounts with RBI. The treasury officer or any other officer of the
Government is authorized to draw of the pay money from these
accounts. At the end of the each of the each month, the closing
S,
balances of these accounts are sent to the central accounts section

of RBI, Nagpur which works as clearing house and makes the
PE
different adjustments in the accounts of the Union and State

Governments. After adjusting the accounts, the closing balances of
these accounts are sent by RBI to the respective Account. Generals
of different States. Transactions relating to Defence, Railway and
U
Post & Telegraphs Departments are kept separate. These

transactions are passed against the defence account, railway fund,
(c)
and P & T account respectively in the books of RBI directly.

Business Accounting
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372
Transaction with other Government
Notes
Payments may be made and amounts may be received on the
___________________ behold of the Union or State Government by the treasuries. A place
n/S
___________________ where treasury is not situated, this work will be done through
S.B.I. Such a receipts or payment will done first from the cash
___________________
balance of the State concerned and then requisite amount will be
___________________
adjusted by the Account-General through RBI. Similarly all the
tio
___________________ transactions between the Union and State Governments are
___________________ adjusted through their balances by RBI.
Initial Accounts
uc
___________________
___________________ These accounts of all receipts and payments from daily

___________________ transactions are divided into two separate monthly accounts-one
rod
___________________
for Union and one for States. These accounts are dispatched to the
respective Accountant-Generals at the end of each month. The
treasuries made a lump payment to the Railways, Defence, Posts
and Telegraphs and forest Departments. For the PWD the
ep
treasuries issue the checks in payment. For the large departments
mentioned above, the treasuries make the payment and receipts in
lumps. The officers of these departments sent monthly detailed
rR
accounts of their transactions to the treasury through their

respective accounts officers.
t fo
Compilation of Accounts
Civil Accountant-Generals compile the monthly accounts received
from treasuries and the civil departmental officers in to monthly
accounts of the States and Union Government throughout India
No
are compiled from month to month by the Accountant-General. The

transactions of the large departments of the whole India are
similarly compiled by the Director-General of their departments
respectively. Civil accounts officers prepare the progressive figure
S,
of the year of their circle and send them to the Union/State

Government. A compiled copy of all the transaction is furnished to
the Controller and Auditor. In the same manner the Accountant-
PE
Generals of the lager department prepare the consolidated

Statement of all transactions of their respective departments and
submit the same to C.A.G. The Comptroller and Auditor General of
U
India prepare the annual finance account and Application Account

and submit to the president/governor and administrator to present
(c)
the same in the Parliament/State Legislature. The C.A.G.

consolidates the various Finance Accounts and Returns into one
ale
account for the whole country. It is also know as "Combined 373
Finance and Revenue Account" of the Union and States/UTs. It is Notes
submitted to the President of India. ___________________
n/S
Finance Accounts ___________________
Comprehensive Finance Accounts are prepared by the C.A.G. for ___________________

each State Government every year. These accounts are on the ___________________
basis of those account which are prepared by the Accountant-
tio
___________________
General of each States Finance Accounts depicts the receipts and
payments of the Government along with the financial results. The ___________________
Finance Account is made into two parts:
uc
___________________
Part I- Summarized Statement ___________________
Part II- Detailed Account and Other Statements.
rod
___________________
Combined Finance and Revenue Account ___________________
It is a general financial Statement. It is also known as 'Combined

Finance and Revenue Accounts of the Central and the State
ep
Government of India'. It is the summary of annual accounts of the
Central Government and of all the State Governments of the
previous year. This account comprises of (a) General Accounts, (b)
rR
Subsidiary Accounts. This account is prepared by taking the

following accounts-
(a) Finance Accounts of State Governments and Central
Government.
t fo
(b) Annual Accounts of P &T Department

(c) Railway Capital and Revenue Accounts
(d) Accounts of Defence Services
No
(e) Accounts of sterling transactions of Central Government

finally brought to account in England received from the Chief
Accounting Officer of the High Commissioner for India in
London.
S,
(f) Subsidiary Returns.

Check Your Progress
PE
Fill in the blanks:

1. Treasury has two departments (a) for cash, stamps,
opium under the change of treasures and (b)
U
…………………..
2. ……………….. accounts of all receipts and payments
(c)
from daily transactions are divided into two separate

monthly accounts-one for Union and one for States.
Business Accounting
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374
Summary
Notes
In the present unit we have touched the following points-
___________________
Government Accounting is relating to accounting of Central
n/S
___________________ Government and State Governments. The main difference between
___________________ Government Accounting and Commercial Accounting is that
___________________
double entry system is adopted in commercial accounting and
single entry system is adopted in Government accounting Basic
tio
___________________
principles of Government System accounting and Government
___________________ Accounting is classified into consolidated funds, Contingency fund
and public accounts.
uc
___________________
___________________
___________________
Lesson End Activity
rod
___________________ Discuss the various accounts of the union Government and the
State Governments which are dealt by the Reserve Bank of India.
Keywords
ep
Journal: Journal is made to incorporate the previous balance
(opening balance) with the transactions of current year and at the
rR
end of the year closing balance of the account is found out.

Consolidate Funds: Consolidated funds accounts are maintained
for Union Government and the State Governments.
t fo
Ledger: A ledger is the principal book or computer file for

recording and totalling monetary transactions by account, with
debits and credits in separate columns and a beginning balance
No
and ending balance for each account.

Contingency Fund: A separate contingency fund account is
maintained for each Government.
S,

1. What do you mean by Government System Accounting?
PE
2. Distinguish between Commercial Accounting and Government

System Accounting.
3. Explain the basic principles of Government System
U
Accounting.
(c)
4. Give the classification of Government Accounts.

ale
Further Readings 375
Notes
Books ___________________
n/S
Dr. K.K. Verma, Corporate Accounting, Excel Books ___________________
M.C. Shukla & T.S. Grewal, Advanced Accounting ___________________
R.L. Gupta, Advanced Accounting ___________________
tio
Jain & Narang, Advanced Accounting ___________________
___________________
Web Readings
uc
___________________
www.cga.nic.in/html/book3/b3.pdf
___________________
www.coa.gov.ph/NGAS/ngasmanual.asp
rod
___________________
nces.ed.gov/pubs2004/h2r2/ch_4.asp
___________________
jameslchan.com/papers/Chan2003Assess.pdf
ep
rR
t fo
No
S,
U PE
(c)
Business Accounting
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376
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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No
S,
U PE
(c)
UNIT 24: Responsibility Accounting
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Unit 24
377
Notes
Activity
Responsibility Accounting
___________________
n/S
showing the responsibility
___________________
accounting.
___________________
Objectives
___________________
tio
topics: ___________________
\ Meaning and Definition of Responsibility Accounting ___________________

\ Characteristics or process of Responsibility Accounting
uc
___________________
\ Responsibility Centres
___________________
rod
___________________
Introduction
___________________
The effective managerial control is based on the success of
management accounting. Standard costing control and budgetary
ep
control are used for managerial control. For the effective
controlling on the costs and activities, actual performance of the
segments/departments is compared with pre-determined objectives
rR
of goals. If there is adverse variation between these two,

responsibility of it is personalized and necessary corrective action
is taken. For the purpose the responsibility accounting is used in
the organization.
t fo
Meaning and Definition of Responsibility Accounting

Responsibility accounting is also called by the name of Activity
No
Accounting and Profitability Accounting. Responsibility

Accounting is special technique of management technique, a
particular responsibility (activity) is given to a particular manager
to be performed. That manager becomes responsible to prepare the
S,
budgets accumulate information and set target. At the end of a

period, if the actual performance is found far behind the budgeted
PE
target, for this adverse variation the responsibility is personalized.

Thus that manager becomes accountable for it. In the standard
costing system and budgetary controlling system, the main stress
is on the devices to control the costs, while in the responsibility
U
accounting persons are emphasized to control the costs. In this

system with the purpose of controlling, a centre or department is
(c)
designed for a manager which becomes a segment of the

organization. This manager holds all the responsibility to operate
Business Accounting
ale
378 this department by his/her own ways. This manager determines
Notes the target for the department with the consultation of top
___________________ management. He controls all the activity of his department. He is
also responsible for all variances. Then top level managers utilized
n/S
___________________
these variances to rate the responsible manager.
___________________
Some main definitions of responsibility accounting are given below:
___________________
1. "Responsibility accounting is the classification, management,
tio
___________________
maintenance, review and appraisal of accounts serving the
___________________ purpose of providing information on the quality and the
standard of performance attained by the persons to whom
uc
___________________
authority has been assigned.”
___________________
- Kohler, E.L., A Dictionary of Accounts
___________________
rod
2. "Responsibility accounting is that type of management
___________________
accounting that collects and reports both plans and actual
accounting information in terms of responsibility centres.”
- Antony and Reece
ep
3. "Responsibility accounting is a system of management
accounting under which a system of management accounting
rR
under which accountability is established according to the

responsibility delegated to various levels of management and a
management information and reporting system instituted to
give adequate feedback in terms of the delegated
t fo
responsibility. Under this system division or units of an

organization under a specified authority in a person are
developed as responsibility centres and evaluated individually
for their performance".
No
-I.C.W.A.I.
4. "A system of accounting that recognises various responsibility
centres throughout the organization and that reflects the plan
of action of each of these centre by allocating particular
S,
revenues and costs to the one having the pertinent

responsibility".
PE
- Charls T. Harngren
5. "Responsibility Accounting is a system under which costs are
accumulated and reported at each level of responsibility so
U
that the accounting and costs data maybe used by the

management at each level in controlling the operations and
(c)
their costs.”
- R.M. Bhandari
ale
379
On the basis of the interpretation of the above definitions, costs are
Notes
controlled in the responsibility accounting by delegating the Activity
authority and responsibility the responsible managers, comparing For ___________________
what purposes should we
n/S
adopt the Responsibility
the actual performance with the standards and motivating them. ___________________
Accounting.
___________________
Check Your Progress
___________________
tio
___________________
1. Responsibility accounting is also called by the name of
Activity Accounting and Profitability Accounting. ___________________
uc
2. In the standard costing system and budgetary ___________________
controlling system, the main stress is on the devices to ___________________

control the costs, while in the responsibility accounting
rod
___________________
persons are emphasized to control the costs.
___________________
Characteristics or process of Responsibility

Accounting
ep
Following are the main characteristics of the responsibility
accounting which also considered the steps involved in the process
rR
of responsibility accounting:
(i) Designating the responsibility centres on the basis of
activities: First of all on the basis of organization chart, the
t fo
functional areas of the managers are determined. Then

organization is divided into various responsibility centres.
Responsibility of the centre is delegated to a manager. The
entire cost is classified as per the responsibility centre.
No
(ii) Determination of the objectives of the responsibility

centres: With the help of the manager of the responsibility
centre, the objectives of the responsibility centre is decided.
The objective may be relating to sales, cost, profit and
S,
investment. Thereafter the actual performance of these centres

is compared with these pre-determined objectives. On
PE
variances a responsibility report is prepared and given to the

top level manager.
(iii) Division of cost variances: Cost variances are classified
U
between controllable and uncontrollable variances. Managers

are responsible for those variances only which are under their
(c)
control and uncontrollable variances are ignored.

Business Accounting
ale
380
(iv) Fixing the responsibility: With the purpose of controlling
Notes
Activity process more effectively, the actual performance of the
___________________
unit/centre is recorded on the basis of cost and revenue data.
of your organisation and
n/S
___________________
prepare a brief write up about These records are compared with the budgets/standards of
the ___________________
responsibility centers in these units. On the variance, the responsibility is fixed on the
your organization. responsible manager for the variance.
___________________
(v) Corrective Action: A chart of variances from all
tio
___________________
responsibility centres is prepared and reported to the top level
___________________ managers. Then corrective measures are taken by it.
uc
___________________
Check Your Progress
___________________
Fill in the blanks:
___________________
rod
1. First of all on the basis of organization chart, the
___________________
………………. of the managers are determined.
2. Cost variances are classified between ………………. and
………………. variances.
ep
Responsibility Centres
rR
Under this system the responsibility centres are designed. A

responsibility centre is a part or segment of the organization. The
responsible manager for a particular responsibility centre is
t fo
accountable for a set of activities. The number of responsibility

centres depends on the activities of the organization. When the
responsibility centre involves only the cost or expenditure, it is
called cost/expenditure centre. If it involves cost and revenues
No
both, it is called profit centre. Similarly there can be other centres.

A responsible centre is responsible for a particular activity and for
the best utilization of its resources. Thus responsibility centres
controls on all activities of the centre.
S,
Types of Responsibility Centre

PE
For the effective control on the costs, an organization may design

the following three responsibility centres:
a. Cost or Expenses Centre

U
b. Profit Centre
(c)
c. Investment Centre
ale
Cost Expenses Centre 381
Notes
Through this it is checked that has much expenditure is incurred
on the production of a particular item. Is the cost incurred more or ___________________
n/S
less than the standard cost? This centre is responsible only for cost ___________________
incurred by the centre; it has no direct influence over the revenue
___________________
of the centre. It is also responsible for producing a quality product
___________________
at a reasonable cost. The performance of this centre is measured by
tio
the controlling ability on costs and the quality of the ___________________
product/services. As per I.C.M.A., "A production of service location, ___________________
function, activity or item of equipment whose costs may be
uc
___________________
attributed to cost unit".
___________________
Profit Centre
rod
___________________
The manager of this centre is responsible for the difference (profit) ___________________
between revenues and costs. He is responsible for both the cost and
revenue of the centre. He tries to maximize the profits. This centre
ep
is like a mini business in the organization. Thus a profit centre’s
manager has the responsibility and authority to generate a
desirable profit during a specified period. As per ICMA, "A part of
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business accountable for cost and revenues may be called a

business centre, business unit or strategic business unit".
Investment Centre
t fo
An investment centre is a part of a company having its own

revenues, expenses and investment base. In fact, the manager of
this centre is involved in the decisions to invest in plant,
machinery and others and also responsible for cost and revenues.
No
The performance of this centre is measured by the rate of return on

investment. Rate of return on investment is measured with the
help of the earning of the centre and the amount of investment. As
per ICMA, "A profit centre whose performance is measured by its
S,
return on capital employed".

Check Your Progress
PE
Fill in the blanks:

1. If …………………… involves cost and revenues both, it
is called profit centre.
U
2. …………………… Centre is responsible only for cost

incurred by the centre; it has no direct influence over
the revenue of the centre.
(c)
3. A …………………… is a part of a company having its

own revenues, expenses and investment base.
Business Accounting
ale
382
Responsibility Report
Notes
Responsibility accounting is adopted to control the costs in the
___________________
management accounting. For the success of responsibility
n/S
___________________ accounting it is necessary reporting of the responsibility centers
___________________ should be in such a way, so that responsibility may be fixed on the
___________________
variances. Responsibility report may be understood by the
following examples:
tio
___________________
1. XYZ Company Ltd.
___________________
Responsibility Report for a Cost Center for the Month of March,
uc
___________________
2012
___________________
Costs Budget Actual Variance
___________________ (`) (`) (`)
rod
___________________ Indirect materials 3,40,000 3,20,000 20,000 (F)
Maintenance 2,30,000 2,40,000 10,000 (A)
Supervision 2,30,000 2,45,000 15,000 (A)
Total 8,00,000 8,05,000 5,000 (A)
ep
2. XYZ Company Ltd.
Responsibility Report for an Investment Center for the

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month of April, 2012

Particulars Budget Actual Variance
(`) (`) (`)
Sales 5,00,000 5,50,000 50,000 (F)
t fo
Less: variable cost 4,00,000 4,40,000 40,000 (A)

Contribution 1,00,000 1,10,000 10,000 (F)
Less: Fixed cost 50,000 65,000 15,000 (A)
Profit 50,000 65,000 15,000 (A)
Capital Employed 5,00,000 4,00,000
No
50,000 45,000
Rate of return ----------- × 100 ---------- × 100
5,00,000 4,00,000
10% 11.25%
Note: Fixed cost is treated controllable cost.
S,
Advantages of Responsibility Accounting

PE
In management accounting, the responsibility accounting is used

as an important tool to control the costs. It measures the
performance of the various managers. In addition to these, on the
adoption of responsibility accounting, an organization enjoys the
U
following advantages:
1. High morale of employees: Reward for efficient employees
(c)
and punishment for inefficient employee’s scheme does high

ale
morale of employees. In such a case they do work more 383
efficiently. Notes
2. Delegation of Responsibility: In the responsibility ___________________
n/S
accounting responsibility centers are established and ___________________
responsibility of the managers of these centers is clearly
___________________
defined. If there is adverse variance on a particular
responsibility centre, the managers of this centre can not ___________________
tio
escape from their responsibility. ___________________
3. Cost Control: Under this system, the manager of a ___________________

responsibility centre is directly responsible for the controlling
uc
___________________
of cost and other activities. Therefore, there is found an
___________________
effective control on costs.
rod
___________________
4. Helpful in the planning for cost in future: If, there is
___________________
responsibility accounting in the organization, management
comes to know different information regarding the revenues
and costs. Thus these helps in preparing the plans for future.
ep
5. Helpful in managerial decision: On the accumulation of
the different information from the responsibility centers, the
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managers do not take only the different decisions very easily

but also control the different activities.
Problems/Limitations of Responsibility Accounting

t fo
Really the responsibility accounting is a good technique for

management to control the costs but there are some limitations on
its application which are as follows:
No
1. The preparation of the organization chart, in which

responsibility and authority of the centers are mentioned, is
not an easy task because sometimes, the object is given in
qualitative form not in quantitative form.
S,
2. Sometimes the manager of a responsibility centre takes care

for his own centre’s objects and overlooks for others. Thus
sometimes a conflict creates between the objectives of the
PE
responsibility centers and the objectives of the organization.

3. To adopt the responsibility accounting, it is necessary that
costs may be classified between controllable and non-
U
controllable cost in the place of traditional classification. But

this classification is very tough.
(c)
Business Accounting
ale
384
4. Responsibility accounting is base on human behaviour while
Notes
nature of human being is to escape the responsibility. For the
___________________
success of responsibility accounting, the managers should co-
n/S
___________________ operate to perform their responsibility.
___________________ 5. Due to delay in reporting from responsibility centers the work
___________________ of responsibility accounting cannot be performed effectively.
tio
___________________ 6. As this system is based on the historical data and facts, this
system cannot be adopted in initial years of a new established
___________________
company.
uc
___________________
7. This system is very expensive. Therefore, it can be used only in
___________________
large companies.
___________________
rod
___________________
Check Your Progress
Fill in the blanks:
1. Responsibility accounting is adopted to control the costs
ep
in the ………………….. .
2. Responsibility accounting is base on ………………. while
nature of human being is to escape the responsibility
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Summary
t fo
In the present unit we have discussed the following points:

Responsibility accounting is used to fix the personal liability of the
managers for the variances. For the effective managerial control,
the responsibility accounting is used. On the comparison of actual
No
performance with the budgets/standards, if there is any adverse

variation, responsibility is personalized and corrective actions are
taken.
S,
Lesson End Activity

Discuss the main characteristics and steps involved in the process
PE
of responsibility accounting.
Keywords
U
Responsibility Accounting: Responsibility accounting is the

classification, management, maintenance, review and appraisal of
(c)
accounts serving the purpose of providing information on the

ale
quality and the standard of performance attained by the persons to 385
whom authority has been assigned Notes
Responsibility Centres: A responsibility centre is an organization ___________________
n/S
unit that is headed by a manager who is responsible for its ___________________
activities and results.
___________________
Cost Expenses Centre: This centre is responsible only for cost
___________________
incurred by the centre, it has no direct influence over the revenue
tio
___________________
of the centre.
___________________
Profit Centre: The manager of this centre is responsible for the
uc
difference (profit) between revenues and costs. ___________________
Investment Centre: An investment centre is a part of a company ___________________
having its own revenues, expenses and investment base.
rod
___________________
___________________
1. What do you mean Responsibility Accounting?
ep
2. Explain the procedure of Responsibility Accounting.
3. What do you mean by Responsibility Centers?
rR
4. Explain the different types of Responsibility Centers.

5. Give advantages and limitations of Responsibility Accounting.
t fo
Further Readings
Books
No

S,
Web Readings
PE
www2.gsu.edu/~accvjg/12_Responsibility_Acct.PDF
maaw.info/ResponsibilityAccountingConcept.htm
U
faculty.lebow.drexel.edu/KlineS/Acct601/Chap012.ppt
www.wiley.com/college/weygandt/0471413658/ppt/ch07.ppt
(c)
ic.ucsc.edu/~shep/110/110OVR/malory/chap012.ppt
Business Accounting
ale
386
Notes
___________________
n/S
___________________
___________________
___________________
tio
___________________
___________________
uc
___________________
___________________
___________________
rod
___________________
ep
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No
S,
U PE
(c)
UNIT 25: Case Studies
ale
Unit 25
387
Notes
Case Studies
___________________
n/S
___________________
___________________
Objectives
___________________
After analyzing these cases, the student will have an appreciation of the
tio
___________________
uc
___________________
Case Study 1: Tata Steel Ltd.
___________________
Tata Steel Ltd. wants to establish its EOU in the state of Orissa
through exploration of iron ore. It identified that the state of
rod
___________________
Orissa is one of the ideal states having greater potential of iron
___________________
ore than any other state in India. The firm has reached lease
contract with the Government of Orissa for the amount of Rs.200
Cr towards the extraction of 40,00,000 tonnes iron ore from the
ep
field for 10 years.
The firm would like to establish a processing plant which

amounts to Rs.50 Cr to produce the quality carbon steel for the
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foreign industrial buyers. The life period of the machine is

denominated in terms of 2, 50,000 working hours. The firm is
required to extract the iron ore.
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Year 1 2 3 4 5 6 7 8 9 10
Expected 8 7 6 5 4 3 3 2 1 1
Extraction
Per Year
In Lakh
Hrs. 1,00,000 75,000 25,000 12,500 6,250 6,250 6,250 6,250 6,250 6,250
No
Working
To meet out the cost of escalation, the firm should invest the
amount of depreciation in the interest bearing securities. The rate
of interest is 8%.
S,
Question
Read the case and provide the solution.

PE
U
(c)
Business Accounting
ale
388
Case Study 2: PATREJ Co Ltd.
Notes
PATREJ Co Ltd. is a well-known small scale unit, manufacturing
___________________ wooden furniture, steel almirah since its inception in 1975. It is
known as a well-established export-oriented company in
n/S
___________________
manufacturing furniture’s more specifically for developing
___________________ countries. The company has received an order from the Govt. of
___________________ India through United Nations Organization to meet the needs of
rehabilitation of Indonesia. The firm is required to supply the
tio
___________________
steel almirahs to meet the needs of Tsunami affected areas of
___________________ Indonesia. The production capacity of the firm per year is 10,000
steel almirahs.
uc
___________________
___________________ ` `
Local Steel Material 5,00,000 Excise duty 1,00,000
___________________
rod
Imports of sheet 50,000 Administrative office 1,00,000
___________________ materials expenses
Direct labour in works 5,00,000 Salary of the 30,000
managing director
Indirect labour in works 1,00,000 Salary of the joint 20,000
ep
managing director
Storage of raw materials 25,000 Fees of Consultant 10,000
and spares
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Fuel 75,000 Expenses of 80,000

Promotion
Tools consumed 10,000 Selling expenses 90,000
Depreciation on plant 50,000 Sales depots 60,000
t fo
Salaries of works 50,000 Packaging and 60,000

personnel distribution
But the local business environment conditions are as follows:

Cost of the materials expected to increase by 5%
No
Cost of the direct labour soared up to 20% due to greater demand

for skilled labour in the market.
Fuel cost expected to rise by 2.5% due to Gulf War crisis.
The government has announced 20% decrease in the volume of
S,
excise duty on the import of sheet materials.

The profit margin of 10% on sales is to be charged on the job
PE
work.
In addition to the early information, the government has
announced the amount of subsidy for single unit Rs.40.
U
Question
You are required to find out the price of the steel almirah for the
(c)
domestic market and exports to the country Indonesia.

Glossary
ale
Glossary
389
Notes
___________________
n/S
Absorption: In absorption, an existing company takes over the ___________________
business of one or more existing companies, which dissolve their
___________________
businesses.
___________________
Accounting Conventions: Customs and traditions which guide
tio
___________________
the accountants to record the financial transactions.
___________________
Accounting Equation: The recording of business transactions in
uc
the books of account is based on a fundamental equation called ___________________
Accounting Equation. ___________________
Accounting Policies: The accounting policies refer to the specific
rod
___________________
accounting principles and the methods of applying those principles ___________________
adopted by the enterprise in the preparation and presentation of
ep
transactions, ledger posting, preparation of financial statements
and analyzing and interpretation of them.
rR
Accounting Standards: It is a set of certain generally accepted

rules, principles, concepts and conventions issued by the Institute
of chartered Accountants of India in consultation with other
t fo

Accounting Treatment: Cancellation of the unissued shares
capital does not require any journal entry in the books of the
company because it does not have any effect on the issued shares
No
capital.
Accrual System: The revenues are recognized only at the time of
occurrence and expenses are recognized only at the moment of
incurring.
S,
Amalgamation: When two or more companies having similar

nature of business merge their businesses in order to form a new
PE
company, such a merging is known as amalgamation of companies.

Assets: The economic resources of an entity. They include such
items as cash, accounts receivable (amounts owed to a firm by its
U
customers), inventories, land, buildings, equipment, and even

intangible assets like patents and other legal rights and claims.
(c)
Assets are presumed to entail probable future economic benefits to

the owner.
Business Accounting
ale
390
Balance Sheet: The balance sheet of a company is a statement
Notes
which shows the total value of assets owned and total of the
___________________
company's liabilities owed by of trading on a particular date or at
n/S
___________________ the end of trading period.
___________________ Banking Company: As per Section 5 of the Banking Regulation
___________________ Act, Banking Company may be defined as, "Banking Company
means any company which transacts the business of banking in
tio
___________________
India."
___________________
Basic Accounting Concept or Assumptions: These are common
uc
___________________
basic accounting principles which are used in the preparation of
___________________ financial statements.
___________________ Basic Accounting Principles: These are the rules of recording
rod
___________________ the financial transactions which are adopted by the accountants
universally.
Bill of Exchange: A bill of exchange is an unconditional order
ep
signed by the maker which directs the recipient to pay a fixed sum
of money to a third party at a future date.
Bonus: When a company has a large amount of accumulated profit
rR
in its different revenue reserve and the company wants to

distribute it to its shareholders in addition to regular dividend,
such a distribution is called bonus.
t fo
Book Value: It is the value of the asset maintained in the books of

the account. The book value of the asset could be computed as
follows:
No
Book Value = Gross (Original) value of the asset – Accumulated

depreciation
Calculation of Ratio of Interest: This calculation is based on the
number of equity shares acquired by the holding company and the
S,
total number of equity shares issued by the subsidiary company.

Calls in Advance: If any call has been made but while paying
PE
that call, some shareholders paid the amount of the rest of calls
also, then such amount will be called as calls in advantage.
Calls in Arrears: If any amount has been called by the company
U
either as allotment or call money and a shareholder has not paid

that money, this is known as callas in arrears.
(c)
Glossary
ale
391
Claims: Claim means the insured amount payable by the
Notes
insurance company to the insurer on the happening a particular
event. ___________________
n/S
Consolidate Funds: Consolidated funds accounts are maintained ___________________
for Union Government and the State Governments. ___________________
Consolidated Balance Sheet (CBS): It is the balance sheet in ___________________
tio
which the financial information of parent as well as subsidiary ___________________
company is merged(consolidated) for the financial reporting
___________________
purpose.
uc
___________________
Consolidated profits: Consolidated profits are those profits of the
holding company which are the total of the revenue profits of ___________________
holding company and the share of holding company in the post-
rod
___________________
acquisition profits of subsidiary company. ___________________
Consolidation of Shares: As per Section 94 of the Companies
Act, 1956, a limited company may consolidate its shares of smaller
ep
denomination (value) into larger denomination (value).
Contingency Fund: A separate contingency fund account is
maintained for each Government.
rR
Contributories: When the winding up process of a company

begins, shareholders of that company are known as contributories.
t fo
Cost Accounting: Accounting relating to the ascertainment of cost

of the product.
Cost Expenses Centre: This centre is responsible only for cost
incurred by the centre, it has no direct influence over the revenue
No
of the centre.
Credit: Giver in Personal Account, Going assets in Real Accounts
and Incomes in Nominal Accounts.
Current Cost Accounting Method: Method of measuring assets
S,
in terms of replacement cost.

PE
Current Purchasing Power Accounting Method: It involves

the restatement of some or all of the items in the historical
financial statement for changes in the general price level.
U
Debit: Receiver in Personal Account, Coming Assets in Real

Account and Expenses in Nominal Accounts.
(c)
Debtors and Creditors: When goods are sold on credit by the

holding company to its subsidiary company or vice versa, it is
Business Accounting
ale
392 mutual indebtedness which appears as debtors in the Balance
Notes Sheet of the selling company and as creditors in the Balance Sheet
___________________ of the purchasing company.
n/S
___________________ Director: Directors are the representatives of the company. They
___________________ manage and control the company.
___________________ Dividend: Dividend is that part of the profit which is divided

among the shareholders of the company.
tio
___________________
Divisible Profits: Divisible profits are also known as profits
___________________
uc
___________________
___________________ divisible profits.
___________________ Double Entry System: Accounting which is based on the two
rod
___________________ aspects of the transactions.
Error of Commission: Such types of errors are found when one
account is debited or credited in the place of another account.
ep
Error of Omission: These errors occur when any business
transaction is completely or partially omitted from the recording in
the books of original records.
rR
Error of Principle: These errors occur when there is wrong

classification between the capital and revenue nature incomes or
expenditures.
t fo
External Reconstruction: When the capital structure of a

company is reorganized through the liquidation of the existing
company and formation of the new company, it is called external
No
reconstruction.
Final Account: Final accounts include the Balance Sheet and
Profit & Loss Account.
Final Dividend: Final dividend is declared and approved at the
S,
annual general meeting. It is approved by the shareholders by

looking at the financial position and the divisible profits of the
PE
company.
Financial Statements: These include the Trading and Profit and
Loss Account, and Balance Sheet of the business.
U
Fixed assets: Fixed assets, also known as a non-current asset or

as property, plant, and equipment (PP&E), is a term used
(c)
in accounting for assets and property which cannot easily be

converted into cash.
Glossary
ale
393
Flamholtz Model: This model seeks to remove all the defects of
Notes
the Lev and Schwartz Model.
___________________
Going Concern: The enterprise is normally viewed as a going
n/S
concern, that is, as continuing in operation for the foreseeable ___________________
future. ___________________
Gross Loss: It is the excess of cost of sales over sales. ___________________
tio
Gross Profit: It is calculated by comparing the sales and cost of ___________________
sales. It is the excess of sales over cost of sales. ___________________
Harmanson's Model: Harmanson advocated two methods for the
uc
___________________
valuation of human resources. Both of these are based on the
___________________
economic concept. These methods are: Unpurchased Goodwill
rod
___________________
Model and Adjusted Discounted Future Wages Model.
___________________
Holding Company: Holding companies are those that acquire
majority (more than 50%) of paid up equity shares so as to have a
controlling interest in some other companies.
ep
Human Resource Accounting (HRA): Human resource
accounting means the accounting for human beings, which is the
rR
most important source of an organization.

Inflation Accounting: Inflation accounting is that accounting
which reduces the effect of changing in prices due to inflation.
t fo
Inflation: Inflation in prices reflects the any increase in the price-

level will reduce the purchasing power of money of that country
and vice versa.
Insurance Contract: Various risks occur during the operation of
No
business, to minimize these risks insurance contracts are done

between the owner of business and insurance company.
Insurance: Insurance is a contract between two parties. In which
one party insured undertakes the responsibility to pay the insured
S,
amount to the insurer or any other person nominated by the

insurer, on the death of the insurer or happening a particular
PE
event within a stipulated time for a fixed consideration (premium).

Interim Dividend: The dividend that is declared between two
annual general meetings is called interim dividend. In other words,
U
it can be paid by directors to the shareholders at any time before

closing the final accounts.
(c)
Business Accounting
ale
394
Internal Reconstruction: In the case of internal reconstruction,
Notes
the financial structure of a company is reorganized without
___________________
forming a new company and liquidating an existing company.
n/S
___________________
Investment Centre: An investment centre is a part of a company
___________________ having its own revenues, expenses and investment base.
___________________ Investment: Investment is putting money into something with the
tio
___________________ expectation of gain, usually over a longer term. This may or may
not be backed by research and analysis.
___________________
uc
___________________
first time.
___________________
Ledger: A ledger is the principal book or computer file for
___________________
rod
recording and totalling monetary transactions by account, with
___________________ debits and credits in separate columns and a beginning balance
and ending balance for each account.
Lev and Schwartz Model: This is based on the present value of
ep
future earnings.
Liabilities: Amounts owed to others relating to loans, extensions
rR
of credit, and other obligations arising in the course of business.

Liquidation: The legal procedure to wind up of a limited company
is called the liquidation of a company.
t fo
Liquidator: In the case of voluntary liquidation by members, a

liquidator is appointed by passing a resolution in the general
meeting of the company, and in the case of winding up by creditors
he is appointed in the meeting of creditors and his remuneration is
No
also fixed in the meeting.

Management Accounting: Presenting of accounting information
in such a way as to assist the management in taking the important
decisions and making the policies.
S,
Managerial Personnel: The managerial personnel include the

director, managing director and manager.
PE
Managerial Remuneration: The remuneration paid to

Managerial Personnel is called managerial remuneration.
U
Materiality: Financial statements should disclose all "material"

items, i.e. items the knowledge of which might influence the
decisions of the user of the financial statements.
(c)
Net Loss: Excess of expenditures over revenues is called net loss.

Glossary
ale
395
Net Profit: It is the excess of revenues over expenses. It is
Notes
depicted by P. & L. A/c.
___________________
Nominal A/cs.: Accounts of incomes, expenses and gains or losses.
n/S
___________________
Non-cash Transactions: A Non-cash transaction is a transaction
___________________
in terms of credit and conditions of the enterprise.
___________________
Non-monetary Items: Non-monetary items are those which are
tio
the result of past transactions as plant and machinery, stock and ___________________
depreciation in profit and loss account. ___________________
Personal A/cs.: Accounts which are related to person, firms,
uc
___________________
companies and representatives.
___________________
Preliminary Expenses: Cost of formulation of a company is
rod
___________________
treated as preliminary expenses.
___________________
Premium: Premium is that amount which is paid by the insurer to
the insurance company in the form of consideration.
ep
Process of Accounting: It includes the recording of transactions
into Journal, classifying into Ledger and summarizing into Trial
Balance and Final Accounts.
rR
Profit Centre: The manager of this centre is responsible for the

difference (profit) between revenues and costs.
Proposed Dividend: The dividend which is recommended for the
t fo
shareholders by the directors is called proposed dividend.

Purchase Book: It is known in other words as purchase journal.
It is a book meant for credit purchases only for resale.
No
Real A/cs: All the assets accounts are included into it.
Reconstruction: The word reconstruction of a company implies
the reorganization of the financial structure of the company.
S,
Reduction of share capital: Diminution of capital is unissued

share capital, while reduction of share capital is for
subscribed/paid up capital.
PE
Remuneration: Remuneration is the total compensation that

an employee receives in exchange for the service they perform for
their employer.
U
Responsibility Accounting: Responsibility accounting is the

(c)
classification, management, maintenance, review and appraisal of

accounts serving the purpose of providing information on the
Business Accounting
ale
396 quality and the standard of performance attained by the persons to
Notes whom authority has been assigned
___________________
Responsibility Centres: A responsibility centre is an organization
n/S
___________________ unit that is headed by a manager who is responsible for its
___________________ activities and results.
___________________ Sales Book: It is a book maintained by the enterprise only during

the moment of selling the goods on credit. It is known in other
tio
___________________
words as a sales journal.
___________________
Sales Return Book: Sales return is a book that registers the
uc
___________________
goods sold on credit and received from the buyers.
___________________
Slip System of Posting: This system is used for the rapid posting
___________________ in the books. Under this system slips are used for the posting.
rod
___________________ Stock: The goods purchased are for selling, if the goods are not
sold out fully, a part of the total goods purchased is kept with the
trader unlit it is sold out, it is said to be a stock.
ep
Subsidiary book: It is a book maintained for routine transactions
of the enterprise.
rR
Suspense account: Sometimes, it is not possible to point out

errors easily, and then the difference is put to an account, known
as suspense account.
t fo
Trial Balance: Trial balance is a list in which all the balances of

the accounts of Ledger are showed to test the arithmetical
accuracy of the posting in ledger.
Unrealized profits: If some goods are sold on profits within the
No
group and which is still unsold, profit on such unsold goods is

called unrealized profit.
Wholly-owned subsidiary company: If a holding company
acquires all the shares (100%) having voting rights of a company,
S,
such a company is called wholly-owned subsidiary company.

U PE
(c)

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(c) UNIT 20: Case Study

SLM Development Team

Mr Kapil Mehra Mr A N Sinha

Course Code: BBCF-131D

Course Name: Business Accounting

Version: July 2013

© MPower Applied Learning Enterprise

Unit 9 Financial Statements ................................................................................................. 137

Unit 11 Managerial Remuneration ......................................................................................... 165

Unit 13 Amalgamation, Absorption & External Reconstruction........................................... 205

Unit 16 Holding Company Accounts ....................................................................................... 247

Unit 18 Accounts of Banking Companies................................................................................ 299

Unit 20 Case Study .................................................................................................................. 337

Unit 21 Inflation Accounting ................................................................................................... 341

Unit 23 Government System Accounting................................................................................ 365

Unit 24 Responsibility Accounting .......................................................................................... 377

Glossary ............................................................................................................................................ 389

z Capital and Revenue Items

\ Meaning and Definition of Accounting ___________________

as a language of business. To find out the results of a business, the

sales of the products is high and the number of transaction of the

these business transactions rose. The recording of business

use the writing or record as an evidence to resolve the

investment is—Labours in conducting the negotiations for wages

Certified Public Accountants gave a generally accepted

terms of money transactions and events which are, in part at

science as well as an art of recording of activities of the business

may be drawn as follows:

business which are financial in nature are recorded in

recorded in accounting. As the honesty of the workers cannot

business and balance sheet to know the financial position of

accounting: It not only record classifies and summaries the

Check Your Progress

summarizing in a significant manner of transactions

3. The primary objective of the accounting is to maintain

___________________ Branches of Accounting

period. Under this system record of raw materials used in

(iii) Management Accounting: The accounting which provides

accounting, are done in a manner so that the managers may

accounts prepared as per taxation provisions may differ from

(v) Inflation Accounting: Actually the financial statements are

loss of the business due to inflation. Thus the fresh financial

changes under inflation accounting.

various levels of management. Management information and ___________________

Accounting as Science or an Art

business transactions are recorded on the basis of some principles

any work. On the basis of it, accounting is an art as we do not only

The main purpose of book-keeping and accounting is to furnish the

managers at lower, middle and top level are included. While

public are included. The financial statements are supplied to the

And if there is excess of expenses over the revenue, it is said to

action is taken by the management.

transactions of the business and determination of profit or loss

information about the borrowed capital as well as owned

assets and miscellaneous. Balance sheet is the reflector of the

users: One more objective of the accounting is to provide the

as well as external users. Internal users of the financial

determination of cost of production, controlling internal as well as ___________________

(1) Replacement of human memory: As the human's memory is

transactions of the business are recorded in the books. By this

Thus, recording of the transactions is the replacement of

(2) Helpful in the determination of financial results and

useful in the determination of the profit and loss of a business